Complementary Reforms and the Link between Trade Openness and Growth in Albania

Abstract

This article uses previous findings by Chang, Kaltani & Loayza on the important role that reform complementarities play in the link between trade openness and economic growth to investigate whether reforms in a particular country, Albania, are sufficient for trade to be good for growth. The study simulates the growth-producing effect of Albania's reforms given a pre-established change in trade openness and contrasts it with other countries' performance. It then studies the reform variables and their alternative proxies by comparing their levels with those predicted by Albania's per capita income. The article concludes that Albania's most urgent reforms are in the areas of financial development, infrastructure and governance.

Notes

¹⁴ See O'Driscoll et al. 2003.

¹³ The idea here is that there is an expected negative link between the level of corruption and a country's economic performance. However, this view has been countered by arguments that corruption may not necessarily be inconsistent with the level of development; see Kaufmann (1997) for a discussion.

¹² An initial analysis looked at telephones, electricity and water for infrastructure development; school enrolments, international educational assessment scores, teacher–pupil ratios and expenditure on education for human capital investment; availability of private credit, legal rights, cost of collateral and creditor information for financial development; corruption, rule of law, quality of bureaucracy, accountability of public officials, contract enforcement, property registration and investor protection for governance; difficulty of hiring and firing workers, rigidity of work hours and the size of the informal sector for labour market flexibility; number of procedures, duration, cost and minimum capital for firm entry flexibility. Then, only those proxies that appeared problematic given Albania's level of development and given comments from experts are discussed below.

¹¹ For example, in the specific case of infrastructure development, the economic literature interchangeably uses roads, telephone lines or energy consumption. Other reform areas display the same variety of choices. Here are some cross-country correlations of the alternative variables that are in the analysis below. The correlation between education enrolment and education quality is 0.66. The correlation between measures of energy sector efficiency and telecommunications is 0.5. The correlation between the quantity of credit and the quality of the regulatory environment in the financial sector is 0.54. The correlation between the composite governance index and its sub-components ranges from 0.76 to 0.86. The correlation of the governance index with other measures of governance such as, for instance, the number of procedures required to enforce contracts is − 0.54.

¹⁰ Croatia was picked as a regional comparator despite the fact that its growth rate for 1996–2000 was 4.8%, slightly lower than Albania's, which amounted to 5%. Ireland was picked as an example of a reformer around the world. There was no country that scored higher than Albania in terms of labour market flexibility and also experienced higher growth.

⁹ Clearly, for time-invariant variables the bold line will cover the whole range.

⁸ The ICRG governance index is available since the mid-1980s and shows some time variation. Given that we are forced to assume that its value was the same in the 1960s and 1970s as in the mid-1980s, we make the conservative assumption that its growth effect cannot be estimated separately from that of the unobserved fixed effect, as is the case with the other institutional variables that are completely constant over time.

 ⁷ This is significantly so in the cases of educational investment, public infrastructure and governance. Labour market regulation is not a statistically significant criterion in this simple example but becomes so once we use more satisfactory econometric methods later in the article.

 ⁶ See Chang et al. for an in-depth discussion of the arguments for and against trade liberalisation and for the most prominent empirical findings on this topic.

 ⁵ This section and the next draw heavily on the work of Chang et al. (2005).

 ⁴ World Bank (2004) provides in-depth discussion of the sources of growth in Albania.

 ³ In the years leading to 1997 a large number of Albanians invested big portions of their savings in fictitious businesses promising exuberant returns. The whole set-up collapsed when in early 1997 one of the companies was unable or unwilling to pay back its customers, causing a run that threw the country into unrest and near civil war.

 ² The other seven SEE-8 countries are Bosnia and Herzegovina, Bulgaria, Croatia, Macedonia, Moldova, Romania and Serbia and Montenegro.

¹ In general a Stabilisation and Association Agreement is a treaty between the EU and non-member countries that creates a framework of cooperation among them. In the case of the countries of the Western Balkans an SAA is part of the Stabilisation and Association process (SAp) and includes explicit provisions for future EU membership.