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This paper investigates the effects of financial sector, product market, and trade reforms on labor productivity growth and its two components-the intra-sectoral (within) and inter-sectoral (between) components-in a sample of developing countries over 1975-2005. The paper finds that most of the past trade, product, and financial sector reforms have increased the growth rate of labor productivity. In particular, countries that are further away from the technology leader tend to benefit more from structural reforms than countries closer to the technology frontier. Looking at the subcomponents of labor productivity growth, the paper finds that structural reforms work mostly through the intra-allocative efficiency channel but not through the inter-allocative efficiency channel. The intra-sectoral component is the main driver of the impacts of reforms on labor productivity growth, with a contribution between 76 and 96 percent.

Economic Growth --- Labor Markets --- Labor Productivity --- Macroeconomics and Economic Growth --- Private Sector Development --- Private Sector Economics --- Productivity --- Social Protections and Labor --- Structural Reform --- Structural Transformation --- Trade Reform

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The effect of structural reforms on growth in Europe and Central Asia is assessed by looking separately at each supply-side channel: capital, labor, and productivity, with the last estimated using the stochastic frontier approach. By controlling for the interaction with the economic cycle, the paper also investigates whether timing matters. Improvements in human capital, regulatory quality, and government effectiveness have the most impact on potential growth, along with financial development. European Union accession may also boost growth, mainly by encouraging capital deepening. However, changes in labor market regulation and tariffs may have ambiguous effects. Applying the results to Serbia, the analysis demonstrates that closing certain structural gaps with the frontier would help boost its potential.

Economic Growth --- Economic Theory and Research --- European Union Accession --- Financial Development --- Government Effectiveness --- Human Capital --- Labor Productivity --- Macroeconomics and Economic Growth --- Private Sector Development --- Private Sector Economics --- Public Sector Development --- Regulatory Framework --- Structural Reform

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This paper revisits the early empirical literature on economic growth in transition economies, with particular focus on fiscal policy variables-fiscal balance and the size of government. The baseline model uses a parsimonious specification, drawn from Fischer and Sahay (2000), of economic growth as a function of initial conditions, stabilization, liberalization, and structural reform. The paper expands the data used in previous analyses by up to 10 years and finds unambiguous evidence that fiscal balance matters for growth, while confirming other previous findings on the correlates of economic growth in transition economies. In addition, the paper extends the baseline model and explores potential sources of nonlinearities in the relationship between growth and public finance. A key finding is that determinants of growth may vary in relative importance, depending on the underlying institutional quality. The evidence indicates that there could be higher growth payoffs from macroeconomic stability and public expenditure in countries characterized by relatively better public sector governance as measured by relevant indicators. In addition, the size of government matters for growth in a nonlinear manner: Beyond indicative thresholds of expenditure levels, public spending has a negative impact, while at levels below the threshold, there is no measurable impact on economic growth.

Economic growth --- Fiscal balance --- Fiscal policy --- Governance --- Governance Indicators --- Macroeconomic stability --- National Governance --- Poverty Reduction --- Pro-Poor Growth --- Public expenditure --- Public Finance --- Public sector --- Public Sector Economics and Finance --- Public Sector Expenditure Analysis and Management --- Size of government --- Structural reform --- Transition Economies

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Transition literature has emphasized stabilization and enterprise restructuring. Both cross-country analyses and country-specific studies have tended to focus on fiscal stabilization and its indicators, highlighting the importance of quantitative fiscal adjustment to stabilization outcomes. Less attention has been paid to the qualitative dimensions of fiscal adjustment in transition. Alam and Sundberg take stock of the extent to which fiscal adjustment has occurred during the first decade of transition in both qualitative and quantitative dimensions. They define quality as the extent to which: (1) pro-growth expenditure essential for creating future economic and social assets are maintained; (2) pro-poor expenditure, such as poverty-targeted transfers, necessary to ensure income for the poor and vulnerable are adequately provided; and (3) fiscal risks, impinging on both expenditure and revenue, are managed through transition. The authors conclude that while the quantitative magnitude of the fiscal adjustment was dramatic, the quality of this adjustment has compromised the social and economic objectives of transition, particularly in the Commonwealth of Independent States (CIS). They draw four main conclusions: Investments in public services fell in both absolute and relative terms; Reduced spending on government transfers contributed to a sharp increase in income inequality in the CIS; Fiscal risks increased during the transition; Initial conditions allowed Central European and Baltic countries to maintain higher expenditures, which may have contributed to their faster economic recovery and political support for the reforms. The authors argue that the challenge today for fiscal policy in these countries is to facilitate the transition-particularly in reallocating resources from large state-owned enterprises to new small and medium-size firms, and providing priority public services and targeted transfers to assist those adversely affected by transition and reverse the deterioration in social outcomes. The interplay between fiscal policies and institutional arrangements is increasingly important as transition economies embark on their second decade of reforms. In particular, incentives embedded in the institutional arrangements for fiscal management needs to be strengthened so that policies, resources, and outcomes can be better aligned, and the fiscal adjustment is consistent with qualitative considerations. This paper-a product of the Poverty Reduction and Economic Management Sector Unit, Europe and Central Asia Region-is part of a larger effort in the region to understand economic transition in former centrally planned economies. The authors may be contacted at aalam@worldbank.org or msundberg@worldbank.org.

Banks and Banking Reform --- Debt Markets --- Economic Recovery --- Expenditures --- Finance and Financial Sector Development --- Financial Literacy --- Fiscal Adjustment --- Fiscal Imbalances --- Fiscal Management --- Fiscal Policies --- Fiscal Policy --- Fiscal Risks --- Fiscal Stabilization --- Fiscal Transition --- Incentives --- Macroeconomic Stabilization --- Outcomes --- Public Enterprises --- Public Sector Economics and Finance --- Public Sector Expenditure Analysis and Management --- Public Services --- Revenues --- Social Outcomes --- Structural Reform --- Tax Systems --- Transition Economies

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July 2000 - Empirical econometric evidence shows that Mexico's simulated output recovery after a negative external shock was faster (a third as long) when the country's policymakers let the nominal foreign exchange rate float than when they fixed it, and much faster than in other developing countries that kept nominal foreign exchange rates constant, especially those that resorted to currency board arrangements to support that constancy. The academic and policy debate about optimal foreign exchange rate regimes for emerging economies has focused more on the theoretical costs and benefits of possible regimes than on their actual performance. Giugale and Korobow report on what can be called exchange-rate-regime-dependent differential shock persistence-that is, the time output takes to return to its trend after a negative shock-in a sample of countries representing various points on the spectrum of nominal foreign exchange flexibility. They find strong evidence that Mexico's simulated output recovery after a negative external shock was faster (a third as long) when the country's policymakers let the nominal foreign exchange rate float than when they fixed it, and much faster than in other developing countries that kept nominal foreign exchange rates constant, especially those that resorted to currency board arrangements to support that constancy. These results are insufficient to guide the choice of regime (they lack general equilibrium value and are based on a limited sample of countries), but they highlight an important practical consideration in making that choice: How long it takes for output to adjust after negative shocks is sensitive to the level of rigidity of the foreign exchange regime. This factor may be critical when the social costs of those adjustments are not negligible. This paper-a product of the Mexico Country Department, Latin America and the Caribbean Region-is part of a larger effort in the region to understand policy options open to developing countries for handling macroeconomic volatility in a globalized economy. The authors may be contacted at mgiugale@worldbank.org or akorobow@worldbank.org.

Currencies and Exchange Rates --- Currency --- Currency Board --- Currency Board Arrangements --- Currency Boards --- Debt Markets --- Domestic Economy --- Econometric Evidence --- Economic Stabilization --- Economic Theory and Research --- Economies --- Emerging Markets --- Exchange Rate Flo Exchange Rate Regime --- Exchange Regime --- External Shock --- Finance and Financial Sector Development --- Financial Crises --- Fiscal and Monetary Policy --- Foreign Exchange --- Foreign Exchange Rate --- Foreign Exchange Rates --- Inflation --- International Financial Integration --- Macroeconomic Management --- Macroeconomics and Economic Growth --- Monetary Unions --- Open Capital Accounts --- Private Sector Development --- Public Sector Development --- Structural Reform