57929 POVERTY THE WORLD BANK REDUCTION AND ECONOMIC MANAGEMENT NETWORK (PREM) Economic Premise NOVEMBER 2010 · Number 40 JUNE 2010 · Number 18 Avoiding the Eye of the Storm: How to Deal Effectively Trade and the Competitiveness Agenda with Job CrisesFarole José Guilherme Reis and Thomas Sara Johansson, Pierella Paci, Ana Revenga, and Bob Rijkers The global economic crisis has forced a major rethinking of the respective roles of governments and markets in the processes of trade and growth. Indeed, industrial policy seems to be back in fashion--or, at least, talking about it is. But a renewed "activism" by government in their recurrence is a salient feature of emerging a return to old-style Although economic crises are difficult to predict,the trade and growth agenda need not mean market economies. Neverthe- policies of import substitution and "picking winners." Instead, it may mean that can mitigate the impacts of economic less, many developing countries continue to lack an effective policy infrastructure a stronger focus on competitiveness by unlocking on constraints opportunities without affecting long-term growth prospects. This was painfully highlighted by downturnsthe employment to private sector­led growth. This note discusses the renewed role of government in tradethe and reactions implemented competitiveness angle, and suggests some priorities for the new competitiveness agenda. hastygrowth policy from theby many countries in responseitto the global downturn of 2008­9, and by the ad hoc and reactive nature of many of the policies implemented. The weak ability of governments to systematically foresee, monitor, and offset adverse labor market impacts of economic downturns is of particular concern in developing countries where poverty incidence is high and labor is typically the only asset for the majority of the population (Lustig 2000). The main objectives of Export-Led to highlight the Crisis, and the limit pacts of the crisis (ii) to policy environment regarding trade this note1 are (i)Growth, the need for policies thatEnd earnings volatility and on theguide policy makers through the of an Era challenges inherent in crafting effective and comprehensive policy packages. were becoming more apparent. Indeed, in addi- and growth tion to raising concerns over the global commitment to trade The dramatic expansion in global trade over recent decades liberalization, the crisis has also led to some serious rethink- has contributed significantly to diversification, growth, and ing of some of the conventional wisdom regarding the Creative or Destructive Destruction: The Fafchamps 2003; Dercon 2001). Crises can also lead to excess poverty reduction in many developing countries. This period growth agenda--the most important result of which is the Need for Policy Interventions cleansing and can destroy potentially efficient and innovative of rapid export growth has been enabled by two critical likelihood that governments will play a much more activist firms as they may be the most credit constrained (Barlevy 2002, A host of macroeconomic models (1) the vertical and spatial structural changes in global trade:dating from Schumpeter role in the coming years. There are three principal2010). 2003; Ouyang 2009; Hallward-Driemeier and Rijkers reasons fragmentation of manufacturing into highly integrated (1939) imply that negative shocks can foster "creative destruc- Unmanaged, crises can thus result in actively involved in why governments are likely to be moreirreversible productiv- "global production networks," firms and workers. Howev- tion" by weeding out unproductive and (2) the rise of services ity losses and damage long-term prospects years. industrial and trade policy in the coming for growth and pov- trade and crises show of "offshoring." Both of these, in is er, previousthe growth that when markets are imperfect (as turn, First, the crisis has undone faith in structural changes en- erty reduction. Moreover, even when markets and discred- were made possible by major technological revolutions; and predominantly the case in developing countries), even short- hance productivity, the burden of the simply on trade policy ited laissez-faire approaches that relyadjustment is likely to fall they were can have destructive long-term consequences for lived shocks supported by multilateral trade policy reforms disproportionately on governments and Therefore maximiz- liberalization. Instead, the most vulnerable.local markets have and broad liberalizations in domestic trade and investment aggregate productivity and individual workers' earnings and ing "rediscovered." In this sense, the demand for activist been development potential requires effective crises management environments worldwide. welfare. Households facing income losses may be forced to take government is likely to go well beyond financial markets and through policies that reduce the negative short-term impacts of The out of school, spend less on health, or cut back on ca- childrenglobal economic crisis came crashing into the middle regulation, and it will affect the policy environment in which economic downturns on employment, earnings and household loric consumption and export-led growth party during 2008 of this long-running productive assets (for example, livestock income, and at the strategies are recovery. trade