Economic policy analysis in international development

Economic policy analysis in international development D. Weinhold, A.S. Rigterink DV2169, 2790169 2011 Undergraduate study in Economics, Management, Finance and the Social Sciences This is an extract from a subject guide for an undergraduate course offered as part of the University of London International Programmes in Economics, Management, Finance and the Social Sciences. Materials for these programmes are developed by academics at the London School of Economics and Political Science (LSE). For more information, see: www.londoninternational.ac.uk

This guide was prepared for the University of London International Programmes by: Dr Diana Weinhold, Department of Development Studies, London School of Economics and Political Science Anouk S. Rigterink, Doctoral Candidate, Department of International Development, London School of Economics and Political Science This is one of a series of subject guides published by the University. We regret that due to pressure of work the authors are unable to enter into any correspondence relating to, or arising from, the guide. If you have any comments on this subject guide, favourable or unfavourable, please use the form at the back of this guide. The University of London International Programmes Publications Office Stewart House 32 Russell Square London WC1B 5DN United Kingdom Website: www.londoninternational.ac.uk Published by: University of London University of London 2007 Reprinted with minor revisions 2011 The University of London asserts copyright over all material in this subject guide except where otherwise indicated. All rights reserved. No part of this work may be reproduced in any form, or by any means, without permission in writing from the publisher. We make every effort to contact copyright holders. If you think we have inadvertently used your copyright material, please let us know

Contents Contents Chapter 1: Introduction... 1 Aims of the course... 3 Learning outcomes... 3 How to use this subject guide... 4 Essential reading... 5 Further reading... 7 Online study resources... 10 Examination advice... 11 Syllabus... 12 Chapter 2: Introduction to quantitative methodology... 15 Aims of the chapter... 15 Learning outcomes... 15 Essential reading... 15 Further reading... 15 Introduction... 15 Sampling... 16 Normal distribution and the central limit theorem... 18 Hypothesis testing... 21 Basics of regression... 23 Endogeneity... 28 Cross-section, time series and panel data... 35 Difference-in-difference estimation... 41 Summary... 44 Now read... 44 A reminder of your learning outcomes... 45 Sample examination questions... 45 Chapter 3: Economic growth: basic concepts, ideas and theories... 47 Aims of the chapter... 47 Learning outcomes... 47 Essential reading... 48 Further reading... 48 Introduction... 48 What is growth?... 49 How important is growth?... 50 Economic growth in the far distant past... 55 Modern growth theories: Harrod-Domar and Solow growth model... 56 Modern growth theories: endogenous growth theory... 60 Solow growth model versus endogenous growth theory... 63 A reminder of your learning outcomes... 64 Sample examination questions... 65 Chapter 4: New directions in growth theory... 67 Aims of the chapter... 67 Learning outcomes... 67 Essential reading... 67 i

169 Economic policy analysis in international development ii Further reading... 67 Introduction... 68 Heterogeneous firms, misallocation and intermediate goods... 69 Economic geography... 73 A reminder of your learning outcomes... 77 Sample examination questions... 77 Chapter 5: Institutions and (very) long-run growth... 79 Aims of the chapter... 79 Learning outcomes... 79 Essential reading... 79 Further reading... 80 Introduction... 80 What are institutions?... 80 Investigating how institutions could matter for long-run growth: IV regression revisited... 82 Property rights: Engerman and Sokoloff and Acemoglu, Johnson and Robinson... 85 Critiques: geography and human capital... 89 A reminder of your learning outcomes... 92 Sample examination questions... 92 Chapter 6: Globalisation and trade theory... 93 Aims of the chapter... 93 Learning outcomes... 93 Essential reading... 94 Further reading... 94 Introduction... 94 Classical trade theory: Ricardo and the Heckscher-Ohlin model... 96 New trade theory... 99 New new trade theory: heterogeneous firms... 102 A reminder of your learning outcomes... 104 Sample examination questions... 105 Chapter 7: Finance and financial crises... 107 Aims of the chapter... 107 Learning outcomes... 107 Essential reading... 107 Further reading... 108 Introduction... 108 Inflation... 109 Policy response to inflation... 111 Old style Balance of Payments crises... 111 Structural adjustment programmes (SAPs)... 114 New style currency crises... 117 Policy options for new style crises... 119 A reminder of your learning outcomes... 123 Sample examination questions... 123 Chapter 8: Microfinance... 125 Aims of the chapter... 125 Learning outcomes... 125 Essential reading... 125 Further reading... 125 Introduction... 126

Contents The credit market... 127 Further reading... 127 Microfinance programmes... 132 The success of microfinance: empirical evidence... 136 A reminder of your learning outcomes... 139 Sample examination questions... 139 Chapter 9: Aid effectiveness... 141 Aims of the chapter... 141 Learning outcomes... 141 Essential reading... 141 Further reading... 141 Introduction... 142 Defining aid... 143 Whether and how to give aid? The current big debate on aid effectiveness... 144 Is aid related to growth? Empirical evidence... 150 A reminder of your learning outcomes... 153 Sample examination questions... 153 Appendix A: Sample examination paper... 155 Appendix B: Tables for Questions 1 and 2... 157 Table for Question 1... 157 Table for Question 2... 158 iii

