slides - Faculty of Business and Economics

November 2014
Comments on
HOW DOES THE POLITICAL REGIME
AFFECT FINANCIAL CRISES?
by
Rashad Hasanov and
Prasad Bhattacharya
Ken Clements*
Business School, UWA
* Prepared for the PhD Conference in Economics and Business, Monash University. For helpful
discussions, I thank Riznaldi Akbar and Jiawei Si.
OVERVIEW
• Financial crises across countries and time
• Three types of crises
o Banking – bank runs leading to closures, mergers or bail outs
o Currency - >15% depreciation of the currency in a year
o Debt – default or rescheduling
• Controlling for macroeconomic factors, key role for
political arrangements – dictators vs democracies
• It’s the transition from one system to another
(autocracy to democracy) that drives financial crises
• Companion analysis of impact on interest rates of
political regime
2
LEADERS
Democracy
Autocracy
vs.
3
TWO KEY TAKEAWAYS
Democracy is Risky
Prob (crisis)
Autocracy
Autocracy is Safer
Prob (crisis)
Democracy
Democracy
Autocracy
4
TAKEAWAYS
Takeaway 1
• Transition from autocracy to democracy is a dangerous time –
probably of financial crises increases substantially
• Probability in previous figure on left jumps
• Following democratic transition, immature institutions can allow rent
seekers and lawlessness to thrive
• This, together with populist policies of the democratic regime, leads to
the higher probability of financial crises
• Example: Russia in 1990s -- “The conversion of the world's largest
state-controlled economy into a market-oriented economy would have
been extraordinarily difficult regardless of the policies chosen”
(Wikipedia)
• Moral: Introduce reform slowly after democratisation
Takeaway 2
• Probability increases with duration of democratic regime.
5
FOUR GOOD THINGS
ABOUT THE PAPER
• Key idea smart
• Understandable (mostly)
• Considerable careful work in assembling the data
• I learnt something
6
IMPROVEMENTS
• Theory
• Data
• Results
• Nature of the paper
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THEORY
• “Political economy” theory – more political science
than economics
• Decision to default on government debt
Strong political elements (Argentina now)
o But also economic – a balancing of (i) the costs of restricted
access to international capital markets with (ii) benefits of
being able to start once again with a clean slate
o
• Same for a banking bailout (political fallout of
depositors loosing life savings vs. moral hazard plus
the deadweight costs)
8
DATA
• n = 58 countries (all types); T = 50 years (1960-2010)
• n×T = 2,900 observations
• Lots of data – opportunity for considerable visualisation
• There’s a crisis if there’s either a banking, currency or
debt crisis yct = 1
• Crises are perfect substitutes. Is this reasonable?
• In 1984, Argentina had both a currency and a debt crisis,
but still its yct = 1 in that year. That is, these two crises
were counted as only one
• From Fig. 2, over the past 50 years, on average there are
about 25 crises p. a. With 58 countries, the average
probability of a crisis about 50% p. a. Seems high (but
note large surge in 80s and 90s)
9
MORE ON DATA
Country Size
• All countries are equally weighted
• Do we treat observations on different countries as simply
different independent readings of crisis/no crisis for randomly
drawn countries? Here, each country has the same chance of
being drawn
• Each country contributes equally to the estimates, no matter if
it’s large or small. Indonesia (huge) vs Paraguay (tiny)
• Alternatively, we could draw countries such that each dollar of
GDP in the world has the same chance of being selected. The
probability of drawing a given country is then its share in world
GDP
• Should possibly weight countries by economic size
• This would made the sample more representative of the world
economy
10
RESULTS
• A key variable transit -- the transition to democracy
• Much effort devoted to dealing with possible endogeneity –
•
•
•
•
•
does the political regime cause crises or is it vice versa?
But still...
Suppose the old dictator is finally ejected from office
Likely to be much disruption and turmoil in running the
economy and its institutions as the finance minister, central
bank president, etc. are replaced with supporters of the new
regime
Is the financial crisis that follows just part and parcel of that
turmoil of “regime change”? In what sense can it be said that
transit caused the crisis?
Is the independent variable transit really the dependent
variable in disguise?
11
NATURE OF THE PAPER
• Co-authored paper
• Could be made more readable, more effective and
more convincing by reducing by about 30%:
45 pages in total is too long
o Too much devoted to secondary issues. Distracts from
central message (add as footnotes or in separate appendix)
o Repetition
o
• Needs careful edit
• No list of references
12
OTHER ISSUES/IDEAS
Major
1.
What can the findings be used for?
o Policy?
o Prediction of forthcoming crises?
o Political science? Economics?
2.
Is a crisis really a discrete event – like pregnancy – or more
continuous? Needs discussion
3.
Is a crisis a bad thing or does it allow a “fresh start”, like
bankruptcy?
4.
Look at Altman’s Z-score model of corporate bankruptcy
5.
Literature review section summarised:
“The results differ, which is not surprising given new datasets and
econometric modelling techniques that emerge.”
This overly cautious. Need to be BOLD!
13
OTHER ISSUES/IDEAS (CONT’D)
Minor
1. Clustering of errors within countries – a type of
autocorrelation adjustment. Is contagion (acrosscountry correlation) ruled out?
2. Estimates of the time and country effects are of
interest for “constant quality” indexes of probability
of crisis
3. Country effects do not play role of allowing for
differing country sizes
4. Fig. 5b unclear – how does this distinguish
transition countries from pure democracies?
14
OTHER ISSUES/IDEAS (CONT’D)
Minor (con’d)
5.
The discussion of Lewbell’s method for dealing with
endogeneity, around equations (2) and (3), is
unclear
6.
Were results in Table 6 (interaction terms) ever
discussed/mentioned in text?
15
IMPROVEMENTS NEEDED HERE
• Equation on page 14
16

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