and industrialsame time fosterdesigned.This note offers an and 2009. Between the last quarter of 2007 and the second or household enterprise inventories), leading to future losses in Second, the crisis has highlighted in critical importance overview of some the principal issuesthe formulating effective income, of 2009, global trade contracted by Schady 2009; quarter welfare, and productivity (Ferreira and 36 percent. But diversification policy packages. of crisis-mitigating (of sectors, products, and trading partners) as the recovery started to strengthen in 2010 (at least until in reducing the risks of growth volatility. The recent era of the clouds began to form over Europe), the longer-term im- globalization contributed to substantial specialization of 1 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise 1 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise Constraints and Trade-offs are concentrated in specific geographic areas or sectors, target- ing interventions to those areas or sectors may be needed. How- Most developing countries struck by a jobs crisis face three pol- ever, it is also important to consider the likely impact of second- icy constraints. First, monitoring systems and high frequency round labor market adjustment on earnings, in particular for labor market indicators are largely lacking, and decisions often the most vulnerable. Evidence from recent financial crises, in- need to be made against a backdrop of extreme uncertainty as cluding the 1994 Mexican Tequila crisis and the 1997 East to who is hit the hardest and how. Second, the fiscal space for Asian crisis, suggest that shocks rapidly spread from directly af- policy intervention is often narrow and shrinking. Third, poli- fected sectors to other parts of the economy and that the poor, cy makers may be confronted by institutional and political because of their smaller margins and higher vulnerability, suf- economy constraints, such as few preexisting social insurance fer the most severe welfare losses. Moreover, as the case of Indo- mechanisms on which to build, limited administrative capaci- nesia shows, the trade-off can raise political economy problems, ty, and little maneuvering space to pursue economically opti- precisely because the poorest have little political voice. mal, yet politically unpopular, reforms. The extent to which these constraints are binding will vary A Useful Policy Typology across countries and over time and policies must be based on an assessment of how best to work around these country-specific Government interventions to minimize the adverse impact of constraints. For example, if lack of information or institutional crises on labor markets can broadly be separated into four cate- capacity makes it difficult to identify the groups hardest hit by gories along two dimensions depending on (i) whether their crisis, policy makers may opt for public works programs that main objective is to contain the impact of the crisis in the short- rely on self-selection. Moreover, in the recent crisis for example, run or to accelerate recovery and promote long-term growth, countries with fiscally sound outlooks in Asia and, to a lesser and (ii) whether they promote/sustain labor demand or protect extent, Latin America have been able to implement large coun- household income. Policies to contain short-term impact tercyclical packages, but many other countries, especially in Eu- should typically be temporary, or at least possible to scale up rope and Central Asia and Africa, had limited fiscal scope for during a crisis and scaled down as recovery begins; automatic such responses. And even in the context of shrinking fiscal stabilizers such as unemployment insurance or cash transfers space, expanded safety net spending may make sense, because also fall within this category. Policy interventions to accelerate targeted assistance is likely to result in higher consumption. recovery tend to be more permanent and take aim at structural Policy makers also face two thorny trade-offs. First, policies market imperfections, for example, skills development, credit that ease the short-term impacts on employment may destroy policies, and broader investment climate interventions. incentives for long-term recovery, especially during a prolonged, Careful and comprehensive policy design is needed to resolve structural crisis involving significant sectoral reallocation. a potential tension between the two categories. Structural re- Countercyclical policies that focus on protecting employment forms may cause excessive cleansing and unnecessarily depress levels in unviable firms and sectors may undermine a country's output and labor income in the short run, while short-term pol- medium-term competitiveness, distort adjustment, and lead to icies to protect jobs may hamper job creation in the long run. But increases in public debt, all of which would hurt long-term there are also win-win policies that are beneficial both in the growth prospects. In Indonesia, the 1998 crisis sparked pro-la- short and the long run. Figure 1 presents a rough grouping of bor pressures that led to better enforcement of minimum wag- commonly used policy interventions. The categorization is not es and the introduction of severance pay and dismissal regula- rigid--policies may fit into various categories--but provides