169 Economic policy analysis in international development Notes iv

Chapter 1: Introduction Chapter 1: Introduction Welcome to 169 Economic policy analysis in international development. The purpose of this course is to provide an accessible, yet rigorous, introduction to evidence-based policy analysis for development that is suitable for students from a wide variety of backgrounds. You must have passed 171 Introduction in international development before you study this course. The design of development policies must be derived from development theory. There is no single theory of economic development, but we strive to provide a background review of competing theories of how many complex processes, both at the macroeconomic (country and international) level and the microeconomic (individual, household and firm) level, may lead to development. Given the large number of topics in development economics, this course will focus on macroeconomic theories, although the chapter on microcredit in particular, and the chapter on aid to a lesser extent, include some microeconomics. If these topics are particularly interesting to you, we suggest you consider taking a course in microeconomics of development. Theoretical questions we address in this course include: through what mechanisms are trade and growth related? Will providing microcredit enable farmers to improve their living standards? Does international aid promote growth? How can we explain large differences in living standards between developed and developing countries? For each of these topics there may be several theoretical answers, each theory corresponding to a unique, but not necessarily mutually incompatible, mechanism through which the variables of interest are related. Which policy design will be most successful will in turn depend on which underlying mechanism turns out to be most true. If all the competing theories are on first inspection logical and internally consistent, which policy should we choose? Even if one theory sounds more appealing (or plausible to our ears), how can we assess the validity of our intuition? For many years most debates surrounding development policies were characterised by rhetorical arguments about which theoretical approach was more intrinsically persuasive, something determined at least as much by ideological and political position as by anything else. However in the last 30 years or so, with access to comparable cross-national, household, and individual level data dramatically increasing, the discipline has completely shifted its approach. Today, we strive to evaluate theories and policies on the basis of empirical data; this is what we mean by evidence-based analysis. Broadly speaking, there are three possible approaches to evidencebased analysis that have been used in social science disciplines such as economics, political science and sociology. The first is to derive some testable implications from theory, and then use statistical methods to examine whether these implications are consistent with the observed data. Ideally we look for testable implications that differentiate between theories, or some relationship that is highly unlikely unless the associated theory had strong explanatory power. The second approach arises because sometimes it is difficult to differentiate between many possible theoretical mechanisms, so as a first pass to the problem we focus on a reduced form relationship (in which the 1

169 Economic policy analysis in international development 2 underlying mechanism is something of a black box ) and use observed data empirically to test directly whether some policies have had the causal effect that they were supposed to generate. For example, did trade opening increase growth? Did microfinance reduce poverty? Did building more schools increase enrolment? However, one of the major methodological challenges facing both of these approaches is to convincingly draw out causal conclusions from nonexperimental data. Many social and economic variables are correlated, but how can we discern whether there really is a causal relationship? In this course we will explore several different empirical strategies that have been utilised to identify causal relationships, but these statistical methods may not be applicable, or may be unconvincing, in some cases. As a result in the past decade it has become very popular, when feasible, to design and conduct a randomised controlled experiment to test the effects of a given policy. For example, if new textbooks are assigned randomly to different schools, then the differences in learning outcomes between those schools with and without the new textbooks can be considered to be the impact of the textbook policy. Despite the recent enthusiasm for randomised controlled experiments, it is important to keep in mind that no single methodology provides the most convincing answers to all possible research questions, and that sometimes choosing between particular techniques involves trade-offs. Consider the following: a randomised controlled trial may provide the most convincing evidence on a causal relationship between textbooks and pupil performance. However, designing such an experiment can be very costly and time-consuming, requiring significant financial resources. Non-experimental research could possibly be done using already existing data. Furthermore, the costs of running an experiment will likely force researchers to focus on a small subset of children that may benefit from receiving textbooks children in a particular province in Kenya, for example. If we find that textbooks increase pupil performance in Kenya, can we say with confidence that they will have the same effect on children in the whole of Kenya? All children in Africa? All children in developing countries? The experiment may have conclusively proven that the results hold for this particular subgroup (it has high internal validity), but it may not generalise to other cases (its external validity may be doubtful). In the case of a different research question, researchers may be unable or unwilling to randomise. It seems highly unethical to withhold life-saving drugs from people for the sake of an experiment. It seems infeasible to ask countries to randomise their trade policies. Imagine if policymakers exclusively focus on policies that could be randomised; this would limit their options to a specific category of policies, and these types of policies are not necessarily the most effective. As policymakers depend more and more heavily on evidence-based analyses to guide their decisions, it has become ever more important for a wide range of policymakers and other interested individuals to be able to read and critically assess the ever increasing quantity of quantitative studies. Many politicians, decision-makers, and other policy stakeholders (including the general public) have not had the several years of postgraduate training in statistics and econometrics (the statistical analysis of economic data) that it takes to master the sophisticated methodological tool kit used by modern-day social scientists. In sum, many more people really need the skills to critically read and consume the information conveyed in the academic quantitative literature than possess the time or desire to finish a PhD required to produce those studies.

Chapter 1: Introduction Thus for over more than a decade of teaching in the Department of International Development at the London School of Economics and Political Science, we have focused on conveying the underlying intuition behind the structure of quantitative work, teaching students not how to actually do econometrics, but rather how to read and consume quantitative analyses critically and rigorously. Each year our starting group of students ranges from many with no formal economics or mathematics backgrounds at all to those with extensive statistical educations, from English literature majors to lawyers to geologists to central bankers. By the end of the course they can all pick up any World Bank technical working paper or a good quality academic article in economics or political science and be able to read, critically assess, and come to their own conclusions about the validity of the empirical strategy and policy conclusions. A key lesson that we teach is that good quality quantitative policy analysis is not a purely technical or statistical exercise, but is firmly embedded within the theoretical framework of the processes under study. With a few basic concepts and some new vocabulary, we show you how econometric equations map back to the economic theories we have been discussing in each chapter. Good econometric analysis simply reflects good analysis, full stop, so critically engaging with the quantitative material is more a matter of learning how to think rigorously and thoroughly through a problem (whether it be quantitative or qualitative), and then being able to translate that intuition into the quantitative framework. The authors of this subject guide include one academic with many years of quantitative training and practice and a young researcher, who prior to taking a similar MSc course to this course, had not had any formal training in quantitative methods at all. We are both passionate about passing on the lessons of rigorous, analytical thinking in the context of economic development policy to students from all backgrounds. The process of integrating these new ways of thinking can be time consuming and, at times, frustrating, but we hope you will find that the rewards are well worth the effort. And this subject guide will be there to assist you along your way. Aims of the course The aims of this course are: to provide a critical overview of current growth and welfare policies in developing countries to demonstrate how the underlying theories that inform development policies are evolving in light of continuous empirical testing to provide a comprehensive introduction to evidence-based policy analysis, including a non-technical but operational ability to read and comprehend regression analyses used in quantitative policy evaluation. Learning outcomes On completion of this course, you are expected to be able to: describe the main theories, debates and concepts in development economics demonstrate a clear understanding of the major economic policy issues in developing countries read, comprehend and critique empirical analysis in the context of development policy evaluations at a non-technical level 3

169 Economic policy analysis in international development 4 demonstrate an understanding of how theories of development economics have evolved and shaped policy over the past 50 years. How to use this subject guide The aim of this subject guide is to help you understand the required material, highlight the main points and explain how various readings are connected. Each chapter will start by outlining aims and learning outcomes of the chapter and by listing essential and further reading. It will then take you through the relevant material. To enable you to test yourself, the learning outcomes are restated at the end of each chapter and sample examination questions are provided. We recommend that from Chapter 3 onwards you work through the topics in the order they are given in the subject guide. Read the essential reading at the points at which you are asked to do so. The subject guide will then explain the main points you should take away from what you have just read, and how these relate to other material. If you did not pick up these main points from the reading, you might find it useful to revisit it. When you are particularly interested in a specific topic and feel you have mastered the required material, you can read some of the further reading. Keep in mind that understanding the basics is the sure way to pass the course, but that showing a deeper understanding of how various pieces of research relate to each other and referring to extra material can earn you a higher grade. An essential element of this course is empirical analysis: the quantitative testing of the predictions of theories and the evaluation of policies using real-world data. Understanding regression analysis, an often-used technique for doing so, is therefore essential. In every chapter we will include at least one reading that uses quantitative analysis so that as you progress through the course you will get plenty of practice reading and engaging with regression tables. An outline of the essential knowledge you will need for understanding empirical analysis to the level required in this course is provided in Chapter 2. This chapter contains all methodological concepts necessary to understand the remainder of the subject guide, so it is very important to read it carefully (even if you have already taken or are taking another Statistics course). However, it is not necessary to understand all methodology after the first read: you will practise with the concepts throughout the subject guide and should refer back to Chapter 2 whenever necessary. Please note that you are not required to know how to do regression yourself or to remember numerical results. However, it is important to understand the intuition behind empirical analysis and why any given analysis was set up the way it was. For each reading the particulars may be slightly different, but all the quantitative analyses have the following points in common: The specification should reflect one or more testable implications of some underlying theories. Given the theory, the specification should take into account and try to control for possible omitted variables. Given the theory, the specification should take into account and try to control for possible reverse causality or simultaneity (or endogeneity). The assumptions required to ensure that the results are free from omitted variable and endogeneity bias introduce caveats and limitations to the results interpretation and policy implications. As

Chapter 1: Introduction all empirical work requires some assumptions along these lines, each analysis will be limited in its own way. When reading empirical analyses, it is important to revisit each of these points and be able to show whether (and how well) the analysis handles possible biases and, as a result, how comfortable you are with the resulting policy implications. The subject guide will give you guidance in this as well on a reading-by-reading basis. Empirical analysis plays dual roles in development policy; on the one hand, quantitative analysis is often used to differentiate between competing theoretical explanations of economic phenomena, and empirical policy evaluation is used to help judge the effectiveness of policies derived from those underlying theories. On the other hand, the basic theoretical evolution itself is highly influenced by the outcomes of empirical results. Quantitative analysis may find one set of theories more consistent with observed data and reject another set of theories, which then fall by the historical wayside. Often careful empirical work generates new stylised facts that inspire a new generation of academics to develop new theories. The amount of real-world data and empirical evidence is constantly increasing, and at least partially as a direct result, theory and policy designs are also evolving. You will therefore see that the subject guide does not proclaim one true theory or the best policy in an absolute sense. It will, however, explain from what evidence or observations a theory followed, and how the theory is or is not able to explain what we observe in the real world. We want you to think creatively and critically, but also rigorously and in a disciplined manner. In the end, you should have the tools not only to explain the current state of development policy, but also to track progress in this area going forward through critical reading of academic and popular literature. Essential reading You need to purchase one book: Ray, Debraj Development Economics. (Chichester: Princeton University Press, 1998) [ISBN 9780691017068]. This textbook is an overview of theories in development economics. We will assign relevant parts of this textbook to read throughout the subject guide. There is no need to read specific parts of the book that are not assigned. In some assigned pages and articles there may be some technical material presented that is beyond the scope of this course. This subject guide will point out the sections that you will not be responsible for reproducing, and help you to understand the non-technical intuition. Textbooks often cannot keep up with recent developments in theory. Equally, empirical research is mostly published in academic journal articles. Therefore, the remainder of the essential reading consists of journal articles. These are available through the University of London Online Library. All International Programmes students have free access to this resource and you will be able to find the full-text articles here. You will need a username and password to get access. Alternatively, Google Scholar is a useful searching device. Finding literature can be timeconsuming, but remember that finding literature yourself is an important skill you will need to develop throughout your studies. For each topic, we also provide an extensive list of further reading. You can read extra material if you are particularly interested in the topic at 5

169 Economic policy analysis in international development 6 hand. Read extra material selectively: we by no means expect you to read all, or even most of it. If you are truly struggling with the course, we do not expect you to do any extra reading. Take into account that a student who has mastered the essential reading fully and has done no extra reading will generally do much better on the exam than a student who moved on to further reading before having understood the essential reading. However, when you can show yourself to be proficient in the essential material, showing knowledge of additional readings can take your grade up that extra notch. Full list of Essential reading Acemoglu, Daron, Simon Johnson and James A. Robinson The colonial origins of comparative development. An empirical investigation, American Economic Review 2001, 91(5), pp.1369 401. Amiti, Mary and Josef Konings Trade liberalization, intermediate inputs and productivity: Evidence from Indonesia, American Economic Review 2007, 97(5), pp.1611 638. Banerjee, Abhijit, Esther Duflo, Rachel Glennerster and Cynthia Kinnan The miracle of microfinance? Evidence from a randomized evaluation, Working Paper. (Boston: Massachusetts Institute of Technology, 2009). Available at: www.povertyactionlab.org/sites/default/files/publications/the%20 Miracle%20of%20Microfinance.pdf Bernard, Andrew et al. Firms in international trade, Journal of Economic Perspectives 2007, 21(3), pp.105 30. Bhagwati, Jagdish N. and Anne O. Krueger Exchange control, liberalization and economic development, The American Economic Review 1973, 63(2), pp.419 27. Bleakley, Hoyt Disease and development: Evidence from hookworm eradication in the American South, The Quarterly Journal of Economics 2007, 122(1), pp.73 117. Burnside, Craig and David Dollar Aid, policies and growth, The American Economic Review 2000, 90(4), pp.847 68. Dollar, David and Aart Kraay Growth is good for the poor, Journal of Economic Growth 2002, 7(3), pp.195 225. Dornbusch, Rudi A primer on emerging market crises, NBER Working Paper series No. 8326, 2001. Available at: www.nber.org/papers/w8326 Easterly, William Foreign aid goes military! Review of The bottom billion by Paul Collier, The New York Review of Books 2008, 55(19). Available at: www.nybooks.com/articles/archives/2008/dec/04/foreign-aid-goesmilitary/ Easterly, William The Big Push déjà vu. Review of The end of poverty by Jeffrey Sachs, Journal of Economic Literature 2006, 44(1), pp.96 105. Easterly, William, Ross Levine and David Roodman New data, new doubts: A comment on Burnside and Dollar s Aid, policies and growth (2000), NBER Working Paper No. 9846, 2003. Available at: www.nber.org/papers/ w9846 Engerman, Stanley L. and Kenneth L. Sokoloff Factor endowments, institutions and differential paths of growth among new world economies, NBER Working Paper No. 9259, 1997. Available at: www.nber/org/papers/w9259 Galor, Oded and David N. Weil Population, technology and growth. From Malthusian stagnation to the demographic transition and beyond, The American Economic Review 2000, 90(4), pp.806 28. Glaeser, Edward L., Rafael La Porta, Florencio Lopez-De-Silanez and Andrei Shleifer Do institutions cause growth?, Journal of Economic Growth 2004, 9(3), pp.271 303. Hsieh, Chang-Tai and Peter J. Klenow Misallocation and manufacturing TFP in China and India, The Quarterly Journal of Economics 2009, 124(4), pp.1403 448.

Chapter 1: Introduction Jones, Charles I. Intermediate goods, weak links and superstars. A theory of economic development, NBER Working Paper series No. 13834, 2008. Available at: www.nber.org/papers/w13834 Kaplan, Ethan and Dani Rodrik Did the Malaysian capital controls work?, NBER Working Paper series No. 8142, 2001. Available at: www.nber.org/ papers/w8142 Morales, Juan Antonio and Jeffrey Sachs Bolivia s economic crisis, NBER Working Paper series No. 2620, 1988. Available at: www.nber.org/papers/ w2620 Morduch, Jonathan The microfinance promise, Journal of Economic Literature 1999, 37(4), pp.1569 614. Puga, Diego and Anthony J. Venables The spread of industry. Spatial agglomeration in economic development, Centre for Economic Policy Research Discussion Paper No. 1354, 1996. Available at: http://eprints.lse.ac.uk/20683/ Sachs, Jeffrey How to help the poor: piecemeal progress or strategic plans? Review of The white man s burden by William Easterly, The Lancet 2006, 376, pp.1309 310. Available at: www.thelancet.com/journals/lancet/ article/piis0140-6736(06)68561-9/fulltext Sachs, Jeffrey D. Institutions don t rule. Direct effects of geography on per capita income, NBER Working Paper No. 9490, 2003. Available at: www. nber.org/papers/w9490 Detailed reading references in this subject guide refer to the editions of the set textbooks listed below. New editions of one or more of these textbooks may have been published by the time you study this course. You can use a more recent edition of any of the books; use the detailed chapter and section headings and the index to identify relevant readings. Also check the virtual learning environment (VLE) regularly for updated guidance on readings. Further reading Please note that as long as you read the Essential reading you are then free to read around the subject area in any text, paper or online resource. You will need to support your learning by reading as widely as possible and by thinking about how these principles apply in the real world. To help you read extensively, you have free access to the VLE and University of London Online Library (see below). For ease of reference, here is a full list of all Further reading referred to in this subject guide: Acemoglu, Daron and Simon Johnson Unbundling institutions, Journal of Political Economy 2004, 113(5), pp.949 95. Banerjee, Abhijit V. and Esther Duflo Inequality and growth. What can the data say?, Journal of Economic Growth 2003, 8(3), pp.267 99. Berkowitz, Daniel and Karen Clay American civil law origins. Implications for state constitutions, American Law and Economics Review 2003, 7(1), pp.62 84. Burnside, Craig, Martin Eichenbaum and Sergio Rebelo Prospective deficits and the East Asian currency crisis, World Bank Policy Research Working Paper No. 2174, 1998. Chari, Varadarajan, V., Patrick J. Kehoe and Ellen R. McGrattan Business cycle accounting, Econometrica 2007, 75(3), pp.781 836. Clemens, Michael A. and Gabriel Demombynes When does rigorous impact evaluation make a difference? The case of the Millennium Villages, World Bank Policy Research Paper #5477, 2010. Available at: http://papers.ssrn. com/sol3/papers.cfm?abstract_id=1709849 7

169 Economic policy analysis in international development Coleman, Brett E. The impact of group lending in Northeast Thailand, Journal of Development Economics 2000, 60(1), pp.105 41. Collier, Paul The bottom billion. Why the poorest countries are failing and what can be done about it. (Oxford: Oxford University Press, 2007) [ISBN 9780195311457]. Dell, Melissa The mining Mita: Explaining institutional persistence, MIT Mimeo, 2008. Diamond, Jared Guns, germs and steel. (New York: W.W. Norton & Company, 1997) [ISBN 9780393038910]. Easterly, William The cartel of good intentions: the problem of bureaucracy in foreign aid, The Journal of Policy Reform 2002, 5(4), pp.223 50. Easterly, William The elusive quest for growth. Economists adventures and misadventures in the Tropics. (Cambridge MA: MIT Press, 2001) [ISBN 9780262050654]. Easterly, William The White Man s Burden. Why the West s efforts to aid the Rest have done so much ill and so little good. (Oxford: Oxford University Press, 2006) [ISBN 9780199210824]. Easterly, William What did structural adjustment adjust? The association of policies and growth with repeated IMF and World Bank adjustment loans, Journal of Development Economics 2005, 76(1), pp.1 22. Easterly, William When is fiscal adjustment an illusion?, World Bank draft working paper, 1998. Available at www-wds.worldbank.org/ external/default/wdscontentserver/iw3p/ib/1999/09/14/000094946_9 9060201522384/additional/103503322_20041117150007.pdf Easterly, William and Ross Levine What have we learned from a decade of empirical research on growth? It s not factor accumulation: stylized facts and growth models, World Bank Economic Review 2001, (15)2, pp.177 219. Edwards, Sebastian How effective are capital controls? The Journal of Economic Perspectives 1999, 13(4), pp.65 84. Eichengreen, Barry Capital account liberalization. What do cross-country studies tell us?, The World Bank Economic Review 2001, 15(3), pp.341 65. Eichengreen, Barry, Ricardo Hausmann and Ugo Panizza Currency mismatches, debt intolerance and original sin. Why they are not the same and why it matters, NBER Working Paper series No. w10036, 2003. Fernald, John G. and Brent Neiman Measuring the miracle. Market imperfections and Asia s growth experience, FRB of San Francisco Working Paper No. 2006 17, 2006. Grossman, Gene M. and Elbahan Helpman Trade, knowledge spillovers and growth, European Economic Review 1991, 35(2), pp.517 26. Helpman, E. and P. Krugman Market Structure and Foreign Trade. (Cambridge, Massachusetts: MIT Press, 1985) [ISBN 9780262580878]. Henderson, Vernon, Todd Lee and Yung Joon Lee Scale externalities in Korea, Journal of Urban Economics 2001, 49(3), pp.479 504. Henderson, Vernon J., Adam Storeygard and David N. Weil Measuring economic growth from outer space, NBER Working Paper No. w15199, 2009. Kanbur, Ravi The economics of international aid in Kolm, Serge-Christophe and Jean Mercier Ythier (eds) Handbook of the economics of giving, altruism and reciprocity. (Amsterdam: Elsevier B.V., 2006) [ISBN 9780444506979] pp.1559 88. Klenow, Peter J. and Andres Rodriguez-Clare The Neoclassical revival in growth economics. Has it gone too far? NBER Macroeconomics Annual 1997, 12, pp.73 103. Kopits, George and Steve Symansky Fiscal policy rules, International Monetary Fund Occasional Paper. (Washington D.C.: International Monetary Fund, 1998). 8