an tions. More stringent regulation helped raise the earnings and overview of the potential trade-offs policy makers need to know. employment stability of manufacturing workers, but ham- What Policies Have Worked? pered the overall recovery of jobs (Manning 2000; Narjoko and Hill 2007). In such a setting, policy interventions should in- Three broad lessons emerge from the literature on policy re- stead be designed to facilitate, rather than hamper, the required sponses in previous crises (Paci, Revenga and Rijkers 2010). transformation. However, such a trade-off does not always ex- First, no single set of policies will work everywhere, and at all ist. Policies to smooth the transition can still yield high payoffs times. Policy interventions need to be tailored to country-spe- by mitigating excess cleansing, preserving human capital accu- cific circumstances, including the nature of the shock, the fiscal mulation, and encouraging continued innovation. space, institutional capacity, and political economy. Second, Limited resources mean that policy makers may also have to comprehensive policy packages beat piecemeal responses be- choose between support for those most directly affected by the cause of synergy and complementarity. Third, "on the run" crisis--typically urban-based exporters, construction, manu- policy making is no substitute for sound, existing institutions. facturing--and protection of the most vulnerable--typically In practice, many policy interventions have yielded limited re- the chronically poor. If first-round labor market adjustments turns because of weak targeting and the difficulties associated 2 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise Figure 1. Commonly Used Policy Interventions policies to contain the policies to accelerate impact of the crisis recovery and promote growth win-win policies · payroll tax · productivity- · alleviate credit holidays enhancing constraints, focus on · wage subsidies public works including jobs and · public works programs microcredit productivity programs · credit market · remove con- · emergency policies straints to firm credit facilita- · targeted entry and exit, tion self- such as bank- · reduced work- employment ruptcy laws ing hours assistance · reform labor · working hours and product + training market regulation focus on · unemployment conditional cash · training pro- income insurance transfers grams and and employ- · cash transfers education ability · job-search assistance (or sanctions for failing to search) Source: Paci, Revenga, and Rijkers (2010). with implementing incentive-compatible packages from ble employment contracts for youth and women in the wake of scratch (Paci, Revenga and Rijkers 2010). Expanding existing the 1995 crisis resulted in the elimination of most of the pro- programs is likely to be a more effective strategy than imple- gram. But this program may be more effective if targeted at menting new and untested programs (World Bank 2008). Dur- small firms rather than capital-intensive firms (Abrahart, Kaur, ing the 1998 Russian crisis, for instance, while the safety net and Tzannatos 2000; Kang and others 2001). fell short of fully protecting living standards, it helped provide Public work programs have been used widely in past crises, protection against poverty (Ravallion and Loshkin 2000). In such as in Latin America and Asia, and are also the most com- addition, some tentative messages are emerging from the litera- mon response to the current crisis (ILO 2009). Appropriately ture on which policies are most likely to be effective in achiev- designed programs provide a fairly efficient instrument for tar- ing different policy objectives. geting earnings vulnerability because a low wage ensures that the scheme is attractive for the poor only, and during crises only Policies designed to contain short-term impact (Ravallion 2008; del Ninno, Subbarao, and Milazzo 2009). Protecting existing jobs and providing "replacement jobs" However, their cost-effectiveness depends on budget leverage, Temporary payroll, tax holidays, and wage subsidies can help to labor intensity, overhead costs for supervision, and targeting limit short-term labor retrenchment and can be targeted to vul- performance, which need to be weighed against other means, nerable groups. But such schemes (i) affect workers in the for- such as direct transfers. mal sector only; (ii) typically result in high costs per job created/ Maintaining labor-related income maintained; and (iii) can run up against political economy con- Extending unemployment benefits or using them to cover re- straints. For example, in Argentina, union opposition to flexi- duced hours and part-time training has been a common re- 3 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise sponse to the current jobs crisis (ILO 2009). Unemployment protect poor children's school enrollment in times of shocks. insurance may be appropriate when formal sector workers are However, poorly designed schemes can exclude the most most affected, when adjustment occurs through jobs rather vulnerable, such as those who do not have access to the public than earnings, and governments have the fiscal and institution- services that transfers are conditioned upon (Fizbein and al capacity to design, implement, monitor, and target benefits. Schady 2009). Where cash transfer programs are not in place, Many countries do not, however, and only a small number of as in many low-income countries, conditional schemes are developing countries have a comprehensive and effective sys- likely to take longer to implement than unconditional schemes. tem of unemployment benefits in place. Even in such coun- As a crisis response, targeted unconditional cash transfers may tries, like Chile, unemployment insurance has been comple- then yield better results. mented by public works schemes. Credit market policies have shown some promise in resolving When labor market adjustments take place through reduc- cash-flow problems in otherwise viable firms, thus protecting tion in earnings rather than job destruction, targeted cash trans- them from going out of business. But credit policies can result fers can also provide a more cost-effective means of compensat- in substantial incentive problems. In Japan, banks levied addi- ing the vulnerable: they have relatively low administrative costs tional credit to the weakest firms to avoid balance sheet prob- and do not distort prices. There are drawbacks to the targeted lems, leaving more viable firms to exit, and stifling economic transfers, however: they cannot rely on self-selection and politi- recovery. Quick fixes such as loan forgiveness, subsidized lend- cal pressures may potentially make a scaling back of temporary ing, and interest caps risk limiting long-term access to financ- programs impossible once the crisis is over. ing. Microfinance schemes may work better in contexts of high self-employment and informality. In Indonesia, microfinance Policies designed to accelerate recovery and promote growth institutions (MFIs) appear to have been very resilient to the Job creation and imperfect markets East Asian crisis because of their specific design features. How- While there is evidence that weaknesses in the investment cli- ever, there are other cases where MFI lending has been procycli- mate hamper growth and job creation in stable times, there is cal and has exacerbated crisis situations (Marconi and Mosley no evidence on the impact of business and labor market policies 2006). during crises. Job search assistance schemes, for example, may ef- Productivity-enhancing public works schemes, finally, also fit fectively address information gaps that constrain employment into this category. Cost-efficient schemes that provide public/ during normal times, but are not likely to work during times of community goods can protect labor income while simultane- mass unemployment (Betcherman and others 2004). ously reducing vulnerability and increase income growth in the future. Improving employability The impact of training programs to enhance worker productivi- Conclusions: Prepare, Preserve, and Ex- ty has been limited, although it strongly depends on context pand Policies That Work and implementation (Auer, Efendioglu, and Leschke 2008). Training also seems to be most effective when used in conjunc- Events of the last two years have reminded us that crises are a tion with other policies. Overall, training policies risk exclud- recurring phenomenon with deep and protracted impacts on ing the most vulnerable and least productive workers. labor markets. Designing, implementing, and evaluating sound policies ex ante is a more effective crisis coping strategy than Self-employment assistance programs likewise often show low scrambling for responses ex post. Good policies and institu- cost-effectiveness and limited outreach. This is because assisted tions--prudent fiscal management, reliable labor market infor- enterprises drive out other potentially more efficient enterpris- mation systems, flexible labor market regulations, well-func- es (new or incumbent) from the market and program beneficia- tioning credit markets, and sound safety net systems--can ries include entrepreneurially skilled persons who would have provide the basis for a coordinated and coherent response to a started up their own enterprises anyway--and their outreach crisis, while maximizing future growth prospects. For countries tends to be very limited. They can be more promising when in need of additional policies, crises can provide an opportune targeted at particular groups such as women and older individ- time to institute needed safety nets. Experiences with previous uals (Auer, Efendioglu, and Leschke 2008; Abrahart, Kaur, and and recent crises have clearly shown that having a system of au- Tzannatos 2000). tomatic stabilizers in place to mitigate the impact of the crisis is Win-win policies not a luxury. It is a necessity to avoid considerable long-term Conditional cash transfer (CCT) programs provide cash trans- costs in terms of foregone growth prospects. Automatic stabiliz- fers conditional upon investments by households in education ers are particularly vital for countries where a large proportion and health that in turn should benefit productivity and growth of the population is in poverty or highly vulnerable. over the long run. Mexico's Oportunidades and Indonesia's Efficient and effective policy making and crisis response re- scholarship program Jaring Pengamanan Sosial show CCTs can quire timely and relevant information. The global jobs crisis has 4 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise also shown the importance of being better prepared on the ana- Fafchamps, Marcel. 