Chapter 1: Introduction Krugman, Paul A model of innovation, technology transfer and the world distribution of income, The Journal of Political Economy 1979, 87(2), pp.253 66. La Porta, Rafael, Florencio Lopez-de-Silanes, Andrei Shleifer and Robert Vishny Law and finance, Journal of Political Economy 1998, 106(6), pp.1113 55. Levitt, Steven D. Using electoral cycles in police hiring to estimate the effect of police on crime, The American Economic Review 1997, 87(3), pp.270 90. Limao, Nuno and Anthony J. Venables Infrastructure, geographical disadvantage, transport costs and trade, World Bank Economic Review 2001, 15(3), pp.451 79. Melitz, Marc J. The impact of trade on intra-industry reallocations and aggregate industry productivity, Econometrica 2003, 71(6), pp.1695 725. Moretti, Enrico Social returns to education and human capital externalities. Evidence from cities, Unpublished working paper, 1998. Available at: http://darp.lse.ac.uk/papersdb/moretti_(98).pdf Moyo, Dambisa Dead Aid. Why aid is not working and how there is another way for Africa. (New York: Allen Lane, 2008) [ISBN 9780262580878]. North, Douglas Institutions, institutional change and economic performance. (Cambridge UK: Cambridge University Press, 1990) [ISBN 9780521397346]. Nunn, Nathan and Diego Puga Ruggedness: The blessing of bad geography in Africa, Mimeo, 2007. Pavcnik, Nina Trade liberalization, exit and productivity improvements: Evidence from Chilean plants, The Review of Economic Studies 2002, 69(1), pp.245 76. Pritchett, Lant Divergence, big time, Journal of Economic Perspectives 1997, 11(3), pp.3 17. Quah, Danny Empirics for growth and distributions. Stratification, polarization and convergence clubs, Journal of Economic Growth 1997, 2(1), pp.27 59. Quah, Danny Some simple arithmetic on how income inequality and economic growth matter, Working Paper, 2001. Available at: http://citeseerx.ist.psu. edu/viewdoc/download?doi=10.1.1.64.4890&rep=rep1&type=pdf Rajan, Raghuram G. and Arvind Subramanian Aid and growth: What does the cross country evidence really show?, The Review of Economics and Statistics 2008, 90(4), pp.643 65. Reinhart, Carmen M. and Kenneth Rogoff Banking crises. An equal opportunity menace, NBER Working Paper series No. w14587, 2008. Rodrik, Dani Why we learn nothing from regressing economic growth on policies, Harvard University Working Paper, 2005. Available at: http:// international.ucla.edu/media/files/rodrik.pdf Sachs, Jeffrey The end of poverty: Economic possibilities for our time. (New York: Penguin Press, 2005) [ISBN 9780141018669]. Sala-i-Martin The disturbing rise of global income inequality, NBER Working Paper No. w8904, 2002a. Stiglitz, Joseph E. and Andrew Weiss Credit rationing in markets with imperfect information, The American Economic Review 1981, 71(3), pp.393 410. Williamson, Jeffrey G. Five centuries of Latin American inequality, NBER Working Paper No. w15305, 2009. Young, Alwyn The African growth miracle, Working Paper, 2009. Available at: http://econ.as.nyu.edu/docs/io/11950/africangrowthmiracle.pdf. Young, Alwyn The tyranny of numbers. Confronting the statistical realities of the East Asian growth experience, The Quarterly Journal of Economics 1995, 110(3), pp.641 80. 9

169 Economic policy analysis in international development Journals These academic journals are particularly relevant to (development) economists: American Economic Journal: Applied Economics American Economic Journal: Economic Policy American Economic Review Econometrica Journal of Development Economics Journal of Economics Perspectives Journal of International Economics Journal of Political Economy Journal of Public Economics NBER working paper series Review of Economic Studies Quarterly Journal of Economics World Bank Economic Review. Unless otherwise stated, all websites in this subject guide were accessed in April 2011. We cannot guarantee, however, that they will stay current and you may need to perform an internet search to find the relevant pages. Online study resources In addition to the subject guide and the Essential reading, it is crucial that you take advantage of the study resources that are available online for this course, including the VLE and the Online Library. You can access the VLE, the Online Library and your University of London email account via the Student Portal at: http://my.londoninternational.ac.uk You should have received your login details for the Student Portal with your official offer, which was emailed to the address that you gave on your application form. You have probably already logged in to the Student Portal in order to register! As soon as you registered, you will automatically have been granted access to the VLE, Online Library and your fully functional University of London email account. If you forget your login details at any point, please email uolia.support@ london.ac.uk quoting your student number. The VLE The VLE, which complements this subject guide, has been designed to enhance your learning experience, providing additional support and a sense of community. It forms an important part of your study experience with the University of London and you should access it regularly. The VLE provides a range of resources for EMFSS courses: Self-testing activities: Doing these allows you to test your own understanding of subject material. Electronic study materials: The printed materials that you receive from the University of London are available to download, including updated reading lists and references. 10

Chapter 1: Introduction Past examination papers and Examiners commentaries: These provide advice on how each examination question might best be answered. A student discussion forum: This is an open space for you to discuss interests and experiences, seek support from your peers, work collaboratively to solve problems and discuss subject material. Videos: There are recorded academic introductions to the subject, interviews and debates and, for some courses, audio-visual tutorials and conclusions. Recorded lectures: For some courses, where appropriate, the sessions from previous years Study Weekends have been recorded and made available. Study skills: Expert advice on preparing for examinations and developing your digital literacy skills. Feedback forms. Some of these resources are available for certain courses only, but we are expanding our provision all the time and you should check the VLE regularly for updates. Making use of the Online Library The Online Library contains a huge array of journal articles and other resources to help you read widely and extensively. To access the majority of resources via the Online Library you will either need to use your University of London Student Portal login details, or you will be required to register and use an Athens login: http://tinyurl.com/ollathens The easiest way to locate relevant content and journal articles in the Online Library is to use the Summon search engine. If you are having trouble finding an article listed in a reading list, try removing any punctuation from the title, such as single quotation marks, question marks and colons. For further advice, please see the online help pages: www.external.shl.lon.ac.uk/summon/about.php Unless otherwise stated, all websites in this subject guide were accessed in 2007. We cannot guarantee, however, that they will stay current and you may need to perform an internet search to find the relevant pages. Examination advice Important: the information and advice given here are based on the examination structure used at the time this guide was written. Please note that subject guides may be used for several years. Because of this we strongly advise you to always check both the current Regulations for relevant information about the examination, and the VLE where you should be advised of any forthcoming changes. You should also carefully check the rubric/instructions on the paper you actually sit and follow those instructions. The examination paper for this course is three hours in duration and you are expected to answer three questions, from a choice of 10. The Examiners attempt to ensure that all the topics covered in the syllabus and subject guide are examined. Some questions could cover more than one topic from the syllabus since the different topics are not self-contained. 11

169 Economic policy analysis in international development 12 The most important thing to do in the exam is first to read the question carefully and fully understand what is asked. In answering the question, provide a clear argument, using the theories and empirical analyses you have learned. Remember that it is very important to provide evidence. Answering that institutions lead to growth because the theory says it will is not sufficient. Provide examples of empirical analyses or real-world observations that support this claim. A Sample examination paper appears as an appendix to this guide. The Examiners commentaries contain valuable information about how to approach the examination, so you are strongly advised to read them carefully. Past examination papers and the associated commentaries are valuable resources in preparing for the examination. Remember, it is important to check the VLE for: up-to-date information on examination and assessment arrangements for this course Syllabus where available, past examination papers and Examiners commentaries for the course which give advice on how each question might best be answered. Chapter 2: Introduction to quantitative analysis Sampling Hypothesis testing Normal distribution and central limit theorem Regression: basics, control variables, dummy variables, interaction terms Endogeneity Regression: IV regression, difference-in-difference estimation Cross-section, time series and panel data Chapter 3: Economic growth: basic concepts, ideas and theories Introduction to growth and GDP Growth and inequality Historical growth experience Neoclassical or Solow growth model Endogenous growth models Chapter 4: New directions in growth theory Extensions to the neoclassical model: heterogeneous firms, misallocation and intermediate goods Economic geography Chapter 5: Institutions and (very) long run growth Introduction to institutions and growth Property rights: Acemoglu, Johnson and Robinson Factor endowments: Engerman and Sokolof Geography and growth Human capital and growth

Chapter 1: Introduction Chapter 6: Globalisation and trade theory Ricardian comparative advantage Heckscher-Ohlin model New trade theory New new trade theory Chapter 7: Finance and financial crises Causes and consequences of inflation Old style financial crises: balance of payments crises and structural adjustment programmes New style financial crises and currency crises Policy options during financial crises Chapter 8: Microfinance The credit market: incomplete information and limited liability Consequences of imperfect credit markets for developing countries and the poor Introduction to microfinance Evaluating the success of microfinance Chapter 9: Aid effectiveness Introduction to ODA Big debate on aid: Jeffrey Sachs, William Easterly, Paul Collier and Dambisa Moyo Empirical evidence on aid and growth on country and programme level 13

169 Economic policy analysis in international development Notes 14

Chapter 2: Introduction to quantitative methodology Chapter 2: Introduction to quantitative methodology Aims of the chapter This chapter aims to familiarise you with some quantitative methodology, mainly regression analysis, to the point where you are able to consume (understand and critically assess) empirical academic papers in development economics. It is meant as a reference chapter that you can return to when reading the remaining chapters of this subject guide. Learning outcomes By the end of this chapter, and having completed the Essential reading and Activities, you should be able to: recognise when the topics introduced in this chapter are applied in subsequent chapters and reading. When you have completed the course you should be able to: read and critically assess empirical research employing the aspects of quantitative methodology covered in this chapter. One purpose of this chapter is to familiarise you with quantitative techniques used in the papers you will read throughout the course. Therefore, we urge you to read this chapter thoroughly now (even if you have taken another Statistics course) and review this chapter when reading these papers. Essential reading Ray, Debraj Development Economics. (Chichester: Princeton University Press, 1998). Appendix 2, pp.777 804. Further reading Levitt, Steven D. Using electoral cycles in police hiring to estimate the effect of police on crime, The American Economic Review 1997, 87(3), pp.270 90. Introduction The second chapter of this course is about quantitative methodology, mainly regression analysis. The techniques reviewed here are used extensively, but by no means exclusively, in research in development economics and development policy analysis. Scholars use regression analysis in their attempts to answer questions such as: What are the drivers of economic growth? Is openness to trade related to growth? Can a particular aid programme (a microfinance programme, a programme providing books to school children, budget support for developing country governments) be considered successful? As you can see from these questions, the aspects of quantitative methodology covered in this chapter can be applied to every topic in the remainder of the subject guide: economic growth, international trade, aid, credit, etc. 15

169 Economic policy analysis in international development There is a reason why we start with methodology and not with any of these topics specific to international development. The knowledge about methodology that you will need is similar for all these topics, and we wanted to provide you with a chapter where it is all neatly put together. In fact, the basics of all the methodology you will need to know are in this chapter. In the subsequent chapters, you will see these basics being applied to different areas again and again. This is to say that while the subject matter of this chapter is very important for understanding the rest of the course, you do not need to have fully grasped it all by the end of this chapter. You will practise with it again and again throughout the whole course. You can revisit relevant sections of this chapter every time you are asked to read an empirical paper and will probably understand the material better every time you do so. A disadvantage of providing you with a methodology reference chapter is that you may feel a bit overwhelmed reading it for the first time. Again, please remember that reading empirical papers and understanding their methodology is a skill that will be built up with time and practice. And as with many skills (like playing the piano, or public speaking), once you learn them, they stick with you and they can be applied in other contexts. If you learn the piano playing Mozart, you will probably do pretty okay playing Bach. Like piano-playing skills, the skills you learn reading an empirical paper about trade can be employed reading empirical work on child labour, the environment or even topics that are completely unrelated to development. A final thing to remember is that this course aims to teach you how to be a good consumer of empirical research. After working through the subject guide, we hope that you can read an empirical paper, understand most of the quantitative methodology being employed and make an informed argument about how convincing you find the empirical strategy. We do not ask you to be a producer of empirical research. You are not expected to be able to do regression analysis, use statistical programmes or do any calculations whatsoever. You will also never be asked to reproduce numerical results of an empirical paper. In terms of our earlier example, an examination question will never be: By what percentage does the productivity of firms go up, if trade barriers are lowered by 10 per cent, according to paper X? but it may be similar to: Why would we expect lower trade barriers to increase firm productivity? How does paper X test this expectation? Do you feel that the authors of paper X have successfully avoided [potential problems with this analysis]?. Sampling When carrying out research, we often want to draw conclusions about a large number of entities: a population. We may want to know the average income of all people in a country, the productivity of all firms in a country, the effect of having new schoolbooks on the attendance of all school children in a region. We can go and collect data on the whole population, but this is likely to be time consuming and expensive. When done correctly, sampling can provide a much cheaper alternative to a complete census at a small accuracy cost. Sampling is the process by which we select a subset of observations from all possible observations in a population. When taking a sample, the first step is to define the target population. This consists of all the observations about which the research aims to draw conclusions. The sampled population consists of all observations 16