2003. Rural Poverty, Risk and Development. Cheltenham: Edgar Elgar. lytical front. First, increasing the collection and availability of Fereirra, F., and N. Schady. 2009. "Aggregate Economic Shocks, Child School- high frequency data is critical for monitoring the impact of cri- ing and Child Health." World Bank Research Observer 24 (2): 147­81. ses and policy responses on labor markets. Second, it is impor- Fizbein, Ariel, and Norbert Schady, eds. 2009. Conditional Cash Transfers. Re- tant to be prepared by evaluating the vast amount of policy re- ducing Present and Future Poverty. Washington, DC: World Bank. sponses undertaken to the current crisis and identifying Hallward-Driemeier, M., and B. Rijkers. 2010. "Do Crises Catalyze Creative Destruction? Firm-level Evidence from Indonesia." Mimeo. effective policies and by developing simulation tools to assess ILO. 2009. Protecting People, Promoting Jobs. ILO report to the G-20 Leaders' impacts ex ante. The repeated crises faced by the developing Summit, Pittsburg, September. world should act as catalysts for an increased global effort to put ------. 2010. "Global Employment Trends. January 2010." ILO Global Jobs Cri- in place efficient policy systems and high frequency data collec- sis Observatory February. Available at http://www.ilo.org/empelm/what/ pubs/lang--en/docName--WCMS_120471/index.htm. tion to monitor labor market outcomes. Kang, S., J. Keum, D. Kim, and D. Shin. 2001. "Korea: Labor Market Out- About the Authors comes and Policy Responses after the Crisis." In East Asian Labor Markets and the Economic Crisis: Impacts, Responses, and Lessons, ed. Gordon Betch- Sara Johansson is a consultant in the Africa Region's Social Protec- erman and Rizwanul Islam. Washington, DC: World Bank. Lustig, N. 2000. "Crises and the Poor: Socially Responsible Macroeconomics." tion Unit; Pierella Paci is sector manager of the Gender and Devel- Economia 1(1):1­19. opment Department of the Poverty Reduction and Economic Man- Manning, C. 2000. "Labour Market Adjustment to Indonesia's Economic Cri- agement Network; Ana Revenga is sector director of the World sis: Context, Trends and Implications." Bulletin of Indonesian Economic Development Report Unit; and Bob Rijkers is an economist in the Studies 36 (1): 105­36. Macroeconomics and Growth Unit of the Development Economics Marconi, R., and P. Mosley. 2006. "Bolivia during the Global Crisis 1998- 2004: Towards a `Macroeconomics of Microfinance.'" Journal of Interna- Vice-Presidency in the World Bank. tional Development 18 (2): 237­61. Narjoko, D., and H. Hill. 2007. "Winners and Losers during a Deep Economic Rerefences Crisis: Firm-level Evidence from Indonesian Manufacturing." Asian Eco- Abrahart, A., I. Kaur, and Z. Tzannatos. 2000. "Government Employment and nomic Journal 21 (4): 343­68. Active Labor Market Policies in MENA in a Comparative International Ouyang, M. 2009. "The Scarring Effect of Recessions." The Journal of Monetary Context." Paper presented at the Third Mediterranean Development Fo- Economics 56(2): 184­99. rum (MDF3), March 5­8. Paci, P., A. Revenga, and B. Rijkers. 2010. "Weathering the Storm: Policies to Auer, P., U. Efendioglu, and J. Leschke. 2008. Active Labour Market Policies Protect Employment and Earnings at times of Crises." Mimeo, World around the World: Coping with the Consequences of Globalization. Geneva: Bank, Washington, DC. International Labour Organization. Ravallion, M. 2008. "Bailing out the World's Poorest." Policy Research Working Barlevy, G. 2002. "The Sullying Effect of Recessions." Review of Economic Stud- Paper 4763, World Bank, Washington, DC. ies 69 (1): 65­96. Ravallion, M., and M. Loshkin. 2000. "Welfare Impacts of Russia's 1998 Finan- ------. 2003 "Credit Market Frictions and the Allocation of Resources over the cial Crisis and the Response of the Public Safety Net." Economics of Transi- Business Cycle." Journal of Monetary Economics 50 (8): 1795­1818. tion 8 (2) 269­95. Betcherman, G., K. Olivas, and A. Dar. 2004. "Impacts of Active Labor Market Schumpeter, J. 1939. Business Cycles: A Theoretical, Historical and Statistical Programs: New Evidence from Evaluations with Particular Attention to Analysis of the Capitalist Process. New York: McGraw-Hill. Developing and Transition Countries." World Bank Social Protection Dis- World Bank. 2008. "Double-Jeopardy: Responding to High Food and Fuel cussion Paper 0402, Washington, DC. Prices." G-8 Hokkaido-Toyako Summit Paper, July 2. Del Ninno, C., K. Subbarao, and A. Milazzo. 2009. "How to Make Public Works Work: A Review of the Experiences." Social Protection Discussion Note Paper 905, World Bank, Washington, DC. Dercon, S. 2001. Insurance Against Poverty. New York: Oxford University Press. 1. This note draws heavily on Paci, Revenga, and Rijkers (2010). The Economic Premise note series is intended to summarize good practices and key policy findings on topics related to economic policy. They are produced by the Poverty Reduc- tion and Economic Management (PREM) Network Vice-Presidency of the World Bank. The views expressed here are those of the authors and do not necessarily reflect those of the World Bank. The notes are available at: www.worldbank.org/economicpremise. 5 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise