The Political Economy Of The BRICS Countries (In 3 Volumes) 9811202176, 9789811202179

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THE POLITICAL ECONOMY OF THE BRICS COUNTRIES  BRICS: The Quest for Inclusive Growth

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THE POLITICAL ECONOMY OF THE BRICS COUNTRIES Editors-in-Chief

Edward D. Mansfield University of Pennsylvania, USA

Nita Rudra

Georgetown University, USA

 BRICS: The Quest for Inclusive Growth Editors

Biju Paul Abraham

Indian Institute of Management Calcutta, India

Partha Ray

Indian Institute of Management Calcutta, India

World Scientific NEW JERSEY

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Published by World Scientific Publishing Co. Pte. Ltd. 5 Toh Tuck Link, Singapore 596224 USA office: 27 Warren Street, Suite 401-402, Hackensack, NJ 07601 UK office: 57 Shelton Street, Covent Garden, London WC2H 9HE

Library of Congress Cataloging-in-Publication Data Names: Abraham, Biju Paul, editor. | Ray, Partha, editor. | Kim, Soo Yeon, editor. Title: The political economy of the BRICS countries / editor-in-chief: Edward D Mansfield (University of Pennsylvania, USA) and Nita Rudra (Georgetown University, USA); edited by Biju Paul Abraham (Indian Institute of Management Calcutta, India), Partha Ray (Indian Institute of Management Calcutta, India), Soo Yeon Kim (National University of Singapore, Singapore) and Santiago López-Cariboni. (Universidad Católica del Uruguay, Uruguay). Description: New Jersey : World Scientific, [2019-] | Includes bibliographical references and index. Contents: v.1.BRICS: The quest for inclusive growth -- v.2. BRICS and the global economy - v.3. Political economy of informality in BRIC countries. Identifiers: LCCN 2019011951| ISBN 9789811202179 (set : alk. paper) | ISBN 9789811202186 (v. 1: hc : alk. paper) | ISBN 9789811202193 (v. 2: hc : alk. paper) | ISBN 9789811202209 (v. 3: hc : alk. paper) Subjects: LCSH: Economic development--BRIC countries. | BRIC countries--Economic conditions. | BRIC countries--Economic policy. | BRIC countries--Social policy. | BRIC countries--Foreign relations. Classification: LCC HD82 .P5485 2019 | DDC 330.9172/4--dc23 LC record available at https://lccn.loc.gov/2019011951 British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library.

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For any available supplementary material, please visit https://www.worldscientific.com/worldscibooks/10.1142/11330#t=suppl Desk Editors: Dr. Sree Meenakshi Sajani/Jiang Yulin Typeset by Stallion Press Email: [email protected] Printed in Singapore

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Preface

Over the last two decades the economies of Brazil, Russia, India, China, and South Africa (BRICS) have emerged as a major source of global economic growth. All these countries are part of the G-20 group and are increasingly seen as playing a significant role in global political and economic affairs. However, the growth pattern in these countries have not been always inclusive. There are two broad aspects of growth in the BRICS economies that are worth noting — their heterogeneity and their lack of inclusivity. The edited book, BRICS: The Quest for Inclusive Growth aims to expose the reader to the quest for inclusive growth in these countries. Specifically, the chapters in this volume discuss economic growth in the BRICS countries with a view to understanding whether the nature of their growth is such that it is broad-based and leads to equitable economic/social outcomes. The objective of the volume is not to look at each economy exhaustively across different dimensions of growth. The chapters analyze specific dimensions of growth in these five economies that constrain their ability to act effectively and cohesively in international affairs. The nine chapters in this volume address different aspects of economic growth in the five economies. We would like to thank Professor Edward Mansfield, Professor of Political Science at the University of Pennsylvania and Professor Nita Rudra, Professor of Government at Georgetown University, the Editors-in-Chief of the three-volume study of the The Political Economy of the BRICS Countries for inducting us into this effort and for including this volume in the three-volume study. Some of the papers in this volume were initially presented at an International Conference on The Political Economy of Emerging Market Countries: The Challenges of Developing More Humane Societies in December 2016/January 2017 jointly organized by Princeton University, Georgetown University, USA, and Indian Institute of

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Management Calcutta in Kolkata and Santiniketan in West Bengal, India. Hence the information base of most of the papers pertain till that period. We would like to thank Princeton University, Georgetown University and the Management Centre for Human Values at the Indian Institute of Management Calcutta for their funding support for the Conference. Biju Paul Abraham and Partha Ray Kolkata, March 2019

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About the Editors-in-Chief

Edward D. Mansfield is the Hum Rosen Professor of Political Science and Director of the Christopher H. Browne Center for International Politics at the University of Pennsylvania. His research focuses on international security and international political economy. He is the author of Power, Trade, and War (Princeton University Press, 1994); Electing to Fight: Why Emerging Democracies Go to War (with Jack Snyder) (MIT Press, 2005); Votes, Vetoes, and the Political Economy of International Trade Agreements (with Helen V. Milner) (Princeton University Press, 2012); and The Political Economy of International Trade (World Scientific, 2015). He is also the editor of 14 books and journal special issues, and has published articles in the American Political Science Review, British Journal of Political Science, Comparative Political Studies, International Organization, International Security, International Studies Quarterly, Journal of Conflict Resolution, World Politics, and various other journals and books. The recipient of the 2000 Karl W. Deutsch Award in International Relations and Peace Research, Mansfield has been a National Fellow at the Hoover Institution and his research has been supported by grants from the Harry Frank Guggenheim Foundation, the Mershon Center, and the United States Institute of Peace. He is the co-editor of the University of Michigan Press Series on International Political Economy and was the Vice President of the International Studies Association. He has been a Term Member of the Council on Foreign Relations, a member of the Graduate Record Examination Political Science Committee, Associate Editor of International Organization, and Program Co-Chair for the 2001 annual meeting of the American Political Science Association. Mansfield received his BA, MA, and PhD from the University of Pennsylvania; and before joining the faculty there, he taught at Columbia University and Ohio State University. vii

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Nita Rudra is a Professor in the Department of Government at Georgetown University. Her research interests include the politics of globalization, trade, foreign investment, development, democracy, inequality, taxation, and redistribution. Her works appear in the British Journal of Political Science, Journal of Politics, American Journal of Political Science, Comparative Political Studies, International Organization, and International Studies Quarterly. Her most recent book with Cambridge University Press is entitled Democracies in Peril. She has been a recipient of the Woodrow Wilson International Center for Scholars Fellowship, the Fulbright–Nehru Foundation Academic Fellowship, and the International Affairs Fellowship by the Council on Foreign Relations.

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About the Editors

Biju Paul Abraham is currently a Professor of Public Policy at the Indian Institute of Management Calcutta. His primary teaching and research interests have been in the area of public systems and policy, particularly national and international regulation and its impact on investment and firms. He has also been part of consulting teams that have carried out strategic reviews of organizations and assessment of program implementation for various ministries of the Government of India as well as the Planning Commission. He was the coeditor of the book Good Governance, Democratic Societies and Globalization (2004) published by Sage and co-author of the book The Intelligent Person’s Guide to Good Governance (2009) also published by Sage. His articles have been published in both national and international journals such as Technovation, the International Journal of Electronic Business, and the Journal of Rural Development. Partha Ray is currently a Professor of Economics at the Indian Institute of Management Calcutta, where he teaches Macroeconomics, Global Political Economy, and Issues in Monetary Policy. During 2007–2011, he was an Adviser to the Executive Director (India) at the International Monetary Fund, Washington, D.C. Earlier, he was working in the specialist cadre of Economists in Reserve Bank of India’s Economic Research Department during 1989–2006 in various capacities; his last position was as the Director, Department of Economic and Policy Research, RBI. During 1985–1989, he taught Economics in

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Calcutta. He has written extensively on issues relating to global financial crisis, global economy, monetary policy, banking, and finance. His recent publications include Macroeconomic Policies for Emerging and Developing Economies (with A. Vasudevan; Sage Publications, 2018), Financial and Fiscal Policies: Crises and New Reality (with Y. V. Reddy and Narayan Valluri; Oxford University Press, 2015), and Monetary Policy (Oxford University Press, 2013).

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About the Contributors

Achin Chakraborty is a Professor of Economics and Director of the Institute of Development Studies Kolkata (IDSK), specializing in welfare economics, development economics and methodology of social science. He obtained his PhD in Economics from the University of California at Riverside, USA. He has published widely in such journals as Economic Theory, Social Indicators Research, Journal of Quantitative Economics, Environment and Development Economics, Economic and Political Weekly, and others. He has co-edited with Anthony D’Costa the recently published book The Land Question in India: State, Dispossession and Capitalist Transition (OUP, 2017). Anup Sinha was Professor of Economics at the Indian Institute of Management Calcutta. He earlier taught in Presidency College Calcutta and has been a Visiting Professor at the University of Southern California and the University of Washington at St. Louis. His primary research interests are in the areas of sustainable development, where he has contributed a number of papers and books. His recent publications include Another Development: Participation, Empowerment and Well-Being in Rural India (with Runa Sarkar) published by Routledge in 2015. He also serves as the Chairman of the Bandhan Bank, which provides banking products and services which are often overlooked by the formal banking systems. Aparajita Gangopadhyay is the Director of the UGC Centre for Latin American Studies at Goa University, Goa, India. Her areas of specialization are India–Latin America relations, India’s foreign policy, and regional integration in South America. She has been a Visiting Faculty at the Chengchi National University, Taiwan, the Marie Curie Sklodowski University, Lublin, Poland, and Vilnius University, Lithuania. She has also delivered lectures in many universities like the Argentine Institute of International Relations (CARI), University of Salvador, La xi

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Plata University, Universidade Siglo 21, Universidade Nacional Rosario and the Universidade Nacional de Rio Cuarto, Argentina. She was also a member of the Indian Delegation to Brazil as part of India–Brazil 1.5 Dialogue in 2013. She has attended many national and international conferences and seminars, and widely published in Indian and international journals. She is also a member of the Academic Council of the Indian Studies Programme, USRJ, Brazil and an Advisory Council Member on Centre on Studies and Services on Contemporary India and Southern Asia, Universidad Externado de Colombia, Bogota. Indrani Gupta is Professor and Head, Health Policy Research Unit (HPRU) at the Institute of Economic Growth, Delhi. She received her PhD in Economics from the University of Maryland, USA in 1992. Her work experience has been varied, including working at teaching and academic institutes, the World Bank, and the Government of India. She has been instrumental in setting up a center for health economics and policy research at IEG, which remains one of the few places in India that undertakes policy-oriented research on the health sector. Her areas of interest cover a wide range of topics, and include demand for health and health care, health insurance and financing, poverty and health, costing and cost-effectiveness, economics of diseases, and international agreements and their impact on public health. R. Nagaraj is currently a Professor at the Indira Gandhi Institute of Development Research, Mumbai. He did his PhD from Centre for Development Studies, Trivandrum. He has been a Visiting Professor, Woodrow Wilson School, Princeton University and at the Indian Institute of Management Calcutta. He was a member of a working group on the Index of Industrial Production, constituted by the Central Statistical Organization, Government of India and a member of the subcommittee on private corporate sector, set up by advisory committee on National Accounts Statistics. Saibal Ghosh is an Expert to the Qatar Central Bank in Doha. He was earlier a Director in the Centre for Advanced Financial Research and Learning of the Reserve Bank of India in Mumbai. Prior to that, he worked in several areas in the Reserve Bank including banking, monetary policy, and international relations. He did his PhD from the Indira Gandhi Institute of Development Research (IGIDR), Mumbai. His research interests are primarily in the areas of banking and finance. His recent interest is in the areas of financial inclusion and gender diversity in emerging economies.

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Samik Chowdhury holds a PhD in Economics from Jawaharlal Nehru University, New Delhi. He teaches at Ambedkar University, Delhi. Prior to this, he was with the Health Policy Research Unit, Institute of Economic Growth (IEG), Delhi. His primary area of research is health policy in India with particular focus on health financing. His other research interests include public policy and governance. Simantini Mukhopadhyay is an Assistant Professor at the Institute of Development Studies, Kolkata. She obtained her PhD in Economics from University of Calcutta in 2015. The topic of her PhD thesis was Aspects of Child Undernutrition in India. She has presented her work in many national and international conferences and has published papers in various international journals including BMJ Global Health, BMJ Open, Journal of Biosocial Science, Asian Population Studies, and Journal of Human Development and Capabilities. Sripad Motiram is an Associate Professor at the University of Massachusetts, Boston. He works in the areas of development economics, welfare economics, political economy, and microeconomics. His recent research focuses on urbanization, inequality, and poverty in developing countries, particularly India. He has recently co-edited a volume on the Political Economy of Contemporary India published by Cambridge University Press. His articles have been published in journals like Review of Development Economics, Economic Development and Cultural Change, and Economic and Political Weekly.

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Contents

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Preface

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About the Editors-in-Chief

About the Editorsix About the Contributorsxi xvii

Introduction Chapter 1 BRICS: The Political Economy of Non-Inclusive Growth Biju Paul Abraham Chapter 2  Future of BRICS as an Economic Block: Does Macroeconomic Heterogeneity and Unshared Political Mandate Stand in Its Way? Partha Ray

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Chapter 3  China’s and India’s Economic Performance After the Financial Crisis: A Comparative Analysis R. Nagaraj

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Chapter 4  Inter-Group Disparities in Growing Economies: India Among the BRICS Achin Chakraborty and Simantini Mukhopadhyay

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Chapter 5  Inequality and Poverty in India and Brazil Since the 1990s: A Comparative Analysis Sripad Motiram

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Chapter 6 Sustainable Development and BRICS: Unity Amid Diversity? Anup Sinha Chapter 7  Universal Health Coverage in BRICS: What India Can Learn from the BRICS Experience? Indrani Gupta and Samik Chowdhury

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Chapter 8 Inclusive Finance: India Through the BRICS Lens Saibal Ghosh

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Chapter 9 Gender, Education, and Programma Bolsa Familia in Brazil Aparajita Gangopadhyay

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Index217

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Introduction

The rapid growth of emerging economies, and their increasing global influence, has been one of the major features of the post-Cold War world. Countries in Asia, such as China and India, have ‘reemerged’ to become two of the largest economies of the world, reclaiming positions they held before the advent of the colonial era brought about their relative economic decline. Brazil in Latin America and South Africa have also achieved high rates of economic growth that have made them significant players in the global economy. Russia has emerged from the ruins of the former Soviet Union and reestablished itself as a major oil producer and political power on the international stage. Despite these changes, the nature of international political and economic ­institutions such as the UN, the IMF, and the World Bank has not changed significantly to reflect the new realities. This slow pace of reform, and the reluctance of major global powers, particularly those belonging to the G7, to restructure international institutions has forced newly emerging economies to act collectively to bring about this change. The formation of the BRICS group of countries, comprising Brazil, Russia, India, China, and South Africa as a counterweight to groupings such as the G7 is one such attempt. While the genesis of the BRICS group may be sought in an internal report of Goldman Sachs in 2001, over the last decade and half the group has emerged as an economic powerhouse. After all, the BRICS group of countries together comprise 2.8 billion people — over 40% of the world’s population — cover more than a quarter of the world’s land area, and currently account for about 25% of the world’s GDP. The five countries are undoubtedly major powers regionally, and at least one of them, viz., China, globally. But how effective are they as a group? Will they be able to work together effectively and achieve for themselves a more influential position in world affairs? Or will they be constrained in their ability to act abroad by domestic instability arising from growth that is iniquitous and xvii

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non-inclusive? What are the different dimensions of such non-inclusivity? Will the dominance of China be counterproductive in making the group effective? Without any claim of completeness, these are some of the questions that this volume seeks to address. The chapters in this volume discuss economic growth in the BRICS countries with a view to understanding whether the nature of their growth is such that it is broad-based and leads to equitable economic/social outcomes. The objective of the volume is neither to look at each economy exhaustively across different dimensions of growth, nor do we have a standard template to do so. What we do is analyze specific dimensions of growth in these five economies that constrain their ability to act effectively and cohesively in international affairs. The nine chapters in this volume address different aspects of economic growth in the five economies. The first two chapters discuss the political-economy of growth in BRICS and the economic heterogeneity of the five countries that constrain their ability to act as a cohesive international group. The third chapter discusses the growth experience of India and China after the global financial crisis. Two chapters analyze inequality and intergroup disparities in growth in BRICS economies. The remaining four chapters look at different socio-economic dimensions of growth, such as sustainable development, health care, financial inclusion, and social welfare programs. In Chapter 1, Biju Paul Abraham looks at the economic development of the five BRICS economies from a political-economy perspective. He argues that while all five economies are increasing their share of the global economy, their ability to act externally is undermined by domestic weaknesses, in particular by iniquitous and non-inclusive growth. Such growth could potentially undermine both political and economic stability. The chapter analyzes three aspects of economic growth in the five countries that leads to this non-inclusiveness — their initial growth paths, development of socio-economic inequity in growth outcomes, and corruption and political capture of economic policy. It argues that in four of the five economies, the initial growth paths were such that they excluded large sections of these countries’ populations from effective participation in the growth process. The only exception was China, where, in the initial decade of Communist Party rule, there was significant growth in food production in rural areas, as well as improvements in health care and education through the commune system. However, both in China and the other four BRICS countries the evolution of growth policy was such that it fostered non-inclusive growth, which deepened socio-economic inequities. Policy reform in all five countries is hindered by the capture of economic policy by elites and that makes it unlikely that there will be significant improvement in equity and inclusivity in growth. The chapter concludes that this failure to reform means that all five countries are vulnerable to domestic instability. This is likely to have a

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significant impact on their ability to act cohesively as a group and constrain their international influence. Tracing the formation of the block in the original 2001 report of Goldman Sachs Global Economics, titled Building Better Global Economic BRICs, Partha Ray in Chapter 2 notes that the BRICS has emerged against the backdrop of the global financial crisis. In deciphering the economic momentum, the chapter takes a look at trajectories of various macroeconomic variables (such as economic size, monetary, fiscal, and exchange rate policies) across the BRICS countries. His analysis indicates that while the Goldman Sachs report has stood the test of time and generated a movement toward economic cooperation among these nations, there are issues of heterogeneity among the constituent countries. Illustratively, in terms of economic size when measured as per GDP (at PPP) in 2017, as against a USD 23 trillion economy of China, India stood at USD 9.5 trillion, the sizes of Russia, Brazil, and South Africa stood at USD 4 trillion, USD 3.2 trillion, and USD 766 billion, respectively. There are differences in their underlying economic models as well. While Chinese growth seems to have been driven primarily by exports and investment, in case of India, growth momentum has been dominated by domestic consumption; for Russia and Brazil, coil and commodities played leading roles. Such differing ­economic models got reflected in their economic policy configuration. In foreign trade, while BRICS accounts for roughly 20% of global exports and 15% of global imports, China alone accounts for nearly 14% of global exports and 10% of global imports. Notwithstanding the establishment of the New Development Bank (popularly called the BRICS Bank) in 2015, he concludes that the Chinese dominance coupled with lack of any binding force of history, politics or shared identity could come in the way of effective emergence of BRICS as a block. In dealing specifically with China’s and India’s economic performance after the financial crisis, Nagaraj notes that economic growth in China and India (together accounting for about 18% of global GDP in 2015) decelerated sharply after the financial crisis. As the export-led boom for both the economies ended in 2008, they are now faced with a severe demand constraint. China’s sustained rise in investment and decelerating output growth has led to a fall in productivity; India witnessed a sharp decline in investment demand. Both the countries are now saddled with bloated private corporate debt due to credit binge during the boom. Nagaraj feels that if China can avoid (potential) debt deflation and a bubble-like situation in the property market, reorient investment toward social infrastructure, and consumption, economic growth could possibly turn around. On the contrary, India probably needs to revive demand by stepping up public infrastructure investment to release critical supply bottlenecks, redirect bank credit for agriculture and small- and medium-sized enterprises to stimulate agriculture growth and labor-intensive manufacturing.

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China’s constraints to shift the policies appear more political-economic; India perhaps needs to reconfigure the fiscal rules for a more active role of the state in promoting investment. While there was recovery until 2011–2012 on account of monetary and fiscal stimulus, and resumption of capital inflows on account of the QE, with modest recovery of developed economies, the widely asked question is this: Can these giant domestic-oriented economies help revive global economic growth? Achin Chakraborty and Simantini Mukhopadhyay look into a particular aspect of inclusive growth, namely inequality between groups, rather than interpersonal inequality. In the process, they reexamine some of the issues in the measurement of inter-group inequality and tried to relate changing interpersonal and inter-group inequality to the fact that some of these countries have been growing at a much faster rate compared to others in the developed world. They find that while in the 1970s and the 1980s Brazil was seen as a case of ‘un-aimed opulence’, since 1988 when Brazil made the transition to a regime of democratic governance, a number of radical pro-poor measures have been undertaken, which have had visible impacts on the overall inequality as well as inequality between the racial groups. In India, by contrast, overall inequality has increased in the past two decades, and the recent evidence suggests that the degree of inequality in the space of income and wealth is no less in India than that in China and the Latin American high-inequality countries. Brazil’s transition from ‘un-aimed opulence’ to a more inclusive approach based on active social policies can be a lesson for India, which is clearly faltering in the task of making the growth process inclusive. They note that while there are some similarities among the three countries — India, China, and Brazil — in their policies over the last 15 years (such as attaining macroeconomic stability associated with high growth and low inflation), there are big differences in the roles played by policies directly aimed at redistributing incomes. Looking more closely at their histories and policy regimes, they arrive at the conclusion that Brazil and India seem to have more in common with each other than with China. In comparing inequality and poverty in India and Brazil since the early 1990’s, Sripad Motiram noted that while India has been one of the fastest growing countries in the world, disparities have increased on many dimensions and progress on the front of poverty reduction has been disappointing. While growth in Brazil has been less impressive, considerable progress has been made in the reduction of inequality and poverty. After documenting findings on inequality and poverty from India and Brazil, this chapter discusses the explanations for these findings. The chapter argues that a crucial difference between the two countries has been in the implementation of public policies, particularly policies oriented toward the social sector. Anup Sinha in his chapter compares the performance of the five BRICS countries on three parameters of sustainable development, economic, social, and

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environmental growth. He concludes that the five countries vary, not just in terms of their geo-political and socio-cultural features, but also in terms of performance on sustainable development indicators. He considers studies of their performance on the basis of three indicators — basic needs, well-being, and opportunities — which reveal that Brazil is the best performer among the BRICS countries followed by Russia, China, and South Africa. India performs the worst on these parameters. The analysis reveals that per capita income and levels of development are closely linked to sustainable development in BRICS economies. China and India which face major challenges of increasing growth rates and lifting people out of poverty ignore environmental concerns, while relatively more prosperous countries like Brazil are more willing to make voluntary efforts to ensure more sustainable growth. He concludes that none of the BRICS economies is likely to target sustainable growth as a priority, since they are more preoccupied with increasing economic growth rates. This choice, he feels, is likely to have a domestic political impact in these countries, with those affected by the negative impact of maintaining high growth rates like to raise their voices and protest at the nature of economic policies. Indrani Gupta and Samik Chowdhury consider Universal Health Coverage in the BRICS economies. They attribute improvements in universal health coverage to two factors — the time period for which health has been a priority sector for national governments and the level of public funding for health care. China and Brazil have significantly improved health coverage by increasing spending. China, however, has performed better than Brazil because it has focused on health care for a longer period of time and also devoted significant resources to improve universal health coverage. Though Brazil has significantly improved health coverage, focused attention and greater resources for health care is a more recent phenomena in Brazil, and this is reflected in much poorer health indicators when compared to China. Though Russia has benefited from the health care infrastructure created under Communist rule, significant improvement in health indicators has not been observed in recent years, when compared to resources invested. This, the authors feel, can be attributed to the lack of focus on health care reform during the transition from Communist to democratic rule. South Africa has also not been able to reduce differences in coverage between the rich white and relatively poorer black population in the country. This is again attributable to lack of sufficient funding and lack of targeted reform. The authors conclude that India, the worst performer among the five countries, can improve access to health care only by increasing funding and extensive reform of existing health care programs. Saibal Ghosh has analyzed a particular aspect of inclusive growth, namely financial inclusion with particular reference to India. In a fairly detailed empirical analysis, Ghosh finds that at a broader plane, driven by manifold developments,

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including technological advancements, there has been a marked progress in financial inclusion in the BRICS that can be traced in both economic and structural factors. To examine financial inclusion in the BRICS countries, he takes three main indicators, viz., ownership of account at a financial institution, the saving behavior at a formal financial institution, and the use of bank credit. He finds that between 2011 and 2017, most of these measures have witnessed a discernible rise. Illustratively, 66% of Chinese individuals had a formal finance account in 2011, which increased to nearly 80% by 2014 and has remained at that level. Only 56% of individuals in Brazil and 54% in South Africa had a formal account in 2011, which increased by nearly 14 percentage points in both countries in 2017. The situation is very much different as regards the use of formal credit. Just around 14% of the individuals in Russia reported having obtained formal credit in the past year in 2017 (the highest in the sample), the global average being 11%. In India, only 7% of individuals borrowed from a financial institution in 2017, the lowest among the BRICS. In his econometric analysis, he finds that GDP per capita and domestic credit to private sector turn out to be significant determinants of access to formal finance. In the final chapter of the volume, Aparajita Gangopadhyay considers the case of social programs in Brazil, particularly the Bolsa Familia program, a conditional cash transfer program, which is often held out as an example of successful government intervention to reduce inequality and improve health and education outcomes. She finds that though the amounts transferred are low, it has guaranteed a minimum quality of life for its recipients. However, it has not been successful at moving them out of poverty. She also points to a major factor that has enabled the program to continue despite the dominance of elites in the Brazilian political system. The amount of resources that is spent on these programs does not threaten the entitlements of the rich or the middle class, and this reduces elite opposition to such resource transfers. She concludes that unless the political system evolves to such an extent that this elite dominance of the Brazilian political system can be effectively countered, the future of these programs will always remain uncertain. The chapters in this volume discuss different dimensions of the political economy, economic growth, and its inclusivity across various matrices. While being exuberant about the growth potential of these countries, all the chapters remain skeptical about two aspects of this growth process — the internal cohesiveness of BRICS as an economic and political bloc, and concerns regarding the inclusiveness of the growth process. How these five countries resolve their internal contraction in future years remains to be seen. Unless they address the various challenges described in the chapters, the effectiveness of BRICS as a bloc will be seriously constrained.

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CHAPTER 1

BRICS: The Political Economy of Non-Inclusive Growth Biju Paul Abraham Public Policy and Management Group, Indian Institute of Management Calcutta, Kolkata, India

Introduction The growth of the BRICS group of emerging economies (comprising of Brazil, Russia, India, China, and South Africa) as a power bloc, similar to the G7 and G20, in global politics has been one of the most important geo-political developments in international affairs since the 2008 financial crisis. At first glance, these five countries might seem unlikely partners in a bloc. They vary widely in geographical size, size of their GDPs, internal political systems, and international influence (Armijo, 2007: 8–9). However, what seems to unite them is their belief that they are ‘punching below their weight’ in international affairs and are thus being prevented from playing a more influential role globally by existing great powers, particularly the G7 countries, which remain deeply reluctant to accommodate emerging powers meaningfully in the existing international system. This new bloc could be seen as a symbol of assertion by countries who feel marginalized in global politics despite their strong economic growth and future potential. The group’s declared objective of reshaping the existing international political and economic order, by significantly reforming the ‘Bretton Woods’ institutions, is undoubtedly an attempt to challenge the dominance of the G7 in international political and economic affairs (Hou, 2014). 1

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While the declared objective of reshaping the international political and economic order might seem a natural demand from a group of countries whose economic growth has made them a significant part of the global economy, the achievement of these objectives depends on four critical factors — maintenance of relatively higher rates of economic growth when compared to the G7 economies, much deeper integration into the international economic and trading system, greater cohesion among members of the bloc in both articulating and pressing their demands for significant reform of international economic institutions, and finally domestic political stability that would underpin greater assertiveness abroad. This chapter will consider the last of these critical factors from a political economy perspective. It will be argued that while all five economies are undoubtedly becoming more significant in the global economy, their ability to exert greater global influence is undermined by critical domestic fault lines. In particular, the political economy of growth in these countries has led to inequitable and non-inclusive growth that could potentially undermine both political and economic stability. This is likely to have a significant impact on their ability to act cohesively as a group and bring about significant changes in the way international institutions and agencies work. The chapter is divided into five parts. The first part looks at the emergence of BRICS within the context of international relations theory. It will be argued that rather than neo-realist approaches, neo-classical realist approaches which consider domestic factors that could undermine states’ ability to act decisively abroad might be better at explaining both the emergence and future potential of BRICS. This is followed by a discussion of three aspects of the growth strategy followed by the BRICS countries which make their growth non-inclusive. These three aspects are critical for understanding both their current status and the hurdles to them fulfilling long-term potential. First, the initial growth paths that all five countries followed is discussed to explain the different contexts within which each of these five emerging economies have developed. The persisting social and economic inequalities in all five countries is discussed next. The third part discusses the impact of corruption and political capture on growth policies and how they hinder radical shifts in growth policy. A concluding section will consider the impact of non-inclusive growth on domestic stability and its impact on the ability of BRICS countries to play a more influential role in international affairs.

Domestic Stability and International Influence International relations theory has for long tried to explain differences in state behavior within the international political system. The attempt has been to identify factors that would explain differences in the behavior of states. Three approaches have dominated such analysis. The first is Innenpolitik which seeks to explain state behavior as being affected by domestic political ideology as

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well as domestic economic and social interest groups (Zakaria, 1992). This approach, for example, suggests that democracies will not go to war with each other because ­democratic states are primarily interested in peace and stability (Ray, 1998). However, the major criticism of this approach has been that it does not explain why countries with similar domestic systems behave differently abroad (Rose, 1998: 148). The second analytical approach, neo-realism, postulates that international relations is an ‘autonomous realm’ where states leverage their capabilities to seek greater recognition and influence within the international system (Koslowski and Kratochwil, 1994). This approach does not concern itself with domestic politics in these countries or its impact on their domestic stability. Neo-realists argue that in an international system that is anarchic, states make choices in terms of their international behavior based on their belief that they can survive only if they follow patterns of behavior set by existing major powers. The limitations of this approach was most evident in neo-realist analyses of the Soviet Union’s behavior before its collapse in 1991 which failed to take into account the impact of domestic economic decline and could not foresee its longer term implications for Soviet influence abroad and also global power politics (Wohlforth, 2001). The third approach, neo-classical realism, while accepting that emerging states do try to imitate existing great powers to increase their influence in world affairs also takes into account domestic factors which might constrain emerging powers in their ability to achieve their goals (Ziegler, 2014: 592–593). Rather than see state behavior either as a function of domestic politics, or a single-minded pursuit of greater international influence, neo-classical realists see state behavior as being affected by relative changes in power. With increasing relative power comes a desire to gain more influence internationally. When relative power decreases, the desire for greater international influence is concomitantly reduced (Rose, 1998: 151–152). This implies that any decline in relative power, caused by domestic factors, could seriously undermine a states’ ability to seek greater power and influence abroad. Most studies of the emergence BRICS have focused on a neo-realist approach to understanding their motivations in joining hands to gain for themselves a more influential role in international affairs. Seen from this perspective, the attempt by the BRICS countries to bring about changes in the international system is based on their belief that their economic strength vis-à-vis the G7 had increased since the 2008 financial crisis and therefore necessities their recognition as major powers in the international system through structural reform of existing international institutions — the UN, the IMF and the World Bank (Stuenkel, 2014; Hou, 2014). However, it is also apparent that BRICS countries have not been very successful in molding the direction of international debate on reform of international political institutions in a manner that is favorable to them. Reform of the UN continues to remain stalled, the reform of the IMFs quota system still does not adequately reflect

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current realities in terms of economic strength, and the Doha Round of Trade negotiations at the WTO remain deadlocked with differences between developed and developing countries over the future direction of trade reform. Domestic problems such as inequality, corruption, lack of skills, and environmental issues mean that the BRICS countries seem destined to focus more on internal problems rather than on cohesive action abroad. In the words of one analyst, BRICS seems more of ‘marriage of convenience’ than a lasting relationship (Kralikova, 2014). Seen from this perspective, the path to economic growth chosen by the five BRICS countries and the impact these choices have on internal stability and regime legitimacy will determine the ability of the BRICS bloc to exert enough influence internationally to bring about significant changes in the international system.

Initial Growth Paths Identifying initial growth paths for the five countries that comprise BRICS can be difficult given their diverse histories. However, it is relatively easier to establish the dates of regime changes that led to significant changes in growth policies that impact the nature and quality of economic growth at present. India and China gained the ability to develop autarkic development policy in the 1940s — India when it gained independence from Britain in 1947 and China when the Communist Party captured power in 1949. Democratic governments were established in Brazil in 1985, in Russia in 1991, and in South Africa in 1994. Economic policy under new regimes in all five countries were designed with the objective of achieving rapid and equitable economic growth. However, the outcome of policy has been varied, and these could be traced back to the initial growth strategies adopted by these five countries. India and China demonstrate most vividly how differences in initial growth paths can affect the nature and quality of long-term economic growth. Both were predominantly agrarian economies with an abundance of agricultural labor as well as a rapidly growing population. Both countries realized that the long-term challenge was to develop both agriculture as well as industries that would absorb the surplus labor which was unemployed or underemployed in agriculture. However, differences in political ideologies played a key role in the two countries choosing differing paths to achieve the same economic objectives. China under the Chinese Communist Party placed considerable emphasis on effective land reform and rural development through workers communes. The landlords and ‘middle peasants’ were almost completely eliminated, and their land distributed among landless laborers. The land was farmed by agricultural communes which, at least in the initial decade, addressed some of the critical problems that China faced. Collective land ownership by the communes, an effective taxation system, local mechanisms to share

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agricultural machinery, development of irrigation systems, and the setting up of rural banks were all critical in substantially increasing agricultural production in China in the late 1940s and early 1950s (Studwell, 2013: 14–16). However, it was not just in agricultural production that the communes played a positive developmental role. They ensured limited industrialization within the commune and provided basic health care, education, and food security (Saith, 2008: 735). The significant progress that China achieved in literacy levels, life expectancy, and other social indicators of development can be traced back to the development of communes which provided basic social security and created the conditions for later social and economic development. Significant poverty reduction had happened by the time the Chinese economy began to liberalize in the 1980s (Bardhan, 2006: 2). The high levels of literacy and life expectancy also laid the foundations of rapid economic growth and industrialization from the 1980s onward, when China abolished the communes, allowed private ownership of land, and liberalized foreign investment. The roots of the ‘Chinese miracle’ after Deng Xiao Ping opened up the Chinese economy in 1978 is traceable to policy in the late 1940s and early 1950s. It needs to be recognized that China’s initial path to economic development was the consequence of a revolution in China that brought a Communist Party, committed to elimination of landlordism and capitalist modes of production, to power. China’s relative homogeneity, provided by the dominance of the Han Chinese in its population, also ensured domestic stability (Saith, 2008: 726). In India, by contrast, the government that came to power in 1947, though democratic and socialist in orientation, was dominated by urban elites, indigenous industrialists, and rural landowners. It placed greater emphasis on developing agriculture by incentivizing higher levels of production within existing rural land-ownership structures and in rapid industrialization through a process of planned economic development (Patnaik, 2000). The economy was also affected by violence that accompanied the partition of the sub-continent into two states, India and Pakistan. Land reform measures, though enacted were never implemented, except in a few regions, because of strong organized resistance from rural landlords who were often local leaders of the ruling Congress Party (Kaviraj, 2000: 50). Lack of access to economic resources meant that the vast majority of rural landless peasants were dependent on the rural landowning classes for their survival. This dependence reduced their ability to influence government policy through the democratic political process. It is ironic that this failure of government to ensure basic levels of social security and economic empowerment happened in a liberal democracy which held regular elections, and relatively greater success was achieved in China under a Communist regime that was not faced with the prospect of loss of power through democratic processes.

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Brazil and South Africa transitioned to democratic governments under conditions that were far more peaceful and orderly than either India or China. However, initial economic policies in both countries were unsuccessful in laying the foundations of strong, inclusive growth. The 1985 transition to a democratic government in Brazil happened in the midst of an economic crisis. Military governments which had ruled Brazil between 1964 and 1985 had ensured rapid economic growth in the 1967–1973 period. However, when growth slowed as a consequence of the oil price shock of 1973 the government responded by resorting to heavy borrowing abroad. This contributed to a debt crisis and a decline in economic growth in the 1980s that finally forced the military to hand over power to a civilian democratic government. The restoration of democratic government posed unique challenges to Brazilian policymakers. Groups that felt alienated from the government under military rule began to demand greater resources and attention, and in a democratic environment, this led to populist responses (Kingstone, 2009: 108). ‘Social inclusion’ of groups that had been marginalized under military government was given priority over stable economic growth (Alston et al., 2016: 208). The use of economic stabilization plans for garnering greater political support was successful electorally for the ruling party in mid-term elections in 1987, but it had a catastrophic impact on the economy with inflation touching astronomical levels by the end of the 1980s. The government began to monetize fiscal deficits to fulfil populist promises, and by the early 1990s annual inflation rates was 3,000% (Sweetwood, 2002: 54–56). It required a period of economic austerity and the ‘Real Plan’ of 1994 to stabilize the economy and put it on a more stable growth path. This decade of lost growth was to have an impact on the quality of growth in later decades as well. The nature of transition from apartheid government to a stable democracy in 1994 marked South Africa as one of the few countries that had managed change peacefully. While economic inequalities brought about by apartheid policies had impoverished large sections of the black population in South Africa, the newly democratic country had the benefit of strong institutions, such as an independent judiciary, an efficient civil service, and a modern industry with good infrastructure. However, what it lacked was good local-level ‘micro-institutions’ that could convert political freedom to economic opportunity. While good macroeconomic management stabilized the economy, it was not accompanied by a push for economic and social development in black townships. This failure was partly the consequence of a leadership vacuum that was created in black townships when many of the more capable local workers and activists left the townships to take up jobs in the provincial and national governments (Mangcu, 2012: 482). The focus of the national government was more at the macro-level on the policy of Black Economic Empowerment (BEE) meant to give the black population a share in ownership of firms and employment.

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This increased the representation of blacks at top levels of enterprises, but, in the absence of significant investments in education, did little to secure stable and wellpaying jobs for black workers (Horwitz and Jain, 2011). Though considered a developed state, Russia inherited an economy from the former Soviet Union that was suffering from problems of underinvestment, inefficiency, and relative backwardness when compared not just with the more advanced Western economies but also with many of the more dynamic East Asian economies (Robinson, 2011: 9). Initial economic policy in the post-Soviet era was based on stabilization of the domestic economy by cutting budget and trade deficits, removing price controls, liberalizing the internal market by throwing it open to foreign competition, and privatizing state-owned enterprises. However, the process was deeply flawed and led to a period of economic crisis and declining economic output that lasted for the rest of the 1990s. The successor state to the USSR, which was the second largest economy in the world when it collapsed in 1991, became the twelfth largest by 1998 (Intriligator, 1998: 242–243). Economic decline was accompanied by a steep decline in living standards and growing criminalization of the economy (Zhuravskaya, 2007).

Persisting Social and Economic Inequalities Countries that suffer from socio-economic inequalities face two significant challenges. The first is to raise total income levels of the population, and the second to ensure that it is more equitably distributed. The first is achieved by attaining high rates of economic growth and the second by socio-economic interventions, including taxation and welfare spending, that ensures that income is more equitably distributed. The varied paths that the five countries have followed is reflected in any current evaluations of the nature of economic growth and socio-economic outcomes in the five BRICS countries (Ardichvili et al., 2012; Arrighi et al., 2010). India, Brazil, South Africa, and Russia, despite having enjoyed periods of high-economic growth, continue to experience persistent inequality in income distribution. China, which was relatively more successful in achieving both high growth and greater income equality in the early years of its development, has seen inequality rise since the liberalization of the economy in 1978. The Global Inequality Report which tracks inequality around the world by measuring the percentage of national income accruing to the top 10% of the population of each country ranks BRICS countries as being among the most unequal in the world. In India and Brazil, the top 10% get 55% of total national income. In Russia, it is 46% and in China 41% (World Inequality Lab, 2018: 9). In South Africa, the top 10% accounted for 66% of national income (World Inequalities Report, 2018:

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146). All five countries have seen this disparity increase since 1990. The growth in inequality comes despite the fact that three of these countries, India, South Africa, and Brazil, have programs specifically aimed at more inclusive growth and a more equitable distribution of national wealth. Equality is one of the core tenets of the ruling Communist Party in China. Russia too sees reduction of inequality as a policy goal and has reformed its wage regulation to ensure greater distribution of wealth (World Economic Forum, 2017). India presents a paradox as far as equitable growth is concerned. Since liberalization in 1991, it has enjoyed very high rates of growth. The GDP has increased more than nine-fold from US $275 billion in 1991 to US $2.3 trillion (Turaga et al., 2018: 26). During this period, the government has enacted legislations to implement a number of welfare schemes to ensure greater growth equity. It has also implemented programs for providing employment, food security, and access to education. India also put in place, soon after Independence, a program of reservations (affirmative action) that is intended to overcome the inequities imposed on large sections of its population because of rigidities in its caste system. Yet, both in terms of wealth distribution and in terms of social indicators, its performance has been poor compared to many developing nations at similar stages of development, in some respects even worse than Least Developed Countries (LDCs) in sub-Saharan Africa. In health care, while there have been improvements in health indicators, inequalities between different regions has increased since 2001 (Goli and Arokiasamy, 2014: 162). In 2014, the UNDP Gender Equality Study ranked India 135 out of 187 countries, In addition to barriers to social mobility imposed by the caste system, social exclusion and low levels of human development seem to be major detriments to inclusive growth (Onis, 2016). There are two major problems that negatively affect the effectiveness of welfare programs in India. The first is lack of adequate resources. India spends only about 8% of its GDP on social services, which is not just behind OECD countries which spend 20%, but also behind countries like Brazil and South Africa which spend more about 16% of their GDP on social welfare schemes. The second is the inefficiencies in implementation with actual income transfers to those targeting being much less than funds allocated because of very high transaction costs (Jha, 2014). South Africa reflects a similar pattern. Efforts to remove inequalities in growth inherited from the apartheid government have been hampered by inefficiencies in implementation of equitable growth policies and also by lack of resources. When the new democratic government came to power in South Africa in 1994, it had the task of reducing inequalities in a country that was deeply divided, not just economically but also spatially. The black townships were separated from white areas, and these townships lacked the basic resources and infrastructure needed to ensure a basic

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minimum standard of living. Thus, the problem of equitable development was not just related to equitable distribution of wealth but also to balanced development of regions which had developed unequally (McDonald and Piesse, 1999). However, equitable growth policies that were enacted by the government primarily focused on overcoming inequalities brought about by decades of white apartheid government by bringing more blacks into employment and firm ownership through the BEE program. The Broad-Based Black Economic Empowerment (BBBEE) legislation emphasized black participation in ownership and management, increasing the ­number of blacks in the workforce and increasing indirect benefits to the black population through preferences in procurement contracts and enterprise development (Horwitz and Jain, 2011: 302). What was required, but was lacking, was greater investment in sectors that would have increased productivity in the economy, such as education and health care, better physical infrastructure, and access by providing rural workers with access to productive land. South Africa continues to perform very poorly in most socio-economic indicators. Income inequality remains high, with 60% of the population taking in 10% of national income. Lack of access to basic education hampers access to higher education, with only 1.5% of the population having a degree in 2012. Land distribution remains skewed, with 8% of the population owning 70% of the land, after almost two decades of post-apartheid governments (Omilola and Akanabi, 2014: 566). Poverty continues to remain widespread, with inequality hindering poverty reduction efforts across South Africa (Barros and Gupta, 2017: 29). Brazil is unique among BRICS countries in terms of both improvements in income equality and socioeconomic indicators since 2000. Brazil was the only BRICS country which saw its Gini coefficient decrease between 1990 and 2010. The other four BRICS nations saw income inequality increase with an increase in economic growth. Brazil also saw the steepest decline in infant mortality (69%) and child mortality (71%) among the BRICS countries (Mujica et al., 2014: 406). This divergence from other BRICS countries is not surprising given significant shifts in political power that occurred in Brazil since 2000. The government of President Luiz Inácio Lula da Silva of the Brazilian Workers Party, which came to power in 2003, was left-wing in orientation. It laid considerable stress on reducing income inequality and implemented income transfer schemes to help poor Brazilians get access to health care and education. Brazil also spends about 23.7% of its GDP on direct transfers, pensions, education, and health (Lustig, 2016: 26), one of the highest among BRICS countries, and the impact of this is reflected in sharp improvements in socio-economic indicators that Brazil has demonstrated. The income transfer schemes of the Brazilian government had two significant effects on the quality of economic growth. Some of the schemes, such as the Bolsa Famila scheme, were conditional transfer schemes which meant that the money

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transferred was used only for intended objectives — to ensure that expectant mothers visited antenatal clinics regularly and ensured that their children were properly vaccinated and attended school regularly. Other schemes such as the Continued Provision Benefits were unconditional transfer schemes which increased purchasing power among the poor. There is evidence to prove that such transfers led to increased private sector investment in underdeveloped regions of Brazil, particularly the North-East (Limoeiro, 2015). Brazil under the Workers Party government provides evidence, just as the Chinese case in the late 1940s and early 1950s, that targeted government intervention can have a significant positive impact on income equality and socio-economic development. However, as the experience of China demonstrates, such interventions can lose momentum as a result of significant changes in government policy leading to a reversal of policy gains. China, despite its significant achievements in poverty reduction, gender equality, health care, and education, has experienced higher levels of inequality since beginning the process of liberalization and opening of its economy to Foreign Direct Investment (FDI). Household income inequalities have increased to levels which are considered ‘moderately high’ by international standards (Li and Sicular, 2014: 35). The disparities increased after the government established control after the Tiananmen Square uprising and focused on achieving rapid economic growth. Rising prosperity was not equally shared, and a society that was once largely egalitarian in character began to experience higher levels of inequality comparable to many of its East Asian neighbors. The increase in disparities was largely brought about by price reforms which increased costs to consumers. Reduction of government funding for health care and education, and introduction of user fees and higher charges has meant increasing disparity in access to them, especially in rural regions (Saith, 2008: 749). A second factor was the shift from a focus on agriculture to development of industries both through support for state-owned enterprises and FDI-led coastal industrial development. These coastal provinces were given benefits by way of tax concessions, regional autonomy, and the right to lease and sell land to foreign nations (Yao and Zhu, 1998: 146–148). The coastal development policies and the opening up to FDI in the 1990s led to mass migration of workers from rural to urban coastal cities, leading to greater inter-provincial inequalities in growth (Wei, 1999: 51). Inland regions were not given similar benefits. Provinces which are open to international trade and have seen increases in investment have also seen increases in income inequality (Chen, 2015). Russia experienced a period of rapid economic growth after recovering from the initial phase of economic and social disruption caused by the collapse of the Soviet Union. This enabled the country to reduce poverty, which had sharply increased during the initial phase of the transition. However, one of the major problems that

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Russia has faced in ensuring greater equity in growth outcomes has been persistent, and increasing, income inequality (Benini and Czyzewski, 2007: 131–36). This makes poverty reduction and improvement in other social indicators dependent on government social sector spending. High commodity prices since 2000 helped the Russian government to increase spending on ‘populist’ social welfare programs aimed at increasing domestic political support. However, income inequality has increased, and in recent years when economic recession has forced cutbacks in government spending, there has been an increase in people living below the poverty line (Popova et al., 2018: 3). Wealth inequality has also increased quite substantially with levels of concentration of wealth increasing between 1995 and 2015 (Novokmet et al., 2017: 39). The share of national income of the top 50% of the population has increased to over 80% today from 70% in 1989. The share of the top 1% has increased to 45% (World Inequalities Report, 2018: 113).

Corruption and Political Capture All five BRICS economies show high levels of income inequality and poor socio-­ economic indicators despite periods of high growth. In China, Brazil, India, and South Africa, income inequalities and levels of development are such that government intervention and subsidies are required to ensure maintenance of even minimum living standards among the poorest sections of society. Even Russia, relatively the most developed of the five economies with the highest per capita income, is impacted negatively by reductions in government spending on social welfare programs in times of economic crisis. What explains the high levels of income inequality and the failure of all five countries to ensure more sustained and inclusive economic growth? While there are undoubtedly country-specific reasons for this failure, there is one factor that is common to all five countries — high levels of corruption and political capture of government policy which impedes both the effectiveness and inclusiveness of growth. Political capture and corruption lead to non-inclusive growth in diverse ways. Political capture often leads to governments taking decisions which benefit a few firms or individuals to common detriment. It often leads to significant loss of government revenue as natural resources or assets are transferred at less than its true value. Corruption leads to inefficiencies in implementation of social welfare programs and raises social welfare costs significantly. In India, the nature of state–society relations is such that personal relationships, particularly those related to caste, kinship, and social class, play an important role in government decision-making (McCartney and Roy, 2016: 589). This often leads to political capture of government policy that has a detrimental impact on the quality of growth. An analysis of the rise in the number of billionaires in India illustrates

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the effect of political capture on income inequality. The number of billionaires in India increased from two in the mid-1990s to 46 in 2012. Of these, 20 billionaires controlled firms involved in sectors considered ‘rent-thick’. Between 2003 and 2008, the share of national wealth held by these billionaires increased from 0.9% to 9.9%. These sectors included mining, infrastructure, telecom, media, and real estate, all of which were heavily regulated. Most of these billionaires were from social groups who were traditionally associated with business and none from groups which were at the lower end of the caste spectrum (Gandhi and Walton, 2012: 10–11). These are also some of the sectors where numerous instances of corruption in award of licenses, which led to significant revenue losses, have been detected by the national auditor. Corruption has also been one of the biggest problems which has hindered effective implementation of social welfare programs in India, especially in the provision of subsidized food (Jha, 2014: 228). China, because of Communist Party rule, has not developed formal legal and market institutions that limit government power through review by an independent judiciary. Personal relationships, the guanxi, still play a major role in government decision-making process, making policy vulnerable to political capture (Li, 2008). With the advent of economic reform, the instances of ‘high-level’ corruption spread to higher levels of the Chinese government while corruption at lower levels remained more or less then same as before (Wedeman, 2004: 920–921). The process of liberalization and opening up also brought it with the rise of ‘princelings’ in China, the children and sons/daughters-in-law of high ranking officials who came to occupy high positions in the Chinese Communist Party (Choi, 2012: 971). The current anti-corruption campaign by the Chinese President Xi Jinping has stressed the importance of the drive to achieve economic objectives. It was driven in large part by a realization that public perceptions of corruption were affecting the legitimacy of the Communist Party. A PEW Poll in 2016 found that corruption ranked higher in the public’s concerns than income inequality, crime, food adulteration, and pollution (Chen and Zong, 2017). The anti-corruption campaign has resulted in 9% of the membership of the Central Committee of the Chinese Communist Party being detained on corruption charges between December 2012 and October 2017. More than 150 top-ranking officials in the bureaucracy, military, and private-sector businesses have lost their jobs because of the campaign (Mitchell, 2017). In particular, the campaign is likely to help small entrepreneurs increase their investment since corruption is often one of the biggest hurdles to additional investment for them (Gianetti et al., 2017). Brazil and South Africa are countries that have long suffered from political capture of economic policy by the elites. Brazil — even when it was modernizing and industrializing — still remained dominated by feudal structures centered on

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agricultural landownership. The political culture that developed enabled elites to influence the direction of economic policy and maintain their dominance over the poor. Prolonged periods of military rule and the lack of an effective party system meant that the political system was always dominated by the elites (Wilkin, 2008: 99). The mechanisms of economic policymaking that developed revolved around distribution of patronage. This did not change significantly even when military rule was replaced by democratic governments. Federal fund transfers to the regions, especially to the poorest communities, remain prone to such capture, further skewing resource distribution and entrenching income inequalities (Mendes, 2005: 440–441). Though the Brazilian Workers Party of President Lula came to power promising an end to elite domination and corruption, it too soon found itself mired in accusations of corruption in government programs and procurement contracts (Michener and Pereira, 2016: 480). Given the fragmented nature of the Brazilian Parliament, the government could effectively function only by distribution of government patronage. The impeachment of Lula’s successor as President, Dilma Rousseff, and Lula’s own imprisonment on corruption charges illustrate the enduring power of such patronage systems in Brazil. The collapse of the Brazilian Workers Party government has also raised concerns about the continuation of many of the social welfare programs that they had implemented. It also illustrates how persistence of political capture can destabilize governments and threaten even successfully functioning social welfare programs. South Africa inherited a deeply flawed economic system when it became a democratic country in 1994. Poverty was widespread, society was deeply divided, and the government bureaucracy and infrastructure that the new government inherited were designed to serve only a minority of the population (Pillay, 2004: 588). Policies enacted to address the problems of economic inequality afflicting the country further entrenched rather than reduced inequality. Government policy initiatives stressed a system of racial preferences in ownership and employment that easily lent itself to political capture. An increase in black ownership of firms was achieved through debt-funded purchases of equity by a small number of black entrepreneurs (Handley, 2005: 220). Many of these entrepreneurs were closely connected to the ruling African National Congress. In the absence of sufficient number of blacks with the requisite skills to take advantage of the opportunities provided by BEE legislation, the positive impact has been more in terms of number of blacks in senior board positions rather than in employment. The major benefits in terms of BEE legislation have accrued to a newly emerging ‘black middle class’, which has benefited from increased opportunities for employment, rather than to poorer blacks (Horwitz and Jain, 2011: 314; Iheduru, 2004).

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Russia presents a broadly similar picture. The privatization of state enterprises by the government of Boris Yeltsin following breakup of the Soviet Union was marked by the sell-off of state assets cheaply to crony capitalists. About 34 of the 84 Russian billionaires earned their wealth through the privatization in the 1990s (Triesman, 2016: 238). This period of ‘chaotic capitalism’ was replaced by the ‘state-led capitalism’ of Yeltsin’s successor, President Vladimir Putin, under whom many of these assets were renationalized. Putin stressed political centralization, seeing nationalization of previous privatized assets as a means of reasserting state control and eliminating the political threat posed by the ‘Russian Oligarchs’ who had b ­ enefited from the privatization. Centralization of political power has not resulted in an increase in the efficiency of state agencies. On the contrary, it has led to persistence of corruption and continuing low levels of efficiency in the government (Robinson, 2011: 13–14).

Conclusion It is not surprising that the BRICS economies would seek to play a much greater role in global politics, given the rapid growth of their economies, and their increasing share of global economic output. With international political and economic institutions still structured to reflect immediate post-World War II economic realities, it is also clear that international reform of these institutions is long overdue. The ability of the BRICS economies to influence the G7 to initiate these reforms is, however, constrained both by differences between them and also by their domestic vulnerabilities. While all the five BRICS economies have seen periods of rapid economic growth, continuing income inequalities and the non-inclusive nature of their growth make them susceptible to domestic instability. Rising economic inequality could undermine domestic stability, further reducing their ability to work together internationally. The effectiveness of BRICS as an emerging power bloc might be more apparent than real.

References Alston, L. J., M. Marcus Andre, M. Bernardo and P. Carlos (2016). “Why countries transition? the case of Brazil”, Atlantic Economic Journal, 44: 197–224. Ardichvili, A., Z. Elena and M. Vera (2012). “Human capital development: Comparative analysis of BRICS”, European Journal of Training and Development, 36(2/3): 213–233. Arrighi, G., A. Nicole and S. Ben (2010). “Accumulation by dispossession and its limits: The Southern African paradigm revisited”, Studies in Comparative International Development, 45: 410–438.

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Armijo, L. E. (2007). “The BRICS countries (Brazil, Russia, India and China) as analytical category: Mirage or insight”, Asian Perspectives, 31(4): 7–42. Bardhan, P. (2006). “Awakening giants, feet of clay: A comparative assessment of the rise of China and India”, Journal of South Asian Development, 1(1): 1–17. Barros, C. P. and R. Gupta (2017). “Development, poverty and inequality: A spatial analysis of South African provinces”, The Journal of Developing Areas, 51(1): 19–32. Benini, R. and A. Czyzewski (2007). “Regional disparities and economic growth in Russia: New growth patterns and growing up”, Economic Change, 40: 91–135. Chen, C. (2015). “The Impact of foreign direct investment on urban-rural income inequality: Evidence from China”, China Agricultural Economic Review, 8(3): 480–497. Chen, N. and Z. Z. Zhong (2017). The Economic Impact of China’s Anti-Corruption Campaign. Available at SSRN: https://ssrn.com/abstract=2996009 or http://dx.doi.org/10.2139/ ssrn.2996009. Choi, E. K. (2012 ). “Patronage and performance: Factors in the Political mobility of provincial leaders in posts-deng China”, The China Quarterly, 212: 965–981. Gandhi, A. and M. Walton (2012). “Where do India’s billionaires get their wealth”, Economic & Political Weekly, XLVII(40): 10–14. Gianetti, M., Guanmin, L., Jiaxing, Y. and Yu, X. (2017). The Externalities of Corruption: Evidence from Entrepreneurial Activity in China, Finance Working Paper Number 536. ECGI Working Paper Series in Finance. Goli, S. and P. Arokiasamy (2014). “Trends in health and health inequalities among major states of India: assessing progress thorough convergence models”, Health Economics, Policy and Law, 9: 143–168. Handley, A. (2005). “Business, government and economic policymaking in the new South Africa, 1990–2000”, Journal of Modern African Studies, 43(2): 211–239. Horwitz, F. M. and H. Jain (2011). “An assessment of employment equity and Broad Based Black Economic Empowerment developments in South Africa”, Equality, Diversity and Inclusion: An International Journal, 30(4): 297–317. Hou, Z. (2014). “The BRICS and global governance reform: Can the BRICS provide leadership?”, Development, 56(3): 356–362. Iheduru, O. C. (2004). “Black economic power and nation-building in post-apartheid South Africa”, The Journal of Modern African Studies, 42(1): 1–30. Intriligator, M. D. (1998). “Democracy in reforming collapsed communist countries: Blessing or curse?”, Contemporary Economic Policy, 16(2): 241–246. Jha, R. (2014). “Welfare schemes and social protection in India”, International Journal of Sociology and Social Policy, 34(3/4): 214–231. Kaviraj, S. (2000). “The Modern State in India” in Z. Hasan (ed.), Politics and the State in India. Sage Publications. Kingstone, P. (2009). “Sobering up and going global: Brazil’s progress from populism and protectionism”, Law and Business Review of the Americas, 15(1): 105–126. Koslowski, R. and F. V. Kratochwil (1994). “Understanding change in international politics: The Soviet Empire’s demise and the international system”, International Organization, 48(2): 215.

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Kralikova, K. (2014). “BRICS: Can a marriage of convenience last?”, European View, 13: 243–250. Li, S. and T. Sicular (2014). “The distribution of household income in China: Inequality, poverty and policies”, The China Quarterly, 217: 1–41. Li, P. P. (2008). “The duality of crony corruption in economic transition: Toward an integrated framework”, Journal of Business Ethics, 85: 41–55. Limoeiro, D. (2015). “Beyond income transfers: The decline of regional inequality in Brazil during the 2000s”, Progress in Development Studies, 15(1): 6–21. Lustig, N. (2016). “Inequality and fiscal redistribution in middle income countries: Brazil, Chile, Columbia, Indonesia, Medico, Peru and South Africa”, De Gruyter, 7(1): 17–60. Mangcu, X. (2012). “Rethinking Africa’s political economy: An institutionalist perspective in South Africa”, Development, 55(4): 477–483. McCartney, M. and I. Roy (2016). “A Consensus Unravels: NREGA and the Paradox of Rules-Based Welfare in India”, European Journal of Development Research, 28: 588–604. McDonald, S. and J. Piesse (1999). “Legacies of apartheid: The distribution of income in South Africa”, Journal of International Development, 11(7): 985–1004. Mendes, M. (2005). “Capture of fiscal transfers: A study of Brazilian local governments”, Economic Applications, 9(3): 427–444. Michener, G. and Pereira (2016). “A great leap forward for democracy and the rule of law? Brazil’s Mensalao trial”, Journal of Latin American Studies, 48: 477–507. Mitchell, T. (2017). “China anti-corruption purge hits Central Committee members”, Financial Times, October 18. Mujica, O. J., E. Vazuez, E. C. Duarte, J. J. Cortez-Escalante, J. Molina and J. B. da Silva (2014). “Socioeconomic inequalities and mortality trends in BRICS, 1990–2010”, Bulletin of the World Health Organization, 92: 405–412. Novokmet, F., T. Piketty and G. Zucman (2017). “From Soviets to Oligarchs: Inequality and Property in Russia 1905–2016”, WID.world Working Paper Series No. 2017/09. Omilola, B. and O. A. Akanabi (2014). “Impact of macroeconomic, institutional and structural factors on inequality in South Africa”, Development, 57(3–4): 559–577. Onis, Z. (2016). “Democracy in uncertain times: Inequality and democratic development in the global North and global South”, METU Studies in Development, 43: 317–336. Patnaik, P. (2000). “The State in India’s Economic Development” in Z. Hasan (ed.), Politics and the State in India. Sage Publications. Pillay, S. (2004). “Corruption — The challenge to good governance: A South African perspective”, The International Journal of Public Sector Management, 17(6/7): 586–605. Popova, D., M. Matysin and E. Sinnot (2018). “Distributional impact of taxes and social transfers in Russia over the downturn”, Journal of European Social Policy, https://doi. org/10.1177/0958928718767608. Ray, J. L. (1998). “Does democracy cause peace”, Annual Review of Political Science, 1: 27–46.

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Robinson, N. (2011). “Political barriers to economic development in Russia: Obstacles to modernization under Yeltzin and Putin”, International Journal of Development Issues, 10(1): 5–19. Rose, G. (1998). “Neoclassical realism and theories of foreign policy”, World Politics, 51: 144–177. Saith, A. (2008). “China and India: The institutional roots of differential performance”, Development & Change, 39(5): 723–757. Shleifer, A. and D. Treisman (2015). “A normal country: Russia after communism”, Journal of Economic Perspectives, 19(1): 151–174. Studwell, J. (2013). How Asia Works. Success and failure in the world’s most dynamic region, New York: Grove Press. Stuenkel, O. (2014). “Emerging powers and status: The case of the first BRICs summit”, Asian Perspectives, 38: 89–109. Sweetwood, D. M. (2002). “Is Brazil’s economy coming back to life”, Multinational Business Review, 10(1): 54–59. Triesman, D. (2016). “Russia’s billionaires”. American Economic Review: Papers & Proceedings, 106(5): 236–241. Turaga, R. M. R., M. Chakrabarti, M. Chatterjee, S. Jolad, Ka Vaijayanti and M. S. Sriram (2018). “State of inclusive growth in India: Some perspectives”, Vikalpa, 43(1): 24–46. Wedeman, A. (2004). “The intensification of corruption in China”, The China Quarterly, 180(12): 895–921. Wei, Y. D. (1999). “Regional inequality in China”, Progress in Human Geography, 23(1): 45–59. Wen, W. and G. Zhaoyu (2017). “10 myths about Brics debunked”, Financial Times, September 1. Wilkin, P. (2008). “Global communication and political culture in the semi-periphery: The rise of the Globo corporation”, Review of International Studies, 34: 93–113. Wohlforth, W. C. (2001). “The Russian-Soviet empire: A test of neorealism”, Review of International Studies, 27: 213–235. World Economic Forum (2017). The Inclusive Growth and Development Report, Geneva: World Economic Forum. World Inequality Lab (2018). World Inequality Report, Paris: World Inequality Lab. Yao, S. and L. Zhu (1998). “Understanding income inequality in China: A multi-angle perspective”, Economics of Planning, 31: 133–150. Zakaria, F. (1992). “Realism and domestic politics: A review essay”, International Security, 17(1): 177–198. Zhuravskaya, E. (2007). “Whither Russia? A review of Andrei Shleifer’s a normal country”, Journal of Economic Literature, XLVI: 127–146. Ziegler, C. E. (2014). “Russia in Central Asia: The dynamics of great-power politics in a volatile region”, Asian Perspectives, 38: 589–617.

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CHAPTER 2

Future of BRICS as an Economic Block: Does Macroeconomic Heterogeneity and Unshared Political Mandate Stand in Its Way? Partha Ray Economics Group, Indian Institute of Management Calcutta, Kolkata, India

Introduction Economic blocks are normally the outcome of certain historical and political process.1 One can discern the birth of G7 in the pre-Cold War days when France, Italy, Japan, the UK, the US, and West Germany formed the Group of Six in 1975 and Canada joined the following year. Effectively, it emerged as a forum for the nonCommunist powers to address pressing economic concerns such as inflation and the recession sparked by the OPEC oil crisis and dominated by Cold War politics. Or take the case of the euro area, which was born in the aftermath of the Cold War perhaps motivated by a search to question the hegemony of the US dollar. From that standpoint the genesis of the BRIC block, having emanated from the research report of a global investment bank, was indeed unique. Research reports of global investment banks are perhaps more known for their topicality and contemporary policy relevance rather than analytical rigor. After all, these reports are primarily meant for assistance of their clients’ investment strategy. The term economic block is used generically — hence, it includes regional trade blocks, customs unions, or currency areas.

1 

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Thus, it may not be an exaggeration to say that these reports are typically known to have a relatively short shelf life. But when the Goldman Sachs Global Economics Paper No.: 66, titled Building Better Global Economic BRICs, was brought forth by the London-based Goldman Sachs Economic Research Group (led by Jim O’Neill, M.D. & Head of Global Economic Research) in 2001, the authors of the report also might not have realized that they were about to create history. From the vantage point of 2018, it seems that the report has stood the test of time and generated enormous research output and a movement toward economic cooperation among these nations. Initially the focus of the analysis was confined to four economies, viz., Brazil, Russia, India, and China — thus giving birth to the acronym of ‘BRIC’ economies. In projecting future GDP trends in BRIC economies, the Goldman Sachs 2001 report considered a number of scenarios.2 The report arrived at a startling result: “Over the next 10 years, the weight of the BRICs and especially China in world GDP will grow, raising important issues about the global economic impact of fiscal and monetary policy in the BRICs” (Goldman Sachs, 2001). In particular, in all four scenarios, the relative weight of the BRICs rises from 8.0% at present (in current USD) to 14.2%, or from 23.3% to 27.0%, converting at purchasing power parity (PPP). Subsequently, in a sequel to the original report, Goldman Sachs argued: “If things go right, the BRICs could become a very important source of new global spending in the not too distant future. … India’s economy, for instance, could be larger than Japan’s by 2032, and China’s larger than the US by 2041 (and larger than everyone else as early as 2016). The BRICs economies taken together could be larger than the G6 by 2039” (Goldman Sachs, 2003). Such discussion has been the subject of a number of academic studies as well.3 Interestingly, the discussion was not limited to academic research or research reports of investment banks. In due course, BRIC economies emerged as a formal group after the meeting of the leaders of Russia, India, and China on the margins of G8-Outreach Summit in July 2006 in St. Petersburg. The grouping was formalized during the first meeting of BRIC Foreign Ministers on the margins of the UN General Assembly in New York in September 2006 (Government of India, 2016). The following four scenarios were considered in particular: (a) future nominal GDP projections are converted at end-2000 exchange rates; (b) future nominal GDP projections are converted using their fair value exchange rate estimates; (c) future nominals are converted at end-2000 exchange rates, but assume that the 2001/2002 nominal GDP paths continue for 10 years; and (d) projected GDP trends are arrived at using PPP conversions rather than estimated end-2011 current USDs. 3  See for example, Baracuhy (2012) and Glosny (2010). Even Goldman Sachs came out with a volume on articles on BRICS and other emerging economies; see Goldman Sachs (2007). 2 

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Later, in the aftermath of the global financial crisis, the BRICS block got a shot in the arm and the first BRIC Summit was held in Yekaterinburg, Russia, in June 2009. Subsequently, the foreign ministers of BRIC nations, at their meeting in New York in September 2010, agreed that South Africa may be invited to join BRIC. Accordingly, the group of ‘BRIC countries’ was extended as ‘BRICS countries’ so as to include South Africa, and South Africa formally joined the group in April 2011. More recently, following the report from the Finance Ministers at the fifth BRICS summit in Durban (2013), the BRICS leaders signed the Agreement establishing the New Development Bank (NDB) (formerly referred to as the BRICS Development Bank) which is expected to, ‘strengthen cooperation among BRICS and will supplement the efforts of multilateral and regional financial institutions for global development, thus contributing to collective commitments for achieving the goal of strong, sustainable and balanced growth’. Are all these developments pointers toward the emergence of BRICS as a new kid on the global economic power block? Are these five countries going to pose a threat to G7 economies in the years to come? This chapter argues that there are ample dampeners in the way of this expectation turning out to be true. While such a possible outcome could be reasoned out using differing viewpoints, viz., economic, social, or political, my focus here is somewhat limited. In particular, I will argue that the differences in macroeconomic structure and economic policies could make the BRICS block (and not necessarily individual countries) fragile with little cohesion. The rest of the chapter is organized as follows. First, I look into select metrics of economic importance of BRICS economies. This is followed by a discussion of three aspects of macroeconomic policies, viz., monetary, fiscal, and exchange rate. The trade pattern of the BRICS block is discussed next. Before I conclude, the case and future of economic cooperation between these countries is explored.

Size of the BRICS Economies and Their Growth Trajectory The first element of heterogeneity is perhaps reflected in the differing sizes of the BRICS countries. In 2017 in terms of GDP (at PPP), as against the US $23 trillion economy of China, India stood at US $9.5 trillion, and Brazil, Russia, and South Africa stood at US $3.2 trillion, US $4 trillion, and US $766 billion, respectively. Put differently, in 2017, the size of the Chinese economy was roughly 2.5 times of that of the Indian economy, while it was nearly 7 times and 6 times for Brazil and Russia, respectively, and for the South African economy it was 30 times! This is more effectively demonstrated in these countries’ share in global GDP at PPP (Figure 1(a)), where China clearly, as the biggest economy in the world (in terms of PPP), emerged much bigger vis-à-vis other partners. Moreover, as China has

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15

% of Global GDP

10 5

40 35 30 25 20

G7

2016

2014

2012

2010

2008

2006

2004

2002

1998

2000

1996

2016

2012

(a) Share of BRICS in Global GDP

2014

2008

2006

2002

2004

2010

China Russia

15 1994

Brazil India South Africa

2000

1998

1996

1994

1992

1990

0

1992

% of Global GDP

20

BRICS

(b) Share of BRICS versus G7 in Global GDP

Figure 1:   Share of the BRICS economies and G7 block in global GDP (at PPP). Source: Calculated from World Economic Outlook Database, April 2018, IMF.

surpassed the US economy in terms of share in global GDP (at PPP), the share of BRICS has surpassed that of the G7 economies (Figure 1(b)). Thus, by 2016, BRICS emerged as the biggest economic power in terms of share in global GDP (at PPP).4 Of course, this does not mean that the extent of well-being across these economies is so different. Differing population size is the key to understand trends in per capita GDP. After all, in 2017 in terms of population, China (1.4 billion) and India (1.3 billion) were far above Brazil (207 million), Russia (144 million), and South Africa (57 million). Thus, effectively, the economic sizes of the BRICS countries are at variance with average well-being (Figure 2). Illustratively, in 2017, in terms of per capita GDP, Russia at nearly US $28,000 was way above Brazil (US $15,600) or China (US $16,660), while India’s per capita GDP at nearly US $7,000 was the lowest. The growth performance of the BRICS countries also differed considerably. Notwithstanding recent deceleration, China grew at about 10% for nearly 25 years. Indian growth too has registered a steady acceleration since the initiation of its reform program in the early 1990s. After tumbling in the 1990s, Russian growth experienced a roller roaster movement in sync with petroleum prices. Brazil and South Africa too experienced lower growth rates in comparison with China and India (Table 1). More importantly, the economic drivers varied grossly across these economies. While over the years China has become a global manufacturing hub, India’s growth has been driven primarily by domestic consumption and its vibrant services sector. At market exchange rate, the sizes of the BRICS economies are, however, much smaller.

4 

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US$

20,000 15,000 10,000 5,000

Brazil

China

India

Russia

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

1990

0

South Africa

Figure 2:   Per capita GDP of the BRICS economies (US$). Source: Calculated from World Economic Outlook Database, April 2018, IMF.

Table 1:   Decadal growth rates of the BRICS economies (%). Brazil

China

India

Russia

South Africa

1990–1999

1.8

10.0

5.7

–3.8

1.4

2000–2009

3.4

10.3

6.9

5.5

3.6

2010–2017

1.4

7.9

7.3

1.8

2.0

Source: Calculated from World Economic Outlook Database, April 2018, IMF.

Russian growth has been the outcome of its oil and gas opulence; in the case of Brazil and South Africa, commodities played major roles. The BRICS report of the Government of India has aptly noted, “Each of the BRICS countries has multiple and different attributes and thus each has a huge potential to develop. Brazil is extremely rich in resources such as coffee, soybeans, sugar cane, iron ore, and crude oil, with around 60 million hectares of arable land (just 7 per cent of its land area) but with an agricultural area of 31.2 per cent of the total land area. Russia is noted for its massive deposits of oil, natural gas, and minerals. India is a strong service provider with a rising manufacturing base, while China is seen as the manufacturing workshop of the world with a highly skilled workforce and relatively low wage costs. South Africa is … . It is a mediumsized country with a total land area of slightly more than 1.2 ­million sq. km and around 12 per cent arable land area. It is the world’s largest producer of platinum and chromium and holds the world’s largest known reserves of manganese, platinum group metals, chromium, vanadium, and alumino-silicates” (Government of India, 2012: 3).

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But do these differences in economic size, population, and growth drivers get reflected in their macroeconomic policies?

Macroeconomic Policies in BRICS We discuss the macroeconomic policies under the three broad heads of monetary policy, exchange rate regime, and fiscal policy. Monetary Policies At the current juncture, out of the five BRICS countries, three economies (viz., Brazil, India, and South Africa) have adopted inflation targeting as the framework of the monetary policy. This is in sync with the global fashion of adoption of inflation targeting in order to rein in inflation and fiscal profligacy as well as to assert a certain degree of independence of central banks. While for the most part, the Bank of Russia has had several goals for its policy, there was a gradual shift toward fullfledged inflation targeting since early 2015, abandoning the exchange rate targets in November 2014 (Korhonen and Nuutilainen, 2017). China is perhaps the only country in the block which continues to adopt a multiple indicator approach but an implicit exchange rate targeting (Table 2). In the context of monetary policy, a discussion on inflation is in order. There are several difficulties in comparing inflation rates across the BRICS countries. First, inflation numbers for the Russian Federation are not available till 1993. Second, both Brazil and Russia had experienced astronomical inflation rates during the 1990s. Illustratively, during 1990–1995 Brazilian inflation rate was 1,400%, and it started tapering off since the mid-1990s; similarly, inflation for Russia during the 1990s was more than 200%. In fact, Brazil had yearly inflation rates well above 1,000% from 1989 (except 1991) until the Real Plan stabilized inflationary momentum (Garcia et al., 2019).5 While such a hyperinflationary trend in Brazil was reflective of unbridled monetary expansion, in the case of Russia, removal of long-maintained price controls and dismantling of the erstwhile socialist regime seemed to have played major roles. Figure 3 plots inflation rates for India, China, and South Africa since 1991 and for Russia and Brazil since 2000. It appears that at least in the recent past inflation did not turn out to be a major problem in these countries. In 1994, the Real Plan introduced a new currency, the Real. One real was valued at 2750 Cruzeiros Reais (the short-lived currency of Brazil between August 1, 1993 and June 30, 1994). The plan imposed restrictions on fiscal and monetary expansions and introduced price freezing.

5 

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Table 2:   Monetary policy framework in BRICS countries. Country

Monetary Policy Framework

Key Monetary Policy Tools

Objectives

Interest rate (Selic rate): interest rate on overnight interbank loans collateralized on federal debt instruments.

Inflation — point target of 4.5% with ± 2 percentage points for headline CPI.

South Africa

Inflation targeting

Key policy rate: repurchase rate

Inflation target range for headline CPI of 3–6% combined with financial stability objective.

India

Inflation targeting

Repo rate and CRR

In May 2016, the Indian Central Bank adopted the flexible inflation targeting framework whereby the Central Bank is mandated to target 4% Consumer Price Index (CPI) inflation from August 5, 2016 to March 31, 2021 with ± 2% band.

China

Multiple indicators approach

Reserve requirement ratio, Central Bank base interest rate, rediscounting, Central Bank lending, open market operation, and other policy instruments specified by the State Council

Maintain the stability of the value of the currency and thereby promote economic growth.

Russia

No single target indicator •  Inflation (CPI) target for a 3-year period •  Managing floating exchange rate regime

Refinancing rate, Reserve requirements

To ensure stability of national currency.

Source: Khundrakpam (2012) and respective central banks’ websites.

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Brazil



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China

India

South Africa

Russia

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

30 25 20 15 10 5 0 −5

1990

26  P. Ray

Brazil

Figure 3:   Consumer price inflation in the BRICS economies (% per annum). Source: Calculated from World Economic Outlook Database, April 2018, IMF. Table 3:   Exchange rate and monetary policy regimes in BRICS countries. Monetary Policy Exchange Rate Arrangements

Monetary Aggregate Target Framework

Inflation Targeting Framework

Other Managed Arrangement

China

—

Floating Exchange Rate

—

India, Brazil, South Africa

Free Floating

—

Russia

Source: IMF (2016).

Exchange Rate Regime A related issue in this context is the choice of exchange rate regime in these countries. The IMF’s exchange rate classification system groups India, South Africa, and Brazil under the floating exchange rate regime while that of the Russian ruble is branded as free floating (Table 3). Although Chinese RMB is classified by the IMF as ‘other managed arrangement’, China has been seen widely as a currency manipulator by the global community. A recent report of the US Treasury commented: “(A)fter engaging in one-way, large-scale intervention to resist appreciation of the renminbi (RMB) for a decade, China’s recent intervention in foreign exchange markets, tightened capital controls, and increased discretion over setting the daily fixing rate of the RMB have likely prevented a disorderly currency depreciation that would have had negative consequences for the United States, China, and the global economy” (US Treasury, 2017).

Exchange rate movements are reflected in Table 4. While both South African rand, and Indian rupee showed two-way movements, the Russian ruble has bouts

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Future of BRICS as an Economic Block 27 Table 4:   Exchange rate movements and current account balances in BRICS countries. Exchange Rate Depreciation (−)/ Appreciation (+) (Percentage Variation Over the Previous Year) China

Current Account Deficit (−)/ Surplus (+) (% of GDP)

Brazil

India

South Africa

Russia

China

Brazil

India

South Africa

Russia

2000

0.0

−0.5

−4.2

−11.9

−12.5

1.7

−3.8

−0.6

−0.1

16.3

2001

0.0

−22.2

−4.7

−19.3

−3.6

1.3

−4.2

0.7

0.3

9.7

2002

0.0

−19.5

−2.9

−18.1

−7.0

2.4

−1.6

1.2

0.9

7.4

2003

0.0

−5.0

4.4

39.2

2.1

2.6

0.7

2.3

−0.8

7.2

2004

0.0

5.1

2.9

17.3

6.5

3.5

1.7

−0.3

−2.8

9.2

2005

1.0

20.2

2.9

1.3

1.9

5.7

1.5

−1.2

−3.1

10.3

2006

2.8

12.0

−2.6

−6.0

4.0

8.4

1.2

−1.0

−4.5

8.7

2007

4.8

11.7

9.7

−4.0

6.3

9.9

0.0

−1.3

−5.4

5.2

2008

9.5

6.2

−5.1

−14.6

2.9

9.1

−1.8

−2.3

−5.5

5.8

2009

1.7

−8.3

−10.2

−1.9

−21.7

4.8

−1.6

−2.8

−2.7

3.8

2010

0.9

13.5

5.9

15.0

4.5

3.9

−3.4

−2.8

−1.5

4.1

2011

4.7

5.2

−2.0

0.9

3.4

1.8

−2.9

−4.3

−2.2

4.7

2012

2.4

−14.4

−12.7

−11.6

−4.7

2.5

−3.0

−4.8

−5.1

3.2

2013

2.6

−9.4

−8.8

−15.0

−3.1

1.5

−3.0

−1.7

−5.9

1.5

2014

−0.2

−8.3

−4.1

−11.1

−17.0

2.2

−4.2

−1.3

−5.3

2.8

2015

−1.9

−29.5

−4.9

−15.1

−37.0

2.7

−3.3

−1.1

−4.4

5.0

2016

−5.4

−4.2

−4.5

−13.1

−9.1

1.8

−1.3

−0.7

−3.3

2.0

2017

−1.7

9.2

3.2

10.4

14.9

1.4

−0.5

−2.0

−2.3

2.6

Note: For the purpose of calculating exchange rate movements, exchange rates have been calculated with the home country’s currency as the numeraire; e.g. in calculating Yuan’s exchange rate, it is expressed as USD per one RMB. Source: Calculated from exchange rate data available from Federal Reserve Bank of St. Louis (https://fred. stlouisfed.org).

of instability. Of late, Brazilian real too showed volatility. The Chinese yuan after remaining almost constant for a long time started appreciating slightly during 2006–2013; since then, however, it has stared depreciating. A key difference between these economies is the extent of current account balance. Three countries, viz., Brazil, India, and South Africa, have been consistently having current account deficit since 2008. China and Russia, on the contrary, have been experiencing current account surplus. Of course, in case of Russia the extent of current account surplus has come down in tune with fall in oil prices. In the case of China too, the amount of surplus has come down since the global financial crisis

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and associated efforts toward ‘rebalancing’, whereby China has been repeatedly counseled by the global community to increase its consumption and reduce savings.6 Former US Fed Chairman Ben Bernanke is the chief exponent of this view, who in a lecture delivered Chinese Academy of Social Sciences in 2006 commented, “China today is running substantial trade and current account surpluses. These external surpluses are caused in part by China’s remarkably high saving rate. Because China›s national saving rate is even higher than its rate of domestic investment, the country has excess funds to lend in the global capital m ­ arket; it ­follows from the balance-of-payments accounts that China›s net lending abroad (or its acquisition of foreign assets) equals the country›s current account surplus. A large portion of this lending finances foreigners› purchases of Chinese net exports (the trade surplus). High household saving and the corresponding low level of consumption in China contribute to the trade surplus by depressing the demand for imports and by forcing domestic firms to look abroad for markets” (Bernanke, 2006).

This has profound implications for the trade cooperation among the BRICS countries. Fiscal Policies The heterogeneity is reflected in fiscal positions of the governments as well. Depending on oil prices, Russia has been the only economy in this block that had experienced fiscal surplus during the first of the first decade of 2000s (Figure 4(a)). The fiscal situation seemed to have deteriorated both in South Africa and China; India continued to remain at the bottom in terms of general government borrowing. While public debt has not been a cause of concern in all these five countries, due to presence of petroleum resources Russian debt is least among them (Figure 4(b)). In terms of a timeline, Brazilian fiscal policy is often tracked in terms a shift from a

Since the macroeconomic identity can be written as, Y = C + I + G + X − M (where Y = GDP, C = Consumption; I = Investment; G = Government Consumption; X = Exports, and I = Imports), one would get, (Y − C − G) − I = X − M, so that it can be written as, S − I = X − M (where S = Savings). Since at a global level, aggregate exports have to be equal to global exports, current account balance at the global level has to be zero. By the mid-2000s, while the US and a few European countries had substantial current account deficits, this was matched by the surpluses of number of Asian economies led by China and oil exporters. See Ray and Nag (2017) for details. 6 

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Future of BRICS as an Economic Block 29 10

100

5

Brazil India South Africa

China Russia

(a) General government net lending/borrowing (% of GDP)

Brazil India South Africa

2016

2014

2012

2010

2008

2006

2004

2002

2016

2014

2012

2010

2008

2006

2004

0

2002

–15 2000

20 1998

–10

1996

40

1994

–5

1992

60

1990

0

2000

80

China Russia

(b) General government gross debt (% of GDP)

Figure 4:   Fiscal position in the BRICS economies. Source: Calculated from World Economic Outlook Database, April 2018, IMF.

period of fiscal consolidation (1999–2005) to a phase of fiscal expansion (2005–2014) (Octavio and Gobetti, 2017).

Foreign Trade What has been the pattern of foreign trade in these countries? We have already seen that in terms of current account balance, China and Russia are the surplus countries while India, Brazil, and South Africa are deficit ones. Thus, there is a differing degree of openness among these countries. Illustratively, while the rank of China in terms of merchandise exports is first, the closest next Russia is at seventh (Table 5). As a group, while BRICS account for roughly one-fifth of global exports, its share in global imports is about 15%. But China alone accounts for nearly 14% of global exports and 10% of global imports. This disproportionately higher share of China in global trade has its implications. Who are the major trading partners of BRICS? More importantly, among the BRICS countries while China appears to be among the top five export destinations for all the BRICS countries no other BRIC countries are in the top five export destination, implying that trade relations among the BRICS countries is hugely dominated by China (Table 6). Interestingly, China also dominates for all the countries’ import destination as well (including China, because of round tripping from Hong Kong). This dominance of China in trade relations almost makes the BRICS group as a sub-loop where all the four countries are in one group and China in another. In fact, there are adverse implications of this

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30  P. Ray Table 5:   Trade profile of BRICS economies. China

Russia

Brazil

India

South Africa

1. Some trade indicators   Current account balance (% GDP, 2016)

1.8

1.7

−1.3

−0.9

−3.3

  Trade per capita (USD, 2014–2016)

1,601

2,622

1,192

369

1,813

  Trade (% GDP, 2014–2016)

20.0

24.0

12.1

22.4

31.2

2. Rank in world trade, 2016: Exports  Merchandise 

1

17

20

25

38

   excluding intra-EU trade

1

11

14

18

24

  Commercial services

5

25

8

32

49

   excluding intra-EU trade

3

14

5

20

31

 Merchandise 

2

14

28

24

34

   excluding intra-EU trade

3

9

20

17

23

  Commercial services

2

10

21

18

46

   excluding intra-EU trade

3

6

13

12

30

3. Rank in world trade, 2016: Imports

Source: World Trade Organisation, available at http://stat.wto.org/CountryProfile/WSDBCountryPFView.aspx.

supremacy of China even within the BRICS block. Illustratively, there are reports of India banning select items of Chinese imports and Chinese officials terming such acts as reflective of Indian jingoism (Hindustan Times, 2016). But why does the trade performance differ so much across the BRICS nations? What are the drivers of export growth? Econometric analysis of growth drivers across emerging market economies tends to focus on the following variables: (i) real effective exchange rate change; (ii) growth of real non-oil goods import demand of trading partners; (iii) change in most favored nations’ (MFN) tariff rates; (iv) inflow of foreign direct investment (FDI); (v) change in export diversification; (vi) change in manufacturing export quality; (vii) number of documents required for export; and (viii) change in good market efficiency score (IMF, 2017). In terms of export diversification, while China, India, and South Africa are fairly diversified, expectedly, exports of Russia and Brazil are far more concentrated. In terms of the determinants mentioned above, the situation in China seems to be grossly distinct from its other BRICS partners. In fact, Chinese trade is comparable to other advanced countries — its share in global exports is higher than countries like the US, Japan, France, and Germany. Mathai et al. (2016) have noted: “China has become the world’s largest trading nation and the center of the global supply chain. A negligible player in global trade just a few decades ago, China

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Future of BRICS as an Economic Block 31 Table 6:   Major trading partners of BRICS. Top 5 Export Destinations Brazil

China

100.0

World

100.0

18.6

China

17.9

USA

12.7

USA

15.6

Argentina

6.7

Germany

6.1

Netherlands

5.3

Argentina

6.0

World

2.7

Korea

3.2

100.0

World

100.0

11.7

China

19.3 10.4

China

8.2

Germany

Italy

4.7

USA

6.3

Germany

4.6

Belarus

4.4

Japan

4.2

Italy

4.3

World

100.0

World

100.0

USA

15.2

China

15.8

UAE

11.3

Saudi Arabia

5.5 5.4

Hong Kong

4.6

Switzerland

China

3.6

USA

5.2

UK

3.4

UAE

5.2

100.0

World

100.0

USA

World

18.0

Korea

10.4

Hong Kong

14.6

USA

9.0

Japan

6.0

Chinese Taipei

8.6

Korea

4.4

China*

8.6

Germany South Africa

Share in Country’s Imports, % in 2015

World

Netherlands

India

Top 5 Import Sources

China

Germany Russia

Share in Country’s Exports, % in 2015

World

3.0

Japan

100.0

World

8.5 100.0

China

8.3

China

18.3

USA

7.5

Germany

11.8

Germany

6.1

USA

6.7

Namibia

5.5

Nigeria

5.8

Botswana

5.4

India

5.0

Notes: *China’s imports from China can be explained by the reimport activity. It is related to processing trade. More than 90% of China’s imports from China are produced in China, exported to Hong Kong, and then reimported to China. 73% of products reimported are used as inward processing materials and 70% are imported by the province of Guangdong, due to the geographic and logistic convenience of Guangdong with Hong Kong. Goods entering for processing trade are exempted from import duties. The business management of multinational enterprises and their distribution centres are often based in Hong Kong. Source: Exim Bank (2016).

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now accounts for more than 12 percent of world exports and 10 per cent of world imports, more than any other single country. Nominal exports grew by 17 per cent on average each year from 1990 to 2012, receiving a particular boost after China’s accession to the World Trade Organization in 2001. … China is now the world’s largest importer of intermediate goods and the anchor of the global supply chain trade. The number of China’s major trading partners rose several-fold over the same period …, and as trade grew, so also did foreign direct investment, of which China is now the world’s largest recipient (as well as an increasingly important source)” (Mathai et al., 2016: 6).

Future of BRICS Cooperation Having discussed the extent of heterogeneity among the BRICS, this penultimate section looks at the possible vistas of economic cooperation among BRICS. BRICS summit declarations and official statements are normally euphoric and may not reflect compulsions of reality. Illustratively, the Government of India (2012) enumerated 13 fields of economic cooperation among the BRICS block; these include the following: (i) Intra-BRICS Trade and Investment Cooperation; (ii) Cooperation in Infrastructure Financing; (iii) Industrial Development and Cooperation; (iv)  Cooperation in Transportation; (v) Cooperation in Food Security; (vi) Cooperation in Technical Education; (vii) Cooperation in Financial Market Development; (viii) Cooperation in Research and Development; (ix) Cooperation in Area of Culture and Tourism; (x) Cooperation in International Issues; (xi) Cooperation in Energy Security; (xii) Cooperation to Build Effective Institutions; and (xiii) International Development Bank for Fostering South–South Investment. While the list may appear to be quite exhaustive — the current experience tends to indicate differing degrees of success across these fields. Also, some of the developments in this regard seem to be symbolic in nature. Illustratively, there is a BRICS business council that was established in March 2013 during the Fifth BRICS Summit held in Durban, South Africa. The BRICS Business Council aims to facilitate cooperation between the five countries in various sectors as well as promote trade and industry amongst them. In its Report on the BRICS Business Council Meeting in India (held during October 12–16, 2016), the Council went over the board and recommended 16 areas of cooperation.7 Many of these areas have, till date, remained more of intention rather than of actualization. The areas of cooperation include: (1) BRICS Social Security Agreements; (2) Financial Framework for Sustainable Development; (3) BRICS Infrastructure Project Preparation Facility; (4) Local Capital Markets development through NDB; (5) BRICS Angels Network

7 

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In fact, in terms of specific instances, there are a number of issues between China and Russia on the one hand and between China and India on the other that could hinder the future of BRICS cooperation. It has been rightly observed that “Strategic tensions between the Asian BRICS are a key factor in their relations. As Chinese economic and strategic influence increases in Asia and further afield, especially Africa and South America, these strains might increase. … Tensions also exist in China’s relations with India, partly due to growing competition between them for economic influence in states such as Nepal, Burma/Myanmar, and Cambodia. … Some Indian security analysts perceive a growing Chinese encirclement of India through its maritime influence in the region. … These tensions persist despite their involvement in the Shanghai Cooperation Organi­ zation, of which China and Russia are full members and India has observer status. Another key contemporary issue on which the BRICS have different priorities is climate Russia. … Russia has diverged from the other BRICS on key aspects of ‘post-Kyoto Protocol’ environmental negotiations in calling for binding targets for everyone, something the Chinese and Indian governments in particular reject” (Luckhurst, 2013: 257).8

Hence for the sake of tractability and focus, this section will discuss a specific issue where there has been some apparent progress, viz., the NDB. The NDB was conceived in the fourth BRICS Summit in New Delhi (2012). Later, following the report from the finance ministers at the fifth BRICS summit in Durban (2013), the leaders agreed on the establishment of the NDB, and finally during the sixth BRICS Summit in Fortaleza (2014), an agreement establishing the NDB was signed. In the Fortaleza Declaration, the leaders stressed, “The NDB will strengthen cooperation among BRICS and will supplement the efforts of multilateral and regional financial institutions for global development, thus contributing to (for start-ups); (6) BRICS Trade Settlement in Local Currencies; (7) BRICS cooperation in Agri-business; (8) BRICS cooperation in Energy; (9) BRICS cooperation in Skill Development; (10) BRICS cooperation in Manufacturing; (11) BRICS Trade Facilitation Network; (12) BRICS Standardization Research Framework; (13) Advisory role and observer status for BRICS Business Council in NDB; (14) Cooperation and Facilitation of intra-BRICS Investments; (15) BRICS Rating Agency; and (16) New International Payment Card System for BRICS. 8  Lieber (2014) was more critical and went on to say, “Other than where clear and unambiguous self-interest is present, the actual record of BRICS cooperation on a wide range of international collective action problems thus provides limited evidence of positive engagement let alone embracing of a ‘stake-holder’ role” (p. 143).

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collective commitments for achieving the goal of strong, sustainable and balanced growth”. There are at least two distinct ways in which one can see the genesis and rationale of the NDB. The first is clearly the dissatisfaction of the emerging economies with the governance of the Bretton Woods institutions, like the International Monetary Fund and the Word Bank, which are quota based as the quotas tended to represent an archaic global economic power structure.9 All the BRICS countries on different occasions have expressed dissatisfaction over the state of governance and democratic deficit in the IMF or World Bank. Second, and more importantly, almost all the BRICS countries have accumulated some foreign exchange reserves which are normally investment in safe assets, primarily in the form of securities of governments issuing four major currencies, US dollar, Euro, Pound Sterling, and Japanese Yen (of course, led by US dollar). Admittedly, there are differences in foreign exchange holding across BRICS countries. Illustratively, in 2017, China’s forex reserves stood at nearly US $3 trillion, as compared with little more than US $360 billion for both Brazil and Russia, little over US $400 billion for India, and around US $42 billion in South Africa. More interestingly, all these countries have experienced a steep and steady rise in their forex reserves from the late 1990s to early 2010s (Figure 5). The presence of such substantial forex reserves made the establishment of the NDB comparatively easier for the BRICS countries. Thus, the NDB was founded during the fifth BRICS Summit in Fortaleza in July 2014 and launched on July 7, 2015, with an initial authorized capital of US $100 billion and initial subscribed capital of US $50 billion, equally shared among founding members. Effectively, it functioned as a multilateral development bank with the “objective of financing infrastructure and sustainable development projects in BRICS and other emerging economies and developing countries, complementing the efforts of multilateral and regional financial institutions toward global growth and development”.10 The professed main objectives of NDB operations are four-fold: (a) fostering development of member countries; (b) supporting economic growth; (c) promoting competitiveness and facilitating job creation; and (d) building a knowledge-sharing platform among developing countries. In 2016–2017, the NDB approved loans involving financial assistance of over US $3.4 billion for projects in the areas of green and renewable energy, transportation, water sanitation, irrigation, and other areas. In particular, as per the NDB’s General Strategy Document,  In fact, notwithstanding their economic status, quotas of the BRICS block in the IMF have been meagre and stood as per the current quota formula as follows: Brazil 2.32%, China 6.41%, India 2.76%; Russia 2.71%; South Africa 0.64%; see https://www.imf.org/external/ np/sec/memdir/members.aspx for details. 10  https://www.ndb.int/about-us/essence/our-work/. 9

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Future of BRICS as an Economic Block 35 600

4,000

500

3,500

400

3,000

300

2,500 2,000

200

1,500

100

1,000

(a) Forex Reserves of Brazil, India, Russia and South Africa (USD Billion)

2017

2015

2013

2011

2009

2007

2005

2003

2001

1999

South Africa

1997

Russia

0 1995

India

500 1993

Brazil

2017

2015

2013

2011

2009

2007

2005

2003

2001

1999

1997

1995

1993

0

(b) Forex Reserves of China (USD Billion)

Figure 5:   Foreign exchange reserves of BRICS countries (USD billion). Source: World Bank.

sustainable infrastructure development is at the core of NDB’s operational strategy of 2017–2021, and it is going to dedicate about two-thirds of its financing commitment to this area. Has the NDB been effective in its operations? One may note its sharp contrast to the Asian Infrastructure Investment Bank (AIIB). With its headquarter in Beijing, the AIIB commenced operations in January 2016 and has now grown to more than 50 approved members from around the world. Has the NDB got the attention it deserved? It has been aptly noted: “The launch of the NDB has been over-shadowed by the China-backed Asian Infrastructure Investment Bank (AIIB). While the AIIB is consistent with a model of structural-driven change in global politics, the NDB necessitates a more nuanced analysis around collective agency. With 26.06 per cent of voting rights and a 30.34 per cent … stake of the US$100 billion capital base …, China possesses a de facto veto in the AIIB. In sharp contrast the initial subscribed capital of US$50 billion in the NDB is equally shared among its five members … While the NDB has so far restrained from expanding beyond the BRICS, the AIIB opened up to 57 ­founding members thereby driving a wedge between those countries willing to follow Beijing’s lead and those (notably the United States and Japan) resistant in doing so. Although the extent of the global reach of the NDB is still very much in doubt, the AIIB is tied more explicitly to the ‘One Belt One Road’ (OBOR) … designed to advance infrastructural development both on the westward land route from China through Central Asia and on the southerly maritime routes from China through Southeast Asia and to South Asia, Africa, and Europe” (Cooper, 2017: 275).

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Thus, it appears that the spirit of multilateralism in the NDB could have been a laggard in comparison with the AIIB that has been dictated by Chinese interest.

Concluding Observations Having described the genesis and establishment of the BRICS block, this chapter has tried to gauge different elements of heterogeneity. Such heterogeneity exists in terms of different matrices, such as size of the economy, operation and state of monetary and fiscal policies, exchange rate flexibility, and quantum of foreign exchange reserves. The presence of such heterogeneity is accentuated by the presence of China whose size tends to overshadow all other economies in the block. Perhaps the effective emergence of the BRICS block purely in terms of economic multilateralism without any binding force of history, politics, or shared identity is difficult.11 On the contrary, the presence of complex political issues among the three major partners of the block (viz., China, Russia, and India) could have made the BRICS block suffer from blue baby syndrome, thus bringing into question its healthy existence (if not the longevity).

References Baracuhy, B. (2012). “The Geopolitics of Multilaterism: The WTO Doha Round Deadlock, the BRICs, and the Challenges of Institutionalised Power Transitions”, CRP Working Paper, University of Cambridge. Bernanke, B. S. (2006). “The Chinese Economy: Progress and Challenges”, Speech at the Chinese Academy of Social Sciences, Beijing, China, December 15, 200, available at https://www.federalreserve.gov/newsevents/speech/bernanke20061215a.htm (accessed during January–March 2017). Cooper, A. F. (2017). “The BRICS’ New Development Bank: Shifting from Material Leverage to Innovative Capacity”, Global Policy, 8(3): 275–284. Exim Bank (2016). “Intra-BRICS Trade: An Indian Perspective”, Working Paper No. 56. Garcia, M., D. Guillen and P. Kehoe (2019). “The Monetary and Fiscal History of Brazil, 1960–2016”, IDB Working Paper No. IDB-WP-990, available at https://publications.

Lindsay and Van Rossem (2014) argued from a neo-Weberian perspective that power in the global system is multidimensional and relational. Comparing the paths of the BRICs to integration in the global political, economic, and military networks, they argued that as the paths of the BRICS block differ fundamentally, these countries cannot be classified as a category of rising powers. 11 

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iadb.org/publications/english/document/The_Monetary_and_Fiscal_History_of_ Brazil_1960-2016_en_en.pdf. Glosny, M. A. (2010). “China and the BRICs: A Real (but Limited) Partnership in a Unipolar World”, Polity, 42(1): 100–129. Goldman Sachs (2001). “Building Better Global Economic BRICs”, Global Economics Paper No. 66. Goldman Sachs (2003). “Dreaming With BRICs: The Path to 2050”, Global Economics Paper No. 99. Goldman Sachs (2007). BRICs and Beyond, New York: Goldman Sachs Global Economics. Government of India (Ministry of External Affairs) (2016). “India and the BRICS”, available at https://www.mea.gov.in/Portal/ForeignRelation/BRICS_02_may_2016.pdf (accessed during January–March 2017). Government of India (Ministry of Finance) (2012). The BRICS Report, Delhi: Oxford University Press. Hindustan Times (2016). “India’s boycott of Chinese goods akin to jingoism- a senior Chinese official has said”, Nov 02, 2016, available at https://www.hindustantimes.com/world-news/ india-s-boycott-of-chinese-goods-akin-to-jingoism/story-RKHO4ls9hggRfkmq7YNLrO. html (accessed during January–March 2017). IMF (2016). Annual Report on Exchange Arrangements and Exchange Restrictions, Washington DC: IMF. IMF (2017). India: Selected Issues, IMF Country Report No. 17/55, available at https:// www.imf.org/~/media/Files/Publications/CR/2017/cr1755.ashx (accessed during January–March 2017). Khundrakpam, J. (2012). “Coordination Among BRICS Central Banks for Monetary Policy- Why the Need But Why So Difficult?”, Presentation at the Meeting of BRICS Economics Research Group in National Institute of Public Finance and Policy, New Delhi on February 27. Korhonen, I. and R. Nuutilainen (2017). “Breaking monetary policy rules in Russia”, Russian Journal of Economics, 3: 366–378. Lieber, R. J. (2014). “The Rise of the BRICS and American Primacy”, International Politics, 51(2): 137–154. Lindsay, M. J. and R. Van Rossem (2014). “The BRIC Phantom: A comparative analysis of the BRICs as a category of rising powers”, Journal of Policy Modeling, 36S: S47–S66. Luckhurst, J. (2013). “Building Cooperation between the BRICS and Leading Industrialized States”, Latin American Policy, 4(2): 251–268. Mathai, K., G. Gottlieb, G. H. Hong, S. E. Jung, J. Schmittmann, and J. Yu (2016). China’s Changing Trade and Implications for the CLMV Economies, Washington DC: IMF. Octávio, O. R. and S. W. Gobetti (2017). “Brazilian Fiscal Policy in Perspective: From Expansion to Austerity”, International Policy Centre for Inclusive Growth Working Paper, No. 160, available at http://www.ipc-undp.org/pub/eng/WP160_Brazilian_­fiscal_policy_in_ perspective.pdf (accessed during January–March 2017).

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Ray, P. and B. Nag (2017). “Two Crises Separated by Two Decades: Savings Glut and Trade Strategy in select East Asian Economies”, IIM Calcutta Working Paper No. WPS 799. US Treasury (2017). Foreign Exchange Policies of Major Trading Partners of the United States, Office Of International Affairs Report to the US Congress U.S. October 17, 2017, ­available at https://www.treasury.gov/press-center/press-releases/Documents/2017-10-17%20 (Fall%202017%20FX%20Report)%20FINAL.PDF (accessed during January–March 2017).

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CHAPTER 3

China’s and India’s Economic Performance After the Financial Crisis: A Comparative Analysis R. Nagaraj Indira Gandhi Institute of Development Research, Mumbai, India

Introduction In 2015, as per IMF data, nominal GDP in current dollar terms, China and India are world’s second and seventh largest economies, at $11 trillion and $2.25 trillion, respectively. In per capita terms, in global ranking, China stood 74th with $8,141, and India at 141th position with $1,604. In geo-political terms, though China carries considerable heft, it is as yet an emerging market economy (EME) as per the Morgan Stanley index for emerging market index (MSCI). These countries are the leading members of the ‘BRICS’ economies — a short hand for fast growing industrializing nations accounting for a quarter of world’s land mass and 40% of population — a grouping of non-western nations that Goldman Sachs created in 2001 for the purpose of developing financial products. Though the financial firm ceased to use the country grouping for selling financial products, BRICS as a category has stayed in policy discourse and in financial markets. Just prior to the global financial crisis (GFC) in 2008–2009, China was world’s fastest growing large economy expanding annually at 9–10 for over 20 years; India was seen as a close second growing at about 9% annually (though for just 3 years). If China had emerged as world’s factory, India was getting to be reckoned (at least 39

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for a while) as its back office. The GFC and the great recession thereafter probably hit China much harder, given its much higher export/GDP ratio (at 30.7%) in 2008, compared to India’s share at 23.6%. Moreover, financial flows into China were much higher than in India. As part of the G20 initiative, both the countries undertook fiscal and monetary stimulus to prevent a repetition of the great depression — China did it on an enormous scale compared to India, given its greater external exposure, and to prevent large-scale unemployment and the potential political backlash domestically. Economic growth in both the countries recovered quickly, giving rise to (instant) theorizing of ‘de-coupling’ of the EMEs (especially BRICS countries) from the developed economies, signifying the autonomous nature of their growth. Soon, it was realized that growth in China and India were sustained by large-scale short-term capital inflows on account of the QE in the advanced economies, that is, capital flowing into these economies in search of higher yield (or rate of return). However, the hint of a tapering off of the QE in August 2013 led to panic known as ‘taper tantrum, putting breaks on the capital inflows, adversely affecting growth in these countries. Thus, China’s annual growth rate got nearly halved, from 13% to 14% immediately prior to the financial crisis to less than 7% last year. In a slight contrast, India’s growth rate which also went down sharply to less than 5% in 2013–2014, has reportedly climbed back to over 7% — now claiming to be world’s fastest growing large economy. Among the BRICS nations, China and India are perhaps the only ones to maintain positive growth in the last few years. With the advanced economies still gripped by the great recession (despite visible signs of improvement in the US), and a bleak IMF growth forecast for 2017 at 3.4% (as per July 2016 report), global economic performance seems to hinge on how these two large economies perform. Can China and India — accounting for 18% of global GDP in 2015 and one-third of population — emerge as a significant node for global economic recovery? This short chapter seeks to offer a tentative and speculative answer. The chapter is structured as follows. Careful scholarship on Chinese economy has long been concerned about the quality and veracity of official economic statistics. Hence, it is useful to briefly review the data concerns to be able to make a reasonable assessment of its economic performance and prospects. Indian macroeconomic statistics have lately come under cloud with the latest revision of the base year of GDP in 2015. So, the chapter will begin in Section 1 with an assessment of the economic statistics of both the countries. Section 2 will briefly review China’s and India’s the economic performance after the financial crisis. Section 3 will make a comparative assessment of the prospects their economic revival — necessarily a speculative effort. Section 4 will conclude the study summarizing the main findings.

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Section 1: Concerns About Quality of Macroeconomic Data Chinese official statistics are widely believed to overstate economic growth rate systematically. One of the known inconsistencies is that the sum of the provincial output is systematically higher than national GDP estimates. Apparently, the overestimation happens because the official have an incentive to record the plan targets as achievements, since their career prospects often depend on performance as measured by output growth (Wu, 2002). The long-held scepticism about Chinese the growth value got confirmed in WikiLeaks by Li Kequing, when the then Party Committee Secretary of Liaong province in 2007 told the US Ambassador in Beijing that Chinese GDP numbers are for reference only (NYT, February 26, 2016). The true measures of Chinese economic growth are rail cargo volume, electricity consumption, and bank credit. Taking cue from this, private financial firms (including The Economist) have created a Li Kequing index as a proxy for Chinese GDP growth. Questioning of the Chinese official growth estimates intensified after the financial crisis, when critics claimed that growth could be considerably lower than official estimates (Figure 1).1 There are also concerns about the true state of the real estate economy with questions about the accuracy of property price index, bank credit accruing to the sector, and data on sale of property. The scepticism got recently confirmed when a top Chinese official admitted to data falsification. To quote the official: “Currently, some local statistics are falsified, and fraud and deception happen from time to time, in violation of statistics laws and regulations,” Ning Jizhe, director of the National Bureau of Statistics, wrote in a column for Communist Party mouthpiece the People’s Daily on December 8, 2016 (as quoted in The Financial Times, December 12, 2016). All this goes to show the need for caution in using Chinese official statistics.2 India’s macroeconomic statistics has come under cloud after the recent revision to the new base year in (2011–2012) in 2015, when the growth rates got inflated compared to the previous series (Figure 2). Since the revised growth estimates are quite at variance with other macro correlates — such as flow of bank credit or industrial capacity utilization — there is a growing scepticism of the new series of Harry Wu of the Conference Board has been a long-time critic of the official statistics. More recently, Christopher Balding of HSBC Business School in Shenzhen has written extensively on the issue. 2  More recently, officials at one of the provinces, Potemkin, admitted to falsifying output data “A big Chinese province admits faking its economic data” (The Economist, January 28, 2017). 1 

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Figure 1:   A comparison of China’s official GDP growth with Li Keqiang index. Source: China GDP Delate gate, by Tom Orlik, Bloomberh Intelligence Economist, September 15, 2015.

Agriculture Mining Manufacturing Industry

Elec gas and water Construction Trade, hotel and restaurants Transport and communication Financial services Community, Commun ity, social and personal Total GVA –4

–2

0

2

4

6 Per cent

NAS 20011–12 base year series

8

10

12

14

16

NAS 2004–05 base year series

Figure 2:   Disaggregated GDP growth rates for 2013–2014. Source: http://www.ideasforindia.in/article.aspx?article_id=1728.

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National Accounts Statistics (NAS).3 The problem can be illustrated with respect to manufacturing sector growth. Since 2013–2014, while GDP manufacturing ­steadily rose from 5.6% per year in 2013–2014 to 9.3 cent per year in 2015–2016, the Index of Industrial production (IIP, the leading indicator of physical output) shows dismal improvement — from (−) 0.1% per year in 2013–2014 to 2.4% per year in 2015–2016. Surely, IIP is underestimating the growth as its base year is outdated (2004–2005), yet the gap between the two series is too wide to be attributed only to the dated base year. The change in the methodology of estimating gross value added in manufacturing in the new series is probably responsible for the discrepancy in considerable measure (Nagaraj, 2015). Considering the foregoing evidence on the scepticism of China’s and India’s ­output estimates, a reasonable view about the recent growth rates may be as as follows: 1. In the last 3 years or so, China and India have probably been growing roughly at the same rate. 2. The view that India has overtaken China to become world’s fastest growing economy may be an overstatement. Such euphoria in India ignores the fact that the level of China’s GDP per capita was five times that of India’s in 2015 (as noted above). 3. Growth rates of both the economies have decelerated after 2011–2012: China very dramatically, and India somewhat modestly. 4. China’s claim that its economy is getting rapidly rebalanced in favor of the consumption and services sector output may be suspect given the data issues. The major part of services growth in China is claimed to be due to the stock market and financial sector, which could be suspected. The reports that there are long queues at quality public hospitals tell us about the shortages of these services in China (even in Beijing), and hence the argument that the rebalancing is happening rapidly seems questionable.

Section 2: Policy and Performance After the Financial Crisis China China’s party-state draws its political legitimacy by delivering consistently rising living standards with employment generation. While the political power is For a synoptic view of the debate between the official position and the critics’ viewpoints, see http://www.ideasforindia.in/article.aspx?article_id=1728; or, refer to the symposium. For details refer to Nagaraj (2015).

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concentrated in the central government (and party apex), economic decision-making is decentralized at the level of provinces and cities, with the centralized party, army, and bureaucracy forming the glue that binds the large, unevenly developed country. The party-state sets the national economic goals via 5-year plans, the achievement of which becomes the target for the provinces. Provincial bureaucracy and the party-state are incentivized to achieve the plan targets and maintain social harmony (proxied by employment generation locally). Fiscal decentralization without an institutional mechanism of devolution of financial resources from the center to the provinces (perhaps after abolition of agricultural taxes) seems to have compelled provinces to depend on land sale and property sale and long-term lease as means of raising fiscal resources. This is possible in China because land, by definition, belongs to the state. However, Chinese provinces cannot raise public debt, but they get access to bank credit for capital investment as long as they support economic growth (via local party-bureaucracy’s influence on the banking system, which is almost entirely state-controlled). Further, state-level party and bureaucracy seem to have an incentive to prioritize economic growth (over other socioeconomic objectives) because their professional upward mobility seems contingent upon delivering output growth and employment generation in their territory. Similarly, provincial statistical offices have an incentive to show that the targets are met, which is said to be a reason for the overestimation of provincial output growth and an underestimation of unemployment rates. Given the incentive structure, and political legitimacy derived from generating growth and employment, the aftermath of the financial crisis posed a major challenge to Chinese policymakers. China, therefore, undertook massive fiscal and monetary stimulus measures — perhaps the largest among G20 countries — to prop up domestic demand in the face of collapse of the external markets [need to quantify these measures as GDP%]. Most of these resources went into infrastructure and urban housing. Urbanization therefore became a policy goal it itself.4 Though such a policy did not revive economic growth to pre-financial crisis level, it perhaps prevented a collapse of domestic demand and employment. Investment levels were maintained (or even surpassed the pre-crisis levels), and the best evidence of it is the rise in debt/GDP ratio from about 160% of GDP before the crisis to the current level of 230–260% of GDP (Figure 3).

Uprooting rural settlements to house them in multi-storied apartments seems to have caused considerable dislocation in rural economic activity and rural way of life. 4 

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Figure 3:   China’s debt–GDP ratio. Source: Goldman Sachs: Walled in: China’s Great Dillemma (2016).

Composition of Debt Incremental debt largely accrued to the private corporate sector (PCS), which  is  mostly associated with provincial governments, which use local ­government financial vehicles (LGFVs) to draw credit from the banking system to promote local infrastructure and housing investment. This is evident from an IMF study: “A significant part of corporate borrowing in reality financed off-budget fiscal spending. Off-budget local government borrowing has increased substantially since the GFC. It was undertaken by LGFVs; as local governments were not allowed to borrow explicitly. The loans typically financed infrastructure projects and repayment was covered by future disbursements from local governments (e.g.,  in a form of service fees). The ‘augmented’ deficit, which LGFV spending given the fiscal nature of such operations, thus jumped from the average of around 4 percent of GDP before 2008 to about 10 percent in 2015” (IMF, 2014; Maliszewski et al., 2016: 20).

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Figure 4:   Rising share of shadow banking in China’s credit growth. Source: Maliszewski et al. (2016).

Another reason for the rapid rise in debt–GDP ratio is the growth in shadow banking institutions, often sponsored by regular financial institutions to circumvent strict regulation and offer higher rates of return to its savers (Figure 4). The above-mentioned debt ratio may be an underestimate as private sector firms have substantial overseas borrowings undertaken by their foreign subsidiaries. Such borrowings do not get registered as China’s external debt as they is recorded by the residency of the issuing entity, not by their nationality. If such borrowing is used to finance capital expenditure in China, then it could cause currency and maturity mismatch, increasing the cost of such borrowing and leading to a rise of financial fragility. Further, in the event of rising international interest rates (as is the case now with the Fed raising the rates) such a hidden debt could add to the external instability (Shin and Zhao, 2013) (Figure 5). China has also sought to rebalance the economy away from manufacturing to services, and away from investment-led economy to consumption-driven economy (Figure 6). On the face of it, looking at the official numbers, there is a change in the desired direction, in particular in the rise of financial services. But how much of it represents expansion of genuine financial services and how much of it is statistical illusion caused by over blown shadow banking seem to be open to question.

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Figure 5:   International debt securities outstanding for non-financial corporate by nationality and by residence. Source: Shin and Zhao (2013).

Figure 6:   Rising share of services in China’s GDP. Source: Steve Johnson, “Old economy focus ‘understates’ Chinese growth”, FT, December 9, 2015.

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That China has made excessive investment in physical infrastructure and in urban housing — relative to effective demand — is a widely accepted fact (based on innumerable news reports about ‘ghost’ towns, unused roads, and bridges). Rising credit and debt growth (as GDP%) after the financial crisis and decelerating outgrowth has resulted in rising incremental capital output ratios (ICORs), or credit intensity of output. Rising Real Estate Prices While the rate of investment in real estate seems to be decelerating lately, property prices seem to continue to rise (Figure 7). The usual official defence of such an investment strategy is two-fold: (1) it is wise to build infrastructure ahead of demand to avoid short-run bottlenecks (as exemplified by Indian experience), as recommended in development literature (à la Arthur Lewis); (2) as capital stock per head in China is way below that in the developed economies, China has to invest more, and not less, quickly if it is to graduate to the status of a developed economy. But there has been a growing concern about China’s debt sustainability, and the potential instability that could follow. There are apprehensions that the magnitude of debt could, if it crosses the tipping point, potentially lead to Japanese-style debt deflation, or a real estate bubble burst.

Figure 7:   Rising real estate prices. Source: The Economist (2016).

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There are other concerns about potential capital outflows on account of global financial instability or domestic political consideration (in particular the on-going anti-corruption drive) that could lead to capital flight (as evident from depreciation of yuan, or due to capital market gyrations last year). Given China’s huge foreign exchange (forex) reserves, prima facie, external debt crisis seems to be ruled out. Moreover, since the majority of China’s private sector debt is in domestic currency, it is argued that the Chinese government can reschedule the debt without destabilizing its external sector. But the question of whether China can avoid getting into Japanese-style debt deflation is hard to speculate. Similarly, the Chinese central government seems unable to regulate housing investment adequately as much of it seems to be financed by shadow banking driven by interests at the provincial level. So, whether China can avoid a real estate crash remains an open question. One is inclined to argue that the outcome would ultimately depend on political economic factors. Apparently, China is a strong state (yet brittle state?) with the capacity to carry through its political mandate (even if it means high social and economic costs). But if there are serious fissures in the state apparatus, as seems to be emerging after the crackdown on corruption under the present regime (which is apparently hurting many powerful political actors as evident from their efforts to hide their investments abroad), the outcome could be unpredictable. India India witnessed a decade-long cycle of boom and bust, starting in 2003. During the boom, the Indian economy grew close to 9% annually, led by IT services and exports. This was accompanied by a rapid rise investment to GDP ratio (to 38–89% of GDP) largely in the PCS financed by rising domestic saving rate (35–36% of GDP), and supplemented by a flood of foreign private capital peaking at 10% of GDP in 2007–2008. This was accomplished under benign macroeconomic conditions, especially with stable fiscal balance as the state withdrew from infrastructure investment in favor of PCS to reduce fiscal deficit. After the GFC in 2008, economic growth recovered quickly on the strength of capital inflows caused by QE in the advanced economies and fiscal stimulus and monetary easing undertaken to stimulate domestic demand to compensate for the loss of external markets. However, the high growth rate could not be sustained beyond 2011–2012, when the macroeconomic conditions changed quickly. GDP growth rate plummeted below 5% in 2013–2014, but recovered somewhat thereafter, though it is hard to be sure of the strength of the recovery.

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After the boom went bust, India is now saddled with excess capacity in manufacturing due to lack of investment demand and plummeting external demand for both services and manufacturing. A large number of infrastructure projects under private–public partnership (PPP) remained incomplete, as the cost of financing shot up and legal and technical issues bogged down their completion. This non-financial PCS is saddled with an unprecedented amount of unserviceable debt, which has turned into banking sector’s non-performing assets (NPAs), pulling down its profits and thus adversely affecting fresh lending. This is associated with a sharp fall in domestic saving and investment rates. The problem of bad debt is unprecedented, but seems quite in line with many EMEs currently, but it is smaller than that of China’s. With poor economic recovery from the great recession (Nagaraj, 2013), India’s external market for services and its capital- and skill-intensive manufacturing have dwindled — with explicit protectionist law such as ‘Buy America’ enacted by the Obama administration and the Trump administration’s explicitly protectionist policies, along with the threat of automation. India as well as China have the advantage of a large domestic market. Yet the PCS is not in a position to step up investment given the high debt ratios and declining profitability. Therefore, the way out of the present impasse is to step up public infrastructure investment to ease demand constraint for capital and intermediate goods industries and supply cheap credit to agriculture and small-scale sector so as to augment food production and to labor-intensive manufactures.5 In political economic terms, unlike China, India is a liberal democracy, with reasonable political stability, with well-defined separation of powers between political executives, legislators and judiciary, well-developed market-based institutions such as capital markets, a strong domestic PCS, and market regulators (Huang and Khanna, 2003).

Section 3: A Comparison between China and India Similarities Both the economies slowed down after the financial crisis and both lost their export markets; thus, they face excess capacities, high-corporate debt, and corporate invisible debt via subsidiaries.

This is a gist of the India’s story of “Dream Run” of 9% growth rate. For a detailed account of the boom and bust, and policy options to revive growth, refer to (Nagaraj, 2013, 2014).

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Differences China is an investment-driven economy, and household consumption is just onethird of GDP; India’s investment rate is lower than China’s, and it further declined rapidly after the financial crisis. The consumption/GDP ratio in India is over 60%, with supply constraint still a matter of long-term concern. China’s debt is 260% of GDP; the ratio for India’s is just about 60%. Excess capacities in India are probably modest compared to China’s. China is over-invested in infrastructure and housing, whereas India suffers from shortages in these areas. Question 1: Can China avoid further deterioration of growth rate, given the debt overhand and the limits of further debt-led growth? Can India engineer a turnaround with more reforms and FDI without public investment (as envisioned by current policymakers) — given the overhang corporate debt on the banking sector? Answer 1: In both China and India, after the financial crisis, growth was sustained by easy credit extended to PCS by domestic banks and by foreign capital inflows (facilitated by QE) — China much more than India. Growth in China’s debt/GDP ratio is unprecedented; in India, the rise in the ratio has been modest (if at all). It is a question of degree, not kind: External debt in both the countries is higher than officially reported because of debt taken on by subsidiaries of private corporate firms (as highlighted by Shin of BIS). Can China avoid a debt crisis? Given China’s huge foreign exchange reserves, the possibility of external debt crisis seems remote. But if there is panic, no amount of reserves probably matter, as evident from last year’s episode when China almost lost $1 trillion in no time at all. However, since the majority of China’s private sector debt is denominated in domestic currency, which in principle can be rescheduled without destabilizing the external sector, the question arises if China can avoid getting into Japanese-style debt deflation, which is another matter entirely. Japan’s debt was (and continues to be) mostly in the domestic currency, more so than China today. Similarly, China’s real estate market seems to be in the bubble territory. The Chinese government seems unable to regulate it adequately since much of it seems financed by shadow banking. So, whether China can avoid a real estate crash remains an open question. Admittedly, Chinese authorities are tightening the rules for real estate lending by increasing the equity or the contribution of the buyer. India’s external debt is modest in a comparison to most EMEs, and especially China. Even if the global interest rates rise, India is unlikely to face a debt crisis, though there could be instability in the foreign exchange market in the short run.

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But the question of whether India can avoid a prolonged period of slow growth (without a change in policies) is another matter. Question 2: Can China change its debt and investment-led growth, given the incentive structure of local governments and their access to bank credit? In other words, can China disembark its credit-led investment growth strategy to keep employment growth going without causing political unrest? In other words, is it a case of Chinese policymakers riding the political tiger? Answer 2: Given China’s seemingly solid macro foundations, there is no apparent reason why the government cannot shift public investment away from physical infrastructure (road, rails, bridges, and urban housing) to schools and hospitals, and make them available for free for poor. Descriptive accounts show how Chinese struggle to get treated in good public hospitals (Burkitt, 2012). The answer probably lies in China’s contradiction between centralized politics and the decentralized economy. India, on the other hand, may find it hard to reverse the declining domestic investment rate given: (i) the NPAs of the banking system, (ii) reluctance of foreign private capital to step up investment given the debt situation of the PCS, and (iii) government’s reluctance to raise public infrastructure investment given its commitment to fiscal orthodoxy. Question 3: Can China embrace consumption-led growth given the interests of local state for revenue from land sale and property development? Can India curb its consumption-led growth towards public investment- and capital good-led industrialization?6 Answer 3: It is well known that China’s social infrastructure and personal consumption growth are modest, though claimed to be improving. These need to be stepped up and physical infrastructure growth needs to curtailed if China is to change its growth pattern. But very little of it seems evident on the ground (despite avowed objective). China’s disposable income is just 44% of GDP. Why? (comparable figure for India is 86%). The answer, perhaps lies in the incentive structure of the local party-state. Building public hospitals and better schools or providing better facilities does not seem to bring in revenue for the local governments and the private benefits to party-bureaucracy in the same way as infrastructure and real estate investments do. Question 4: Housing starts and sales are declining, but prices continue to rise. Why? Access to non-bank credit (shadow banking) seems to be a cause for concern. Will Disconcertingly, much of the so-called FDI into India lately represents import-led growth financed by private equity funding of e-commerce companies.

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the inflated real estate prices deflate gently as demand grows, or could it result in a burst causing a disruption? Answer 4: Could China’s high-debt ratio trigger a financial crisis is the million dollar question among China watchers, but the answer is anybody’s guess. Economic literature provides very little guidance in this matter.7 Those raising a red flag about it are mostly guided by the debt–GDP ratio and its steady rise since the GFC in 2008. The ratio is among the highest in the world. My cautious answer to the question is as follows: Though very high, China’s debt is mostly domestic, and China’s domestic saving and investment ratios are also very high by any standards. Moreover, the party state has enough instruments (though some of them blunt) to quell any financial meltdown. However, Japanese-style prolonged deflation or stagnation cannot be ruled out if return on investment falls drastically, and the state is unable to stimulate domestic consumption faced with an aging population. India, on the other hand, needs to get its fixed investment rate back to 38–39% of GDP (to secure East Asian-like economic outcomes). Given the current levels of bad debts, it is really wishful to expect PCS to resume a fresh investment cycle, unless the government writes off loans (or socializes their costs). Perhaps a better option would be to step up public infrastructure investment by adopting a flexible fiscal deficit targets. The ‘Priority sector’ lending for agriculture and SMEs needs to be revived, boosting capital formation in the unorganized or HH sector, implying a stronger role of the state in steering the economy. Correspondingly, the objective of FDI needs to be to augment capacity expansion to meet ‘make in India’ campaign, not for augmenting import-led consumption growth (as mentioned above). If India cannot get its policy act right, the reasons for this would be policy­ makers’ commitment to fiscal orthodoxy not the economy’s objective conditions.

Section 4: Summary and Conclusion Both China and India are still poor countries with low per capita income — with the average of OECD member countries being $38,423 as of 2014. There is a need (and a potential) for substantial growth of China and India that can help revive global economy. Both countries have large domestic markets that are their biggest advantages in present times, which can help withstand external demand shocks. China needs to move away from housing and infrastructure investment to social Before the 2008 financial crisis, very few really believed that there was a bubble in the sub-prime market in the US. There was an oblique hint of it in Raghuram Rajan’s paper in the 2006 Jackson Hole conference, a suggestion that Lawrence Summers rejected outright. 7 

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sector investment and consumption-led growth — though widely admitted, it finds it hard to change the policy gears apparently due to political economic reasons. Rules governing the distribution of fiscal resources between the center and provinces perhaps need to be redrawn to reduce the incentive for provinces to rely on land sale and real estate. India perhaps needs to make a move in the opposite direction of regaining the investment-led growth witnessed during the last decade to improve not just physical infrastructure but social infrastructure to stimulate private investment and improve human resources. This is urgently needed if India has to seize the one time opportunity offered by potential demographic dividend. Critical questions: Will China succumb to Japanese-style debt deflation? It is a difficult question to answer. India does not seem to face a similar fragility; it may be growing slowly and its growth numbers may be suspect, but the prospect of macroeconomic crisis seems remote relative to China. India’s external financial position is not very sound, but in a comparative EME perspective, the risks do not seem large. Though India’s corporate debt is very large compared to its past levels, it is not high by the contemporary levels among EMEs. India also has greater political stability and certainty, its market institutions are more rule-based and hence supportive of market economy. China on the other hand is far more state dominated; though it may appear strong, it is in fact brittle. I suspect a contradiction could emerge in China between the center’s desire to stabilize the economy on to a more sustainable path, whereas the provinces may continue to pour money (via bank credit) into fixed investments and shadow banks would continue to finance real estate investment. (This is evident from the fact that when the central government decides to scrap excess capacity in manufacturing or close down unsafe mines, the efforts are thwarted by local interest groups who tacitly oppose it, because such efforts are not in the interests of provisional partystate in terms of keeping peace and generating employment and earning tax revenue for provinces.) Then, at some point, the economy risks spinning out of control of the central government and monetary authorities, unless the rules of engagement between the center and provinces are amicably changed with an alternative political incentive structure in place.

Acknowledgments The author is grateful to Lynette Ong and Yue Zhang for the comments and suggestions on an earlier draft of the chapter and to the participants of the Conference on ‘Political Economy of Emerging Market Countries: The Challenges of Developing More Humane Societies’ held during January 2–4, 2017, in Santiniketan, West Bengal.

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Appendix 1: China’s Economic Indicators (Source: IMF’s country report, 2016). China: Selected Economic Indicators 2016 2011

2012

2013

2014

2017

2015

2018

2019

2020

2021

Projections

NATIONAL ACCOUNTS Real GDP

7.8

7.3

6.9

6.6

6.2

6.0

6.0

5.9

5.8

7.9

8.1

7.2

7.2

7.2

6.5

6.2

6.1

6.0

5.9

  Consumption

12.2

8.7

7.2

7.2

8.3

7.8

7.7

7.1

6.8

6.6

6.4

  Investment

9.2

7.1

9.1

7.1

6.1

6.4

5.2

5.2

5.3

5.3

5.3

   Fixed

8.8

9.0

9.3

6.8

6.8

6.6

5.3

5.3

5.4

5.4

5.4

   Inventories (contribution)

0.4

-0.7

0.1

0.3

-0.2

0.0

0.0

0.0

0.0

0.0

0.0

  Net exports (contribution)

-0.8

0.2

-0.1

0.3

-0.1

-0.5

-0.2

-0.1

0.0

0.0

0.0

Total capital formation (percent of GDP)

48.0

47.2

47.3

46.7

45.0

43.9

43.3

42.8

42.2

41.6

41.0

Gross national saving (percent of GDP)

49.8

49.7

48.8

49.3

47.9

46.3

44.9

44.1

43.2

42.4

41.6

…

…

5.0

5.1

5.1

5.1

5.1

5.0

5.0

5.0

5.0

16.7

14.0

12.9

10.0

9.9

9.0

8.7

8.5

8.5

8.3

8.1

Consumer prices (average)

5.4

2.6

2.6

2.0

1.4

2.1

2.3

2.4

2.6

3.0

3.0

GDP Deflator

8.1

3.2

2.4

1.2

0.4

0.7

0.9

1.4

1.6

2.0

2.1

6.4

4.6

5.4

5.1

2.5

…

…

…

…

…

…

LABOR MARKET Unemployment rate (annual average)a Wages PRICES

FINANCIAL 7-day repo rate (percent)

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10-year government bond rate (percent)

3.4

3.6

4.6

3.7

2.9

…

…

…

…

…

…

Real effective exchange rate (average)

2.8

5.6

6.3

3.1

10.1

…

…

…

…

…

…

(Continued)

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10.7

China’s and India’s Economic Performance After the Financial Crisis 55

9.5

  Total domestic demand

2016 2011 Nominal effective exchange rate (average)

2012

2013

2014

2017

2015

2018

2019

2020

2021

Projections

0.1

5.0

5.3

3.1

9.5

…

…

…

…

…

…

Total social financingb

18.1

19.1

17.5

14.3

12.4

12.7

11.9

11.4

11.0

10.3

10.1

  In percent of GDP

157.9

169.0

180.0

189.5

198.4

208.3

217.4

225.1

232.0

236.9

241.6



China: Selected Economic Indicators

56  R. Nagaraj

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Appendix 1.  (Continued )

MACRO-FINANCIAL

  In percent of GDP House pricec

16.2

19.8

16.6

13.5

14.7

14.7

13.4

12.1

10.9

9.9

9.7

124.8

134.3

141.9

148.2

158.3

169.2

179.0

186.5

192.1

195.5

198.7

5.7

8.7

7.7

1.4

9.1

8.9

7.3

7.0

7.3

6.9

6.8

Household disposable income (percent of GDP)

58.3

59.4

60.0

60.7

62.2

63.2

63.6

63.9

64.2

64.2

64.2

Household savings (percent of disposable income)

41.0

40.8

38.5

37.9

37.4

36.9

35.8

34.7

33.7

32.7

31.7

Household debt (percent of GDP)

27.8

29.6

33.0

35.3

38.4

41.8

45.5

49.1

52.4

55.3

57.5

Nonfinancial corporate domestic debt (percent of GDP)

97.0

104.7

108.9

112.8

120.0

127.4

133.5

137.5

139.7

140.2

141.2

Net lending/borrowingd

-0.1

-0.7

-0.8

-0.9

-2.7

-3.0

-3.1

-2.9

-2.9

-2.8

-2.7

 Revenue

26.9

27.8

27.7

28.0

28.6

27.8

28.1

28.0

27.8

27.7

27.5

 Expenditure

27.0

28.4

28.5

28.9

31.3

30.8

31.2

30.9

30.7

30.4

30.2

Debt

15.2

15.2

15.9

38.5

38.3

38.6

39.1

39.3

39.3

39.2

39.0

Structural balance

-0.1

-0.5

-0.5

-0.5

-2.4

-2.9

-3.1

-2.9

-2.9

-2.8

-2.7

Current account balance

1.8

2.5

1.5

2.6

3.0

2.4

1.6

1.3

1.0

0.8

0.6

  Trade balance

3.0

3.6

3.7

4.1

5.1

5.1

4.5

4.3

4.0

3.8

3.7

GENERAL GOVERNMENT (Percent of GDP)

e

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  Services balance

-0.6

Net international investment position

-1.3

-1.6

-1.6

-2.0

-2.3

-2.6

-2.7

-2.9

-2.9

22.4

21.8

20.7

15.2

14.3

16.5

16.9

16.7

16.3

15.5

14.8

3,256

3,388

3,880

3,899

3,406

3,181

3,064

2,993

2,890

2,813

2,740

48,604 54,099 59,696 64,849 69,630 74,715 80,118 86,159 92,834 100,244 108,246

Nominal GDP (bn RMB)f

45.8

47.1

51.0

51.8

55.8

60.4

64.5

67.8

70.4

72.2

73.5

Augmented net lending/borrowing (percent of GDP)g

-6.0

-5.1

-7.6

-7.2

-7.8

-8.4

-8.2

-7.8

-7.4

-7.0

-6.6

Augmented fiscal balance (percent of GDP)h

-8.2

-7.8

-10.3

-9.8

-9.5

-10.1

-9.8

-9.3

-8.8

-8.4

-8.0

Augmented debt (percent of GDP)

g

Sources: CEIC Data Co., Ltd.: IMF, Information Notice System; and IMF staff estimates and projections. a  Surveyed unemployment rate. b  After adjusting local government debt swap, staff estimate that TSF stood at 203 percent of GDP in 2015. c  Average selling prices estimated by IMF staff based on housing price data (Commodity Building Residential Price) of 70 large and mid-sized cities published by National Bureau of Statistics (NBS). d  Adjustments are made to the authorities’ fiscal budgetary balances to reflect consolidated general government balance, including government-managed funds, stateadministered SOE funds, adjustment to the stabilization fund, and social security fund. e  Estimates of debt levels before 2015 include central government debt and explicit local government debt (identified by MoF and NPC in Sep 2015). The large increase in general government debt in 2014 reflects the authorities’ recognition of the off-budget local government debt borrowed previously. The estimation of debt levels after 2015 assumes zero off-budget borrowing from 2015 to 2021. f  Expenditure side nominal GDP. g  Augmented fiscal data expand the perimeter of government to include local government financing vehicles and other off-budget activity. h  “Augmented fiscal balance” = “augmented net lending/borrowing” — “net land sales proceeds” (in percent of GDP) as we treat net land sales proceeds as financing.

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MEMORANDUM

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Gross official reserves (bn US$)

-0.9



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Appendix 2: India’s Economic Indicators II. Economic Indicators 2011/12 2012/13 2013/14 2014/15 Growth (in percent) Real GDP (at market prices)a Industrial production Prices (percent change, period average) Consumer prices- Combined Saving and investment (percent of GDP) Gross savingb Gross investmentb Fiscal position (percent of GDP)c Central government deficit General government deficit General government debtd Structural balance (% of potential GDP) Structural primary balance (% of potential GDP) Money and credit (y/y percent change, end-period) Broad money Credit to private sector Financial indicators (percent, end-period) 91-day treasury bill yield (end-period)e 10-year government bond yield (end-period)e Stock market (y/y percent change, end-period)f External tradeg Merchandise exports (in billions of U.S. dollars) (Annual percent change) Merchandise imports (in billions of U.S. dollars) (Annual percent change) Terms of trade (G&S, annual percent change)

2015/16 2016/17 Proj. Proj.

6.6 2.9

5.1 1.1

6.9 -0.1

7.3 2.3

7.2 …

7.5 …

9.5

9.9

9.4

5.9

5.0

5.3

34.7 38.9

31.5 36.3

30.8 32.5

30.2 31.6

29.8 31.1

29.6 31.1

-6.1 -8.1 68.1 -8.4

-5.1 -7.4 67.5 -7.3

-4.6 -7.6 65.8 -7.5

-4.2 -7.0 66.1 -6.9

-4.2 -7.0 66.3 -6.9

-4.0 -7.0 65.7 -6.9

-3.9

-2.8

-2.8

-2.2

-2.3

-2.1

13.5 17.8

13.6 13.5

13.4 13.7

10.8 9.2

11.1 11.1

13.6 13.7

9.0

8.2

8.9

8.3

7.2

…

8.6

8.0

8.9

7.8

7.7

…

-10.5

8.4

18.7

24.9

-9.1

…

309.8

306.6

318.6

316.5

277.9

280.1

20.9 499.5

-1.0 502.2

3.9 466.2

-0.6 461.5

-12.2 429.8

0.8 449.3

30.3 -6.1

0.5 -0.3

-7.2 2.3

-1.0 3.5

-6.9 7.0

4.5 1.8

(Continued)

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China’s and India’s Economic Performance After the Financial Crisis 59 Appendix 2.  (Continued ) II. Economic Indicators 2011/12 2012/13 2013/14 2014/15 Balance of payments (in billions of US dollars) Current account balance

2015/16 2016/17 Proj. Proj.

-78.2

-88.2

-32.4

-26.7

-27.7

-34.8

(in percent of GDP)

-4.2

-4.8

-1.7

-1.3

-1.3

-1.5

Foreign direct investment, net

22.1

19.8

21.6

31.3

34.2

37.4

Portfolio investment, net (equity and debt)

17.2

26.9

4.8

42.2

-6.8

12.4

-12.8

3.8

15.5

61.4

22.7

40.8

294.4

292.0

304.2

341.6

364.3

405.1

Overall balance External indicators Gross reserves (in billions of U.S. dollars, end-period)

6.1

6.4

6.7

7.9

8.0

7.9

External debt (in billions of U.S. dollars, end-period)

360.8

409.4

446.3

475.2

513.3

550.4

External debt (percent of GDP, end-period)

19.6

22.3

23.8

23.2

24.0

23.6

Of which: Short-term debti

7.5

9.0

9.8

9.0

9.6

9.7

Ratio of gross reserves to shortterm debt (end-period)h

2.1

1.8

1.7

1.9

1.8

1.8

Debt service ratioj

6.0

5.9

5.9

7.5

7.1

7.8

6.0

…

(In months of imports)h

Real effective exchange rate (percent change)k (based on annual average level)

-3.4

-2.3

-2.4

7.3

Exchange rate (rupee/U.S. dollar, end-period)e

50.3

54.4

61.0

62.6

66.8

…

-5.8

-4.9

-4.3

-4.0

-3.9

-3.8

Memorandum item (in percent of GDP) Fiscal balance under authorities’ definition

Sources: IMF Country Report, 2016, based on data provided by the Indian authorities; CBC Data Company Ltd; Bloomberg LP.; World Bank, World Development Indicators; and IMF staff estimates and projections. a  Data are for April–March fiscal years. b  Differs from official data, calculated with gross investment and current account. Gross investment includes errors and omissions. c  Divestment and license auction proceeds treated as below-the-line financing. d  Includes combined domestic liabilities of the center and the states, and external debt at year-end exchange rates. e  For 2015/16, as of 6 January 2016. f  For 2015/16 year-to-date as of 6 January 2016. g  On balance of payments basis. h  Imports of goods and services projected over the following 12 months. i  Short-term debt on residual maturity basis, including estimated short-term NRI deposits on residual maturity basis. j  In percent of current account receipts, excluding grants. k  For 2015/16, year-to-date as of November 2015.

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References Burkitt, L. (2012). “Report: China’s Health Care System: Deeply Sick”, The Wall Street Journal, August 29. Haung, Y. and T. Khanna (2003). “Can India Overtake China?”, Foreign Policy, July/August. Maliszewski, W., S. Arslanalp, J. Caparusso, J. Garrido, S. Guo, J. S. Kang, W. R. Lam, T. D. Law, W. Liao, N. Rendak, P. Wingender, J. Yu and L. Zhang (2016). “Resolving China’s Corporate Debt Problem”, IMF Working Paper No. 16/203. Nagaraj, R. (2013). “The dream run: 2003–08: Understanding the recent boom and its aftermath”, Economic and Political Weekly, 48. Nagaraj, R. (2014). “Economic challenges to the new government: A policy proposal”, Economic and Political Weekly, 49(21). Nagaraj, R. (2015). “Seeds of doubts on new GDP numbers: Private corporate sector overestimated?”, Economic and Political Weekly, 50(13). Shin, H. S. and L. Y. Zhao (2013). Firms as Surrogate intermediaries: Evidence from Emerging Economies, Asian Development Bank. Available at: http://www.princeton.edu/~hsshin/ www/Firms_as_surrogate_intermediaries.pdf. The Economist (2016). “Chinese property: When a bubble is not a bubble”, The Economist, October 13. Wu, H. (2002). “How fast has Chinese industry grown? — Measuring the real output of Chinese industry”, The Review of Income and Wealth, 48(2): 179–204.

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CHAPTER 4

Inter-Group Disparities in Growing Economies: India Among the BRICS Achin Chakraborty and Simantini Mukhopadhyay Institute of Development Studies Kolkata, India

Introduction Discussions on economic inequality by scholars, policymakers, and others had never attained such visibility as they have in the recent years. “It’s a golden age for studying inequality”, commented The Economist (2016). Publication of a series of important, well-researched books by reputed economists in the recent years has triggered further interest in the issue of inequality and its different aspects.1 In spite of the renewed interest in the problem of inequality across the world, discussions on inequalities based on ethnic, racial, or caste groups have been less visible than general or interpersonal inequality. However, in contrast to this general neglect of inter-group inequality by economists in the context of the rest of the world, there has been a growing scholarly interest in assessing inequalities between the social groups (Scheduled Castes, Scheduled Tribes, and others) in India in the past two decades or so. Even though a common characteristic of all the BRICS countries now is that the degree of inequality in interpersonal income distribution is rather high, Brazil stands out as it has experienced a decline in inequality in the past two decades unlike others. In this chapter, our focus is on inequality between groups, rather than interpersonal inequality as the former is less discussed in the context of BRICS. To name a few, Stiglitz (2013), Piketty (2014), Atkinson (2015) and Milanovic (2016).

1 

61

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The complex social stratification along the lines of caste, tribe, religion, and gender has been a persistent feature of the Indian society for very long time. In the heyday of positivist thinking in social sciences, it was generally presumed that inequalities due to race, gender, and even class background were all forms of ascription that would go away with the development of impersonal market forces. The protagonists of this view shared the same belief in the rationalizing logic of modernity as propounded by the development economists of the earlier generation, even though they differed significantly on whether the market or the central planner would be the agent of modernity. The subsequent rise of neo-Marxian scholarship restored class analysis to a central position. It was then assumed that class-based loyalties were in the end fundamental. In recent decades, however, social science disciplines have turned full circle. The class-centered approach has given way to new multi-dimensional accounts of identities that include ethnic, caste, religion, and gender categories, and thus social identities seem to have come to the centrestage. In India, popular discourses show an overwhelming presence of issues around identities. However, on the changing salience of caste-based differences in the Indian context, there is a counter-position as well. Beteille (2012), for example, criticizes the ‘pre-occupation’ with caste that he observes among the experts who express opinions in the media on Indian affairs. He has argued that “rapid economic growth and the expansion of middle class are accompanied by new opportunities for individual mobility which further loosens the association between caste and occupation”. In other words, Beteille questions the material basis of the presumed persistence of caste-based differences in a rapidly changing Indian economy. Some of the recent studies have documented how the role of caste has been weaker than before in shaping economic well-being. Migration, expansion of lower and middle castes in nontraditional occupations, changes in agriculture, and most importantly affirmative action have all led to improvement in the relative position of the Scheduled Castes in India (Kapur et al., 2010). Yet, the political salience of the caste issue has hardly weakened. In the context of limited opportunities, overall and growing aspirations for upward mobility, competitively assertive caste identities for distributional gains continue to dominate the political discourse in India, the connection of which with the so-called material basis has been changing as a consequence. Given the diversity of opinions regarding the importance of caste and other social groupings in Indian society, the question still remains what exactly has been happening to the distributional outcomes across social groups as a result of economic progress. Beteille (1983) made a useful distinction between two aspects of inequality — the relational and the distributional aspects. While sociologists and political scientists are mostly concerned with the first kind, economists are generally concerned with the second. In the first case, inequalities are seen as built into the

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social structure in the form of relations of super-ordination and sub-ordination, i.e. the patterns of privileges, rights, and obligations. An economist, on the other hand, sees inequality in the distribution of wealth or income, or, as Sen (1980) has proposed, in the distribution of human “functionings’ such as health or educational status. Why has the economist been rather less concerned about inequality across racial, ethnic, or caste groups? The answer probably lies in the methodological preference of the economist for a depersonalized agent as the unit of analysis. The agent acts independently to choose the best course of action given the opportunities. This way of thinking has definitely been fruitful in illuminating a variety of problems. It cannot, however, fully capture the ways inter-group inequality persists over time. There is no point in denying that one’s location within the network of social affiliations substantially affects one’s access to resources. While the inter-relationship between economic development and economic inequality has long been explored by economists, and the earlier belief in an inverted U-shape between the two has been questioned in the light of extensive cross-country data for longer periods, there is very little analytical exploration into what might happen to inter-group inequality in course of rapid economic development. In this chapter, we first assess changes in measured inequalities between social groups in India in both income and non-income dimensions. In the process, we re-examine some of the issues in measurement of inter-group inequality, which would help us relook at inter-group disparities in other countries as well. Finally, we try to relate changing interpersonal and inter-group inequality to the fact that although some of the countries, such as Brazil, have not grown as fast as the Indian economy has grown, their record of reduction in inter-group inequality has surpassed India’s by a wide margin.

Why Between-Group Inequality Relative disparities in well-being are often the concerns of the policymakers since sharpening disparities have the potential for creating conflicts in societies. Inequality between socially identifiable groups of people is considered ‘politically more salient and consequential than interpersonal comparison’ (Subramanian, 2011). Besides being considered intrinsically bad from an ethical standpoint, inequality between groups, what is often called ‘horizontal inequality’, has also been seen as having negative consequences on social coherence and peace (Stewart et al., 2005), even though the relationship between such inequality and the outbreak of violent conflict is not straightforward. There is perhaps an inverted U-shaped relationship between the two. When there is a large gap between the privileged and the disadvantaged groups, the disparity is either accepted with resignation or the privileged group might show

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some amount of magnanimity towards the less privileged so long as there is little threat from the bottom. The potential for conflict intensifies as the gap between the groups diminishes. While analyzing the occurrence of communal riots in India, Mitra and Ray (2014) find evidence in support of this hypothesis. Between-group inequality also has an important bearing on the concept of inequality of opportunity. One way of assessing inequality of opportunity is the one that relies on the distinction between ‘circumstances’ and ‘effort’. While the unequal distribution of outcome across individuals may result from the differential efforts they put in to better their lives, it could also be due to the unequal circumstances they are in. The circumstances are defined to be those conditions which are beyond the control of the individual. In this conceptualization, individuals within a group are assumed to share the same circumstances and groups differ in terms of circumstances. If there was a systematic disparity between the average achievement levels of two different groups, it could be attributed to differences in circumstances, and as the argument goes, the focus of public policy should be on reducing the disparity due to circumstances. In a society where individuals participating in the economic process are endowed with unequal quantities not only of economic assets but also of social assets, exclusion takes different forms. By social assets, we mean those ‘goods’ that belong to the realm of rights and entitlements. The fact that unequal access to publicly provided goods cannot be explained by the market process calls for such categories as social assets that include both political (e.g. citizenship rights) and cultural assets (i.e. ethnic markers such as ethnicity, religion, language, and so on). Access to employment, education, and productive assets, which is considered to be crucial in determining economic circumstances, varies across social groups in a manner which lies outside the control of an individual. Racial or caste identification of workers can interact with the social processes of human capital accumulation in communities and human capital valuation by employers in ways that generate externalities. In the presence of such externalities, as economic theory suggests, market processes may not lead to efficient outcomes. In the new economics of race, there is an emphasis on the links between under-investment in human capital due to circumstances and labor market outcomes.

Issues in Measurement There has been a long stream of literature that has attempted to measure inequality across identifiable sub-groups using the method of ‘decomposition’. This approach views total inequality in personal income distribution as the sum of ‘between-group’ and ‘within-group’ components, and following this approach the between-group

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component is expressed as a percentage of the total inequality to reckon the ­contribution of between-group inequality to total inequality. Among the inequality measures, Theil’s entropy measure is commonly used for this purpose as it is readily decomposable, unlike the Gini coefficient — by far the most popular inequality measure — which is not decomposable in the way Theil’s measure is. The general entropy class (Cowell and Jenkins, 1995) of measures is given by  y  c  1 GE (c ) = (c − 1) ∑  i  − 1 nc  i  µ   =

µ 1 log   ∑ n i  yi 

for c = 0

=

 yi  y  1 log  i  ∑   n i µ µ

for c = 1,





for c ≠ 0, 1

where n is the total population, yi is the outcome (in our case income) of individual i, µ is the mean income, and c is a parameter chosen by the researcher. As the value of c increases, the sensitivity to inequality among those in the upper end of the distribution increases. While Theil entropy measure is obtained from a c-value of 1, a c-value of 0 gives Theil L or mean log deviation. GE (2) is ordinally equivalent to the squared coefficient of variation (Elbers et al., 2008). The general entropy class of measures can be conveniently decomposed into between-group and within-group components (Shorrocks, 1984) as follows: C    µj  1 GE = (c − 1)  ∑g j   –1 + ∑GE j g j c  µ j  j 

 µj   µ 

C

for c ≠ 0, 1

  µ  =  ∑g j log    + ∑GE j g j  µ j   j  j

for c = 0

  µj   µj    µj  =  ∑g j   log    + ∑GE j g j    µ  µ j  j µ

for c = 1,

where j is the population sub-group, gj is the population share of the jth subgroup, and GEj is the inequality within the jth subgroup.

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While the first term measures the between-group component of total ­inequality, the second term denotes inequality within the subgroups. The between-group component gives the level of inequality pertaining to a distribution where everyone within each sub-group has the same outcome µj. The between-group component can be summarized as RB (Π) =

I B (Π ) , I

for any population partition ∏, where IB(∏) is the between-group component and I is total inequality. Empirical applications of decomposable measures to the data on income distribution typically do not find significant inter-group inequality. For example, one of the earliest studies in this direction which made significant impact on the subsequent empirical literature was done by Anand (1983) on Malaysia, who found that inequality between the native Malays and Chinese Malaysians accounted for only 15% of the overall inequality in the country in the early 1970s. Based on this finding, he recommended that the strategy of the government should be directed to the sources of inequality among the people within the same ethnic group rather than focus on between-group inequality. Studies in India have also found a small contribution of between-group inequality to total inequality, where the groups are SCs, STs, and others. Mutatkar (2005) found less than 5% contribution of inequality between groups in three rounds of National Sample Survey (NSS) data in the 1980s and 1990s. Using data from the 1993–1994 round of NSS, Deshpande (2000) finds an even lower contribution between these three social groups in Kerala. Part of the reason for this observed low between-group inequality is inherent in the nature of the standard inequality decomposition method itself. The paper by Elbers et al. (2008) points out that the standard procedure for decomposing inequality into a between-group and a within-group component fails to capture the true extent of between-group inequality as it is compared with the overall inequality which can be seen as inter-group inequality when each individual constitutes a group. Therefore, overall inequality tends to be way above between-group inequality as in the former the number of groups is exactly equal to the number of individuals, which is large. In the standard procedure, between-group inequality tends to increase as the number of groups increases, and such inequality is also sensitive to the relative population composition of the groups. Ray Chaudhury (2014) finds that in 2009–2010 the shares of inequality in the distribution of consumer expenditure attributable to the differences between two broadly defined social groups — SC/ST (comprising Scheduled Castes and Scheduled Tribes) and non-SC/ST (comprising ‘other

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backward castes’ and ‘others’) — in two Indian states of Kerala and Punjab were 1% and 3.1%, respectively, even though there was no significant difference in the relative disparity in mean expenditures between non-SC/ST and SC/ST in these two states. Therefore, the difference in the degree of between-group inequality in these two states, as measured by the between-group component of the overall inequality, might largely be due to the difference in the population shares of the social groups (non-SC/ST and SC/ST), rather than the difference in relative mean expenditures of these social groups. We first use the traditional method of inequality decomposition and find out how the between-group component differs when we consider different groupings, namely caste, class, and religion. However, since the traditional method of inequality decomposition is sensitive to the relative sizes and the number of groups under question, the decompositions are not comparable across alternative groupings. For instance, by the conventional method, the shares of between-group inequality in income (groups defined in terms of racial identities) in three countries infamous for racial inequality (namely United States, Brazil, and South Africa) have been shown by Elbers et al. (2008) to be 8%, 16%, and 33%, respectively. They question if ‘these numbers provide a good yardstick with which to judge the relevance of race to an understanding of inequality in these countries’. They further point out that while the mean difference in income between the white and non-white groups is stark in all three countries, the population shares of the white versus non-white groups vary widely (with non-whites comprising 80%, 50%, and 28% of the population in South Africa, Brazil, and the United States, respectively). Furthermore, the number of racial groups is also not invariant across the countries (four for Brazil and South Africa and five for the United States). Elbers et al. (2008) illustrate that the difference in the share of the between-group component may not be reflective of the differences in relative mean incomes alone, since it is not normalized for differences in the number and the relative size of groups. As we indicated above, the share of the between-group component in total inequality, as decomposed by the traditional method, has been typically low since it is taken to be the ratio between observed group inequality and total (or interpersonal) inequality. The latter may be looked upon as a particular type of between-group inequality, where every household (or individual, depending upon the unit of analysis) constitutes a separate group. Elbers et al. (2008) argue that it is perhaps unrealistic to compute the share of observed between-group inequality against the benchmark of total interpersonal inequality, since the actual number of social groups considered in a decomposition exercise is too small compared to the total population. They suggest an alternative measure of the share of between-group inequality that is normalized with respect to the number and relative size of groups. They replace

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total inequality in the denominator of the conventional ratio with the ‘maximum between-group inequality that could be obtained if the number of groups and their sizes were restricted to be the same as for the numerator’. Elbers et al. (2008) compare the extent of between-group inequality with a differently constructed benchmark, which is obtained by partitioning the individual incomes into two non-overlapping groups. If there are two groups are of sizes n1 and n2, the incomes are rearranged in such a manner that the richest person of the poorer group is poorer than the poorest person in the richer group. The between-group inequality between these reconstructed groups can now be seen as the maximum possible between-group inequality given the relative sizes of the groups. The modified measure allows meaningful comparison of between-group inequality across different social settings, where the number and relative size of groups are different. Thus they propose a seemingly small adaptation of the conventional procedure to produce an alternative statistic that overcomes some of these limitations of the conventional decomposition procedure. Elbers et al. (2008) illustrate this point with reference to South Africa. They show that when inequality is decomposed by racial group defined in terms of a ‘white/non-white’ classification, the conventional decomposition suggests that only about 27% of inequality is attributable to between-group differences. Their alternative statistic, on the other hand, shows that two groups are 80% of the way towards a completely partitioned South African income distribution. The alternative index proposed by Elbers et al. (2008) is given by  B (Π) = I B (Π) {I | Π( j (n), J )} = R (Π ) I {I Π( j (n), J )}, R B B B Max Max where the denominator gives ‘the maximum between-group inequality that could be obtained by reassigning individuals across the J sub-groups in partition ∏ of size j(n)’.

Data and Results We apply the idea drawn on Elbers et al. (2008) to the data collected from two rounds of the India Human Development Survey (IHDS) conducted in 2004–2005 and 2011–2012. The National Council of Applied Economic Research (NCAER) collaborated with the University of Maryland to collect this unique data set on India. The survey covers almost all the states and union territories of India (except Andaman and Nicobar Islands and Lakshadweep). Using stratified random sampling technique, 27,010 rural households from 1,503 villages and 13,126 urban households from over 971 urban blocks were surveyed in 2004–2005. In the second round,

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Inter-Group Disparities in Growing Economies 69 Table 1:   Changes in income inequality in India by different measures. IHDS Round

Log MD

Theil

GE(2)

Round 1 (2004–2005)

0.51535

0.55455

1.36538

Round 2 (2011–2012)

0.53376

0.57783

1.50460

Source: Calculated from IHDS data.

conducted in 2011–2012, around 83% of the households were reinterviewed, which also include split households located within the same village or town. Altogether, 42,152 households were surveyed in the second round. First, we take a look at the changes in overall inequality in household per capita income in India during the period between 2004–2005 and 2011–2012. Strikingly, no matter which measure we use, income inequality has unambiguously worsened in India during this period (Table 1). The belief that estimates of inequalities in reported consumption expenditure, which are usually made on the basis of different rounds of National Sample Surveys (NSS), grossly underestimate the true extent of economic inequality in India is somewhat vindicated by this finding. This is no more than reconfirmation of Amaresh Dubey’s finding, based on the same IHDS data, that Gini coefficient for income is around 0.55 in India as compared to that of consumption, which is 0.37 (cited in Dev, 2016). Studies based on NSS data have also shown that inequality in consumption expenditure has increased in the post-reform period, but the increase has been more in urban than in rural areas. Does the higher level of overall interpersonal inequality necessarily imply higher inter-group inequality? Even though it is conceivable that the higher the overall inequality, the greater is the inequality between groups, the decomposition formula is also consistent with the scenario when overall inequality is rising while betweengroup inequality is declining or not changing. We now examine the contribution of the between-group component to total inequality following the conventional method of decomposition and with four mutually exclusive and exhaustive categories across the religious and caste divides, viz., Muslims, SCs, STs, and Hindu others. The last category is the residual category excluding the SC and ST households from all Hindu households. We find that the general entropy measures for c = 0, 1, 2 — all show declines in the contributions of between-group components to total inequality (Table 2). It can also be observed that the contributions seem rather low because of the reason explained earlier. As discussed earlier, the conventional method is sensitive to the number of groups considered as well as the relative composition of the groups. We check this

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70  A. Chakraborty & S. Mukhopadhyay Table 2:   Contributions of between-group component (conventional decomposition) (with four social groups). IHDS Round

Mean log Deviation GE(0)

Theil Measure GE(1)

GE(2)

Round 1

5.6%

4.9%

1.9%

Round 2

4.6%

4.0%

1.5%

Source: Calculated from IHDS data.

Table 3:   Contributions of between-group component (conventional decomposition) (with six social groups). IHDS Round

Mean log Deviation GE(0)

Theil Measure GE(1)

GE(2)

Round 1

10.6%

10.6%

4.7%

Round 2

7.9%

7.7%

3.3%

Source: Calculated from IHDS data.

Table 4:   Shares of between-group component (Elbers et al.) (with four groups). IHDS Round

Mean log Deviation GE(0)

Theil Measure GE(1)

GE(2)

Round 1

8.7%

11.8%

13.6%

Round 2

6.9%

9.5%

10.8%

Source: Calculated from IHDS data.

point with six mutually exclusive groups, splitting the Hindu others category into Brahmins, high castes, and Other Backward Castes (OBC). As expected, the contributions of between-group inequality to overall inequality increase, and the contribution of between-group inequality declines between the two survey rounds (Table 3). On application of the modified decomposition method as suggested by Elbers et al. (2008), we find some interesting differences as far as the GE family of measures is concerned. Clearly, the contributions of between-group inequality at both the time points have increased, as expected. The contribution of between-group inequality by applying GE(2) in 2004–2005 turns out to be as high as 13.6%. Yet again, the between-group contributions are all found to have declined in this period (Table 4). Interestingly, in this modified approach, the contribution of between-group inequality does not necessarily increase with increase in the number of groups, unlike in the case of the conventional approach. A comparison between Tables 4 and 5 illustrates the point. However, what stands out is that, no matter whether we apply the conventional decomposition method or the method suggested by Elbers et al., the contribution of between-group inequality to total inequality between the two rounds of IHDS shows a decline.

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Inter-Group Disparities in Growing Economies 71 Table 5:   Shares of the between-group component (Elbers et al.) (with six groups). IHDS Round

Mean log Deviation GE(0)

Theil Measure GE(1)

GE(2)

Round 1

11.6%

12.2%

8.9%

Round 2

8.6%

8.9%

6.2%

Source: Calculated from IHDS data.

Table 6:   Income shares and population shares of four social groups in the two rounds of IHDS. Round 1

Round 2

Income Population Income Share/ Income Population Income Share/ Share Share Population Share Share Share Population Share Muslim

0.100

0.122

0.818

0.096

0.123

0.784

SC

0.153

0.218

0.701

0.173

0.220

0.787

ST

0.042

0.065

0.652

0.040

0.068

0.595

Hindu others

0.705

0.595

1.185

0.691

0.591

1.170

Source: Calculated from IHDS data.

This takes us to a further limitation of this way of looking at inequality between groups. Even though the decomposition methods give the quantitative contribution of between-group inequality in an overall sense, which in our case has declined, it does not allow us to say anything about the relative attainments of different groups among the four groups considered. In order to examine this further, we look at the respective income shares and population shares of four mutually exclusive and exhaustive social groups, viz., SC, ST, Muslims, and Hindu ‘others’. This is one of the simplest approaches toward assessing inequality between groups — called ‘representational inequality’ by Reddy and Jayadev (2011) — which substantially differs from the commonly used approach that views inter-group inequality as a constituent part of overall interpersonal inequality. Table 6 allows us to compare the changes in the respective shares, which shows that among the four groups, only the SC households as a group have been able to improve their income share vis-à-vis their population share, which is reflected in a higher ratio of the two shares in IHDS round 2. This is at the expense of the declining ratios for other three groups. The category Hindu others in Table 6 includes a wide range of sub-categories with significant differences. We, therefore, further split this category into Brahmins, high castes, and Other Backward Castes (OBC) in order to see if significant differences exist. Now, with six mutually exclusive categories, we find that SCs and OBCs have experienced improvement in their respective income shares vis-à-vis

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72  A. Chakraborty & S. Mukhopadhyay Table 7:   Income shares and population shares of six social groups in the two rounds of IHDS. Round 1 Income Population Share Share

Round 2

Income Share/ Income Population Population Share Share Share

Income Share/ Population Share

Brahmin

0.099

0.055

1.808

0.085

0.052

1.633

High caste

0.263

0.164

1.601

0.251

0.163

1.538

OBC

0.343

0.376

0.913

0.356

0.376

0.946

SC

0.154

0.220

0.701

0.174

0.221

0.786

ST

0.043

0.065

0.651

0.040

0.067

0.597

Muslim

0.099

0.120

0.821

0.095

0.121

0.785

Source: Calculated from IHDS data.

Table 8:   Growth in per capita household incomes of six different groups Round 1

Round 2

Per Capita Income

Per Capita Income

Growth (%)

Brahmin

23065

34954

52

High caste

24117

36297

51

OBC

13953

22183

59

SC

11724

19255

64

ST

11103

16575

42

Muslim

12915

19081

48

population shares, but the ratio of the income share to the population share for each of the other four categories, viz., STs, Muslims, Brahmins, and other high castes, has declined (Table 7). This can be supported by an alternative way of looking at the data as well. If we look at the average per capita incomes of the households belonging to different categories, our finding on STs is further strengthened. Among the six groups, STs have experienced the smallest growth (in percentage terms) in their average per capita income during the period between 2004–2005 and 2011–2012 (Table 8). The unfair disadvantage that certain castes and tribes experience in terms of opportunities in the education and labor market can be viewed as the culmination of the discriminatory social practices that prevailed in the past. The Constitution of India mandated punitive action against all forms of discrimination and, at the same time, adopted the policy of reservation in public employment and publicly funded

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educational institutions. Even though questions can be raised about the efficacy of the kind of affirmative action policy that has been in place in India for long, it is generally acknowledged that without such policy the erstwhile disadvantaged groups could hardly move up to the level they have succeeded to reach so far. However, the larger question of whether the reservation policy with respect to public sector jobs and admission to higher education has succeeded in reducing the gaps between the most marginalized group in the Indian society (i.e. the STs) and others still remains. Similar findings on the relative attainments of SCs and STs and OBCs in the context of poverty have also been noted by others. Poverty declined much faster for all the social groups during the period 2004–2005 to 2011–2012 as compared to the period 1993–1994 to 2004–2005. However, the rate of decline in poverty is the highest for SCs and lower than the national average for the STs, even though STs show a much higher level of poverty (Panagariya and More, 2013).

India Among the BRICS Dreze and Sen (1995) made a distinction between two alternative paths of development — growth-mediated and support-led. While the development experience of the East Asian countries, especially South Korea, could be seen as manifestation of growth-mediated development, Sri Lanka, Costa Rica, and the Indian state of Kerala could be seen as examples of support-led development, according to their characterization. In this context, they also discussed the pitfalls of what they called ‘un-aimed opulence’, which aptly characterized Brazil in the 1980s. In the 1960s and 1970s, Brazil was one of the fastest growing countries in the world. But the country could hardly be seen as an example of growth-mediated development. As a matter of fact, Dreze and Sen expressed the fear that unless serious attention is paid to the persistent deprivation of basic necessities of life by large sections of the population, India might be in danger of ‘going Brazil’s way, rather than South Korea’s’. While their apprehension has been vindicated to a great extent by the experience of India, Brazil meanwhile seems to have changed its course so that ‘un-aimed opulence’ can hardly be used now to characterize Brazil. If we compared the levels of well-being among the BRICS countries, we wouldn’t miss the fact that India turns out to be an outlier. While every country in the group has achieved universal literacy in the younger age groups, India lags far behind ­others. All of them also embarked on programs of market-oriented economic reforms, China was the first where the process started in 1978. Then it was Russia, after the disintegration of the USSR, and finally Brazil and India followed, embarking on the path of reform in the early to mid-1990s. In terms of the pattern of growth and distributional change, China and India have had more in common; both have

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seen rapid growth, but with rising inequality (with more of both in China). Brazil has seen moderate growth, lower in the post-2000 period compared to what was achieved in the 1980s and 1990s. But falling inequality from 2000 onwards is what makes the Brazil case most remarkable among the BRICS. As a matter of fact, falling inequality has been the most common feature across most of the Latin American countries in this period.2 As the principal focus of this chapter is inequality between social groups, rather than interpersonal inequality, it would be worthwhile to compare the Indian scenario with some other BRICS countries, namely, Brazil and South Africa, drawing on the secondary literature. Fortunately, we can draw on at least one paper that has its focus on racial/ethnic inequality in India, Brazil, and South Africa, among others. Table 9 draws on Elbers et al. (2008). Theil’s GE(0) measure has been applied to consumption expenditure data roughly pertaining to the year 2000. Clearly, overall inequality turns out to be rather low in India3 compared to the other two countries. We have shown earlier that income inequality in India estimated from IHDS data is not so low. What is to be noted from Table 9 is that the contribution of between-group inequality in India also turns out to be low. The modified formula, as proposed by Elbers et al. (2008) and discussed in the earlier sections, shows higher values for all three countries, but India’s between-group inequality figure is still much lower than that of the other two (see the last column in Table 9). Post-apartheid South Africa is known to have one of the most unequal income distributions in the world, and racial disparity in income remains at the core of this high inequality. Recent evidence suggests that Brazil has been able to reduce racial inequality in the post-2000 years. Affirmative action was introduced in Brazil in 2002, and the Secretary of Policy for the Promotion of Racial Equality was established in 2003. Disparities between the racial groups, viz., black (preto), white (branco), mixed-race (pardo), Asian (amarelo), and Indigenous (indígena), have declined in several respects. Marteleto (2012) has shown that racial gap in schooling has been bridged. Yet, between 1980 and 2008, there was no visible downward trend in the difference in life expectancies of whites and non-whites in Brazil (Table 10). This is surprising since a number of initiatives in the health care sector have been taken since the country made the transition from the military rule to a democratic regime in 1988. The democratic constitution of Brazil included the right to health as Cornia (2015) observes that between 2002 and 2010 inequality fell, although to a different extent and with different timing, in all the Latin American countries except Nicaragua and Costa Rica. 3  Here they have taken only rural India, which held roughly three-fourths of India’s population at the beginning of this millennium. 2 

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Inter-Group Disparities in Growing Economies 75 Table 9:   Contributions of between-group inequality to overall inequality. ∧ Country Groups GE(0) RB RB India

SC, ST, Others

0.136

 5.1

10.1

Brazil

‘White’, ‘Black’, ‘Pardo’, ‘Indigenous’

0.404

15.8

21.6

South Africa

‘White’, ‘African’, ‘Colored’, ‘Asian/Indian’

0.607

33.3

56.4

Sources: Elbers et al. (2008).

Table 10:   Life expectancy at birth by race (1950–2008) in Brazil. 1950

1960

1980

1991

2008

White

47.5

54.7

66.1

70.8

73.1

Non-white

40.1

44.7

59.4

64.0

67.0

Difference

7.4

10.0

6.7

6.8

6.1

Source: Bucciferro (2017).

a justiciable right. The ‘Unified Health System’ aimed at providing free health care to everyone without discrimination. While all this led to a significant improvement in the health outcome in general, it seems that the gap between the racial groups in terms of such a long term indicator as life expectancy at birth would take a bit longer to go away.

Conclusion In this chapter, we have focused on a particular aspect of inequality, namely inequality between socially identifiable groups, which is believed to have implications for the socio-political dynamics of a country. In the 1970s and 1980s, Brazil was seen as a case of ‘un-aimed opulence’, the consequence of which was accentuating inequality in income and wealth. Since 1988 when Brazil made the transition to a regime of democratic governance, a number of radical pro-poor measures have been undertaken, which have had visible impacts on the overall inequality as well as inequality between the racial groups. In India, by contrast, overall inequality has increased in the past two decades, and recent evidence suggests that the degree of inequality in the space of income and wealth is no less in India than that in China and the Latin American high inequality countries. Brazil’s transition from ‘un-aimed opulence’ to a more inclusive approach based on active social policies can be a lesson for India which is clearly faltering on the task of making the growth process inclusive. There are some similarities among the three countries — India, China, and Brazil — in their policies over the last 15 years, notably in the importance attached

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to macroeconomic stability, especially bringing inflation under control. But there are some big differences too, such as in the role played by policies directly aimed at redistributing incomes. When one looks more closely at their histories and policy regimes, Brazil and India seem to have more in common with each other than with China, particularly when we consider the more recent phase of constitutional democracy in Brazil. However, at the risk of sounding cliché, one can say that each of these countries has something to teach the others. And other developing countries that have been less successful against reducing inequality and deprivation can learn from both the strengths and weaknesses of the approaches taken by the BRICS countries.

References Anand, S. (1983). Inequality and Poverty in Malaysia: Measurement and Decomposition, Oxford: Oxford University Press. Atkinson, A. B. (2015). Inequality: What Can Be Done? Cambridge, Massachusetts: Harvard University Press. Beteille, A. (ed.) (1983). Equality and Inequality: Theory and Practice, New Delhi: Oxford University Press. Beteille, A. (2012). “India’s Destiny Not Caste in Stone”, The Hindu, February 21, 2012. Available at: http://www.thehindu.com/opinion/lead/indias-destiny-not-caste-in-stone/ article2913662.ece. Bucciferro, J. R. (2017). “Racial inequality in Brazil from independence to the present”, in L. Bértola and J. Williamson (eds.), Has Latin American Inequality Changed Direction? Cham: Springer. Cornia, G. A. (2015). “Income inequality in Latin America”, UNU-WIDER Working Paper, 2015/020. Deshpande, A. (2000). “Does caste still define disparity? A look at inequality in Kerala, India”, The American Economic Review, 90(2): Papers and Proceedings of the 112th Annual Meeting of the American Economic Association, May, 2000, pp. 322–325. Dev, S. M. (2016). “The Problem of Inequality”, Malcolm Adiseshiah Memorial Lecture. Dreze, J. and A. Sen (1995). India: Economic Development and Social Opportunity, Oxford: Oxford University Press. Elbers, C., P. Lanjouw, J. Mistiaen and B. Ozler (2008). “Re-interpreting sub-group inequality decompositions”, Journal of Economic Inequality, 6(3): 1569–1721. Marteleto, L. J. (2012). “Educational inequality by race in Brazil, 1982-2007: Structural changes and shifts in racial classification”, Demography, 49: 337–358. Milanovic, B. (2016). Global Inequality: A New Approach for the Age of Globalization, Cambridge: Harvard University Press. Mitra, A. and D. Ray (2014). “Implications of an economic theory of conflict: Hindu–Muslim violence in India”, Journal of Political Economy, 122(4): 719–765.

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Mutatkar, R. (2005). “Social Group Disparities and Poverty in India”, Indira Gandhi Institute of Development Research, Working Paper Series No. WP-20005-004. Panagariya, A. and V. More (2013). “Poverty by Social, Religious & Economic Groups in India and its Large States: 1993–94 to 2011–12”, Working Paper No. 2013-02, Columbia University, Program on Indian Economic Policies, USA. Ray Chaudhury, A. (2014). Horizontal Inequality: Concept, Measurement and Determinants, PhD thesis, University of Calcutta. Reddy, S. G. and A. Jayadev (2011). “Inequalities between groups: Theory and empirics”, World Development, 39(2): 159–173. Sen, A. (1980). “Equality of what?”, in S. M. McMurrin (ed.), Tanner Lectures on Human Values, Cambridge: Cambridge University Press. Stewart, F., G. Brown and L. Mancini (2005). “Why Horizontal Inequalities Matter: Some Implications for Measurement”, CRISE Working Paper No. 19, June. Stiglitz, J. (2013). The Price of Inequality. London: Penguin Books. Subramanian, S. (2011). “Inter-group disparities in the distributional analysis of human development: concepts, measurement, and illustrative applications”, Review of Black Political Economy, 38: 27–52.

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CHAPTER 5

Inequality and Poverty in India and Brazil Since the 1990s: A Comparative Analysis* Sripad Motiram Department of Economics, University of Massachusetts, Boston, USA

Introduction This chapter deals with inequality and poverty in India and Brazil in roughly the past two-and-half decades. Apart from being members of the BRICS group that is playing an important role in the world today, there are two other similarities between these countries that make their comparison interesting. First, as described below, both India and Brazil underwent cataclysmic changes during the past two to three decades which have radically restructured their economies and societies. Second, both India and Brazil are complex and diverse societies that are characterized by disparities on several dimensions. Following Stewart (2001), it has become customary to distinguish between vertical (interpersonal) and horizontal (group-based) inequalities. Studies on interpersonal inequality have mostly focused on income or consumption, whereas those on horizontal inequality (which is essentially multi-dimensional), have * This is a revised version of a paper presented at the conference: Political Economy of Emerging Market Countries: The Challenges of Developing More Humane Societies organized by Niehaus Center for Globalization and Governance at Princeton University, India Initiative at Georgetown University, and Indian Institute of Management Calcutta in January 2017. For their comments on a previous version, I thank the discussants Hema Swaminathan and Emilie Hafner-Burton and participants of the conference. 79

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focused on both income and non-income dimensions (Stewart, 2001, 2010). Despite its importance, horizontal inequality has been relatively under-researched, although the situation has been rectified to a certain extent in recent times. Interpersonal and class-based inequalities are important in both countries. In addition, caste-based and ethno-racial inequalities are important in India and Brazil, respectively. This chapter is motivated by the idea that a comparative analysis of India and Brazil can provide insights into the interrelationship between inequalities and development and also shed light on policies that can ameliorate inequality. In light of the above, in the second and third sections, I examine inequality and poverty in India and Brazil, respectively. I draw upon secondary literature to do so, including several of my own contributions on India. In the fourth section, I provide an explanation for the trends documented and present a comparison of the India and Brazil. The final section concludes.

Inequality and Poverty in India Since the Onset of Economic Reforms After following a model of planned development for almost four and half decades, in the wake of a serious balance of payments crisis, India embarked upon a set of economic reforms in the early 1990s.1 These reforms aimed to radically restructure the Indian economy. Broadly speaking, the role of the state was reduced, and markets (both national and global) were provided a larger role. 2 India has been growing rapidly since the early 1990s after these reforms were initiated. Nagaraj (2013) has argued that the best growth phase for India was during the period 2003–2008, when the average annual growth rate of real gross domestic product (GDP) was 8.9%. During the period 1991–2008, the corresponding figure was 6.5%. There is considerable debate on the reasons for accelerated growth and when Indian growth really took off, in particular whether it took off in the 1980s or after the reforms.3 There is also a recent controversy on the new estimates put forward by the Central Statistical Office (CSO) which has rendered the official growth figures problematic.4 In my opinion, these debates and controversies do not distract from the broad idea India attained independence from British colonial rule in 1947. For an overview of India’s planned development, see Chakravarty (1987). 2  On these reforms and their impact, see, e.g. Bhadhuri and Nayyar (1996), Joshi and Little (1996), Srinivasan (2000), and Dreze and Sen (1995, 2013). 3  For an analysis of Indian growth since independence and a discussion of these issues, see Balakrishnan (2010). 4  See Nagaraj (2015) and the ensuing debate in the pages of the Economic and Political Weekly. 1 

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that Indian economy has displayed unprecedented growth by its own historical standards and has been one of the fastest growing economies in the world in recent decades. Also, what is relevant for us is the distributional changes associated with this growth process. We will first focus on changes in the interpersonal distribution. Many scholars and policymakers have used the surveys on consumption expenditure conducted by the National Sample Survey Organization (NSSO) to understand the Indian interpersonal distribution.5 These are large, nationally representative surveys that are cross-sectional in nature (i.e. not panels) and usually conducted every five years, in various rounds. The relevant rounds for us are: 50th (1993–1994), 55th (1999–2000), 61st (2004–2005), 66th (2009–2010), and 68th (2011–2012).6 The limitations of these surveys are well known and have been discussed in the literature (e.g. Jayadev et al., 2007; Motiram and Vakulabharanam, 2012) viz., the rich are underrepresented and their consumption is undervalued. These limitations are likely to result in an underestimation of the level of inequality and its increase over time. The consumption expenditure survey in 1999–2000 (55th round) differed in its methodology from previous surveys, and therefore many recent studies ignore it.7 Most studies of inequality in India have used relative measures of inequality (e.g. the Relative Gini (RG) or Theil). These measures are unaffected if the consumption expenditure of every one is scaled up or down by the same factor (e.g. doubled or halved). This requirement, referred to as scale invariance, facilitates comparisons. An important insight provided by Kolm (1973a, 1973b) is that while relative measures have the virtue of convenience, they come with their own ethical baggage. He termed these as ‘rightist’ measures and compared them with ‘leftist’ (absolute) measures and illustrated his point by considering the case of strikes by workers in France in the late 1960s. An analogous hypothetical example can be given from the Indian context: suppose the daily wages of workers and managers, which stand at Rs. 100 and 1000, respectively, are doubled. Inequality, as measured by a relative measure remains unchanged, but since the managers are earning much more than the workers now, some could argue that inequality has actually increased.8 Although still sparse, There is a lack of reliable income data on India, although recently (in 2004–2005 and 2011–2012) the India Human Development Survey conducted by National Council for Applied Economic Research and University of Maryland collected data on incomes. 6  In a departure from past practice, a large survey was conducted in 2011–2012, just two years after the previous one. 7  Before data from the 61st round was released, several studies attempted to make the data from the 55th round comparable to data from previous rounds. See, e.g. Himanshu and Sen (2004a, 2004b) and the references therein. 8  The difference in wages has increased from Rs. 900 to 1800. 5 

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a recent literature has emerged in the Indian context that draws upon these insights and goes beyond relative measures. I will draw upon Motiram (2013) to provide a brief and non-technical description of the relevant concepts and ideas. A more elaborate and technical description is presented in Kolm’s work cited above and Subramanian and Jayaraj (2013). Let ci denote the consumption expenditure of an individual i (= 1, 2, … , N) and μ denote the mean consumption. The RG is as follows: RG =

1 2μ N 2

N

N

∑∑ c i =1 j =1

i

− c j  .

(1)

Note that the RG is unit-less. Absolute inequality measures embody the principle of translation invariance, which requires that they are unaffected if all incomes increase or decrease by the same amount. Examples of absolute inequality measures are the Absolute Gini (AG) and Standard Deviation. The AG is calculated as follows: AG =



1 2N 2

N

N

∑∑ c i =1 j =1

i

− c j  .

(2)

For the above hypothetical example, it is quite easy to see that the AG increases when the incomes of the workers and managers double. However, the AG is not unit-less. Can we preserve the convenience of relative inequality measures while avoiding the ethical problem that they embody? Intermediate measures try to achieve this trade-off by incorporating the principle of unit consistency, which requires that inequality ranking between two distributions is unaffected if both are scaled by the same factor, i.e. inequality comparisons do not depend upon the units in which distributions are expressed. Examples of intermediate measures are the Intermediate Gini (IG) and the product of Standard Deviation and Coefficient of Variation. The IG is determined as follows:



1 1 IG = RG ∗ AG =  μ  2N 2

2

 c i − c j  . (3) ∑∑  i =1 j =1 N

N

Note that IG satisfies unit consistency since RG is unaffected by scaling, and if distributions are scaled by a factor, AG simply gets multiplied by this factor. In my opinion, it is useful to examine inequality using different measures, and I therefore present various estimates in Tables 1 and 2. As we can observe (from column (1)), RG for nominal consumption expenditure has increased in both rural and urban areas, although the increase in urban areas is more pronounced. Column (2) presents the RG for real consumption expenditure, and the trends are roughly

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RG (Real)

AG

IG

W

1993–1994

Year

0.286

0.2844

6.998

1.998

0.222

2004–2005

0.305

0.2997

8.629

2.630

0.227

2009–2010

0.300

0.3059

9.353

2.798

0.223

2011–2012

0.311

Notes: RG: Relative Gini, AG: Absolute Gini, IG: Intermediate Gini, W: Wolfson Index.

Table 2:   Inequality in Monthly Per-Capita Expenditure (MPCE), urban India. Year

RG (Nominal)

RG (Real)

AG

IG

W

1993–1994

0.344

0.3448

13.551

4.664

0.284

2004–2005

0.376

0.3757

16.870

6.342

0.317

2009–2010

0.393

0.4015

21.504

8.455

0.326

2011–2012

0.390

Notes: 1. Estimates for RG (Nominal) are author’s computations from NSS data. 2. Estimates for RG (Real) are from Dubey and Thorat (2012). 3. Absolute and IG are from Subramanian and Jayaraj (2013). These are for real MPCE computed by using Consumer Price Index for Agricultural Laborers (CPIAL) in rural areas and Consumer Price Index for Industrial Workers (CPIIW) in urban areas. 4. Estimates for Wolfson Index are for nominal MPCE and from Motiram and Sarma (2014).

similar. Both AG and IG show increases in rural and urban areas. India is a large country with substantial variation in prices that different households face. Mishra and Ray (2011) take this into account and show that inequality has increased even after doing so. A growing body of research has emerged recently that argues that we should move beyond traditional notions and measures of inequality, particularly if we want to understand conflict. This literature on ‘polarization’ is discussed in greater detail in Chakravarty (2009) and Motiram and Sarma (2014). One important concept in this literature is ‘bipolarization,’ which is based upon the understanding that a decline in the share of the middle could have negative implications for stability and could accentuate the possibility of conflict. Measures of bipolarization are derived by conceptualizing the middle in terms of the median and replacing the Dalton–Pigou principle used in traditional measures of inequality (e.g. RG) with two other principles: Increasing Spread and Increased Bipolarity. The Dalton–Pigou principle holds that a regressive transfer (from a poorer to a richer person) should

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increase inequality and a progressive transfer should decrease inequality. The principle of Increasing Spread holds that bipolarization increases under the following circumstances: a rich person becomes richer or a poor person becomes poorer with the median being unaffected; or a transfer occurs from a poor person to a rich person across the middle (median). On the contrary, Increased Bipolarity holds that bipolarization increases if a richer and poorer person on the same side of the median are brought together due to a transfer from the former to the latter — this process is linked to the formation of poles on either side of the median. One popular index that has been proposed in the literature is the Wolfson Index. Let m and L(0.5) denote the median and the share of consumption held by the bottom half of the population, respectively.9 The Wolfson’s index is denoted as follows: W=



4μ  1 RG   − L(0.5) −  . (4) 2  m 2

From Tables 1 and 2, we can observe that bipolarization has been stable in rural areas, but increased in urban areas since the 1990s. While the above measures are based upon consumption expenditure, the NSSO also conducts an All-India Debt and Investment Survey, which can be used to estimate inequality in wealth. This survey is conducted at less frequent intervals, and for the period that we are interested in, three years are relevant: 1991, 2002, and 2012. Despite the availability of these data, wealth inequality in India has been underexplored (particularly compared to consumption expenditure inequality). Jayadev et al. (2007), Subramanian and Jayaraj (2013), and Anand and Thampi (2016) are some exceptions. Anand and Thampi (2016) present the most recent analysis and show that the RG of wealth as measured by total assets has increased from 0.65 to 0.74. If wealth is measured in terms of net worth, the RG increased from 0.66 to 0.75. Having examined interpersonal inequality, we will now move to group-based inequality. Caste is one of the important forms of social stratification in the Indian context. The ‘caste system’ is incredibly complex, defying easy understanding and generalization, and continues to be the subject of considerable debate and controversy today. In the interest of space, it is not possible to go into these debates, but readers can refer to the following studies (and the references therein): Chatterjee (1998), Gupta (2000), Dirks (2001), and Rawat and Satyanarayana (2016). I will examine the broad caste groupings that secondary statistical data like the NSS allow us to analyze: Scheduled Castes (SC), Scheduled Tribes (ST), Other Backward Classes (OBC), and Others. The first three groups (particularly SCs and STs) have been L(0.5) is nothing but the ordinate of the Lorenz curve at 50% (or 0.5).

9 

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historically disadvantaged against and lag behind on many dimensions: income, education, etc. In fact, the scheduled groups are referred to in this manner because they are given a special place (schedule) in the Indian constitution. Motiram and Naraparaju (2015) presented the cumulative distribution functions (CDFs) of consumption expenditure for these four groups in 2011–2012 and showed that the CDFs of the disadvantaged caste groups lie above that of Others in both rural and urban areas. The average consumptions are lower for the scheduled groups compared to OBCs, who themselves have lower average consumption compared to Others. A serious controversy has erupted in recent times on poverty measurement in India. The official poverty lines recommended by two official committees (Tendulkar and Rangarajan to be artificially low and based upon methodologies that are indefensible.10 However, as the CDFs discussed above reveal (and as noted by Motiram and Naraparaju, 2015), irrespective of the poverty line one uses, there was an unambiguous ranking of poverty rates in both rural and urban areas in 2011–12.11 The Head Count Ratio (HCR) of poverty for the scheduled groups is the highest, followed by the same for OBCs, and then for the Others. Studies that have examined poverty in previous years using official poverty lines (e.g. Motiram and Vakulabharanam, 2011) have come to a similar conclusion. What about poverty of the entire population? In Table 3, I present (from Motiram and Naraparaju, 2015) the various quantiles of real consumption and their growth in the period 2004–2005 to 2011–2012. As we can observe, all the quantiles, including the poorest, have experienced growth. This implies that poverty has fallen, irrespective of the poverty line that is used. However, the poorer groups have grown at slower rates compared to the middle and richer groups; this is particularly pronounced in the urban areas. Motiram and Naraparaju (2015) also show that the poor among disadvantaged caste groups have grown at slower rates compared to the overall average person (median). Motiram and Vakulabharanam (2012) carry out a decomposition exercise to examine whether inequality between scheduled and non-scheduled groups in consumption has increased or not.12 In this exercise, an inequality measure that belongs to the single-parameter entropy family of inequality indices (e.g. Log-Mean Deviation or Theil, see Shorrocks and Wan, 2005) is decomposed into two components: inequality between groups and For a discussion of debates and controversies on Indian poverty, see Subramanian (2012, 2014), Vakulabharanam and Motiram (2012), and the references therein. 11  Technically, this is an instance of first order stochastic dominance. 12  Prior to 1999–2000 (55th Round), the NSS surveys did not enumerate OBCs separately, but combined them with the Others. So, it is only possible to examine the inequality between scheduled and non-scheduled groups. 10 

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86  S. Motiram Table 3:   Growth of rural and urban quantiles between 2004–2005 and 2011–2012, India. Rural (Real) Percentile 5

Urban (Real)

2004– 2005 (Rs.)

2011– 2012 (Rs.)

Growth of the Quantile (%)

2004– 2005 (Rs.)

2011– 2012 (Rs.)

Growth of the Quantile (%)

432.53

525.80

21.56

586.92

726.50

23.78

10

497.70

598.80

20.31

691.62

861.00

24.49

15

549.05

665.30

21.17

774.68

983.50

26.96

20

591.58

721.63

21.98

854.60

1089.00

27.43

25

632.44

772.25

22.11

935.56

1191.50

27.36

30

675.18

826.00

22.34

1015.25

1296.00

27.65

35

714.80

877.17

22.72

1093.67

1397.89

27.82

40

757.16

923.25

21.94

1184.75

1510.25

27.47

45

802.36

976.00

21.64

1285.65

1633.33

27.04

50

849.49

1035.50

21.90

1389.92

1758.00

26.48

55

898.71

1099.63

22.36

1505.73

1905.40

26.54

60

952.26

1167.20

22.57

1626.67

2070.00

27.25

65

1013.08

1248.50

23.24

1783.85

2236.00

25.35

70

1083.05

1335.86

23.34

1936.06

2459.33

27.03

75

1170.16

1447.60

23.71

2145.05

2717.25

26.68

80

1281.28

1582.70

23.52

2415.98

3068.00

26.99

85

1431.20

1771.75

23.79

2762.24

3510.50

27.09

90

1668.92

2053.67

23.05

3313.48

4280.60

29.19

95

2174.28

2626.25

20.79

4446.99

6014.40

35.25

Notes: Data are expressed in 2011–2012 prices. Real values are computed using price indices implicit in official poverty lines. Source: Motiram and Naraparaju (2015).

inequality within groups. The former, and its contribution to overall inequality, can be used to understand whether group-based inequality has increased. After rising during the period 1993–1994 to 2004–2005, inequality between scheduled and non-scheduled groups has fallen since. Class is another important cleavage in the Indian context. Motiram and Naraparaju (2015) use the NSS data on consumption expenditure to divide rural India into seven classes based upon their ‘household type’13 and land possessed: Rural households are divided into five types based upon their main source of livelihood, Self-employed in agriculture, Self-employed in Non-agriculture, Agricultural Laborers, Other Laborers, and Others (a residual category). 13 

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Large farmers (greater than 10 hectares), Medium farmers (between 2 and 10 hectares), Small farmers (between 1 and 2 hectares), Marginal farmers (between 0 and 1 hectare), Self-employed in non-agriculture, Agricultural and other laborers, and Others. They show that the rankings of poverty rates and average consumption are as expected, with the lower classes characterized by higher poverty rates and lower average consumption. In urban areas, Motiram and Naraparaju (2015) use the household type (Self-employed, Regular Wage, Casual Labor, and Others) to divide the population. They show that the poverty rates show a clear ranking from highest to lowest: Casual Labor, Self-employed, and Regular Wage. Average consumption shows the reverse ranking. They also show that consumption of the poor among Casual Laborers has grown at a slower pace compared to the overall average (median). Vakulabharanam (2010, 2014) developed a rigorous class-schema based upon landownership and occupations to classify the Indian population into various classes. He used NSS consumption data and performed a decomposition exercise based on the Gini index to show that class-based inequality has been rising since the 1990s.14 Overall, during the high-growth period since early 1990s, India has witnessed an increase in interpersonal inequality in consumption and wealth. This is robust to the way we conceptualize and measure inequality (traditional: relative, absolute, and intermediate; polarization) although the results look much stronger with absolute and intermediate measures. We should also appreciate the (highly likely) possibility that the real increase in inequality is starker than what the data reveals, given the limitations that we discussed above. Class-based inequality has also increased. Caste-based inequality has come down in consumption and other domains (e.g. education) although there are still stark differences among caste groups.15 Having examined the Indian context, we now move to the Brazilian context.

Brazil in the Age of a Second Democratization In the following discussion, I will draw upon secondary literature to examine inequality and poverty in Brazil in recent decades. Before doing so, it would be worthwhile to provide some background.16 The period since the mid-1980s saw a transition from a military regime and has been described as a phase of “modernization” within a This decomposition is similar to one based upon the single-parameter entropy family of indices discussed above, except for an overlapping component in addition to the between and within components. 15  On the reducing gap in illiteracy, see Nagarajan (2013). Motiram and Sarma (2014) ­present differences in average consumptions. 16  I will draw upon Ferreira de Souza (2012) and Fausto and Fausto (2014, Chapter 10). 14 

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democratic framework (Fausto and Fausto, 2014) or ‘redemocratization’ (Skidmore, 1996).17 Despite the end of military rule and the emergence of a constitution (in 1988), the 1980s and early 1990s saw enormous political and economic turmoil. Fernando Collor de Mello, the elected president resigned in 1992; the rate of inflation kept increasing throughout the 1980s (Baer, 1995 as cited in Skidmore (1996: 194)) and was as high as 2500% in 1993 (Ferreira de Souza, 2012); and five different plans were implemented during the period 1986–1991. The Real Plan (Plano Real) implemented in 1994 tried to control inflation through a new currency, tighter monetary policy, trade liberalization, and privatization. Although this plan was successful in controlling inflation, the Brazilian economy came under stress due to the two crises that hit the world in the late nineties, viz, East Asian and Russian, which led the Central Bank to adopt inflation targeting. In the 2000s, Brazil benefited from Chinese growth, which fueled a rise in the prices of Brazilian exports (commodities) and from increased foreign direct investment. The Brazilian government took advantage of better economic conditions to increase spending on social programs (more on this below). During the period 1998–2007, Brazilian real GDP grew at the average annual rate of 3.0%. In the subsequent years, it displayed high growth rates in 2008 (5.1%) and 2009 (7.5%).18 Given this background, we now turn to an examination of inequality in Brazil. Latin America has historically been characterized by very high levels of inequality.19 In a comparison to various regions of the world in 2004, Lopez-Calva and Lustig (2010, Figure 1-1) show Latin America to be characterized by the highest level of inequality. Latin America has an RG of about 55%, whereas the corresponding figure for South Asia and East Asia are about 40%. Brazil is no exception to this Latin American feature, and has typically been characterized by high levels of inequality, e.g. second highest in the world in 1984 (Ferreira et al., 2008). To understand Brazilian inequality, scholars have used various household surveys, but the Pesquisa Nacional por Amostra de Domicílios (PNAD) is quite popular (Ferreira de Souza, 2012). Like the surveys conducted by NSSO in India discussed earlier, these are large

Fausto and Fausto (2014) divide Brazilian history prior to 1985 into the following phases: 1500–1822, 1822–1889, 1889–1930, 1930–1945, 1945–1964, and 1964–1984. On the contrary, Skidmore (1996) divides it into eight phases: 1500–1750, 1750–1830, 1830–1870, 1870–1910, 1910–1945, 1945–1964, and 1964–1985. 18  These figures are from the Statistical Appendix of the latest World Economic Outlook of the International Monetary Fund (IMF, 2016, Table A4). 19  Cornia (2015) discusses the colonial origins of high inequality in Latin America and shows that Latin American inequality has grown since the nineteenth century. 17 

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Relative Gini

1993

0.60

1995

0.60

1997

0.60

1999

0.59

2001

0.59

2003

0.58

2005

0.57

2007

0.55

2009

0.54

Source: 1993–2007 estimates are from Barros et al. (2010). 2009 estimate is from Ferreira de Souza (2012).

cross-sectional surveys. However, unlike the Indian surveys, these are conducted at more frequent intervals, almost annually. To the best of my knowledge, the literature on Brazilian inequality has focused upon relative measures (e.g. RG) and ratios of income shares of rich and poor quantiles (e.g. richest 20% to poorest 20%) to estimate inequality. I will therefore (and unlike in the discussion on India in the second section) only discuss relative measures for Brazil. Barros et al. (2010) present the RG of income inequality using the PNAD surveys for the 30-year period 1977–2007. Inequality reached its peak level (about 63%) in 1989 and its lowest level (about 55%) in 2007. In Table 4, I present inequality estimates for the period since 1990s from Barros et al. (2010) and Ferreira de Souza (2012). From this table, it is clear that inequality has been falling steadily since the 1990s, although it continues to be high compared to international standards. Among Latin American countries, Brazil is not unique in this regard. Lopez-Calvo and Lustig (2010, Figure 1-2) consider 17 countries in Latin America and show that during 2000–2006, inequality fell in 12 of them, with Ecuador ­registering the sharpest fall. Several scholars (e.g. Ferreira de Souza, 2012; Soares et al., 2016) have pointed out that poverty has been falling in Brazil in recent times. The Brazilian government has suggested two different thresholds of household per-capita income, one for poverty (100 Real) and the other for extreme poverty (50 Real) (Soares et al., 2016). Both poverty and extreme poverty have decreased sharply. During the period 2004–2013, the former fell by about 14 percentage points (22.4% to 8.9%) and the latter fell by about 4 percentage points (7.6% to 4%) (Soares et al. 2016). Average

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income has been rising in Brazil since the mid-1990s, particularly since 2003. The mean real income (household income per-capita, in US dollar Purchasing Power Parity (PPP) terms) grew from $221 in 1995 to $245 in 2003 and then to $372 in 2009 (Ferreira de Souza, 2012, Figure 1). What is more interesting is that the income of all the centiles, including the poor, grew. In fact, the incomes of the poor grew at a much faster rate than those of the middle and richer groups. The growth incidence curve from Ferreira de Souza (2012, Figure 2) has a distinctly downward slope. Moving from interpersonal to group-based considerations, Soares et al. (2016) classify Brazilian households into four groups based upon occupations: agricultural, pluriactive, non-agricultural rural, and non-agricultural urban, based upon source of income and official designation (of rural or urban).20 In the early 2000s, the ranking of deprivation of these groups (highest to lowest) was as follows: agricultural, pluriactive, non-agricultural rural, and non-agricultural urban. Soares et al. (2016, Figure 1A) show that poverty has fallen steeply during 2004–2013 for all the groups; except for Pluriactive households, extreme poverty has also fallen for all groups (Soares et al., 2016, Figure 1B). The performance for the most deprived group, agricultural households, is particularly impressive — poverty has fallen from almost 50% to about 25%, and extreme poverty has fallen from about 20% to about 5%. The share of agricultural households has been falling, whereas the share of non-agricultural urban households has been rising (as is expected from the perspective of structural transformation). On the contrary, the shares of Pluriactive and Non-agricultural rural households have been stable (at about 8% and 4%, respectively). Soares et al. (2016) argue that the stability of the share of pluriactive households, combined with the lack of progress in eradicating extreme poverty among them, is a cause for concern and that these households should be the target of specific policies. Inequality based upon race and ethnicity is also of considerable interest in the case of Brazil and has in fact attracted attention in the media recently, e.g. The Economist (2008) and Barbara (2015). Racial/ethnic inequality has deep historical roots going back to the colonial period and slavery. In the interest of space, I will not 20   

“1. Agricultural households are defined as any household in which at least one member is employed in the agricultural sector, and 67 per cent or more of the household income comes from agricultural activities. 2. Pluriactive households are defined as those in which at least one member is employed in the agricultural sector, but less than 67 percent of the household income is derived from agriculture. 3. Non-agricultural rural households are defined as households located in areas officially designated as rural, but without any household members working in agriculture. 4. Non-agricultural urban households are defined as those located in official urban areas, without any household members working in agriculture” (Soares et al. 2006, p. 3).

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go into these details and instead refer the readers to Skidmore (1996) and Bucciferro (2017). Bucciferro (2017) presents a comprehensive analysis of the evolution of racial inequality on many dimensions: education, life expectancy, occupation, and income. In general, racial differences have narrowed over time, but continue to be high. In the period of concern to us, progress was modest, e.g. the difference between years of education of whites and non-whites has fallen from 2.1 years in 1998 to 1.8 years in 2008. Bucciferro (2017, Figure 5) presents the evolution of incomes of various groups (Black/Pardo, Black, Indigenous, Asian, Pardo (Brown)) relative to that of whites since the 19th century. The ratio of average non-white to white earnings rose from 0.417 to 0.505 during 1998–2008. We now move to a comparison of India and Brazil and some explanations for their different performance.

Comparison and Explanations Over the past two-and-half decades or so, India has grown rapidly, but disparities have also grown. Interpersonal inequality has increased, in whatever way we conceptualize and measure it, particularly in urban areas. Class-based disparities have also increased. One idea that has captured the imagination of both scholars and policymakers in India is ‘inclusion’ or ‘inclusive growth’. In fact, inclusive growth was made an objective by the erstwhile Planning Commission, although its conceptualization was too broad and not operationalized. Several scholars have tried to operationalize the idea of inclusion and examine whether Indian growth has been inclusive. Motiram and Naraparaju (2015) use a framework developed in the literature on pro-poor growth to argue that Indian growth in the 2000s has not been inclusive. They do so by examining whether the growth of quantiles of the poor is adequate or not (in comparison to the growth of the average person). They find that poverty has declined, but the poor have grown at slower rates compared to the middle and richer groups. The shortfall in the growth of the poor is particularly severe in urban areas. They also extend this framework to examine subgroups of the population and find that growth of the poor belonging to disadvantaged groups (castes and classes) has been inadequate. Other scholars (e.g. Jayaraj and Subramanian, 2012a, 2012b; Suryanarayana and Das, 2014) have used other methodologies to assess inclusion, and come to the same conclusion. I have discussed the details of these studies in Motiram (2015), so I will provide only a brief summary here. Jayaraj and Subramanian (2012a, 2012b) draw upon the literature on the “Talmudic Estate Problem” (that concerns the division of an estate among heirs) and the allocation of a poverty alleviation budget. They employ various fairness criteria and use NSS data on consumption expenditure to examine how the pie of Indian growth has

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been divided among various quantiles of the population and among socioeconomic groups. They conclude that the actual allocation among these sections of the population falls short of even the minimally fair criterion. Suryanarayana and Das (2014) examine two different elasticities (mean consumption with respect to mean income, median consumption with respect to mean consumption) and an “inclusive coefficient,” which depends upon the share of the population that has less than 60% of the median consumption. The above elasticities have to be greater than unity and the inclusive coefficient needs to be high for growth to be considered broad-based. They consider the entire population and disadvantaged caste groups and use NSS data on consumption expenditure to conclude that this is not the case — in fact, they find that the inclusive coefficient has fallen during the period 1993–1994 to 2011–2012. Why has high growth in India not translated into inclusion? Why has Indian inequality increased? First, policies followed since the early 1990s (of course, in conjunction with other factors) have benefited the richer groups disproportionately. In particular, remunerative jobs that can absorb the rural or urban poor have not been created adequately. Creation of jobs in labor-intensive manufacturing would have gone a long way toward alleviating poverty and increasing the incomes of the poor. However, this has not occurred and manufacturing has been quite sluggish. Instead, jobs have been created in sectors like construction — in particular, rural construction — these jobs are not remunerative.21 To explain this, some have focused on labor regulations as the culprit, but this is in my opinion a red herring.22 Paradoxically, the nature of the growth process itself, and increasing inequality, is likely to be responsible for this. The growth process has disproportionately benefited the rich and created a demand for goods (e.g. foreign vacations, iPhones) that do not give a fillip to investment and job-creation in labor-intensive sectors.23 Second, policies toward the social sector and social welfare have been inadequate. The Mahatma Gandhi National Rural Employment Guarantee Act (MNREGA) (an employment guarantee scheme in rural India) put in place by the United Progressive Alliance government that came to power in 2004 elections has undoubtedly contributed to improvement in rural areas, but its implementation has varied across states. No comparable scheme exists in urban areas, where the fight against poverty has seen serious setbacks.24 Moreover, some of the welfare schemes suffer from poor For details of jobs created since 1993–1994 in various sectors, see Thomas (2014). See Papola and Pais (2007) and Papola (2013) for an extensive discussion of labor regulations and their reform. 23  See Kotwal et al. (2011) for a detailed discussion. 24  See Mishra and Ray (2011), and Vakulabharanam and Motiram (2012) for a discussion of this issue. 21  22 

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implementation, e.g. Construction Worker Welfare Boards have been put in place, and money has also been allotted to them, but many construction workers are not even aware of their existence (e.g. see Naraparaju, 2015, for an example from Navi Mumbai). Coming to Brazil, inequality continues to be high, but has fallen substantially. Both poverty and extreme poverty have fallen. Some studies that have rigorously examined whether Brazilian growth has been pro-poor or not have concluded in the affirmative, e.g. Kakwani et al. (2010) for the period 2001–2004. Why has inequality fallen and growth been pro-poor? Several studies shed light on this question. Barros et al. (2010) use a decomposition analysis to understand the various proximate factors that have contributed to the reduction in inequality. A major contribution has been made by change in the distribution of labor income per adult, which has in turn been driven by a reduction in skill premium and decrease in educational inequality. A second important component is the change in the distribution of non-labor income per adult. Non-labor incomes have increased considerably due to public transfers — pensions, social security benefits, and conditional cash transfers (Bolsa Escola and Bolsa Familia). Ferreira et al. (2009) provide evidence from several studies to show that social policies and their effective targeting have played a major role in reducing inequality and poverty.25 They also document expenditures on the social sector since the 1980s (Ferreira et al., 2009, Figure 1) showing that there is a sharp increase after 1988, when the constitution came into effect, e.g. during the period 1991–1998, the monthly benefit bill increased by more than four times ($180–750 million). Ferreira de Souza (2012) points out that social security and pensions comprised about 11% of the GDP in 2006. He also highlights the crucial role played in the reduction of inequality and poverty by the minimum wage, which is also linked to government benefits. Since the constitution came into effect, the minimum wage has increased considerably — in real terms it more than trebled (US $PPP 83 to US $295) during the period 1995–2011 (Ferreira de Souza, 2012, Figure 6). Cornia (2015, Table 8) also documents a substantial increase in real minimum wage in Brazil as well as in some other Latin American countries. The comparison of India and Brazil illustrates the key role of social policy in the reduction of inequality and poverty — the success of Brazil despite much lower growth can be attributed largely to this. It is also worth commenting briefly about the role of ideology and the different political regimes that India and Brazil have witnessed. Indian state and elites have displayed only a lukewarm commitment toward the social sector and poverty alleviation. Rubrics like neo-liberal, Kakwani et al. (2010) have also highlighted the crucial role that social policies have played in protecting the poor from adverse shocks and delivering pro-poor growth.

25 

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pro-business, and predatory that have been applied to the Indian state in recent times are quite ­suggestive.26 By the standards of even developing countries, Indian public expenditure on the social sector is abysmally low. A good illustration of this can be provided by examining public expenditure on health, which in 2013 stood at 1.2% of GDP, much lower than the same for Brazil (4.2%), Mexico (2.9%), and China (2.7%).27 On the contrary, the Brazilian state (at least in some phases) has shown a more social democratic character. In this regard, Brazil has not been an exception, and many Latin American governments, which have been left-wing have shown a more serious commitment toward redressing inequality and alleviation of poverty. Cornia (2015) classifies Latin American countries in the decade of 2000s into four groups based upon the ideological profiles of the governing parties: Radical Left, Social Democratic Left, Centrist, and Center Right and Right. He shows that the sharpest decreases in inequality per year have been experienced by the countries ruled by the Social Democratic Left, followed by the Radical Left, Centrist, and Center Right and Right. He classifies Brazil under Social Democratic Left and shows that it experienced a decline of 0.65 percentage points per year in its Gini index during the period 2003–2009. He also conducted a regression analysis for the entire Latin American region to show that the nature of the regime (social democratic and radical populist) and quality of democracy are significantly associated with lower inequality.

Discussion and Conclusions In the analysis above, I have provided an overview of changes in inequality and poverty in India and Brazil in roughly the past two and half decades. In India, inequality has increased, and although poverty has decreased, the reduction has been disappointing given the high growth. On the contrary, in Brazil, inequality and poverty have both reduced substantially, although inequality still continues to be quite high. This chapter highlights the crucial role played by social policies in these differential outcomes. Before concluding, it is important to make two caveats. First, as we have discussed above, Brazil has made only modest progress in the reduction of ethnic/ racial inequality. While social policy has been effective in reducing interpersonal For a recent survey of conceptualizations of the Indian state, see Nagaraj and Motiram (2017). 27  The comparison with developed countries is even starker: US — 8.5%, UK — 8.0%, and Norway — 8.1%. These figures are taken from the Economic Survey of India, Government of India (2013). Also see Kohli (2002) and Dreze and Sen (2013). 26 

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and class-based inequalities, it did not contribute much on this front. Based upon a rigorous methodology and after considering various types of fiscal measures, Pereira (2016) concludes that: “Fiscal interventions did not have a significant impact in reducing the divide between whites and non-whites in Brazil.” Brazil therefore serves as a good example of why horizontal inequalities merit serious attention and are distinct from vertical inequalities. Second, scholars have argued that some of the Brazilian policies have reached their limits, e.g. see Ferreira de Souza’s (2012) discussion on the minimum wage. This issue and the fiscal concerns involved in sustaining the social programs currently in place, require further discussion.

References Anand, I. and A. Thamphi (2016). “Recent trends in wealth inequality in India,” Economic and Political Weekly, LI(50): 59–67. Balakrishnan, P. (2010). Economic Growth in India: History and Prospect, New Delhi: Oxford University Press. Barbara, V. (2015). “In denial over racism in Brazil,” The New York Times, March 23, 2015. Barros, R., M. de Carvalho, S. Franco and R. Mendonca (2010). “Markets, the State and the Dynamics of Inequality: The Case of Brazil,” Discussion Paper, UNDP, New York. Bhadhuri, A. and D. Nayyar (1996). The Intelligent Person’s Guide to Liberalization, New Delhi: Penguin Books. Bucciferro, J. R. (2017). “Racial Inequality in Brazil from Independence to Present”, in L. Bertola and J. Williamson (eds.), Has Latin American Inequality Changed Direction: Looking Over the Long Run? Springer Open. Chakravarty, S. (1987). Development Planning: The Indian Experience, New Delhi: Oxford University Press. Chakravarty, S. (2009). Inequality, Polarization and Poverty: Advances in Distributional Analysis, New York: Springer. Chatterjee, P. (1998). The Nation and its Fragments: Colonial and Postcolonial Histories, Minneapolis: University of Minnesota Press. Cornia, G. A. (2015). “Income inequality in Latin America: Recent decline and prospects for its further reduction,” Working Paper No. 2015/020, UNU-WIDER, Helsinki. Dirks, N. (2001). Castes of Mind: Colonialism and the Making of Modern India, Princeton, NJ: Princeton University Press. Dreze, J. and A. K. Sen (1995). India: Social Opportunity and Development, New Delhi: Oxford University Press. Dreze, J. and A. K. Sen (2013). An Uncertain Glory: India and its Contradictions, London: Allen Lane. Dubey, A. and S. Thorat (2012). “Has Growth Been Socially Inclusive during 1993–4 – 2009–10?” Economic and Political Weekly, 47(10): 43–53.

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Fausto, B. and S. Fausto (2014). A Concise History of Brazil, Cambridge: Cambridge University Press. Ferreira de Souza, P. (2012). “Poverty, Inequality and Social Policies in Brazil, 1995–2009,” Working Paper No. 87, International Policy Centre for Inclusive Growth (IPC-IG), UNDP, Brasilia. Ferreira, F. H. G., P. G. Leite, and M. Ravallion (2009). “Poverty reduction without economic growth? Explaining Brazil’s poverty dynamics, 1985–2004,” Journal of Development Economics, 93(1): 20–36. Government of India (2013). “Human development,” Economic Survey of India 2012-13, New Delhi: Government of India, pp. 269–294. Gupta, D. (2000). Interrogating Caste: Understanding hierarchy & difference in Indian Society, New Delhi: Penguin Books. Himanshu and A. Sen (2004a). “Poverty and Inequality in India-I,” Economic and Political Weekly, 39(38): 4247–4263. Himanshu and A. Sen (2004b). “Poverty and Inequality in India-II,” Economic and Political Weekly, 39(39): 4361–4375. IMF (2006). World Economic Outlook: Statistical Appendix, International Monetary Fund, Washington DC, USA. http://www.imf.org/external/pubs/ft/weo/2016/02/Accessed on December 15, 2016. Jayadev, A., S. Motiram and V. Vakulabharanam (2007). “Patterns of wealth disparities in India during the liberalisation era,” Economic and Political Weekly, 42(39): 3853–3863. Jayaraj, D. and S. Subramanian (2012a). “On the interpersonal inclusiveness of India’s consumption expenditure growth,” Economic and Political Weekly, XLVII(45): 56–66. Jayaraj, D. and S. Subramanian (2012b). “On the inter-group inclusiveness of India’s consumption expenditure growth,” Economic and Political Weekly, XLVII(10): 65–70. Joshi, V. and I. M. D. Little (1996). India’s Economic Reforms, 1991–2001, New Delhi: Oxford University Press. Kakwani, N., M. C. Neri and H. Son (2010). “Linkages between pro-poor growth, social programs and labor market: The recent Brazilian experience,” World Development, 38(6): 881–894. Kohli, A. (2012). Poverty Amid Plenty in the New India, New Delhi: Cambridge University Press. Kolm, S.-C. (1976a). “Unequal inequalities I”, Journal of Economic Theory, 12(3): 416–442. Kolm, S.-C. (1976b). “Unequal inequalities II”, Journal of Economic Theory, 13(1): 82–111. Kotwal, A., B. Ramaswami and W. Wadhwa (2011). “Economic liberalization and Indian economic growth: What’s the evidence?” Journal of Economic Literature, 49(4): 1152–1199. Lopez-Calvo, L.-F. and N. Lustig (eds.) (2010). “Explaining the decline in inequality in Latin America: Technological change, educational upgrading and democracy” Declining Inequality in Latin America: A Decade of Progress? Baltimore, MD: Brookings Institution Press. Mishra, A. and R. Ray (2011). “Prices, inequality and poverty: Methodology and Indian evidence”, Review of Income and Wealth, 57(3): 428–448.

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Motiram, S. (2013). “Growth, poverty and disparities in India, 1993–2013,” South Asian Journal, 42, 30–39. Motiram, S. (2015). “Has Indian growth been inclusive? Theoretical concepts and evidence,” Yojana, Ministry of Information and Broadcasting, Government of India, New Delhi. Motiram, S. and V. Vakulabharanam (2011). “Poverty and inequality in the age of economic liberalisation,” in Dilip Nachane (ed.), India Development Report, New Delhi: Oxford University Press. Motiram, S. and V. Vakulabharanam (2012). “Indian inequality: Patterns and changes, 1993–2010,” in Mahendra Dev (ed.), India Development Report, New Delhi: Oxford University Press. Motiram, S., and N. Sarma (2014). “Polarization, inequality and growth: The Indian e­ xperience,” Oxford Development Studies, 42(3): 297–318. Motiram, S. and K. Naraparaju (2015). “Growth and deprivation in India: What does recent evidence suggest on “inclusiveness?” Oxford Development Studies, 43(2): 145–164. Motiram, S. and R. Nagaraj (eds.) (2017). “Introduction: From ‘intermediate regime’ to crony capitalism,” Political Economy of Contemporary India, Cambridge: Cambridge University Press. Nagaraj, R. (2013). “India’s dream run 2003–2008: Understanding the boom and its aftermath,” Economic and Political Weekly, XLVIII(20): 39–51. Nagaraj, R. (2015). “Seeds of doubts on new GDP numbers: Private corporate sector overestimated?,” Economic and Political Weekly, L(13): 14–17. Nagarajan, R. (2013). “SC/STs take rapid strides, close literacy gap,” Times of India, November 10, 2013. Naraparaju, K. (2015). Essays on Labour Markets and Inclusive Growth in India, Unpublished Dissertation, Indira Gandhi Institute of Development Research, Mumbai. Papola, T. S. (2013). “Role of Labor Regulation and Reforms in India: Country Case Study of Labor Market Segmentation,” Employment Working Paper No. 147, International Labour Office, Geneva. Papola, T. S. and J. Pais (2007). “Debate on labour market reforms in India: A case of misplaced focus,” The Indian Journal of Labour Economics, 50(2): 183–200. Pereira, C. (2016). “Ethno-racial poverty and income inequality in Brazil,” in N. Lustig (ed.), Commitment to Equity Handbook: A Guide to Estimating the Impact of Fiscal Policy on Inequality and Poverty. Washington, D.C.: Brookings Institution Press and CEQ Institute, Tulane University. Rawat, R. and K. Satyanarayana (eds.) (2016). Handbook of Dalit Studies, Durham: Duke University Press. Shorrocks, A. and G. Wan (2005). “Spatial decomposition of inequality,” Journal of Economic Geography, 5(1): 59–81. Skidmore, T. (1996). Brazil: Five Centuries of Change, Oxford: Oxford University Press. Soares, S., L. De Souza, W. Silva, F. G. Silveira and A. Campos (2016). “Poverty Profile: The rural North and Northeast of Brazil,” Working Paper No. 138, International Policy Centre for Inclusive Growth (IPC-IG), UNDP, Brasilia.

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Srinivasan, T. N. (2000). Eight Lectures on Indian Economic Reforms, New Delhi: Oxford University Press. Stewart, F. (2001). “Horizontal inequality: A neglected dimension of development”, in 5th UNU-WIDER Annual Lecture, Helsinki. Stewart, F. (2010). “Horizontal inequalities as a cause of conflict: a review of CRISE findings”, No.1, January 2010, Centre for Research on Inequality, Human Security and Ethnicity, Oxford. Subramanian, S. (2012). The Poverty Line, New Delhi: Oxford University Press. Subramanian, S. (2014). “The poverty line: Getting it wrong again…again,” Economic and Political Weekly, 49(47). Subramanian, S. and D. Jayaraj (2013). “The evolution of consumption and wealth inequality in India: A quantitative assessment”, Journal of Globalization and Development, 4(2): 253–281. Suryanarayana, M. H. and M. Das (2014). “How inclusive is India’s reform(ed) growth?” Economic and Political Weekly, XLIX(6): 44–52. The Economist (2012). “Race in Brazil: Affirming a divide,” The Economist, January 28, 2012. Thomas, J. J. (2014). “The demographic challenge and employment growth in India,” Economic and Political Weekly, 49(6): 15–17. Vakulabharanam, V. (2010). “Does class matter? Class structure and worsening inequality in India,” Economic and Political Weekly, 45(29): 67–76. Vakulabharanam, V. (2014) “Rising inequality in India: The role of class and global capitalist dynamics,” Presented at the conference Religious Pluralism, Cultural Differences, Social and Institutional Stability: What can we learn from India, at Sapienza, University Di Roma, Dipartimento Di Scienze Politiche, June 9–10. Vakulabharanam, V. and S. Motiram (2012). “Understanding poverty and inequality in urban India since reforms: Bringing quantitative and qualitative approaches together,” Economic and Political Weekly, XLVII(47–48): 44–52.

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CHAPTER 6

Sustainable Development and BRICS: Unity Amid Diversity? Anup Sinha Heritage Business School, Kolkata, India

Introduction Sustainable development is about ensuring that the current generations of human beings live in such a fashion that all other living beings, including future generations of human beings, can live within the limited resources available on the planet earth. Human development, with amazing growth in material goods and services aided by technology as well as the energy obtained from fossil fuels, has been quite dramatic in the last 200 years or so. However, it is being increasingly realized that in the process of material growth and development, human beings have wrought severe damage on the physical and natural environment. Some of the damages have been considered to be irreversible and global in nature, such as climate change and its effects. Hence, sustainable development is a global problem that must be tackled through an international consensus on strategies and policies. Within this bigger rubric of global interventions, there are some problems that are local in character and require national or even municipal interventions. For instance, the preservation of biodiversity or some endangered species may be a national problem requiring national policies for conservation and protection. Another example of a local problem could be a factory emitting noxious fumes that cause some serious lung diseases. This is a problem with limited effects around the physical neighborhood 99

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of the factory. A simple solution would be to close it down, or force it to change its technology, or at least pay a price for the social health costs its pollution creates. Given the way our modern societies are organized, nation states do have an important role to play in ensuring the world moves on to a sustainable development path. First of all, when a global problem is being tackled, say for instance global warming and climate change, a global consensus on the policy or actions that are to be taken is required. However, nation states have to agree to the solution and undertake their own parts of the action, consistent with the global decisions. Second, their own national policies can go a long way in efficiently tackling local problems of environmental conservation and protection. Third, a government can play a very critical role in creating an enabling atmosphere where individuals and communities make plans and undertake innovative solutions at the grassroots level. Fourth, the nation state can create social features of sustainable living in terms of improved wellbeing measured in terms of more employment, higher incomes, higher educational attainments, and better health and sanitation facilities. Finally, the nation state might influence, through mass communication techniques, a better sensitization of citizens to the importance of sustainable development. This in turn would nurture an individual’s commitment to changing one’s own lifestyle and consumption habits. Hence even though sustainable development is a global issue, national policies and interventions are an important part of any solution that will drive the world economy on to a sustainable pathway (Sarkar and Sinha, 2018). In the next section, we discuss some of the sustainability issues that are germane to a nation state and its governance. This will give us a better understanding of the importance of the nations referred to as BRICS — Brazil, Russia, India, China, and South Africa.

Environmental Issues, the Nation State, and BRICS Nation states, defined territorially in terms of political boundaries, face a variety of environmental problems (United Nations, 2013). The most common of these problems are air pollution and carbon dioxide emissions, water pollution, loss of soil fertility due to overuse of fertilizers and pesticides, and the presence of chemicals in everyday life such as those found in food, toiletries, and cosmetics. Loss of biodiversity and interrupted bio-geo-chemical cycles like the nitrogen cycle and phosphorous cycle are also present in many nations. Along with these ‘bads’ (opposite of economic goods), there are problems of depletion of resources necessary to support life like fresh water, marine stocks, and the fertility of the top soil (without which food would not be available). The extent of these problems varies from nation to nation, depending on the level of effective government policies, overall economic development, educational attainments, and the geography of the place. For instance, a nation

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like Saudi Arabia that is dependent heavily on a finite stock of oil for development, may face one set of problems related to a non-renewable resource for sustainable development, while another nation like Bolivia may face problems related to cutting down of rainforests for timber and fuel without an adequate pace of replenishment of trees and biodiversity. Other nations like China or India may face problems from a burgeoning population requiring more thermal power and urban space along with the rapidly growing number of cars and trucks. Hence, each country needs to address its own specific set of problems, yet be consistent with global goals and targets. BRICS is not one nation. It is a set of five countries that are quite diverse and spread over four continents — Brazil in South America, Russia in Europe, India and China in Asia, and South Africa in Africa. BRICS was born out of a changing political world order. The unipolar world after the Cold War with US hegemony gave way to a multipolar system after the great financial crisis of 2008. The BRICS nations were growing rapidly and collectively constituted a significant share in the global economy. Goldman Sachs conducted a study which claimed that these economies would be the fastest growing ones and by 2050 would provide leadership to the world economy. In the report, O’Neill (2001) claimed that these nations, especially China, would affect the rest of the world through their domestic policies, particularly fiscal and monetary policies. It was only after the publication of the report that the BRICS began to be considered together and aroused new interest in their progress. In data collected by Santana et al. (2014) Brazil, Russia, India, and China together accounted for 28.9% of the world’s land area, 43.2% of the world’s population, and 20.6% of crude oil production and even generated about 27% of the world’s gross domestic product (GDP). In 2010, South Africa was added to the BRIC acronym. It is quite clear that though these countries are treated as one block, their political, social, cultural, and economic features are quite diverse. Despite their diversity in many respects, they were still treated as one for many other reasons of similarity. It was considered that these nations would comprise the largest economic block by 2050 because of their tremendous growth potential. The similarities were attributed to the presence of fertile land, abundant natural resources, and the large low-cost labor force. This combination of factors, along with good infrastructure, made these nations attractive to foreign direct investment. These features of infrastructure were telecommunications, which was growing rapidly, sharp rise in electricity consumption, increased access to water and growing urbanization, better sanitation, and improved road and rail connectivity. In terms of social and environmental development, all these countries had been successful in pulling a significant number of people out of poverty, allowing for greater consumption levels. All the BRICS are committed to a better environment and have preemptive as well as corrective policies in place to protect and conserve the natural environment. They all share the common aspiration to achieve a better quality of life for their citizens.

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However, despite these positive features, BRICS do have problems that need quick and systematic remedies. These pertain to economic inefficiencies; lack of education, sanitation, and health facilities; and depletion of resources along with very alarming levels of urban pollution. Many of these problems have been a result of rapid economic growth that these nations have experienced in the recent past. Global Citizen (2016) computed a People’s Report Card 20161 grading nations in terms of their performance in relation to the Sustainable Development Goals that replaced the Millennium Development Goals of the United Nations. The report took 2030 as the target date within which the goals were to be achieved. If all the goals were to be achieved, the world would get an A grade. This would be the benchmark, and then 2016 data would be compared to the ‘perfect’ grade, and a relative grade assigned to a nation for 2016. The report computed three sets of indicators: basic needs, well-being, and opportunities. Basic needs included nutrition, medical care, water and sanitation, and shelter and personal safety. The world grade was a C. Well-being included access to basic knowledge, access to information, communications, health and wellness, and the quality of the physical environment. In this category, the world’s grade was slightly better at C+. Finally, the set of opportunity included personal rights, freedom of choice, tolerance and inclusion, and access to advanced education. Here the global grade was C once again. The three sets of measured characteristics were aggregated into a Social Progress Index and the world’s grade was marked as C+ in 2016. The social progress index was computed for a number of countries. Ten nations received an A grade. These included Canada, United Kingdom, Sweden, Finland, and Austria. The worst performers with a grade of D− included Afghanistan, Angola, Central African Republic, Chad, and Yemen. The BRICS were not too good. Brazil was the best with a grade of B−, Russia, China, and South Africa received a grade of C+ which was at par with the world grade. India was the worst performer at D+. These results, though only indicative to a large extent, and perhaps not exhaustive, do reveal that the BRICS may have a long way to go before they can claim to have achieved some important goalpost for sustainable development.

BRICS: The Emerging Superstars of Growth In the BRICS countries, the market-friendly model of development has made them the emerging superstars of world economy, but they have experienced rising inequality and unacceptable levels of poverty and serious environmental damage  http://www.globalcitizen.org/ People’s Report Card (2016) (accessed June 3, 2018).

1

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as a consequence. The real challenge is whether these nations, if they are to lead the world economy in 2050, attain a path of sustainable development? What might be needed is a new model of development that consciously cooperates in changing the energy portfolio to a substantial degree, lowers the ecological footprint, redefines innovations in terms of eco-efficiency, and significantly reduces carbon dioxide and other green-house gas emissions. Brazil is still plagued by drought (through deforestations in the Amazon) and urban pollution, Russia is considered to be terribly inefficient and unsustainable in its energy use patterns. India is marked by large-scale urban pollution and is the third largest emitter of carbon dioxide. China is similarly affected by the consequences of rapid economic growth. Air pollution is markedly high, and China has achieved the dubious distinction of being the highest polluter in the world in terms of carbon dioxide emissions. It may be noted that as per the agreement of the Kyoto Protocol in February 2005, the task of reducing green-house gases and mitigating the effects of global warming were differentiated across developed and developing nations. The Annex I developed countries were accountable for their emissions and expected to reduce them in a systematic way. The Non-Annex I nations on the other hand (mostly developing countries) were not required to reduce emissions except as a voluntary measure. Russia is in Annex I while the other BRICS are in Non-Annex I. Would it be possible to put some numbers to the trends that are observed in terms of economic efficiency, social progress, and environmental improvements? A few studies have been done (Mizhou Research Institute, 2005)2 to try and put comparative values on the three important aspects of sustainable development, namely economic, social, and environmental aspects. Also, it is important that the BRICS show signs of innovative strategies toward sustainability. Exclusive focus on economic growth (from where the concept of BRICS began) will not suffice. The damages from very high rates of growth are well known and noticeable in the BRICS. In a way, what made BRICS a center of attention is exactly the opposite of what is required to keep it in the limelight as global leaders in 2050. The next section discusses some of the important empirics of BRICS success or failure to live up to the expectations it originally generated.

What the Data Suggest This section draws on the results obtained by Santana et al. (2014) in a study done on the BRICS nations. The study is based on real data from 2000 to 2007 using the Data http://www.esri.go. Comparative Analysis of the BRICS: Report prepared by the Mizuho Research Institute Ltd. For the Commission of the Economic & Social Research Institute (2005). 2 

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Envelope Analysis (DEA) technique. The study measured the efficiency of economic, environmental, and social processes where inputs considered were gross fixed capital formation, expenditures on research and development, and employed population. The outputs considered were GDP for economic efficiency, carbon emissions for environmental efficiency, and life expectancy at birth for social efficiency. The following table shows the mean total efficiency results, according to each country. The higher the number, the more efficient is the process. Country

Economic

Environmental

Social

South Africa

0.66

0.99

0.76

Brazil

0.98

0.90

0.99

China

0.65

0.21

0.56

India

0.49

0.81

0.49

Russia

0.51

0.78

0.89

If one considers the ranks, and the sum of ranks, we get the following: Country

Economic

Environmental

Social

Sum of Ranks

South Africa

2

1

3

6

Brazil

1

2

1

4

China

3

5

4

12

India

5

3

5

13

Russia

4

4

2

10

There are a few obvious features of the results that emerge. The countries considered within the block called BRICS are quite heterogeneous, not only in terms of geo-political and other socio-cultural features but also in terms of economic, environmental, and social efficiencies. Overall, Brazil is the best performer given the lowest sum of ranks. India followed closely by China, being the giants in the group, are significantly less efficient that Brazil or South Africa. If we go by environmental efficiency alone, then again Brazil and South Africa perform better than the others, and China is by far the worst.

China Even though China is the largest economy in BRICS and the second largest in the world, with the highest fixed capital, its overall performance leaves much to be desired. China’s argument against cutting down of carbon emissions has been that it needs to grow fast for a longer period of time to remove poverty and unemployment.

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Hence, its performance cannot be expected to be moving to a sustainable path, at least in terms of carbon emissions. China has the highest carbon dioxide emissions in the world, and its economic efficiency (despite phenomenally high growth rates) has been poor. It implies that energy efficiency would be low, and the ability to use resources well, including labor, would be below par. This is revealed in the value for social efficiency too. Despite having the highest input value, its mean efficiency is only 56%. Poverty reduction, energy efficiency, creation of greater equality, and better management of urbanization remain challenges that will hold back China from transitioning to a sustainable development path in the near future. China’s sustainable development strategy covers four broad areas. They are overall macropolicies, social development, sustainable economic development, and protection of natural resources. These four areas are further divided into nine priority areas covering capacity building, sustainable agriculture, cleaner industry, cleaner energy, conservation of nature, pollution control, poverty reduction, population control, and biodiversity conservation. These broad goals and priorities are embodied in the 5-year plans of China as formulated by the national government. China faces a severe resource shortage, and in important resources such as land, water, and petroleum its per capita resource base is far lower compared to the global average. Also, many of the natural resources are distributed unevenly across China, leading to problems of demand and supply in regions. China’s environmental and ecological damage is quite severe. In some cities, air pollution has marked negative health effects on citizens. Water shortage in many regions has compromised the quality of drinking water for residents. The desertification of land and grassland has been occurring at an astonishing pace. China has realized that it requires substantial legal reforms to ensure that its sustainable development strategies can be implemented without too many legal hurdles and costly litigation. China has also taken initiatives to report on a regular basis to the United Nations Framework Convention on Climate Change (UNFCCC). Hence, its emissions and sinks of green-house gases would be known publicly: the steps taken as well as the results arising from them.

India India is the second largest economy in BRICS with high amounts of fixed capital and investments in technological innovations. Yet its economic efficiency is low. India ranks last in both economic efficiency and social efficiency. Even in terms of environmental efficiency, though ranked fourth, the mean efficiency in India is much higher than that of China, at 81%. However, despite this, India is now the third largest emitter of carbon dioxide in the world after China and USA. On this count itself, India, with its excessive dependence on coal, needs to do much better in terms of energy efficiency.

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Like in China, the reduction of poverty remains the key challenge. Associated with this issue of poverty, there are deep rooted issues of unemployment, low income, low levels of educational attainment, and poor health infrastructure. Like China, India too has argued in international fora that it needs to grow faster for a longer period of time to reduce poverty, and hence may not be able to bring down its emission levels in the near future. The strategy for sustainable development in India is contained in a detailed study ‘Empowering People for Sustainable Development’ (EPSD). There was no separate plan for sustainable development. Details of projects would be contained in the nation’s 5-year plan documents, until recently when formal planning was discontinued altogether. The EPSD has four main objectives. They are combating poverty, empowering people, using core competence in science and technology, and setting environmental standards, conservation of natural resources, and improving the core sectors of the economy. There is a sectoral thrust in the EPSD document. While the natural environment’s importance is acknowledged, there is an equal importance assigned to the growth of the energy sector, transportation, and manufacturing industry. Separate targets are set and monitored such as the poverty rate, gender gaps, increase in forest cover, reduction in population growth rate, and increased access to education. According to the Ministry of Environment and Forests, the economy is considered as a sub-system of the regional ecosystem. Hence, a large number of legislations and regulations have been enacted since the 1980s covering air, water, biodiversity, forests, pollution control, and waste management. There are a number of specialized institutions as well that provide research and knowledge for policymakers to take more informed decisions, like the Centre for Environment Education and the Tata Energy and Resource Institute and a number of other civil society organizations.

Brazil Brazil, in the set of BRICS, is the most efficient economy. Brazil is the leading economy in South America and contains rich resources in the form of good agricultural land, mines, as well as developed manufacturing and services sectors. Its per capita income is much higher than that of China or India. Its macroeconomic policies have resulted in low inflation and low public debt. Brazil’s environmental performance is creditable, despite its constant pressure to preserve and maintain its large rainforest terrain. Its environmental efficiency value at 90% is quite good in this regard. Brazil is one of the leaders in climate negotiations by voluntarily pledging to cut emissions. The challenges Brazil face pertain to deforestation, soil degradation, oil spills, water pollution, and loss of biodiversity. In terms of social efficiency, Brazil

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ranked first. Brazil’s stable economic growth (until the recent slowdown) improved social welfare outcomes, and programs designed to lower inequalities have all gone well for the economy. Brazil’s strategies to combat unsustainable development focus on the following broad areas: the transition to a knowledge society, social inclusion for solidarity, rural and urban sustainability, strategic use of natural resources like water, forests, biodiversity, and improved governability and ethics to promote sustainability. Brazil, however, does not embed its sustainability strategy as a national policy objective, though policy objectives do include economic development, social upliftment, and environmental protection. While the concept of responsibility to the future is not a central theme in its policies, the reduction of social and economic inequalities is a top priority. This is done through a twin approach. A federal agency is assigned the task of distributing free food and making compensatory redistributive policies. The government also promotes a variety of specific partnerships among civil society organizations, private sector companies, and government departments to design and support programs for poverty reduction. In terms of selected initiatives of interest, Brazil has come up with an innovative law that defines and penalizes a set of activities dubbed as environmental crimes, which include many infractions from killing of wild animals to creating industrial pollution. Brazil is home to the largest part of the Amazon rainforest, and its destruction often catches the attention of the world simply because of the sheer magnitude of natural wealth contained in the rainforest. A special control program has been designed by the Brazilian government to limit deforestation and unauthorized exploitation. A special commission has also been set up to coordinate the sustainable development presided over by the nation’s Minister of the Environment.

Russia Russia has undergone many changes since the collapse of socialism. It is now market based, participating in the global economy. Russia, however, has been depending heavily on the exploitation of its natural resources like oil, and hence its economic efficiency has suffered. In the BRICS group, Russia has the second lowest GDP after South Africa. Russia’s carbon dioxide emissions remain high as well. Russia has experienced growth in manufacturing industries and services, but still continues to remain vulnerable to global oil price fluctuations. Russia is also exposed to local and regional strife that often attracts international sanctions. On the social efficiency score, Russia is ranked second after Brazil. A large part of this social development is a remnant inherited from the socialist past — especially in the areas of education and health. Russia has had a relatively high per capita GDP and strong growth in

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wages and incomes. However, there remain disagreements about the source of this recent growth: whether it is from a strong economic base of industrialization, or whether it was due to the rising prices of oil and natural gas. Russia is no longer a superpower and its economy has been slowing down in the recent past, primarily due to the sanctions against the nation imposed by EU as well as USA after the Ukraine crisis and the annexation of Crimea. Environmental problems like the melting of the permafrost and the sudden drought that decimated the wheat crop in 2010 and sent global wheat prices soaring are somewhat in line with the kind of problems faced by the other BRICS nations. However, political challenges are much more complex than those faced by the others in BRICS. Russia has also cracked down on NGOs doing work for social upliftment and environmental protection, treating them as foreign agents if they received international grants. However, some good news still emerges out of Russia on the purely environmental front. Russia houses some of the world’s most important fisheries. The Walleye Pollock Fishery in the Sea of Okhotsk has earned the Marine Stewardship Council Sustainability Certification, and the cod fishery in the Barents Sea is being considered as a model of international cooperation. Forestry is another area that makes Russia particularly vulnerable to environmental degradation. About 45% of land in Russia contains 22% of the world’s total forest cover. Of this, 33 million hectares of forests have earned the Forestry Stewardship Certification for responsible forest management.

South Africa South Africa is the smallest of the BRICS nations. On the economic efficiency front, it is quite modest with a mean efficiency of 66%. It was only quite recently that the nation embarked on a comprehensive policy plan to promote inclusive growth, infrastructure, food security, education, rural development, and improved public services especially in the area of health. South Africa is yet to emerge from its history of violence and oppression. As far as environmental efficiency is concerned, South Africa ranks at the top. Since industrial activity is low and level of inputs is the lowest among the BRICS nations, it has the lowest carbon dioxide emissions. In the social efficiency index, its performance is not good. It has the lowest life expectancy at birth within this group at 51.4 years. Health problems widely prevalent in this nation also contribute to a low social efficiency index. These problems not only pertain to violence but also to high incidence of HIV and tuberculosis. South Africa also suffers from very high unemployment rates. Given South Africa’s natural resources and scenic beauty, tourism is a major industry, and ecotourism has become a focus area of business. The industry drives

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economic growth and job creation. The nation attracts more than 10 million tourists annually. The problem is to ensure that while this industry grows, congestion and pollution created by tourists do not erode the quality of the natural environment and the extent of biodiversity. South Africa’s coast is also a valuable resource for the economy. Coastal ecosystems provide natural erosion control and waste management. The economy’s coastal and marine resources are under threat mainly because of excessive urbanization around the major coastal ports and heavy shipping traffic. Fishing is another major activity in South Africa. However, over-harvesting has led to an increased stress on marine life. There is some good news too. The Cape Town City Council in partnership with a non-profit development organization South South North, developed a lowincome energy-efficient housing project in Kuyasa. The housing project focused on energy efficient lighting, insulated ceilings, and solar-powered water heaters. The development project is a model that can be imitated in other countries. It has been recognized by the United Nations as a gold standard clean development project. There are less than 50 such projects in the world. There are over 1.5 million lowincome houses in South Africa with this design.

Is BRICS Important at All? Thus far, we have argued that two important aspects of BRICS and sustainable development. The first was that sustainable development is a global issue and the ultimate success or failure of sustainable development depends on a global consensus on a feasible plan that has to be implemented by all. Each nation or region on the other hand has a role to play too. National problems vary from region to region and from country to country. These specific problems have to be tackled locally or at the national level. However, national-level policies must be consistent with globally arrived at solutions and pathways. The second aspect discussed has been the fact that BRICS represent a wide and diverse set of nations covering four continents. Each nation has its own problems. Degrees of success on the broad measures of sustainability vary within BRICS. So do the policy framework and priorities. The only overarching feature of BRICS that might be considered important would be its size and growth potential which would, in the foreseeable future, make it a formidable block with global economic and political influence. The first feature is a matter of fact and evidence. The second feature of size leading to influence and importance is a matter of conjecture and forecast. The answer to the second question will remain contested, but a quick look at the history of BRICS might give us a better clue about the future. The global sustainable agenda was born in 1992 at the Earth Summit. Two questions emerged from the summit: how to make sustainable development a reality,

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and who would provide the leadership? The contemporary UN agenda for meeting the sustainable development goals (SDGs) is a reflection of the Earth Summit outcomes. Today’s answers require actionable targets and a new mindset for those actions. Sustainability issues have more often than not been cast in two distinct sets of problems: one for the mature market economies already enjoying a high material standard of living and the other for the poor developing nations of the world with large-scale poverty and unemployment. The BRICS nations provide a midway solution to this dichotomy. The five nations together constitute a block which is neither very poor nor very rich, but growing at impressive rates. BRICS can be considered to have the political potential as a coalition to provide leadership on sustainable development on a global scale (Papa, 2017). The wide diversity of these nations also allows new and distinct lessons to be learnt about solutions and making things work toward desired targets and priorities. The sheer geo-political weight of this group can help mobilize a diverse set of agents and organizations. Yet, the small number of governments involved can make consensusbuilding easier. Since the first BRIC summit in 2009, with South Africa joining the following year, the group has made some common progress in terms of cooperation and consensus. BRICS has established several common institutions, including a New Development Bank (NDB) with authorized capital of US $100 billion for infrastructure, and sustainable development projects (Kweitel, 2017). The BRICS group has established strategic and political dialogue within itself and conducts joint programs through its institutions. The biggest contribution BRICS has been making is that it is setting the common goals for sustainable development for all, not only developing, nations. In this sense, it is providing the global leadership it was supposed to. BRICS has also increased its cooperation with the UN, UNESCO, WHO, and UNIDO. This would help build knowledge as well as share experiences about success stories and best practices. However, there are many problems that remain in the still-embryonic coalition. Some criticism has come from the perception that the BRICS economic credentials are waning with the recession in Russia and the serious slowdown in Brazil and South Africa. Even the stars as far GDP growth is concerned, China and India, are marginally slowing down. The group’s environmental ambitions are limited, at least in the short term, when looking at the trade-offs between environmental management and rapid economic growth. Finally, it is argued that the political leverage of the block is also declining. Indeed, a new movement called ‘BRICS from below’ started in South Africa, has been claiming that BRICS is promoting ‘maldevelopment’ based on elitism, consumerism, and eco-destructive corporate-friendly policies. Other critiques have pointed out that though all the BRICS nations clearly have sustainable development as a priority of government policies, the group did

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not speak in one voice during the Open Working Group debates on SDGs set by the UNDP. The lack of progress of sustainability indicators in the BRICS has remained a cause of concern. A 2016 publication by the UN Sustainable Development Solutions Network and Bertelsmann Stiftung found that BRICS nations’ rankings on a sustainability index were very poor. Among 149 countries studied, Russia was ranked 47th, Brazil 52nd, China 76th, South Africa 99th, and India 110th.

Concluding Remarks The world has been changing with regard to the distribution of economic power. The USA, Europe, and Japan have all been caught in low growth traps. The powerhouse of economic activity has been shifting discernibly to countries like China and India. In such a world, it is important that global leadership in diplomacy and policy debates be provided by new nations. Arguably, in terms of the future, the problem of sustainable development remains on the top of the list of concerns. Acceptable solutions are hard to find. Implementing them is a further challenge. It calls for a new kind of thinking that approaches economic wealth creation, innovations, and new ideologies that define the ‘good life’ for future generations in a way that is different and fit for the future. The BRICS group fits the bill in many ways. However, despite the advantage of size and geographical dispersion, they have too many problems of their own. The global consensus and the shared vision necessary are still indistinct. There is an opportunity for BRICS to take up global leadership in this context. Whether they succeed or not remains to be seen. It might be a tough ask. If they fail, however, the result may be costly for the future of humanity.

References Kweitel, J. et al. (2017). “The BRICS Bank Needs a Bold & Participating Strategy for  Sustainable Development”. Available at: http://www.opendemocracy.net (accessed May 23, 18). O’Neill, J. (2001). Building Better Global Economic BRICS, New York: Goldman Sachs. Papa, M. (2017). “Can BRICS lead the way to Sustainable Development?” Available at: http:// www.sustainable goals.org.uk (accessed May 23, 2018). Santana, N. B. et al. (2014). “Sustainable development in BRICS countries: An efficiency analysis by data envelopment analysis”, International Journal of Sustainable Development & World Ecology, 21(3): 259–272. Sarkar, R. and A. Sinha (2018). Economics of Sustainable Development, NY: Business Expert Press. United Nations (2013). World Economic & Social Survey: Sustainable Development Challenges, New York.

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CHAPTER 7

Universal Health Coverage in BRICS: What India Can Learn from the BRICS Experience? Indrani Gupta* and Samik Chowdhury† *Health Policy Research Unit, Institute of Economic Growth, Delhi, India † Ambedkar University, New Delhi, India

Introduction Universal Health Coverage (UHC) has been a major topic of discussion and debate in the recent past globally, especially since the passage of a UN General Assembly resolution on UHC in December 2012.1 While global organizations such as the WHO and the World Bank have defined UHC, it is still not apparent whether all countries interpret UHC in a similar fashion. It has been argued that UHC has been labeled in a variety of ways and implemented based on the interpretation by countries, indicating the need for a global operational definition (O’Connell, 2014). Evidence does exist, however, to indicate that broader health coverage generally leads to improved health, especially for the poor via better access to services (Rodrigo and Smith, 2012).  The first Global Monitoring Report on Tracking UHC, brought out jointly by WHO and the World Bank,2 defines UHC thus: all people receiving the health  Meetings Coverage of the Sixty-seventh General Assembly of the United Nations. Adopting Consensus Text, General Assembly Encourages Member States to Plan, Pursue Transition of National Health Care Systems towards Universal Coverage. Available at http://www. un.org/press/en/2012/ga11326.doc.htm. 2  World Health Organization and The World Bank 2015, Tracking universal health coverage: first global monitoring report. 1

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services they need, including health initiatives designed to promote better health (such as anti-tobacco policies), prevent illness (such as vaccinations), and to provide treatment, rehabilitation, and palliative care (such as end-of-life care) of sufficient quality to be effective, while at the same time ensuring that the use of these services does not expose the user to financial hardship. The Sustainable Development Goals (SDGs) also contain a specific goal for UHC, making progress towards UHC a global as well national imperative. Over the last decade or more, India has also been articulate about the country’s need to have UHC. However, the recent history of the country’s attempt at greater health coverage raises the issues of interpretation of UHC specifically, as well as prioritization of health in general. The BRICS countries as a whole are not necessarily the best examples of how UHC is to be implemented. The group is small, the economic and political situations are somewhat different, and the experiences are diverse. Nevertheless, this diversity of experiences is possibly sufficient to understand the “do’s and don’ts” in the path to UHC, and would contain important lessons for India. There are earlier analyses on this subject as well where a slightly different set of indicators have been used to look at the progress towards UHC (Marten et al., 2014). We aim to expand the analysis substantially with more recent data and also use a slightly different approach to understand where India’s position vis-à-vis the other BRICS countries in the context of UHC. We start by laying out a framework to understand how one might measure progress towards UHC in the second section. In the third section, we look at the health status and disease profile in these countries, which is important to understand priorities within any UHC package. In the fourth section, we look at selected indicators discussed in first section to understand the countries’ progress towards UHC. Fifth and sixth sections analyze governance and health reforms, respectively. In the last section, we present our conclusions based on the analysis on how countries have fared and what India might take away as valuable lessons from these varied experiences.

Understanding UHC in BRICS Countries: A Framework The World Health Report of 2010 (Evans and Etienne, 2010) laid out a simple list of three questions that countries need to take into account to frame policies around UHC: •• Who in the population is covered? •• What services are they covered by? •• What level of financial protection do they have when accessing services? First, these three questions are critical to ask while planning for UHC and require an evidence-based analysis of the current situation. This in turn requires

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that a vision document or a blueprint of intent is drawn up within countries that visualize the various steps that are required to move towards UHC. Whether and to what extent the steps are adhered to subsequently is important, but the intent document is a key indicator of the government’s prioritization and sincerity in implementing UHC. Second, it is now well-established that UHC works well with predominantly compulsory financing mechanisms like taxes or social health insurance contributions (Kutzin, 2016). This makes public finance critical, and evidence exists to show that OOPS is inversely related to government spending (Kutzin, 2016). Therefore, public finances on health are important indicators of a government’s prioritization of the health sector. Yet a third criterion to understand progress towards UHC is to what extent countries have been able to consolidate and merge fragmented pools. It has been argued that fragmented coverage tends to be ineffective, inefficient, and inequitable, and countries should aim for full population coverage from the very beginning (Nicholson et al., 2015). For example, basing priority-setting on socio-demographic characteristics like gender, ethnicity, religion, etc. may not be the most efficient way of progressing towards UHC (Norheim , 2016). The WHO proposes three criteria that countries can consider in evaluating which services to cover: cost-effectiveness, priority to the worse off, and financial risk protection.3 By these criteria, primary health care services are at the top of the list, since these reach the widest of populations and are the first contact point between the patient and the health system. Access to medicines also seems to be high on the list of services that people care about (Wirtz et al., 2016). Thus, countries that have been able to make primary health services accessible and available for their populations can be said to have taken a significant step towards a UHC: a more comprehensive approach can only be built on a functional primary health care system. There is some debate and differences among experts on whether or not costeffectiveness should be given an equal weightage as a criterion for giving priority to the worse off (Norheim et al., 2014). There may be services that are not high up on the cost-effectiveness chart but are mostly targeted at the worse off, and therefore improve utility significantly. In fact, priority to the worse off and financial risk protection may relatively be more important, and within these interventions one can choose the most cost-effective one. Thus, this criterion is not separately evaluated in the country context. Instead, we use the more standard way of looking at financial  World Health Organization (WHO). Making fair choices on the path to universal health coverage. Final report of the WHO Consultative Group on Equity and Universal Health Coverage, 2014. 3

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protection by analyzing trends in OOPS and impoverishment, both of which would give a clear indicator of the extent of protection offered to population in general and to the poor in particular. There are two other parameters that are important in the context of UHC: the first one is to study the reform process that precedes and accompanies the rolling out of the UHC. While many of the indicators mentioned above are relevant to analyze reforms, we study here the presence or absence of continuous and incremental reforms in these countries, to understand the intent to stay on course for reaching the objectives laid out in the vision document. Whether the reforms were reforms in the true sense and were successful are not the main questions: it is whether the countries could monitor and evaluate their policies around UHC and attempt course-correction if required. The second parameter has to do with governance; do countries with better governance perform better to improve access to health services? In fact, governance could also influence the body of reforms and their implementation. While governance is a difficult and different area of enquiry, some summary measures might be helpful to understand where the BRICS countries stand and to understand their performance in the context of UHC. Finally, an important objective is to see how India has fared in improving access to health services for its population and whether there are lessons that it can learn from the experiences of the other countries within the BRICS. The study necessarily draws heavily from existing literature on individual country analyses. Comparable data is sparse, but wherever possible, we have used existing data to make our points and arrive at conclusions.

Health Status and Disease Burden in BRICS Do the countries have a similar disease burden? Table 1 gives the top 10 causes of deaths across the BRICS countries and changes between 2005 and 2015 from the 2015 Global Burden of Diseases. On the whole, non-communicable diseases (NCDs) dominate the top 10 causes of mortality in these countries. Ischemic heart disease, cerebrovascular diseases, and COPD are the three common causes within the top 10 causes of mortality in BRICS nations. Some other relatively common causes of mortality in the top 10 are road injuries, diabetes, and Alzheimer’s disease. Among communicable diseases, lower respiratory infections are common across countries as a major cause of deaths. South Africa is the only country to have as many as four communicable (and preventable) diseases among the top 10 causes of mortality, viz., HIV/AIDS, lower respiratory infections, tuberculosis, and diarrheal diseases. India follows closely with three

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Rank

Top 10 Causes of Death, 2015

Russia % Change 2005–2015

Top 10 Causes of Death, 2015

India % Change 2005–2015

Top 10 Causes of Death, 2015

China

South Africa

Top 10 Causes of Death, 2015

% Change 2005–2015

Top 10 Causes of Death, 2015

16.7

Cerebrovascular disease

−8.9

HIV/AIDS

19.0

Ischemic heart disease

% Change 2005–2015

1

Ischemic heart disease

18.8

Ischemic heart disease

−12.0

Ischemic heart disease

2

Cerebrovascular disease

13.3

Cerebrovascular disease

−24.3

COPD

4.3

Ischemic heart disease

3

Lower respiratory infection

19.3

Cardiomyopathy

−15.5

Cerebrovascular disease

7.3

COPD

4

COPD

19.3

Alzheimer disease

42.6

Lower respiratory infection

−22.6

Lung cancer

5

Diabetes

15.9

Lung cancer

−9.7

Diarrheal diseases

−31.7

Liver cancer

6

Interpersonal violence

−2.1

Self-harm

−30.0

Tuberculosis

−30.7

Stomach cancer

−14.8

Tuberculosis

−24.8

7

Alzheimer disease

35.5

Colorectal cancer

−0.6

−19.7

Interpersonal violence

−16.8

8

Road injuries

45.8

Lower respiratory infection

−16.6

9

Chronic kidney disease

32.7

10

Lung cancer

25.3

−27.1

−5.5

Cerebrovascular disease

−13.1

15.2

Lower respiratory infection

−22.8

−5.4

Diabetes

Diabetes

34.8

Road injuries

−17.8

Chronic kidney disease

20.6

Alzheimer disease

38.8

Road injuries

COPD

−19.6

Neonatal preterm birth

−39.5

Hypertensive heart disease

29.8

COPD

Stomach cancer

−23.7

Road injuries

−2.7

Lower respiratory infection

−14.3

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Source: Global Burden of Disease 2015, Institute of Health Metrics and Evaluation.

−50.1%

Diarrheal diseases

−0.3

−7.6 −47.0

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% Change 2005–2015

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Brazil

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Table 1:   Burden of disease in BRICS.



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(barring HIV/AIDS) of these diseases being the main causes of mortality. The decadal change in the share of each disease in total mortality shows a mixed picture, except for communicable diseases, which show a decline for all countries barring lower respiratory infections in Brazil. The top 10 causes of mortality that register the highest decadal growth are road injuries (Brazil), Alzheimer disease (Russia and China), chronic kidney disease (India), and diabetes (South Africa). On the other hand, top mortality causers with lowest decadal growth are interpersonal violence (Brazil), self-harm (Russia), neonatal pre-term birth (India), COPD (China), and HIV/AIDS (South Africa). The increasing burden of NCDs in BRICS countries is a very important challenge with implications about out-of-pocket spending (OOPS) on the one hand and response of the health system — including UHC — on the other (Jakovljevic and Olivera, 2015). In fact, countries with significant dual burden of diseases face more challenges of investing limited funds across competing uses. A set of four basic health indicators have been presented in Table 2 to show how the countries are faring in terms of specific health outcomes, and a summary outcome index has been constructed to make the comparisons easier. The difference between the highest (China) and the lowest (South Africa) life expectancy at birth is as high as 19 years. The low LEB in South Africa is primarily on account of the HIV/AIDS epidemic because of which it declined from 62 years in 1992 to 52 in 2005. Russia currently is the best performer in basic outcome indicators Table 2:   Health outcomes in BRICS.

Life Expectancy at Birth, 2014

Maternal Mortality Ratio (Modeled Estimate, Per 100,000 Live Births), 2015

Infant Mortality Rate (Per 1,000 Live Births), 2015

Under-5 Mortality Rate (Per 1,000), 2015

Outcome Index (Using Life Expectancy at Birth, Maternal Mortality Rate, and Infant Mortality Rate)

Countries

Trend Trend Trend Trend Growth Growth Growth Growth 2000–2014 2000–2015 2000–2015 2000–2015 Level (%) Level (%) Level (%) Level (%)

Brazil

74.4

0.44

44

-2.39

14.6

-4.67

16.4

-4.74

0.620

China

75.8

0.39

27

-5.59

9.2

-8.12

10.7

-8.41

0.925

India

68.0

0.63

174

-5.23

37.9

-3.87

47.7

-4.47

0.194

South Africa

57.2

0.48

138

3.97

33.6

-3.97

40.5

-5.18

0.026

Russian Federation

70.4

0.72

25

-6.14

8.2

-6.17

9.6

-6.19

0.903

Note: The index for a country is an average of its normalized score in each indicator. The process of normalization is (X−Xmin)/(Xmax−Xmin), where X is the indicator. Source: World Development Indicators, World Bank and World Health Statistics, WHO.

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of maternal and child health. India fares the worst with child mortality rates more than four times and maternal mortality rate close to seven times that of Russia. When compared with the other most populous country, China, India’s maternal and child health outcomes are alarming — a fact that underlines the importance of provision of and access to primary care. Russia has made the highest improvement in life expectancy at birth over time (2000–2014), as exemplified by the trend growth rate, followed by India. However, for child health outcomes, India shows the least improvement in these 15 years while China shows the maximum improvement. Russia registers the largest decline in maternal mortality in this one and half decades, while South Africa actually shows an increase in maternal mortality. China achieves the top position in the overall index of health outcome, followed by Russia, Brazil, India, and South Africa. Needless to say, country-level aggregates conceal the disparities in health outcomes across gender and socio-economic groups, which is an important indicator of equitable health outcomes and access to services.

Progress Towards UHC: Selected Indicators Access to Primary and Basic Care While summary statistics are available that indicate what percentage of population is covered, these are slightly misleading as indicators of UHC coverage because these include different programs and schemes, many of which may not be what the country needs or aligned to the philosophy of UHC. Instead, we use access to quality services for primary health care needs of the population along with a set of recommended indicators for monitoring progress towards UHC, but mainly to understand access to primary care across countries. Health MDG-related UHC indicators or tracer indicators (Marten et al., 2014) include demand for family planning met by modern methods, antenatal care visits, skilled attendants at birth, immunization coverage, improved water and sanitation, access to antiretroviral (ARV) therapy, and TB treatment. Further, Sustainable Development Goal 3.8 specifically mentions the importance of access to “safe, effective, quality and affordable essential medicines and vaccines for all”, making access to medicines an important indicator as well (Wirtz et al., 2016). However, in the absence of data on all the indicators, we select the ones with data for all the five countries and construct an index based on these indicators given in the last column (Table 3). The country with the best access to basic services is Brazil, followed by China and Russia, respectively. South Africa and India trail behind, with India being at

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Tuberculosis Case Detection Rate (%, All Forms), 2014

Births Attended by Skilled Health Staff (% of Total)

Married or In-Union Women of Reproductive Age with Need for Family Planning Satisfied with Modern Methods (%)

Improved Water Source (% of Population with Access), 2014

Improved Sanitation Facilities (% of Population with Access), 2014

Access Index

Brazil

93

82

99.1

89.3

98.1

82.7

0.873

China

99

88

99.9

96.6

94.8

75.4

0.868

India

85

74

74.4

63.9

94.1

39.5

0.177

Russia

97

85

99.6

72.4

96.9

72.2

0.760

South Africa

70

68

81.1

81.1

92.8

65.8

0.233

Countries

Notes: The family planning indicators are for the years 2006 (Brazil), 2001 (China), 2008 (India), 2011 (Russia), and 2004 (South Africa). The skilled birth attendance indicators is for the years 2013 (Brazil and India), 2014 (China), 2008 (Russia), and 2004 (South Africa). The source for both is World Health Statistics, WHO. The index for a country is an average of its normalized score in each indicator. The process of normalization is (X−Xmin)/(Xmax−Xmin), where X is the indicator.

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Table 3:   Access to primary and preventive care in BRICS.

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the bottom of the ranking for these indicators. The most alarming status is that of sanitation in India. Only 40% of Indians have access to improved sanitation. In fact, while India is certainly an outlier in this respect, other BRICS countries too are noticeably short of universal access to improved sanitation. This is applicable to tuberculosis case detection rate as well. Financial Protection Next, we look at the second dimension of path to UHC — financial protection. The share of out-of-pocket expenditure in total health expenditure of a country is a commonly used indicator of the need for financial protection — especially of the poor — from the costs of health care. Figure 1 presents a 15-year trend in this indicator for BRICS. India has the highest share of OOP in total health expenditure, while South Africa has the ­lowest. In fact, India is the only country in this group to have more than half of its health expenditure financed out-of- pocket. All the countries except Russia show a decline in the share of OOP over the years, although the rate of decline varies. The most significant decline has happened in the case of China where the share of OOP declined by 27 percentage points in 15 years, the same being only 6 percentage points for India. Russia presents a peculiar case where the share of OOP in total health expenditure has increased by 16 percentage points in the last 15 years. The immediate fallout of a high-OOP share in total health spending is the risk of catastrophic expenditures and impoverishment. The only indicator for which data was available to measure catastrophic expenditure was for surgical care (Figure 2). 80 70

68

60

59

62

50 40 30 20

46

Brazil

32

Russian Federation

38 30

25

14 6

10

South Africa

India China

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

0

Figure 1:   Out-of-pocket expenditure (OOPS) as % of total health expenditure (THE). Source: Global Health Expenditure Database, World Health Organization.

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South Africa

25.5

China

45.6

India

59.6

Russia

43.7

Brazil

37.4

0

10

20

30

40

50

60

70

Figure 2:   Risk of catastrophic expenditure for surgical care (% of people at risk), 2014. Note: Catastrophic expenditure is defined as direct out-of-pocket payments for surgical and anesthesia care exceeding 10% of total income. Source: World Development Indicators, World Bank. 947

1000

893

800 570

600 400

314

311

200 0

414

391 277

113

81

21 16

1995

75

31

2005 Brazil

420

China

India

2014 Russia

South Africa

Figure 3:   Health expenditure per capita (current US dollar). Source: World Development Indicators, World Bank.

India is the most vulnerable by this measure of financial vulnerability from OOP health care expenses. Needless to state that data for the entire spectrum of health services (not only surgical and anesthetic) would have given a more nuanced picture, but would probably not have altered India’s ranking. Financing for UHC How do the countries compare in terms of how much is spent on health? Figure 3 gives the total per capita expenditure, which includes both public and private finances. Per capita health expenditure in 2014 was the highest ($947) in Brazil (see Figure 3), 13 times that of India at $75. However, the per capita GDP of Brazil was only five times that of India. Brazil has historically been the bigger and the most consistent health spender among BRICS. Between 1995 and 2005, the highest

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increase (20 times) in per capita health spending, however, happened in China followed very distantly by South Africa (eight times). Viewed in conjunction with Figure 1, it can be stated that except Russia, the share of private OOP expenditure had an increasingly marginal contribution to this increase in total expenditure over time. In other words, much of this increase in per capita total health expenditure in China has been on account of increased government spending on health. While not measured as an indicator of UHC, government health finances remain a critical component of UHC, whether spent on expanding its own services to provide access or to expand a social health insurance program, primary care, or pre-payment systems. Higher GDP going into the health of a country has been seen as an important indicator of political commitment (Gottret and Schieber, 2006; Stuckler et al., 2010). Table 4 presents the performance of BRICS nations in some of the key indicators related to public financing of health — total health expenditure in GDP, general government health expenditure in GDP, general government health expenditure in total health expenditure, and general government health expenditure in general government total expenditure. Table 4:   Public financing of health in BRICS. Health Expenditure, Total (% of GDP) Countries Brazil

Health Expenditure, Public (% of GDP)

1995

2005

2014

1995

2005

2014

6.5

8.3

8.3

2.8

3.4

3.8

China

3.5

4.7

5.5

1.8

1.8

3.1

India

4.0

4.3

4.7

1.1

1.1

1.4

Russia

5.4

5.2

7.1

4.0

3.2

3.7

South Africa

8.3

7.8

8.8

3.4

3.3

4.2

Countries 

Health Expenditure, Public (% of Total Health Expenditure)

Health Expenditure, Public (% of Government Expenditure)

1995

1995

2005

2014

2005

2014

Brazil

43.0

41.5

46.0

8.4

5.0

6.8

China

50.5

38.8

55.8

15.9

9.8

10.4

India

26.2

26.5

30.0

4.5

4.5

5.0

Russia

73.9

62.0

52.2

9.1

11.7

9.5

South Africa

41.4

42.7

48.2

13.0

13.0

14.2

Notes: THE: Total Health Expenditure, GGHE: General Government Health Expenditure, GGE: General Government Expenditure. Source: Global Health Expenditure Database, World Health Organization.

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The first aggregate gives the proportion of GDP spent on health and is inclusive of private health expenditure as well. South Africa and Brazil spend more than 8% of their GDP on health. While Brazil, China, India, and Russia have incrementally enhanced their health share of GDP over the 20 years, South Africa has been steadily spending around 8 percent during the same period. India spends less than 5% of its GDP on health and displays one of the lowest percentage point increase between 1995 and 2014. How much do governments spend on health out of total income? For this, the second aggregate — general government health expenditure as a share of GDP — is useful, and it shows that South Africa spends the most with Brazil, Russia, and China following closely. India’s government spending on health is very low, around 1% of GDP. Governments of all the other BRICS nations spend more than double the amount as share of their respective GDP’s. The highest increase in the share of public expenditure on health between 1995 and 2014 happened in China, followed closely by Brazil. The lowest increase in this share was evident in the case of India, while in case of Russia the share actually declined. This pattern is sharper when one looks at how much of the health spending is from government sources, the third column. All the countries, with the exception of India, spend almost half or more of their total health spending from government sources. Except Russia, all the nations increased their share of public finance in total health spending during the 20-year period. This is significant since in the nineties, close to three-fourths of health spending in Russia came from the government, way above the other BRICS nations. The biggest turnaround in this indicator appears to have happened for China, which saw a significant decline in the share of public spending in total health spending between 1995 and 2005, but thereafter increased by 17 percentage points between 2005 and 2014. Currently, China has the highest share of public spending in total health spending among BRICS, at 56%. Finally, the last column shows how health is prioritized by Governments f­ acing competing claims on its resources; general government health spending as a percentage of total government spending is highest in South Africa. This is followed by China and Russia and Brazil. Here again, India ranks low as it spends just 5% of its total government expenditure on health. However, for China and Brazil the share has declined from their 1995 levels. Overall, the three indicators above indicate that China and Brazil have done consistently the best in terms of moving towards UHC, especially if one considers the changes in terms of public spending on health in the recent past. Russia and South Africa are also not doing too badly and often have interchanging places in the rankings among these five countries. However, the gap between the performance of these countries and that of India is often quite stark when we look at the body of evidence presented.

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Enabling Environment: Governance and Reforms Governance There are two important angles to the UHC process that are often overlooked, one more than the other. These are reforms and governance. While reforms are often talked about, there are few studies that have looked at the comparative picture of reforms in the health sector in countries to see why countries have such uneven records in terms of progress towards universal access. We deliberately mention health sector reforms rather than reforms for UHC, because to achieve good outcomes in the health sector requires much more than merely putting in place UHC systems. In fact, for UHC to work, one needs a series of incremental reforms — big or small — happening steadily over time. Mere allocation of public resources does not always yield the desired outcomes. This is primarily due to the quality of governance, a concept that is elusive and, therefore its measurement, very often subjective. An indistinct relationship between public spending and outcome is often related to the aspect of governance (Pritchett, 1996). There have been a number of studies linking overall governance performance with health outcomes. Some studies (Kaufmann et al., 1999, 2004; Gupta et al., 1999) have found governance indicators like voice and accountability, political stability and violence, government effectiveness, regulatory burden, rule of law, and graft to be significantly negatively related to infant mortality. Also, investment patterns have been seen to change with significant corruption, with investments being disproportionately more on physical infrastructure rather than health and education (De la Croix and Delavallade, 2006). Other studies show that greater citizen participation and better governance can lead to greater efficacy in government action in general (Isham et al., 1997). Also, political commitment, higher tax revenues, and greater democracy are associated with a higher share of GDP going to public health spending (Stuckler et al., 2010). Differences in the efficacy of public spending have been attributed to mainly the quality of governance, with better health outcomes from public spending reported from countries with better governance (Rajkumar and Swaroop, 2008). WHO defines governance in the health sector to mean “a wide range of steering and rule-making related functions carried out by governments/ decisions makers as they seek to achieve national health policy objectives that are conducive to UHC”.4

 World Health Organization. Governance. Available at http://www.who.int/healthsystems/ topics/stewardship/en/.

4

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0.32

South Africa

0.59

Russia

0.17

India

0.61

China

0.52

Brazil 0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

Figure 4:   Governance Index. Notes: The index for a country is an average of its normalized score in each indicator. The process of normalization is (X−Xmin)/(Xmax−Xmin), where X is the indicator. Source: Raw indicators (World Development Indicators, Transparency International).

The idea of ‘governance’ ranges from a simple statist interpretation that governance is what governments do, to a much wider interpretation of governance as the way in which individuals, groups, and institutions, both public and private, manage their affairs and resolve conflicts of interest in an orderly manner (Weiss, 2000; DARPP, 2009; Shome, 2012). In this work, we adopt a mixed interpretation of governance whereby good governance pertains to (1) delivery of services (banks, electricity, water, sanitation, physicians, and teachers) of good quality and (2) general governance indicators (ease of doing business, corruption, unemployment, gender equality, and sustainability). We constructed an index for governance based on 11 selected indicators representing these aspects (Figure 4). China appears to be the best governed country, while India lies at the bottom, with a substantial difference in their respective governance indices. Overall, China, Russia, and Brazil seem to have better governance indicators in the group. These findings are consistent with findings on progress towards UHC, especially if one notes that South Africa spends substantially on public financing on health but has not made similar progress on some of the other indicators of UHC, indicating the possibility of governance playing a role — one would expect health spending to be more efficient in the better governed countries generally. While no firm conclusions can be drawn from such a small sample size, it does seem to confirm that better governance and better health coverage would probably go together.

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The indicators of governance and performance of these countries on each of them is given in Table A.1. Health Sector Reforms The most important piece of the puzzle is the role played by reforms in the health sector, specific to UHC or otherwise. We analyze the role of reforms in each of the countries in this section. Brazil Prior to 1988, social security institutions, especially the National Institute for Social Medical Assistance (INAMPS), formed the cornerstone of the health system. In 1988, the new constitution of the country established health as a fundamental right and duty of the state, which started a process of health system reform which was spread over many years. However, the process of reforms can be said to have started somewhat earlier though not in such fundamental form. Brazil’s health coverage was run on a model of social security based on compulsory contributions by employers and employees, leaving a large section of informal and agricultural sector workers uncovered until the 1970s, when it was expanded to include particular services (Elias and Cohn, 2003). It has been argued that the movement for Brazilian health reform involved various segments of society right from the middle of the 1970s, and principles of universality and equality formed the basis of much of the discourse on reforms (Gragnolati et al., 2013). With the constitutional reform, the Unified Health System (SUS) was set up and many administrative and organization changes were effected in the health system in the subsequent years, including a significant expansion of capacity of the system, decentralization for service delivery, measures to address regional disparities among others. The Family Health Program or the FHS is a key part of the national Unified Health System funded primarily through taxes, and it offers free primary care to a majority of Brazilians. It is a cornerstone of the public health delivery system in the country (Bulletin of the World Health Organization, 2008). In addition to the SUS, the country has the Complementary Medical Care System or the SSAM, which caters to a limited segment of the population. According to a World Bank assessment, one of the major accomplishments of the SUS has been to unify and integrate several independent systems of financing and service provision into a single publicly funded system covering the whole population (Gragnolati et al., 2013). Also, all three tiers of the government — federal, state, and municipal — have participated in the reforms, making the vision of reforms quite a unified one.

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There are some issues that remain critical in the Brazilian health system. There are distributional access issues mirroring socioeconomic determinants of health, and inequity in access remains a critical area of concern. While public financing seem high compared to some of the other BRICS countries, funding has remained a challenge, and Brazil’s share of public spending in GDP has remained somewhat low, placing Brazil far below the OECD average for government share of health expenditures (Macinko and Harris, 2015). This is surely going to impact a faster pace of UHC due to the rapidly rising NCDs. Also, the rapid expansion of the FHS has led to a physician shortage, resulting in the controversial Mais Médicos (More Doctors) program (PAHO, 2015) which involved importing doctors from other countries. This has resulted in quality concerns. The quality of health services and inputs are deemed quite uneven at the municipal levels. Also, the non-poor often prefer to seek services in the private sector due to overcrowding and waiting time, though they also visit the public sector to get costly treatments, again leaving the poor to use the SUS (Khazan, 2014). Despite these challenges, Brazil is an example of a country that has carried out incremental reforms in the health sector and has shown sincerity in course correction over the years. The second feature of the Brazilian reforms is the earnest engagement of a wider network of stakeholders and civil society, who took — and continue to take — an active interest in reforms. For example, there have been public protests regarding the need for greater public investment in health care, which could have partially triggered the launch of its pay-for-performance scheme within the FHS (Macinko and Harris, 2015), one of the largest such schemes in the world. Also, by design, FHS is run with community participation and, therefore, is truly based on community participation. Finally, evidence-based policymaking is another feature of the Brazilian system which has helped it continually evolve and make changes, resulting in course ­corrections as and when required (Elias and Cohn, 2003). China China’s success in UHC has been hailed as extraordinary, and China has been the focus of many studies since it started its reform process in 2009 (Yip et al., 2012; Yu, 2015), when it announced its Health Care System Reform. The Implementation Plan for the Recent Priorities of the Health Care System Reform visualized the provision of affordable medical care for all its citizens by 2020.5 The reform envisaged a complete overhaul of China’s healthcare system, and addressed all aspects of  WHO Representative Office-China. Factsheet on Health sector reform in China. Available at http://www.wpro.who.int/china/mediacentre/factsheets/health_sector_reform/en/. 5

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the health system. Particular focus was given to the grassroots medical networks, infrastructure, personnel, hospital reforms, and drugs and medicines. Earlier, China had a well-performing system of rural health care, and the Rural Cooperative Medical Schemes (RCMS) was seen as a success. Social insurance and barefoot doctors made the rural health system a sturdy one (Wan and Wan, 2010). However, the move towards market economy resulted in major reversals and the system witnessed high OOPS, stemming mainly from the government’s omission to address the health system while it transited to a market economy (Yip et al., 2012). Currently, China operates a three-level medical service system: national level, province level, and county level. It has three main coverage systems: the Urban Employee Basic Medical Insurance (UEBMI), the New Cooperative Medical Scheme (NCMS), and the Urban Resident Basic Medical Insurance (URBMI). These programs are run in a parallel manner, without resource or service pooling. It also has an essential drug program which has resulted in significant reduction in OOPS. One main feature of the reforms was to double annual public health spending, which was necessary to achieve the goals set out in its vision for health sector reform. Thus, unlike Brazil, China has moved towards reforms by greatly augmenting its current level of spending. It has also managed to strengthen the primary health care system and bring down OOPS in a relatively short time (World Bank, 2016). However — as in the case of Brazil — China also is facing challenges in terms of rising costs due to shift in disease patterns and others concerns like quality of services and provider incentives. It has been argued that China’s health system is hospital-centric and volume-driven, with quality concerns (World Bank, 2016). However, these concerns have been recognized by the government, and in 2015 a national strategy named “Healthy China” was endorsed which will guide the next phase of reforms (World Bank, 2016). China is an example of a country that has given serious prioritization to health, as displayed by the huge investment made in the health sector and the series of reforms that continues to take place in the country. Russia After the collapse of Soviet Union, the Russian Federation continued with a universal system of basic health care that was state run and free at point of access (Linda, 2015). This system helped to improve and stabilize health outcomes over the years to a large extent, though there remained problems of access to non-basic care. However, during 1980s and 1990s, lack of reforms led to a deterioration of the health system and even basic health outcomes worsened significantly. Lack of personnel and modern equipment were some of the major concerns for the ailing health s­ ector. To this was added the problem of huge influx of migrant workers resulting in deepening of inequality in access and outcomes (Linda, 2015).

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The 1993 Health Insurance Law introduced the legal framework for the health insurance system (Danishevski et al., 2006). In 1996, the Russian Constitution provided all citizens right to free healthcare under Mandatory Medical Insurance in 1996. The National Priority Project in Public Health came into being in early 2000s. With this came a series of reforms and changes in the health system — introduction of medical insurance, competitive contracting, co-payments, and privatization — that resulted in rapid and “massive destatization” (Judyth, 1998). The system did not perform as expected mainly because it was not preceded by administrative, regulatory, and legal reforms. OOPS increased and state finances declined sharply. Two channels of government financing were created, one based on wage taxes and the other on general tax revenues, the latter being the more unstable source (Danishevski et al., 2006). The underfunding of inputs, including that of personnel, created “shadow commercialization”, which essentially meant that government-appointed medical personnel used informal shadow payments for their services (Blam and Kovalev, 2005). In 2010, the law on Federal Mandatory Insurance Fund (FOMS) was introduced in Russia, In 2012, a set of measures was announced designed to overhaul the health care system in Moscow, and some major proposals around personnel and equipment were made that caused a significant level of controversies and protests in the country. The Russian system of decentralization has raised many concerns; the three tiers of the system — federal, regional, and municipal — each have their revenue-collecting and service-providing functions, but the management and regulation of the entire system remains complex (Danishevski et al., 2006). The chronic deficit of FOMS, mismatch between fixed rates for medical services and actual costs, centralized administration of an attempted decentralized system, and chronic personnel shortage have led led to a situation which has often led to alarmist conclusions (Epple , 2015) and a cry for real reforms.6 With relatively high health spending, Russia is a case of substantial ­inefficiencies in spending which translates into suboptimal health outcomes, high OOPS, and ­significant inequalities in access and financing across regions and economic and social classes (Linda, 2015; Gordeev et al., 2011). Private health insurance has increased over the years in Russia (Popovich et al., 2011). While its health outcomes are close to that of China and Brazil, in comparison to OECD countries, Russia does not perform that well. However, there is evidence of sincerity in health sector reforms, and evidence does suggest that incremental changes have been taking place, though a much more evidence-based approach is required to yield superior results.  Russia’s Healthcare System: Current State of Affairs And The Need For Reforms. Report by the Institute of Modern Russia (Open Russia). Available at http://imrussia.org/images/ stories/Reports/Healthcare/IMR_Russia-Healthcare-Reform_10-2016.pdf. 6

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South Africa The post-Apartheid period in South Africa saw a number of incremental reforms in the health sector to address the immense inequalities in access and outcome that was the norm during the apartheid regime. This included public health legislation and policies and a unified national health system, increasing infrastructure at the primary care level and removing user fees for maternal and child health services to name a few (Schaay et al., 2011). Despite this, the country saw unprecedented worsening of burden of disease, with HIV and TB wiping out much of the gains achieved through development. To tackle the worsening health situation, in 2008, the government brought out the Health Sector Road report which resulted in the 10-Point Plan, which was intended ‘to guide government health policy and identify opportunities for coordinated public and private health sector efforts, in order to improve access to affordable, quality health care in South Africa’ (Schaay et al., 2011). A performance agreement between the President and the Minister of Health was signed in October 2010 for the implementation of the Negotiated Service Delivery Agreement (NSDA) for the Health Sector. The NSDA process requires that government departments harmonize the implementation of their respective service delivery agreements so as to facilitate delivery of the 12 key outcomes. In 2011, the Green Paper on National Health Insurance was brought out which contained the principles for developing National Health Insurance (NHI). The objectives were to improve access to quality healthcare services and provide financial risk protection against health-related catastrophic expenditures. The proposal visualized the development of comprehensive healthcare to be provided through accredited and contracted public and private providers, with a strong focus on health promotion and prevention services at the community and household level. The proposal also contained a realistic target timeline, with the first 5 years to be used to strengthen the public sector in preparation for new NHI systems. The plan was to launch the new central NHI fund in 2014/2015 (National Health Insurance, 2013). However, the NHI did not quite take off, and in 2015 the government released the White Paper on NHI. The paper proposed that NHI will be made compulsory and will be introduced in three phases over a 14-year period. In Phase I, focus will be on strengthening the public sector. In the second phase, population registration and creation of a transitional fund to purchase non-specialist primary care would be the focus. Finally, in Phase III, the aim will be to operationalize the NHI fund fully and make it a strategic purchaser and single payer of comprehensive health services, including specialist services (Gray and Vawda, 2016). While it is early to comment on the progress and implementation of the NHI, there is some concern that the necessary homework to make NHI a reality remains

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to be done. For example, there have been delays in operationalizing the independent Office of Health Standards Compliance, necessary for ensuring compliance with standards laid down for treatment. Some of the changes envisaged in the White paper require far-reaching legislative changes as well, in for example, the National Health Act and the Medical Schemes Act, but details are not laid out in the White paper on how exactly such changes should be brought about (Gray and Vawda, 2016). India The constitution of India considers the ‘right to life’ to be fundamental and obliges the government to ensure the ‘right to health’ for all, without any discrimination. The Constitution indicates the government’s role in the health sector and lays down obligations on the Central Government, but makes health a State subject. To a significant extent, India’s health sector has been shaped by the federal structure of the country and center–state divisions of functions, responsibilities, and financing. The total health expenditure in India for 2013–2014 was 4.02% of the country’s GDP, with government expenditure at 1.15% of GDP (National Health Accounts, 2013–2014), which is lower than the average for low-income countries (National Health Profile, 2016). Out of total health expenditure in India, household out-of-pocket expenditures are 69.1%. The high OOPS and low public investment have remained more or less the main features of the Indian health care system over many years. There have been a few attempts at moving towards a wider health coverage system, notably the High-Level Expert Group set up by the Planning Commission, which brought out a blueprint of the possible ways India could move towards UHC. With a change in the government at the Center, a National Health Assurance Mission was set up as well, which submitted another blueprint of UHC to the government. The recommendations of these committees were not implemented. Apart from these, there have been two major programs which can be thought of as highlights of India’s health sector journey over the years. These are the National Rural Health Mission (NRHM) launched in 2005 and the Rashtriya Swasthya Bima Yojana (RSBY) launched in 2008. The NRHM — now called the National Health Mission or NHM — can possibly be called a true health sector reform in that it changed in some fundamental ways the workings of the health systems in the country. The aim of NRHM was to ‘carry out necessary architectural correction in the basic health care delivery system’ (Government of India, 2005) mainly to improve access by strengthening health systems especially in the rural areas. There have been numerous studies on the NRHM, and while some argue that it may not have improved the situation like envisaged initially, it has led to improvements in parameters like immunization, institutional deliveries, and antenatal care (Hussain, 2011). Like most programs that are across the health sector, the NHM may have played a relatively greater role in national program priorities like disease control programs of the government. While the changes were

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not uniform across states, the NRHM did usher in some significant process changes and strengthened health systems considerably in many states of India. The RSBY is one of the largest social welfare schemes that provides health coverage to poor informal sector workers and currently covers more than 41 million poor families. It is a hospitalization scheme that was launched by the Ministry of Labor and Employment (MOLE); and only 2017, it was transferred to the Ministry of Health and Family Welfare (MOHFW). The RSBY is seen by some as the most successful health sector reform — and not merely a program — in India. There is little doubt that enrolment into the program is massive, but whether it has achieved its objective of reducing OOPS on hospitalization and improving access is still being contested. Few studies exist that look at the impact of health insurance on out-of-pocket spending (OOPS), and the evidence seem to be mixed on whether or not coverage for hospitalization like the RSBY reduces OOPS (Seshadri et al., 2012; Selvaraj and Karan, 2012; Fan et al., 2012; Shahrawat and Rao, 2011). Nevertheless, some argue that the mere fact that RSBY happened on such a massive scale was because of strong political will to make a difference in the social welfare situation in India, and it has the potential to move the UHC agenda forward (Zubin et al., 2015). The reason why RSBY cannot be called a health sector reform in the true sense of the term, especially in the context of UHC, is because RSBY happened in isolation, as a scheme and not as a part of a coherent well-planned UHC strategy. RSBY was not based on the principle of risk and income pooling, was not comprehensive, and did not fit into any broader plan for UHC. More worrying is the widespread trend across states to replicate the RSBY model, without paying attention to its merits and demerits and with very little evidence-based understanding of whether or not it will improve access and reduce costs in the system. In the last budget, the Prime Minister announced a National Health Protection Scheme, which is essentially RSBY in a scaled up fashion for the entire BPL population with a higher ceiling amount of Rs. 1,000,00.7 A set of health sector reforms for UHC has yet to take place in India, and it is yet to draw up a blueprint of a comprehensive UHC program. As for incremental reforms, there have not been that many over the years, evidenced by a poorly performing primary health care system, almost totally unregulated private market for health, and lack of comprehensive coverage for the majority of the population. The significant inequity in access and financing situation has remained somewhat the same over the years, and the government’s priorities in the health sector (MOHFW, 2015) can be further questioned based on its very low investment in the sector.  National Health Protection Scheme: Health Insurance Cover of upto Rs. 1 Lakh to the poor and BPL. Available at http://www.pradhanmantriyojana.co.in/national-health-protectionscheme-insurance-cover-rs-1-lakh-poor-bpl/. 7

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UHC in BRICS: Takeaways for India The experiences of the four countries in improving access to health services in their countries towards universality offer valuable insights and lessons that India can learn from. In Table 5, we summarize the key points that emerged from the four-country (excluding India) analysis above. The last column in Table 5 indicates that the two countries that have made substantial progress towards UHC are Brazil and China, with almost all the parameters showing positive results. While both the countries are struggling with concerns like shortage of physicians made worse by increasing NCDs, Brazil in particular has some way to go in raising the share of health in total government expenditure. Nevertheless, Brazil’s attempt at consolidation and pooling is commendable, because it uses general tax revenues to give similar services to all its population groups. All the countries except India have a vision document for UHC, though Russia and South Africa have yet to translate all the stated objectives into action. Both Russia and South Africa could not implement all the administrative and legal reforms, and as a result these countries are struggling with complex and sticky issues of operational inefficiencies. Russia’s is a unique case because of its political economy legacy, but abrupt changes in policies and programs without proper groundwork have delayed and arrested progress towards UHC. As a result, Russia has been struggling with high OOPS. The only two countries with proper reforms and implementation are Brazil and China, despite the varied concerns with the current situation. The governance results indicate that with Brazil and China, Russia has also done well, and it may not be very difficult for it to turn things around with proper planning and foresight. What Lessons Can India Draw from These Experiences? While both Brazil and China have been able to make serious progress towards UHC, the differences between the two are quite stark. Brazil’s reforms were truly incremental, undertaken gradually over many years; China had a much faster process. Also — and this may be related to the previous point — the investment by the government in Brazil has been steady and has grown modestly, while China saw a sharp increase in government expenditure on health. If India wants to fast-pace its move towards UHC, it might want to consider China’s model and immediately prioritize health by moving from the very low expenditure levels to a level that can at least make it possible to take the initial steps towards UHC. Otherwise, if it wants to take it slow — the better model might be that of Brazil’s with numerous reforms preceding the actual UHC roll out and then working incrementally thereafter. The latter is in some ways superior because unless one is absolutely sure of what is

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Functional Primary Health Care System

Pooling

Regulation

Major Reforms

OOPS Declined Over the Years

Progress Towards UHC

Brazil

Yes

Yes, but low

Yes

Yes, unified services

Yes

Yes

Yes

++++

Russia

Yes

No, declined somewhat

Yes

No

No

No

No, it has risen

++

India

No

No

No

No

No

No

Yes, marginally

+

China

Yes

Yes, marginally

Yes

Few separate pools

Yes

Yes

Yes, sharply

+++

South Africa

Yes

Yes

No

No

Incomplete

No

Yes

+

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Table 5:   Key parameters in the progress towards UHC in BRICS nations.



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being implemented, sudden and abrupt changes might not be the best way forward. The experiences of Russia and South Africa indicate that some legal and administrative reforms are absolutely necessary before making major changes in the architecture of health financing and service delivery. The other important fact that emerges from these country experiences is the importance of strengthening primary care. In fact, while Brazil and China have been able to do so, Russia is another example of a country that is able to offer some basic services to its population, due to its historical legacy. While Russia has not done as well in UHC despite fairly high investments, given its positive governance outcomes, a moderately well-functioning primary health care system, and fairly high health expenditure levels, it has the potential to rectify the various inefficiencies that have befallen the health care system — calling for yet another round of well-directed reforms. India has the option of either moving towards a comprehensive UHC program or investing on primary care for now, and building UHC on a strong health system subsequently. While improving social determinants of health would go a long way to improve inequities in the system — as is clear from the case of South Africa — this is a broader developmental issue that can happen simultaneously, and should not stop specific health sector reforms from happening. While India’s poor governance record puts up a natural constraint on any fastpaced reforms, it needs to at least acknowledge the country’s need for comprehensive health coverage and draw up a vision document that can be used as a benchmark to tally progress. Clearly, such a document can only be drawn up with serious prioritization of health, which is not evident yet from its public financing patterns. Also, it would require wider consultation with multiple stakeholders, backed up by solid evidence-based research, as has been happening in Brazil. Civil societies have been able to work with the government in Brazil, and to a much lesser extent in South Africa, but not so much in China and Russia.8 Wider consultations and inputs from civil societies are critical for reality checks. So far, in India, the health sector programs, including the launch of various health insurance schemes, has happened in a very centralized manner without wider stakeholder participation in the processes. This has meant that neither criticisms nor constructive suggestions have been taken on board before launching new schemes or scaling up old ones. A very important issue that emerges from the analysis is the issue of decentralization and regional factors. All the BRICS countries have federal structures where the structure of decentralization has played a key role in access to health services. In fact,   Eduardo J. Gómez, International Development Institute, King’s College London. Confronting Health Inequalities in the BRICs and other emerging economies: International Politics, Institutions, and Civil Society. Available at http://gomez.madebypixel.com/wpcontent/uploads/2015/01/ConfrontingHealthInequalitiesBRICS.pdf. 8

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much of the complexity in delivering equitable and efficient health services has to do with the tiered federal structures in these countries. While South Africa grapples with intense inequalities in access between poor and rich areas and populations, China’s fiscal decentralization has often led to uneven outcomes, and the matching funds arrangement has meant many facilities are dependent on their local governments’ fiscal capacities. Russia has inequalities in human resources and infrastructure across regions, and despite increased funds at the center, the allocations of finances have been quite uneven. Also, it has a very complicated system of federal and regional health budget financing and health insurance funds. While Brazil is also dealing with uneven quality and availability of infrastructure and personnel, it is nowhere as stark as in some of these other countries, and higher spending on health and better allocations with enhanced funds might be able to improve the situation. India on the other hand, has yet to articulate its own vision of UHC and financing in the context of its federal structure, where health is a state subject and the state governments are the major spenders. It makes little sense then for the central government to plan UHC on its own, when neither service provision nor significant financing come from it. The Fourteenth Finance Commission has decreed that a greater part of the divisible pool taxes would now go to the states, making the states squarely responsible for prioritizing health. In this scenario, India would need very careful planning around the center and states’ roles in financing and provisioning of health services. Should there be one consolidated scheme or should each state decide on how it wants to design a UHC package? Given that there are significant personnel and infrastructure gaps currently in many states, and states have historically not prioritized health in the sense of higher spending, what role can the central government play? Here, the Brazil model is useful, and evidence-based planning around UHC is the first step India should take. The planning would also require understanding where reforms are absolutely necessary and which reforms can happen during the course of the roll out. A key area requiring focus is the public–private split in financing and provision. This is going to be a key issue in India where the private providers are the major players. Each of the BRICS countries has had their own private sector issues. Brazil’s private health insurance sector has emerged as a very important player though within rules set out by the relevant federal government institutions. China has been actively encouraging private players and has taken steps to remove regulatory barriers for greater ease of entry and stay; in fact, selected private hospitals are now eligible to provide reimbursable treatment for patients funded through social healthcare insurance.9 South Africa already has a large private provider and insurance sector.  White paper — China’s emerging private healthcare sector. The Economist. March 10th 2016. Available at http://www.eiu.com/industry/article/1954017979/white-paper---chinasemerging-private-healthcare-sector/2016-03-10. 9

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India will have to understand how lack of proper regulation in some of these countries has increased inequalities and decide how long it should wait before putting in place a series of regulation that would curb malpractices and economic burden on households. Whether or not it decides to have UHC, regulation is an area where reforms have been long overdue. In sum, lessons from BRICS countries indicate that since India has yet to articulate a plan or vision for UHC, it can prepare itself better by learning from experiences of other countries, including BRICS. Such experiences are, after all, the best evidence base that the country can have in hand, to plan better for a future where a majority of Indians can access health services that they require at costs that they can easily bear.

Appendix Table A.1:   On governance indicators. Indicators and Index

Brazil

China

India

Russian Federation

South Africa

Commercial bank branches (per 100,000 adults), 2014

47.3

8.1

13.0

37.0

10.9

Ease of doing business index rank (1 = most business-friendly), 2016

123.0

78.0

130.0

40.0

74.0

Electric power transmission and distribution losses (% of output), 2013

16.4

5.8

18.5

10.1

8.5

Improved sanitation facilities (% of population with access), 2015

82.8

76.5

39.6

72.2

66.4

Improved water source (% of population with access), 2015

98.1

95.5

94.1

96.9

93.2

Physicians (per 1,000 people), 2011

1.9

1.5

0.7

4.3

0.8

Research and development expenditure (% of GDP), 2012

1.2

1.9

0.8

1.1

0.7

Unemployment, total (% of total labor force) (national estimate), 2014

4.8

4.1

4.9

5.2

24.9

Proportion of seats held by women in national parliaments (%), 2016

9.9

23.6

12.0

13.6

42.0

Pupil–teacher ratio in primary education (headcount basis), 2014

21.2

16.2

32.3

19.8

32.3

Corruption Perceptions Index Rank (1 = least corrupt), 2015

76

83

76

GOVERNANCE INDEX

0.52

0.61

0.17

119 0.59

61 0.32

Source: World Development Indicators, World Bank.

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CHAPTER 8

Inclusive Finance: India Through the BRICS Lens Saibal Ghosh Qatar Central Bank, Doha, Qatar

Introduction In the post-crisis world, the role and relevance of finance for economic growth has gained increasing attention. The reasons for this focus are not too far to seek. Access to finance, especially to the poor, is essential for promoting inclusive economic growth and eradicating poverty. A significant body of research has identified the beneficial impact of access to financial services on all aspects of social and economic outcomes at the household, industry, and firm levels (King and Levine, 1993; Levine, 2005a, 2005b; Demirguc Kunt et al., 2008, 2017; Demirguc Kunt and Levine, 2008; Rajan and Zingales, 1998). Notwithstanding its beneficial effects, finance does not appear to have adequately permeated vast segments of the population. To exemplify, according to the World Bank’s Global FINDEX, although 700 million adults became first-time account holders between 2011 and 2014, only 62% of adults globally had an account with a formal financial institution in 2014. The recently released global FINDEX (World Bank, 2018) finds that although account ownership had increased to 69% (3.8 billion adults) in 2017, the number of unbanked still stood at 1.7 billion (as compared with 2 billion in 2014). In the case of India, 175 million adults became been added into the fold of account holders during the period 2011–2014. Even more impressive 143

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has been the subsequent progress. In particular, of the 514 million bank accounts opened globally during 2014–2017, around 55% were from India. As a consequence, the extent of financial inclusion, which was 53% in 2014, jumped to 80% in 2017. And yet, close to 50% of the bank accounts witnessed no transactions in the past 1 year. What this suggests is a discernible gap between the availability of finance and its accessibility and use. Both the Government and the Reserve Bank have undertaken significant steps in the recent past to improve financial access. Several strategies have been undertaken including lending to a designated sector and even earlier, selective credit controls. Banks and other smaller financial entities were given targets to open savings bank accounts and provide micro-insurance policies, respectively. The Self-Help Groupbank linkage program (SHG-BLP), Kisan (meaning, farmer) Credit Card scheme for farmers, Atal Pension Yojana (meaning, scheme), financing and refinancing of cooperative banks, regional rural banks that extend credit to rural clientele, and various state-level credit programs for provision of credit to the rural population are examples of more direct efforts. Advancing the process forward, the Reserve Bank has granted ‘in principle’ approval to a multitude of players in the financial eco-system. At the same time, with the rapid expansion of information technology and communications networking, the need to harness technology to reach out to the vast sections of the unbanked populace, incorporating related benefits such as social security transfers, and insurance, has improved further. Other newer forms of digital technology, such as biometrics, including eye scanning and finger printing, have come to occupy an important place in the government’s financial inclusion agenda. In this context, the analysis indicates that access to mobile communications plays a key role in the financial inclusion drive. The Pradhan Mantri Jan Dhan Yojana (literally translated as, Prime Minister’s Mass Money Scheme) of the Government launched in August 2014 marks a landmark effort in the quest for universal financial access. The scheme had set ambitious targets, such as providing access to formal finance to every household within a stipulated period of its introduction. The government is also focusing to pay benefits directly into these accounts (Pickens et al., 2009). This will also ensure that a big chunk of the accounts opened under various schemes, which were earlier dormant, witness ‘movement’, thereby integrating access with use. We analyze the impact of the scheme on the access to and use of finance by households and find that while there has been a perceptible increase in the former, the evidence regarding use is less compelling. Issues of gender have gained currency in the backdrop of the financial inclusion debate. According to the Global Findex 2017, of the unbanked worldwide, 59% or

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1 billion are women. In the Indian case, the number of female savings bank accounts per thousand of the female population was around 570 in 2016 as compared with less than half that number 5 years ago. This is consistent with research which suggests that, on average, among adults the number of females with an account at a formal financial institution is significantly lower as compared with males (Demirguc Kunt and Klapper, 2012). With the G20 and, more recently, the Sustainable Development Goals (SDG-5) of the United Nations advocating the need for greater participation of women in the developing world, there is a greater need to promote women entrepreneurs in the quest for inclusive growth. Our analysis with regard to gender shows that both the access to and use of a bank account is significantly lower for females as compared with males. Against this backdrop, the purpose of the chapter is to analytically assess the financial inclusion process in India, drawing upon international experience and the Indian evidence. Toward this end, the rest of the analysis unfolds as follows. First, we provide a background of financial inclusion in India, encapsulating the philosophy, rationale, and the process. In the subsequent section, we dwell on the international experience, highlighting the key takeaways and providing evidence as to how well India matches up in its financial inclusion efforts in the cross-country sample. Next, we explore how the global financial crisis reshaped the financial inclusion agenda. Fifth section discusses the Indian experience, emphasizing some of the key initiatives that have been undertaken in recent times, supplemented with empirical evidence, as appropriate. The penultimate section syncopates the role of central banks in the financial inclusion drive, and the chapter ends with some concluding remarks.

Inclusive Finance: Philosophy, Rationale, and Process Inclusive finance is as much about protecting customer interests as it is about ensuring the availability of essential financial services to all strata of society at a reasonable and affordable cost (Reddy, 2012). Accordingly, financial sector regulation has endeavored to ensure that these needs are met, while at the same time advocating the need for financial literacy to ensure that customers do not fall prey to financially disquieting credit arrangements. In the Indian context, the role of the financial sector in promoting financial inclusion can be traced to the 1960s. The overarching emphasis of the Reserve Bank was towards channeling the flow of credit to the productive sectors of the economy and hitherto unserved sections of the populace. Starting with the twophase bank nationalization process, major initiatives such as priority sector lending requirements, establishment of development banks and Regional Rural Banks, and

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SHG-BLP were initiatives aimed at expanding banking services to the grass-root level. While critics have been agnostic of the efficacy of this approach, research appears to suggest that such a bottom-up strategy made a significant dent in rural poverty (Burgess and Pande, 2005). Notwithstanding these initiatives, ensuring full-fledged financial inclusion continued to elude the policymakers. While it is difficult to conclude with certainty the reasons thereon, a few broad generalizations can be made. First, the rapid expansion of low-documentation lending within an insufficiently developed legal and institutional framework in the credit market exerted a dampening effect on the process. Second, the lack of reliable credit reporting systems that could have limited problems of overindebtedness and of borrowing from multiple lenders were not in place. These problems were aggravated by the absence of well-functioning personal bankruptcy laws that hindered the orderly discharge of excessive debts. Third, the sector was affected by non-economic interventions in the credit market: MFI clients were implored to stop repaying their loans ahead of elections. The politicization of the process turned it into a tool for rent-seeking and led to a shift away from its primary purpose. Fourth, it was recognized that to hasten the process brick-and-mortar branching needed to be complemented with affordable technological innovations. However, the costs of technology proved prohibitive and impeded large-scale penetration. These considerations led the Reserve Bank to reorient its emphasis towards financial inclusion with a more micro-centric focus. With banks being the mainstay of the financial system, it has emphasized a bank-led model for financial inclusion, although it has also permitted non-bank entities to partner banks in their financial inclusion drive. This contrasts with the widely cited experience of Kenya, which employed a non-bank-led model to drive its financial inclusion agenda (Aker and Mbiti, 2012). Besides, banks were provided the flexibility to determine their own strategies for rolling out financial inclusion plans, based on their business philosophy and risk appetite, within an overall time-defined target. The idea inherent in this strategy was to refocus the perspective of banks towards financial inclusion from mere social obligation to a viable business opportunity. As the concept of inclusive growth came to the forefront of policy agenda, the agenda of financial inclusion assumed even greater prominence (Government of India, 2008). In November 2005, a new concept of basic banking ‘no-frills’ account with nil or very low minimum balance was introduced to make such accounts accessible to vast segments of the population. The nomenclature was subsequently changed in 2012 to Basic Savings Bank Deposit Accounts (BSBDAs) for all individuals with zero minimum balance and the facility to use an ATM

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card/Debit card. Also, to facilitate easy opening of accounts especially for small customers, Know Your Customer (KYC) guidelines were greatly simplified. The process has been fine-tuned, with gradual improvements in the modalities and logistics. At the same time, the branch authorization policy was also relaxed. To further step up the opening of branches in rural areas, commercial banks were directed to open at least a quarter of their total branches in hitherto unbanked areas of the country. However, the difficulty of opening brick-and-mortar branches in all remote corners of the country necessitated the search for innovative solutions. In this context, banks have been encouraged to improve banking penetration through Business Correspondents (BCs)/Business Facilitators (BFs). Contextually, such a ‘correspondent’ banking approach has also been adopted in countries like Brazil to distribute welfare grants to the unbanked, with great success. The list of correspondents has expanded over time, enabling banks to provide doorstep delivery of services, thereby addressing the ‘last mile’ problem. Riding on technological advancements, banks have leveraged on mobile network providers to make available banking services to the lowest common denominator. This hybrid model finds echo in the experience of Philippines wherein a combination of the brand and execution of the service by a mobile network operator in partnership with a commercial bank substantially improved access to finance for households. Besides, other countries have also adopted several out-of-the-box ideas for financial inclusion (Box 1).

Box 1: Innovative ideas for financial inclusion Out-of-the-box ideas have been employed by several countries in order to increase banking penetration in un- and under-served areas, often leading to very encouraging results. In Chile, for instance, supermarket chains have started writing credit histories for their unbanked clients, by means of extending small store credit, which can be expanded based on positive repayment records and which can then translate into broader access to credit. This is financial empowerment in action — especially when combined with consumer protection measures and financial education for preventing over-indebtedness. In Brazil, lottery kiosks, pharmacies, supermarkets, and other retailers are used as business correspondents for banks. Upon launching Bolsa Familia, a conditional (Continued )

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Box 1: (Continued)

cash transfer programmer in 2003, the government determined that all benefits would be paid through Caixa Econômica Federal, Brazil’s public sector bank. However, as many beneficiaries lived in remote areas, without access to banking services, Caixa Econômica had to transport cash for the distribution of monthly benefits at very high costs. Therefore, Caixa started employing correspondents in municipalities where the costs of distribution were particularly high and started to administer the sales of Brazil’s wide-ranging lottery program. This led to a large network of small lottery stores called Lotéricas that began accepting bill payments and the distribution of social transfer payments besides offering additional financial services from Caixa. In many areas, as many as 55% of the households pay their bills through these lottery shops. In South Africa, television and radio have been used for the delivery of financial literacy training. One such project, involved the distribution of financial inclusion storylines through a popular soap opera called Scandal!. The program was aimed at enhancing knowledge, attitudes, and behavior for making sound financial decisions, with a focus on debt management. An impact evaluation of the soap opera showed that its audience exhibited content-specific improvement of financial knowledge, a greater affinity for formal borrowing, reduced use of hire-purchase deals, and reduced inclination for gambling (World Bank, 2013).

Early on in the process, it was recognized that the process of financial inclusion would need to be buttressed with demand-side measures in order to gain traction. In this context, financial literacy emerged as a crucial cog-in-the-wheel in promoting universal financial inclusion and ensuring consumer protection. A two-pronged approach has been adopted in this regard. First, efforts have been directed towards dissemination of simple messages of financial prudence in vernacular languages. To this end, the Reserve Bank website created a link for financial education, containing material in several vernacular languages, messages on financial planning, games on financial education, and a link for accessing the Banking Ombudsman Scheme for customer grievance redressal. In addition, tailored financial literacy content for target groups have been developed that can be used by financial literacy trainers. Second, a National Strategy for Financial Education was enunciated for the medium term. Besides establishing initial contact with adults and educating them on key saving, protection, and investment-related products, it has also been engaging with curriculum-setting bodies to embed such concepts in the school curriculum. Despite these measures, large sections of the population continue to remain financially excluded. Although these measures resulted in impressive gains in rural

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outreach and volume of credit, the structure suffered from weak governance. It was ‘quantitatively impressive but qualitatively weak’. The main reason was that, due to the target-driven approach to social banking, these initiatives were not seamlessly integrated into the business strategy of individual banks. Later in the analysis, we take a closer look at certain demand-side considerations.

Cross-Country Experience Although financial inclusion is a buzzword worldwide, when looked at from a global perspective, India stands out as one of the BRICS economies in which the government has a documented financial inclusion strategy containing specific commitments (Figure 1). Financial Access and Use To carefully examine financial inclusion in the BRICS, we look at measures of financial inclusion from two different perspectives. Accordingly, we focus on three main indicators, in line with Demirguc Kunt and Klapper (2013) and Demirguc Kunt et al. (2015). The first and most traditional one is the ownership of account at a financial institution. This measure focuses on financial access; it does not consider whether the account has been used or not. To rectify this shortcoming, we buttress this with two additional measures focusing on use: first, the saving behavior at a formal financial institution and, second, the use of bank credit. The former captures the willingness of savers (asset side of their balance sheet) to save at a formal financial institution relative to alternate forms of savings. The second looks at their liability side and examines their willingness to borrow bank finance. In essence, these measures comprise the basic triad of financial inclusion: a formal account serves as an entry key to the banking industry because it enables the individual to open a savings account and apply for a loan. Between 2011 and 2017, most of these measures have witnessed a discernible rise (Table 1). To illustrate, 66% of Chinese individuals had a formal finance account in 2011; this increased to nearly 80% by 2014 and has remained at that level since. Only 56% of individuals in Brazil and 54% in South Africa had a formal account in 2011; these increased by nearly 14 percentage points in both countries in 2017. In terms of use, the picture is much less persuasive. On average, 14% of Indian individuals saved at a financial institution in the past 12 months in 2014, up just 2 percentage points since 2011. By 2017, this had increased to 20%. The figure is however much lower than the global average of 27%.

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The government has a documented financial inclusion strategy containing specific commitments that have been partially implemented

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Figure 1:   Geographic distribution of countries with financial inclusion strategy. Notes: The map is for illustration purposes only. The actual geographical boundaries are not confirmed. Source: Economist Intelligence Unit, London.

The government has a documented financial inclusion strategy containing specific commitments and it has been substantially implemented

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Inclusive Finance: India Through the BRICS Lens 151 Table 1:   Key indicators of financial inclusion for BRICS (Age 15+). Account at a Financial Institution 2011

2014

2017

Saved at a Financial Institution 2011

2014

2017

Borrowed from a Financial Institution 2011

2014

2017

Brazil

0.56

0.68

0.70

0.10

0.12

0.14

0.06

0.12

0.09

China

0.64

0.79

0.80

0.32

0.41

0.35

0.07

0.09

0.09

India

0.35

0.53

0.80

0.12

0.14

0.20

0.08

0.06

0.07

Russia

0.48

0.67

0.76

0.11

0.15

0.14

0.08

0.10

0.14

South Africa

0.54

0.69

0.67

0.22

0.33

0.22

0.09

0.12

0.09

Global

0.51

0.62

0.69

0.22

0.27

0.27

0.09

0.11

0.11

Total (billion)

2.6

3.3

3.8

0.6

0.9

1.0

0.2

0.3

0.4

The situation is very much different as regards the use of formal credit. Just around 14% of the individuals in Russia reported having obtained formal credit in 2017, the highest in the sample, with the global average being 11%. In India, only 7% of individuals borrowed from a financial institution in 2017, the lowest among the BRICS. On the whole, the evidence is consistent with the view that financial access is a necessary but not sufficient condition to ensure financial inclusion. Mobile Money When we look at a disaggregated level and especially on mobile money, the picture is even starker and widely uneven across these countries. More specifically, over 80% of individuals in South Africa used ATM for transactions purposes and well over 50% had a debit card (Table 2). In contrast, these figures were substantially smaller for India. In Russia, close to 20% of individuals used mobile phone/internet for transactions; this number is a mere 1% for India. Overall, the evidence highlights the fact that the wide divergence in the use of finance is, to a large extent, the outcome of the low use of mobile technology. When we look at access to technology for financial inclusion, we find that, as of 2014, there were only nine ATMs per 100,000 adult population in India, against 59 in South Africa, and over 150 in Russia. Similarly, only 2% of individuals aged 15 years and above had made payments through electronic means against approximately 7% in China (Figure 2). In terms of remittances send by mobile phones, Kenya has a leading position. In 2017, 63% of its adult population had used mobile phones to send money vis-à-vis

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152  S. Ghosh Table 2:   Disaggregated indicators of financial inclusion for BRICS. ATM Is the Main Mode of Withdrawal (% with Account)*

Use Mobile Phone to Pay Bills

Has Debit Card 2011

2014

2017

2011

2014

2017

2011

2014

2017

Brazil

0.41

0.59

0.59

—

0.01

0.04

0.58

0.75

—

China

0.41

0.48

0.67

—

0.01

0.17

0.33

0.51

—

India

0.08

0.22

0.33

—

0.00

0.01

0.18

0.33

—

Russia

0.37

0.44

0.57

—

0.01

0.10

0.65

0.68

—

—

—

South Africa

0.45

0.55

0.34

Global

0.31

0.41

0.48

0.03

0.07

0.89

0.82

0.02

0.08

0.40

0.52

Note: *The 2017 Global Findex database defines account ownership as having an individual or jointly owned account either at a financial institution or through a mobile money provider.

United States

United Kingdom

South Africa

United Kingdom

South Africa

Russian Federation

Kenya

Indonesia

India

Germany

China

0

Brazil

20

Russian Federation

40

Kenya

60

Indonesia

80

70 60 50 40 30 20 10 0

India

100

Percent

Number

120

Germany

140

Brazil

Used electronic modes to make payments (Age: 15+)

China

ATMs/ 100000 adults

160

Figure 2:   Use of technology in financial inclusion.

1% in India. Similarly, only 1% of the rural population in India had directly received public sector wages into their accounts in the past 1 year, against 8% in Brazil and nearly 11% in Russia (Figure 3). Barriers to Financial Inclusion Individuals often might be financially excluded owing to the presence of several barriers. In Table 3, we look closely at such possible barriers. We find that lack of money is cited as the major reason for not having a formal account. Although the

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United States

South Africa

United Kingdom

Russian…

Kenya

Indonesia

India

Germany

China

50 40 30 20 10 0

Brazil

Percent

Used an account to receive public wages, rural

South Africa

Russian Federation

Kenya

Indonesia

India

65 55 45 35 25 15 5 -5

China

Percent

Mobile phone used to send money, older adults

Figure 3:   Remittances and wage payments. Table 3:   Barriers to financial inclusion in the BRICS. Distance

Cost

Lack of Documentation

Lack of Trust

Lack of Money

Religion

Others

0.16

0.48

0.24

0.22

0.67

0.01

0.29

Year: 2011 Brazil China

0.16

0.10

0.09

0.05

0.61

0.01

0.34

India

0.23

0.24

0.17

0.09

0.63

0.08

0.45

Russia

0.13

0.20

0.11

0.43

0.75

0.05

0.21

South Africa

0.34

0.43

0.24

0.20

0.73

0.03

0.11

Average

0.20

0.29

0.17

0.20

0.68

0.04

0.28

0.08

0.24

0.09

0.08

0.66

0.01

0.36

Year: 2014 Brazil China

0.15

0.11

0.08

0.07

0.50

0.03

0.42

India

0.21

0.25

0.22

0.09

0.49

0.05

0.43

Russia

0.06

0.22

0.07

0.35

0.53

0.02

0.23

South Africa

0.24

0.24

0.30

0.12

0.58

0.05

0.26

Average

0.15

0.21

0.15

0.14

0.55

0.03

0.34

0.11

0.20

0.07

0.09

0.21

0.02

0.18

Year: 2017 Brazil China

0.06

0.04

0.03

0.02

0.17

0.01

0.10

India

0.05

0.06

0.05

0.04

0.11

0.01

0.11

Russia

0.06

0.14

0.04

0.14

0.21

0.01

0.13

South Africa

0.12

0.16

0.09

0.11

0.24

0.04

0.14

Average

0.08

0.12

0.06

0.08

0.20

0.02

0.13

Notes: Average = Simple average of the figures under each head for BRICS. Others include reasons such as family member already having an account, difficulty in operating the account, etc.

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importance of this factor has diminished between 2011 and 2017, it nonetheless remains substantial, averaging 20% in 2017. The evidence is consistent with that of Allen et al. (2016), who report similar results after examining cross-national data. Among others, individuals report the high costs to be an overwhelming consideration: the reason was extremely important in Brazil in 2011 wherein 48% of respondents cited it as important, although its relevance has since declined significantly. Distance was an important consideration inhibiting financial inclusion in both South Africa and India, although its importance has since declined substantially in case of the latter. The role of religion in influencing financial inclusion was most important in India among the BRICS, with 1% of respondents citing it as relevant in 2017, a decline from 8% in 2011. On a related note, the motives for involuntary exclusion are no less compelling: lack of trust and high cost are still important in several countries, most notably in Russia, with 35% of individuals citing it as important in 2014. It still remains an important concern in the country. This is consistent with Fungacova and Weill’s (2013) results which show that these factors have appeal in a country characterized by several bank failures and, more generally, financial instability. Alternative Sources of Borrowings Given the evidence on financial exclusion, it therefore remains to be examined as to what alternative sources of credit are relevant, apart from credit from formal sources. In Table 4, we depict these sources of borrowings. The evidence suggests that, on average, ‘family/friends’ typically dominate, with 26% of individuals having accessed credit from these sources in 2017. This factor overwhelms every other consideration in South Africa with closer to 40% of individuals relying on this method for accessing finance. Reliance on private lenders is much more prominent in India, with 4% of individuals having accessed such finance, whereas formal finance is much more important in Russia, its importance having increased from 8% to 14% during this 7-year period. While the evidence is consistent with the fact that financial access is a necessary but not sufficient condition to ensure financial inclusion, a much more rigorous analytical framework is necessary to clearly discern this relationship. We turn to this aspect in what follows. Determinants of Financial Inclusion When looking at what drives financial inclusion across countries, past evidence highlights several determinants. Among others, Sarma and Pais (2011), for instance, show that income, inequality, adult literacy, and urbanization can be considered

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Inclusive Finance: India Through the BRICS Lens 155 Table 4:   Alternative sources of borrowing in the BRICS. Store

Family/Friends

Private Lender

Any Credit

Formal Finance

Year: 2011 Brazil

0.04

0.15

0.01

0.24

0.06

China

0.03

0.21

0.01

0.26

0.07

India

0.07

0.19

0.07

0.29

0.08

Russia

0.05

0.25

0.02

0.33

0.08

South Africa

0.11

0.36

0.07

0.48

0.09

Average

0.07

0.23

0.03

0.32

0.08

Brazil

0.05

0.06

0.01

0.22

0.12

China

0.03

0.25

0.01

0.33

0.09

Year: 2014

India

0.05

0.32

0.14

0.47

0.06

Russia

0.08

0.17

0.01

0.32

0.10

South Africa

0.20

0.71

0.07

0.86

0.12

Average

0.08

0.30

0.05

0.44

0.11

Brazil

NR

0.14

0.00

0.18

0.09

China

NR

0.25

…

0.27

0.09

India

NR

0.33

0.04

0.35

0.07

Russia

NR

0.23

0.00

0.22

0.14

South Africa

NR

0.38

0.09

0.71

0.09

0.26

0.03

0.35

0.09

Year: 2017

Average

Note: NR = Not Reported; Average = Simple average of the figures under each head for BRICS.

important factors for explaining the level of financial inclusion in a country. Physical and electronic connectivity and information availability have also been found to play an important role. Ardic et al. (2011) found GDP per capita and population density to be both significantly and positively associated with deposit account penetration. The number of outstanding loans, on the other hand, was found to be negatively correlated with inflation. Kendall et al. (2010) found that bank branches per 100,000 adults seem to be a significant determinant of the number of deposit accounts in commercial banks, while inflation was also found to act as a constraint. To investigate this carefully, we conduct a cross-country analysis of 32 emerging market and developing economies (EMDEs) for 2017, using the recently released FINDEX database. We use the following dependent variables: (a) the percentage of the population having account at a formal financial institution (age 15+), and (b) the percentage of the population that had saved at a financial institution (age 15+).

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Without loss of generality, the former is used as a proxy for access to finance and the latter is a proxy for the use of finance. In addition, we control for the overall country’s economic development by using GDP per capita. Inflation is taken as a proxy for macroeconomic stability and domestic credit to private sector as percentage of GDP, and commercial bank branches (per 100,000 adults) are taken as proxies for financial development and financial infrastructure, respectively. Besides, internet usage (per 100 people) is considered to capture the technological infrastructure and educational attainment (captured by the net primary enrolment ratio) as a proxy for human capital. Our focus is on the coefficient for the India dummy. The results in Table 5 show that GDP per capita and domestic credit to private sector are significant determinants of access. Inflation was negative and significant, indicating that in an inflationary environment, people prefer to hold real assets in Table 5:   Determinants of financial inclusion in EMDEs.

Explanatory Variables 1

Access

Use

Dependent Variable: % of Adults (age 15+) with Account at a Financial Institution

Dependent Variable: % of Adults (age 15+) Who Have Saved at a Financial Institution in Last 1 Year

2

3

4

Log per capita income, 2005 USD

0.34** (0.16)

0.23 (0.16)

0.30 (0.19)

0.21 (0.24)

0.10 (0.11)

Population/1000 sq. km

0.10 (0.12)

0.06 (0.13)

0.06 (0.11)

0.19 (0.16)

Inflation (CPI)

−1.93* (0.99)

−1.69** (0.71)

−1.57** −1.10 (0.82) (0.70)

0.24*** (0.08)

0.25*** (0.09)

0.23*** (0.08)

Log net primary enrolment

0.04 (0.06)

0.05 (0.08)

Log commercial bank branches/100,000 adults

0.02 (0.11)

0.07 (0.13)

−0.05 (0.07)

0.29 (0.33)

−0.06 (0.30)

Private credit/GDP

Log Internet users/100

5

6

7

8

9

0.05 (0.08)

0.06 (0.10)

0.07 (0.16)

0.08 (0.07)

0.07 (0.06)

0.08 (0.07)

0.06 (0.09)

−0.35 (0.83)

−0.12 (0.8)

−0.12 (0.74)

−0.33 (0.81)

0.16*** (0.05)

0.19*** (0.06)

0.17*** (0.06)

0.003 (0.01)

0.004 (0.02)

India dummy

0.21** (0.09)

0.19** (0.08)

0.18** (0.08)

0.18** (0.08)

−0.06 −0.07 (0.05) (0.05)

−0.05 (0.04)

−0.02 (0.03)

Intercept

−0.80 (1.19)

−0.62 (1.05)

−0.65 (1.19)

−1.39 (0.85)

−0.54 (0.52)

−0.39 (0.61)

-0.21 (0.63)

32

32

32

0.42

0.43

0.44

N.countries

32

32

32

32

R-squared

0.40

0.59

0.58

0.59

32 0.11

−0.36 (0.51)

Note: Robust standard errors in parentheses.  ***p < 0.01; **p < 0.05; *p < 0.10.

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place of nominal assets. Other variables such as population density, enrolment in primary school, and number of bank branches were also found to positive but not significant. The coefficient of interest — India — was positive and statistically significant, indicating that India fares better than the average EMDE with respect to access to formal finance. On average, access to finance is anywhere between 0.18 and 0.21 percentage points higher in India as compared with other EMDEs. However, when it comes to use, the evidence is less convincing. In other words, having successfully ensured access to finance, the policy needs to reorient itself towards incentivizing people into using these accounts.

Financial Crisis and Financial Inclusion The global financial crisis compelled policymakers to take a fresh look at the financial inclusion initiative. Policymakers have often endorsed marketing to subprime borrowers as a means of ensuring financial inclusion. With the benefit of hindsight, it appears that such over-extension entailed adverse selection, in turn compromising the quality of the credit portfolio of financial entities and sowing the seeds of financial fragility. The position was further exacerbated by regulatory or governmental forbearance which vitiated the overall credit culture. With regard to financial inclusion, the crisis provided several lessons. First, financial inclusion helps provide a more stable retail base of deposits. Overt reliance on borrowed funds, as was manifest during the crisis, greatly eroded the soundness and resilience of financial institutions. During periods of stress, low-income clients exhibit much more stickiness in their deposit behavior, even as other sources of funds become difficult to roll over. Ratnovski and Huang (2009), for instance, note that the relative resilience of Canadian banks during the crisis was, in large part, driven by their reliance on retail deposits. Second, financial inclusion can lead to enhanced financial stability by improving the financial health of the household sector. Lack of access to formal finance can impair the ability of households to receive government transfers, to make payments, or to accumulate cash surpluses for planned expenses or emergencies. In addition, high and usurious interest rates in the informal sector can lead households into a debt trap, with adverse economic and social consequences. Besides lowering both transactions cost and interest burden, such access also entails social benefits such as protection against loss due to theft, improved mechanisms for social transfers, and better economic linkages for the rural and deprived communities. Gine et al. (2012) find that the use of biometric identification in Malawi led to a significant lowering of loan default rates. Empirical evidence for India shows that targeted distribution of LPG subsidy benefits entails a cost saving of US $1 billion a year to the exchequer (Barnwal, 2015).

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Third, the small business is also a beneficiary of financial inclusion. This is driven not only by their improved access to finance as banks have large quantum of lendable resources but also better price (e.g. competitive interest rates) and non-price (e.g. quality and cost of service) terms. In this milieu, increased formal savings can lower the cost of credit and facilitate business expansion, which in turn can have collateral benefits by not only improving the resilience of small businesses but also exert multiplier effects on large businesses through forward and backward linkages. A significant body of research has persuasively documented that finance is a key constraint to SME growth, both in cross-country (Beck et al., 2006, 2008) as well as within-country (Zia, 2008; Banerjee and Duflo, 2014) studies. Fourth, efforts to include an increasingly larger section of the population within the fold of formal finance can engender the deployment of innovative solutions and outsourcing arrangements. Such financial innovations have the potential of reducing costs and thereby enhance financial stability. Muralidharan, Niehans, and Sukthankar (2016) show that the introduction of biometric smart cards in the distribution of social benefits to intended beneficiaries in India reduced leakages by 40 % and improved household income by over 10 %. Finally and from a macroeconomic standpoint, financial inclusion can help facilitate reduction in income inequalities and, by bridging the gap between the haves and the have-nots, promote social and political stability. Both theoretical (Aghion and Bolton, 1997; Galor and Zeira, 1993) as well as empirical research (Demirguc Kunt and Klapper, 2012) point to the fact that inequality in financial inclusion is correlated with the overall income inequality within a country. Amid this changed environment, it would be useful to highlight the role played by the G20 in fostering the cause of financial inclusion. Even though the initiative towards enhancing financial inclusion was put on the G20 agenda in November 2008, its roots pre-dated the crisis. While the liberalization policies undertaken by EMDEs were successful in addressing many of the problems of mismanagement that plagued the financial sector, it proved less than adequate in increasing access by households and firms to financial services. On the contrary, the search for profits led to a gradual withdrawal of services to the poor to the extent these were provided by erstwhile state-owned banks that were re-oriented after liberalization. Recognizing financial inclusion as one of the main pillars of the global development agenda, the G20 Summit in Toronto in June 2010 articulated a set of nine principles to guide governments that seek to make financial services more inclusive. Encouraged by the response, the 2010 Seoul Summit endorsed a concrete Financial Inclusion Action Plan (FIAP). It also committed to launch the key implementation mechanisms for the Action Plan — the Global Partnership for Financial Inclusion (GPFI) — to institutionalize and continue the work begun by the Financial Inclusion Experts Group regarding furtherance of financial inclusion through better national,

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regional, and international coordination, including support for capacity building and training and an SME Innovation Fund, focused on improving finance for small businesses. The G20 initiatives regarding financial inclusion have been a welcome development. On the positive side, greater financial inclusion, which was ostensibly missing from the global policy agenda prior to the crisis, came to occupy center stage. It also heightened the appreciation of financial inclusion among policymakers, practitioners, as well as global standard-setting bodies. A new forum — the Alliance for Financial Inclusion — with over 100 members was created to advance the development of smart financial inclusion policies in developing and emerging countries. The German Presidency of G20 in 2017 provided a fillip to the process by updating the FIAP and developing High-Level principles for digital financial inclusion. With the arrival of mobile telephony and other forms of branchless banking, new technology has enhanced the possibilities of maintaining safe and dependable bank accounts for poor households. Most significantly, it has redirected attention to the huge financing gap for SMEs, straddling the ‘missing middle’ between MFIs — which have neither the balance sheet strength and risk appetite to meet SMEs’ financial needs — and commercial banks — for which SMEs are perceived as too small and risky. In a recent report, the Reserve Bank of India (RBI, 2015) had made several recommendations to address these challenges, such as those relating to certification and training of BCs and a new breed of professionals who would evaluate the financials of SMEs to ascertain their creditworthiness before these being forwarded to banks for subsequent analysis and examination. These recommendations are being closely examined. These advancements at the international also have their echo in India. The Financial Stability and Development Council (FSDC), the apex body tasked with macroprudential oversight of the financial sector was established in December 2010. Chaired by the Finance Minister, the FSDC is vested with two major ­responsibilities. The first is to function as an apex level forum to strengthen and institutionalize the mechanism for maintaining financial stability. The second is to enhance interregulatory coordination and promote financial sector development in the country. To ensure that the financial sector development is addressed in a holistic manner, a sub-Committee has been established which meets more often than the full Council. A key technical group under the aegis of the sub-Committee is the Technical Group on Financial inclusion and financial literacy to deliberate on issues related to this area. This is not to deny that many a times, an excessive penchant for financial inclusion might not necessarily be congruent with financial stability (Ghosh, 2010; Hanning and Jansen, 2010; Khan, 2011). One has to look no further than the recent subprime episode and earlier, the US savings and loan crisis in the 1990s, to appreciate this fact. More generally, it is worthwhile keeping in view the following considerations.

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First, financial inclusion often involves venturing into new business segments or markets. Not only does this involve substantial upfront costs, but also the attendant risks of lending to new segments that are difficult to ascertain, a priori. Second, the potential risks of lending to households with low and uncertain income are difficult to establish. Besides involving high operating costs, the informational inefficiencies and lack of credit history often put enormous burden on loan officers to judge a good credit risk. Since banks have to make provisions for loans gone bad based on defined criteria, erratic or irregular repayment schedules can increase the fragility of banks’ balance sheets. Third, there are also systemic as well as concentration risks for the banking industry relying on a few vendors to address the ‘last mile’ problem. Fourth, the pursuit of financial inclusion through innovative financial products needs to be carefully and thoroughly understood. As was the case with Collateralized Debt Obligations (CDO) during the US subprime crisis, during times of stress, the risks inherent in such products can magnify as market players run for cover to shield themselves from the excesses committed in good times. Finally, several of the smaller entities involved in financial inclusion often suffer from poor governance and correlated risks emanating from lending to same set of clientele as commercial banks. While commercial banks might have the balance sheet strength to shield themselves from the vicissitudes of adverse economic outcomes, these smaller entities might find it difficult to successfully withstand serious market upheavals, jeopardizing financial stability.

Emerging Areas of Focus In this section, we focus on several areas of financial inclusion that have assumed prominence in recent times. Salient among these include issues relating to gender, emerging role of technology, Pradhan Mantri Jan Dhan Yojana, Government-toPerson (G2P) payments, and new institutional initiatives. On a related note, we also touch upon some of the demand-side factors such as financial literacy and customer protection. We discuss each of these in turn. Gender and Financial Inclusion Gender disparity is commonplace in most economic and social spheres. Evidence suggests that on average, women earn 10–30% less than men for comparable work and have labor force participation rates of 55% as compared with 82% for men (World Bank, 2014a, 2014b). Not surprisingly, gender disparity is also quite pervasive with a view to access to finance. Globally, out of the 1.7 billion adults without a bank account, roughly 1 billion are women.

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Evidence proffered by Demirguc-Kunt et al. (2015) from the FINDEX 2014 database suggests that 58% of women as compared with 65% of men worldwide have an account at a formal financial institution such as bank, credit union, cooperative, post office, or microfinance. Even the more recent FINDEX 2017 database documents a 7 percentage point gender gap (72% for men vs. 65% for women) across countries in 2017. These numbers mask the wide difference across countries. By way of example, the gender gap in account ownership is negligible in high-income OECD countries. In developing economies, however, 67% of men have an account, as compared with 59% of women. Lower use of financial services by women can be explained by other genderbased differences. Men are likely to be in better-paying jobs, and hence more likely to require savings accounts. Female entrepreneurs may also choose to enter less capital-intensive industries which require less debt and therefore less finance. Legal and cultural norms also have a big impact on women obtaining equal (or any) access to financial services. For example, dissimilar gender treatment under law or customs may constrain women from entering into contracts under their own name, including the opening of a bank account (International Finance Corporation, 2011). Even after controlling for a host of individual characteristics including income, education, employment status, rural residency, and age, gender remains significantly related to access and usage of financial services (DemirgucKunt et al., 2013). A number of studies show that some microfinance programs can have a positive impact on women’s empowerment (Mayoux, 2006). Recent randomized evaluations in South Africa (Karlan and Zinman, 2009) and India (Banerjee et al., 2015) for instance indicate that microfinance schemes can positively improve both women’s economic situation and indicators of broader empowerment. Studies in Peru (Trivelli, 2009) and the Philippines (Ashraf et al., 2009) demonstrate how savings schemes can improve women’s purchasing power, confidence, and decision-making power in the household, as well as reduce their vulnerability. In India, evidence from the global Findex suggests that in 2017, 83% of men had an account at a financial institution as compared with 77% of women. The government has undertaken various steps to eliminate gender-based financial exclusion. As a step forward, loans to women (up to INR 50000) were placed under priority sector lending; also, to better cater to the needs of women, the Bhartiya Mahila Bank was established in November 2013. Notwithstanding these efforts, evidence from the All India Debt and Investment Survey (AIDIS) data published by the Government of India (2014c) suggests that women in urban and especially in rural areas are in a disadvantaged position with regard to the interest rates paid (Table 6). Illustratively, the simple interest rate paid by female-headed households in rural areas is 25.3%. This is 3.5 percentage points higher as compared to males, and the

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Table 6:   Interest rate paid by male and female headed households.

N.households Interest rate, overall N.households Interest rate, compound N.households Interest rate, simple N.households Interest rate, others

Urban

N. Households (HHs)

Total

HH-head, Female

HH-head, Male

73362

41763

4093

37670

15.2

15.8

16.7

15.8

20204

10297

855

9442

15.4

16.4

17.7

16.3

39807

23473

1995

21478

22.3

23.0

25.3

22.8

22452

13460

1440

12020

1.1

1.4

1.0

1.4

Note: Others = Free/ Concessional; ***p < 0.01; **p < 0.05; *p < 0.10. Source: Computed based on AIDIS (2012).

t-test of Difference 2.98*** 1.96** 5.59*** 3.28***

Total

HH-head, Female

HH-head, Male

31599

3444

28155

14.3

14.6

14.3

9907

902

9005

14.2

15.8

14.1

16334

1813

14521

21.2

21.9

21.2

8992

1097

7895

0.7

0.5

0.8

t-test of Difference 1.19 3.54*** 1.40 2.05**

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Rural

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Inclusive Finance: India Through the BRICS Lens 163 Table 7:   Access to and use of finance. Use Formal  Access

Informal 

Double Hurdle

Variable Estimation

Formal

Bank Probit

Informal

Stage I

Stage II

Stage I

Stage II

Technique

(1)

(2)

(3)

(4A)

(4B)

(5A)

(5B)

−0.23***

−0.09

0.29***

0.03

−0.20***

0.05

0.05

(0.05)

(0.14)

(0.11)

(0.09)

(0.04)

(0.12)

(0.09)

YES

YES

YES

YES

YES

YES

YES

YES

YES

YES

Female Controls Household size FE

YES

YES

YES

Pseudo R2/log-likelihood

0.085

0.104

0.102

−4065

Observations

74,742

52,257

52,257

16,778

YES −2610

8,888

Note: Standard errors (clustered by state) within parentheses. ***p < 0.01; **p < 0.05; *p < 0.10.

difference is statistically significant. Although these differences are much lower in urban areas, in several instances, they are nonetheless quite compelling. Table 7 reports the multivariate regression results regarding access to and use of finance (Ghosh and Dharmarajan, 2017). With regard to access to formal finance, female-headed households (FHHs) are less likely to have access to formal finance as compared with men. Disaggregating by access to bank finance and informal finance shows that FHHs are more inclined to access the latter. Looking at the use of finance, we find that even though female-headed households are less likely to borrow cash, in case they do so, their borrowings are 20% lower as compared to male-headed households. To sum up, the evidence for India is in line with the international evidence which suggests that the gender gap in access to finance remains quite significant. Pradhan Mantri Jan Dhan Yojana (PMJDY) The approach of the State towards financial inclusion in recent times has been based on two major planks. First, setting up of new institutions and, second, provision of policy guidance for existing institutions to actively participate in the inclusion process. The launch of PMJDY was different in the sense that not only was the focus on access to institutional credit by unbanked households, but unlike prior attempts, was also combined with social security through insurance. More specifically, the idea was to ensure that every household in the country has access to a bank account. This account was bundled with an insurance cover, a debit card, and an insurance facility.

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Every household opening an account was also provided with personal accident insurance as well as life insurance of INR 30000, including an overdraft facility after a few months following a credit review. In turn, these were bundled with biometric identification (Aadhaar) mobile phone number, thereby ensuring the operationalization of the JAM (Jan DhanAadhaar-Mobile) trinity to provide subsidies to the poor in a targeted and less distortive manner (Government of India, 2016).1 As of May 2018, a total of 316 million beneficiaries have been opened under PMJDY; the total balance in these accounts stands at INR 812 billion. In 2014–2015, an amount of INR 440 billion was provided by expanding this trinity to 296 million beneficiaries (roughly a quarter of India’s population). In order to ensure a broad perspective of the JAM trinity, we model PMJDY account, Aadhaar cards, and mobile telephony within a simultaneous equation setup (see, for example, Ghosh, 2017b). Accordingly, we estimate a three-equation model for household h in district d at time t:

PMJDYh ,dt = α 0 + β1 Aadhaarh ,dt + β 2 Mobile h ,dt + χ 1X1h ,dt + µ 1d + ε 1h ,dt (1a)



Aadhaarh ,dt = α 1 + γ 1PMJDYh ,dt + γ 2 Mobile h ,dt + χ 2 X 2h ,dt + µ 2d + ε 2h ,dt (1b)



Mobile h ,dt = α 2 + δ 1PMJDYh ,dt + δ 2 Aadhaarh ,dt + χ 3 X 3h ,dt + µ 3d + ε 3h ,dt (1c)

where the left-hand side variables are all dummy coded equal to 1 if the respondent has/uses the account (e.g. PMJDY) or the facility (e.g. Aadhaar, mobile); the vector X is a set of explanatory variables; µ are district fixed effects, and ε is the error term. We estimate the equation set separately for financial access and use and, likewise, separately for 2014 (short-run) and 2015 (long-run). This enables us to ascertain the short- and long-term impact of the JAM trinity. Each equation includes an appropriate set of control variables that enable us to clearly identify the equation, while allowing for possible interdependencies across equations. The results are set out in Table 8. In Panel A, we find that individuals with Aadhaar cards were less likely to have a PMJDY account in the short run, although the reverse was the case for individuals with mobile phones. These findings are reinforced in column 3 where we find a positive and statistically significant coefficient on  The Aadhaar (Targeted Delivery of Financial and Other Subsidies, Benefits and Services) Act, 2016 was passed by the Indian Parliament in March 2016. The Bill aims at providing statutory backing for targeted government subsidies and benefits by integrating them with Aadhaar numbers (Government of India, 2016).

1

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Access PMJDY

Stage

(1)

PMJDY

Aadhaar

A_PMJDY

Aadhaar

(2)

(3)

(4)

(5)

(6)

−0.576 (0.411)

0.295 (0.182)

0.488** (0.214)

−0.599 (0.513)

Aadhaar

−0.010*** (0.004)

Mobile

0.119*** (0.009)

0.325*** (0.047)

Household controls

YES

YES

District controls

YES

District FE

NO

N.Obs Chi-sq. (p-Value) R-sq.

0.203** (0.089)

0.459*** (0.059)

−0.047 (0.203)

YES

YES

YES

NO

NO

YES

NO

NO

YES

YES

NO

YES

YES

2,263

26568 (0.00)

24557 (0.00)

438 (0.00)

1570 (0.00)

1369 (0.00)

−0.0206

0.2631

0.3421

0.1015

0.2318

0.1373

Access

Use

PMJDY

Aadhaar

Mobile

A_PMJDY

Aadhaar

Mobile

(1)

(2)

(3)

(4)

(5)

(6)

2.570*** (0.384)

−0.261*** (0.087)

0.032 (0.150)

0.433 (0.402)

Aadhaar

0.067*** (0.009)

Mobile

0.031*** (0.012)

0.074 (0.080)

Household controls

YES

YES

District controls

YES

District FE

NO

N.Obs

R-sq.

YES

826 (0.00)

PMJDY

Chi-sq. (p-Value)

Mobile

0.191 (0.318)

0.205*** (0.043)

44,173

Panel B [Year: 2015] Stage

Use Mobile

0.324*** (0.091)

0.048 (0.046)

0.607 (0.435)

0.310*** (0.042)

0.124 (0.105)

YES

YES

YES

YES

NO

NO

YES

NO

NO

YES

YES

NO

YES

YES

44,096

5,436

493 (0.00)

11539 (0.00)

17387 (0.00)

794 (0.00)

1487 (0.00)

2637 (0.00)

−0.0127

0.1387

0.2244

0.0960

0.1995

0.1479

Note: Standard errors in brackets. ***, **, and * denote statistical significance at the 1, 5, and 10%, respectively.

Aadhaar. In other words, in the immediate post-PMJDY phase, Aadhaar and mobile telephony were complementary, with each reinforcing the other. However, there was not much effect of Aadhaar on the ownership of PMJDY accounts; if anything, the

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relationship was the opposite, suggesting that individuals with Aadhaar cards were not inclined to open such accounts. These findings broadly carry over to the use of accounts, except for the fact that we find two significant differences. First, individuals with Aadhaar cards are more likely to use PMJDY account, contrary to the results obtained in case of account ownership. On the other hand, the results for 2015 show that individuals with Aadhaar cards are more likely to own PMJDY accounts, contrary to the findings for 2014 where the coefficient had a negative sign. This finding can be explained by the fact that the passage of the Aadhaar (Targeted Delivery of Financial and Other Subsidies, Benefits and Services) Act in March 2016 provided statutory backing for targeted delivery of government subsidies by integrating them with Aadhaar numbers and, as a result, made it incentive-compatible for individuals with Aadhaar cards to use PMJDY accounts. In addition, individuals with PMJDY accounts are less likely to own a mobile phone, presumably reflecting the fact that having a mobile phone is not necessarily to having such an account. The PMJDY approach was based on the twin strategies of a push and a pull. The former entails leveraging the banking architecture to address the ‘last mile’ challenge by imaginatively exploiting the use of Business Correspondents (BCs) as well as recruiting fresh BCs with adequate incentives. This is complemented with exploiting the telecommunications network in order to fast-forward the growth of mobile banking. The infrastructure includes the Intermediate Payment System (IMPS) for which standards and protocols are already in place. The pull strategy comprised three elements: massive media campaign creating a buzz around the program; offer of accidental death insurance on all accounts that are opened under the scheme; offer of a potential overdraft facility; and finally, making application process and logistics simple and easy. In order to address the challenges related to information gaps, Aadhaar has been made an essential piece of the PMJDY campaign. In effect, it has been stated that, to the extent possible, Aadhaar numbers will be used as e-KYC for opening bank accounts and when Aadhaar enrollments are lagging, the Unique Identification Authority of India (UIDAI) will coordinate with banks to ensure that such enrolment takes place at the time of account opening itself. This holistic approach towards exploiting innovations to further the cause of financial inclusion also seems beneficial. They have enabled to build up the credit profile of individuals or firms, which can subsequently be used as the basis for obtaining loans even in the absence of collateral, in turn moderating the transactions costs of gathering information about these borrowers, who have no or limited credit history. The technology is also proving to be a boon for a method of alternative

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credit scoring, such that information about bill payments and deposits is collected and used, possibly in the context of big data, to determine the likelihood of a person being a good credit risk. In addition, it can also provide a mechanism for easily collecting data about access to and patterns of usage of financial services. To examine the effect of PMJDY on the access to and use of accounts by households, we use the three waves of Financial Inclusion Insights Survey (FIIS) by InterMedia, a private company focusing on mobile money and supported by the Bill and Melinda Gates Foundation. The survey is not a panel but cross-sectional data representative at the state level.2 Using this database, we extract information on the variables of interest such as whether the respondent has a bank account and whether the active is used actively (i.e. used to conduct financial transactions in the past 90 days). We also take into account other individual and household determinants, such as the gender (female vs. male), location (rural vs. urban), income profile (based on the Progress out of Poverty Index, PPI),3 work status and education status, marital status, holding of Aadhaar card, and receiving G2P payments in the account. We also take into account the district domestic product to control for the demand-side conditions and the number of bank branches per 1000 persons as a proxy for financial infrastructure. For purposes of brevity, we report only the coefficients of interest and, more specifically, how the access to and use of accounts played out during the pre- and post-PMJDY periods. With access as the dependent variable, we use the Probit model, whereas when use is the dependent variable of interest we use the Heckman two-stage model. Accordingly, in stage 1, the dependent variable is a dummy depending on whether the household has access to bank account, else zero, and in stage II, the regression is estimated only for non-zero numbers. The results are shown in Table 9. We find that access to finance in the rural areas has improved in the postPMJDY period. To illustrate, in column 1, the coefficient on Rural * Pre-PMJDY equals −0.12, and the coefficient on Rural * Post-PMJDY equals 0.23. Both these coefficients are statistically significant at the 0.01 level. In addition, the p-value of the t-test shows that the differences between these coefficients are also statistically significant. In other words, access to finance in rural areas has become reliably higher  The survey excludes the state of Jammu & Kashmir and two union territories (Andaman Nicobar and Lakshadweep). 3  The PPI index is made up of 10 questions on household size, assets, education and cooking sources, and can take a value of 0 to 100 (zero being the lowest). Households scoring less than 54 points are classified as Below Poverty Line (BPL) (living below USD 2.50). In 2015, the median (mean) score was 38 (39.7). 2

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Use Probit

Heckman

Probit

Heckman

Probit

Heckman

District Controls

YES

Probit YES

YES

YES

YES

YES

YES

YES

YES

2014 YR Dummy

YES

YES

YES

YES

YES

YES

YES

YES

YES

Individual and HH

YES

YES

YES

YES

YES

YES

YES

YES

YES

 

(1)

 (2)

(3) 

(4)

(5)

 (6)

(7) 

 (8)

(9) 

0.058

−0.024

−0.036

Rural Rural * Pre-PMJDY Rural * Post-PMJDY

(0.037)

(0.059)

(0.059)

−0.124***

−0.095

−0.092

(0.040)

(0.063)

(0.062)

0.228***

−0.047

−0.044

(0.042)

(0.062)

(0.062)

Female

−0.037** (0.019)

(0.024)

(0.024)

Female * Pre-PMJDY

−0.187***

−0.016

−0.017

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Table 9:   All accounts with pre- and post-PMJDY effects.

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(0.031)

(0.031)

0.188***

0.048

0.051*

(0.023)

(0.030)

(0.030)

BPL

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Female * Post-PMJDY

(0.022)

−0.044

−0.076**

(0.029)

(0.033)

(0.033)

BPL * Pre-PMJDY

-0.142***

-0.051

-0.052

(0.036)

(0.042)

(0.042)

BPL * Post-PMJDY

0.220***

0.000

-0.003

(0.036)

(0.042)

(0.042)

Intercept

-1.815

-1.173

-2.518

(3.105)

(3.097)

(3.113)

-1.272*** -0.980*** -1.289*** -1.269*** -1.319*** -1.019*** (0.325)

0.191

0.186

(0.323)

(0.323)

0.044

0.033

(0.322)

(0.324)

0.107

0.128

73,529

73,495

t-test of difference (p-value) Rural * YR 2013 = Rural * YR

0.000 0.000

Female * YR 2013 = Female * YR

0.000

BPL * YR 2013 = BPL * YR No. Observations

132,193

132,193

Notes: Standard errors in parentheses. ***p < 0.01; **p < 0.05; *p < 0.10.

132,194

73,529

73,495

73,529

73,495

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(0.322)

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−0.139***



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in the post-PMJDY regime. We also find similar evidence in case of access to bank accounts for females and for persons below the poverty line (BPL). However, when we look at use of bank accounts, the evidence is less convincing, corroborating the prior cross-country evidence. Technology and Financial Inclusion A key element of the inclusion story is the use of technology. Three major developments have brought technology in a big way into the inclusion initiative. The first is the decision by the Reserve Bank to appoint Business Correspondents — extension agents of the banks to deal with small-ticket transactions and reach out to people in rural and remote areas. On the one hand, the Reserve Bank allowed banks to appoint agents, and on the other, mandated banks to have a point of presence in all locations with a minimum threshold population. The second initiative has been the use of biometric identification (Aadhaar). This has enabled the provision of a unique identity to each individual. The third is the mapping of Aadhaar numbers to the bank accounts, thereby becoming a base for technology-enabled banking. This has permitted two significant value additions. First, it has lowered the transaction costs of delivering targeted benefits by the government: the PAHAL scheme of transferring LPG subsidies has already reduced leakages by 24%; the potential annual savings is expected to be roughly of the order of INR 127 billion (Government of India, 2016). Second, the process has permitted to eliminate ‘ghost’ and duplicate households from Box 2: G2P payments: Evidence and practices In a number of countries, governments have sought to increase the use of electronic means for government payments and to promote greater financial inclusion Government of India (2014b). While the two agendas have by no means converged yet, in practice they have often been translated into a single objective i.e. to increase the proportion of recipients of government social cash transfers who receive payment directly into a bank account. On the one hand, such payments are seen as likely to reduce the cost of payment for government and make delivery more convenient for recipients, compared with the prevalent cash-based schemes, which could entail significant transactions costs. On the other hand, a bank account has been seen as the means to enter into the wider world of formal financial services (Bold, Porteous and Rotman, 2012). The empirical literature is fairly unambiguous that digital payments provide huge development gains. In the African country of Niger, researchers found that making social safety net payments via mobile phones versus having to go in person reduced (Continued )

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Box 2: (Continued)

overall travel and waiting time by 75 %, providing people with the flexibility of time in attending to more productive tasks (Aker, Boumnijel, McClelland and Tierney, 2016). Mexico’s shift to digital payments cut spending on wages, pensions, and social benefits by 3.3 % annually, or almost $1.3 billion (Babatz, 2013). When Argentina moved payments for a large national social program from cash into accounts, demand for kickbacks virtually disappeared (Duryea and Schargrodsky, 2008). Similar evidence is also in evidence in the Indian context. Evidence proffered by Muralidharan, Niehans, and Sukthankar (2016) shows that digitizing social security transfers caused demands for bribes to drop by 47%, and led to beneficiaries receiving higher payments. Barnwal (2015) estimates that better targeting of LPG subsidies would entail a saving of about US $1 billion for the Indian government. Not surprisingly therefore, the federal government has been switching to digital modes of transfer of subsidies and other benefits to the intended beneficiaries. Direct benefit transfer (DBT) has been introduced by the central government in January 2013 in select districts encompassing 26 central sector (CS) and centrally sponsored schemes (CSS). Presently, 34 CS and CSS schemes and three subsidy-related schemes are being covered under DBT. A total amount of INR 134 billion was disbursed at the end of March 2015, encompassing manifold programs in areas as diverse as public works (e.g. Mahatma Gandhi Rural Employment Guarantee), women welfare (Janani Suraksha), and LPG benefits (PAHAL). Akin to the Federal government, state governments also offer several schemes for the intended beneficiaries Government of India (2014a). To illustrate, the government of West Bengal runs a conditional cash transfer scheme, Kanyashree Prakalpa, for the empowerment of adolescent girls. Under the scheme, zero-balance bank accounts are opened in the name of the girls through simplified account opening procedures. A total of INR 1848 million was spent under the scheme 2014–2015. In a similar vein, Telangana government has introduced an AASARA pension scheme for disabled, old age persons and widows, wherein the monthly pension amount is remitted into the bank/post office account of the pensioner. During 2015–2016, INR 25670 million has been provided for the scheme. The Government of Madhya Pradesh started the Laadli Laxmi Yojana in 2007 with an objective of women empowerment through improvements in their educational and economic status. Under the scheme, National Savings Certificates worth INR 6,000 are purchased by the State Government in the name of a girl every year after she is born till the amount reaches INR 30,000. The government allocated INR 7,780 million for the scheme in 2014–2015. The government of Tamil Nadu runs a maternity benefit scheme for pregnant woman of below poverty line (BPL) group, wherein cash assistance of INR 12,000 is given to pregnant women. While in some cases the state governments have been resorting to electronic modes for payments, it has not yet gathered sufficient momentum.

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beneficiary rolls. Contextually, it may be mentioned that G2P payments have been extensively employed across countries, with varying degrees of success. Second, the recently introduced Unified Payments Interface (UPI) is expected to revolutionize the way retail payments are made in the country. The system permits a one-click, two-factor authentication on mobile phones across bank accounts, based on the Immediate Payment Service (IMPS) platform. Unlike the IMPS which requires details such as Mobile Money Identifier — a seven-digit number issued by a bank — mobile and account numbers to complete a transaction, UPI will require only one identification and does not necessitate information regarding the bank account details of the parties. One aspect of ICT which has attracted the attention of researchers is the usefulness of mobile telephony in enhancing financial inclusion and thereby, via the finance-growth interlinkage, augmenting economic growth (Levine, 2005). Several studies have empirically examined this issue. Using cross-national data, studies have found that cellular services contribute significantly to national output (Waverman et al., 2005). In the case of India, Kathuria et al. (2009) show that mobile penetration in Indian states was associated with a positive and statistically significant improvement in output. Recently, Ghosh (2019) shows that the complementarities of mobile telephony with biometric identification is manifest primarily in case of financial access as compared with use of finance. We explore the impact of mobile telephony on state income. Accordingly, we combine information on mobile telephony with state per capita income and financial inclusion. As for the latter, following Beck et al. (2007c), we consider six indicators: two each relating to penetration, access (deposit and loan accounts), and use (deposit-to-income and loan-to-income). For 32 states and Union Territories (excluded ones are Daman and Diu, Dadra and Nagar Haveli, and Lakshadweep, owing to paucity of data), we normalize these indicators using a max–min strategy and take a simple average of these indicators to arrive at a financial inclusion index (OECD, 2008; Government of India, 2013). We classify states as having high or low financial inclusion (based on the in-sample median index value) and juxtapose it with (log of) state per capita NSDP and fraction of persons in the state using mobile telephony (Fr_Mobile). The evidence appears to suggest that states with higher proportion of mobile users (triangles) have higher per capita NSDP, after controlling for financial inclusion. To further understand whether mobile telephony is a key factor driving financial inclusion, we exploit data on mobile penetration from IndiaStat and combine it with estimates of financial inclusion using the RBI database to estimate an empirical specification as in equation below for state s at time t:

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FI s ,t = α 0 + α 1 y s ,t + α 2 Mobile s ,t + γ X s ,t + µ s + ε s .t ,

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5

GOA

4.8

where FI is the indicator of financial inclusion, represented alternately by the number of deposit and loan accounts and number of bank branches; X is a vector of statelevel controls such as per capita income, education, and number of mobile network operators; μ is the state-fixed effect; and ε is the error term.4

MAH

DELHI PUD

pc NSDP 4.4 4.6

KER ARUNP

CHHTS ODIS

4.2

TRI MEG WB MP

NAG

JHK ASM

SIK

A&N

TN HARY GUJ HP UTTK AP PUN KARN MIZ J&K RAJ MAN

UP

4

BIH

.2

.4

Fr_Mobile

95% CI log PCNSDP

.6

.8

Fitted values log PCNSDP

Based on the empirical evidence presented in Table 10, the following observations can be made. First and more generally, the impact of mobile penetration on financial inclusion is quite substantial, although the effect differs across various measures. Second and more specifically, the biggest impact of mobile penetration is manifest on use and, more specifically, on the use of deposit and loan accounts (columns 3 and 4). New Institutional Initiatives In addition to products, processes, and logistics, a key development has been the licensing of new institutions in the private sector. This further opens up the space for financial inclusion and, in effect, raises the overall level of competition in the banking sector. Three sets of institutions have been permitted. Establishing new institutions, however, is not unique to India, but has been practiced in other countries as well (Box 3). The first is the license given to two new banks in the private sector. Accordingly, two new banks — IDFC bank and Bandhan Bank — started operations from 2015.  The empirical analysis is based on Ghosh (2016a).

4

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174  S. Ghosh Table 10:   Financial inclusion and mobile telephony. Access

Use

Log (Bank Office/ 100,000)

Log (Bank Office/ 1,000 sq. km)

Log (Deposit Ac/1,000)

Log (Credit Ac/1,000)

(1)

(2)

(3)

(4)

Real per capita NSDP, lagged

−0.576 (0.439)

−1.312 (1.533)

−0.659 (0.771)

−0.679 (0.693)

Mobile

0.386* (0.169)

0.114 (0.399)

0.935** (0.257)

1.467** (0.254)

State controls

Yes

Yes

Yes

Yes

Merger dummy

Yes

Yes

Yes

Yes

No. observations

125

125

125

125

Dep. Var

No. states

14

14

14

14

R-squared

0.581

0.325

0.826

0.913

Note: Standard errors (clustered by state and year) in brackets. *p < 0.05; **p < 0.01.

Second, the Reserve Bank permitted Small Finance Banks (SFBs) to operate in the banking space. As compared to the microfinance institutions which also typically operate within small jurisdictions, these banks are differentiated in terms of three factors: (a) a lower start-up equity as compared to comparable newly established private banks, (b) a much higher proportion of priority sector lending requirements, and (c) restricting a minimum proportion of loans as not to exceed a threshold level. Ten such SFBs have been granted ‘in principle’ approval. Third is the permission given to Payments Bank (PBs) to also operate in the financial space. The idea of a PB was that they would accept small savings, particularly of low-income households, manage remittances which would be of particular use to migrant workers, and distribute third-party products. These banks are expected to operate with cutting-edge technologies so as to leapfrog the technological content of banking operations. After scrutinizing the applicant list, ‘in-principle’ licenses were awarded to three distinct types of players: telecom players with a strong distribution network, technology players, and traditional finance companies with a strong retail presence Since it is envisaged that the maximum balance in any account will never exceed INR 100,000 at any point in time, this initiative is expected to reach the smaller segment of the customers. Moreover, the guidelines also specify that these banks are not expected to adhere to the quota of 25% branches in villages with less than 9,999 inhabitants but instead, at least a quarter of its access points should be in such locations, thereby placing a greater emphasis on vertical specialization and technology.

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Box 3: New banking institutions In many countries, innovative institutions have been instituted in order to improve financial access. In the Philippines for example, entry into the banking system for microfinance units was liberalized, permitting the establishment of new banks that are licensed and regulated as regular banks but have to dedicate at least 50% of their loan portfolio to microfinance. In 2009, Mexico permitted the establishment of a new specialized intermediary — a so-called niche bank — that could gather funds from the public, access the payment system, and be subject to the same regulatory standards, but with lower minimum capital requirement. In India, besides new banks in the private sector and other such dedicated institutions, the Micro Units Development and Refinance Agency Bank (MUDRA) has been established in 2015. Beginning with a corpus of INR 200 crore, the entity will focus on lending to micro/small business entities engaged in manufacturing, trading, and service activities.

While all these technological developments can enable to leapfrog and provide financial solutions for the unbanked, it needs no gainsaying that there is always a critical need for a balance between embracing its advantages and maintaining the personal contact that is often vital to gaining customer trust, the exchange of information about unique customer needs, and the absorption of financial capability. A proactive focus on the Business Correspondent Model, addressing its weaknesses while buttressing its benefits, appears to hold considerable promise. The Reserve Bank is examining the modalities to ensure a certification program for BC in order to bring greater discipline in this sector. Government-to-Person (G2P) Payments World over, governments have been switching to G2P payments in order to reach the targeted beneficiaries in a cost-effective and less distortive manner. According to Pickens, Porteous, and Rotman (2009), as many as 49 social transfer scheme presently deliver payments in 33 countries for a total of 125 million recipients; the total gains to the government from such targeted transfers amount to US $12.6 million. The empirical evidence suggests that G2P payments entail significant development gains, as in case of Mexico (Babatz, 2013) and Argentina (Duryea and Schargrodsky, 2007). In the Indian context, the government has begun exploiting the JAM trinity towards less distortive way of reaching out to intended beneficiaries. Payments

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under the flagship Mahatma Gandhi National Rural Employment Guarantee Scheme (MGNREGS) have since 2009 begun to be credited directly to the bank accounts. The PAHAL scheme of transferring LPG subsidies to the poor has already reduced leakages to a significant extent; the potential annual savings is expected to be of the order of INR 127 billion (Government of India, 2016). Empirical evidence conclusively suggests that G2P payments are able to better target the intended recipients and entail significant cost reduction. Using data for the Indian state of Andhra Pradesh, Muralidharan, Niehans, and Sukthankar (2016) find that digitizing social security transfers lower the demand for bribes and raise the payment in the beneficiaries account. Barnwal (2015) estimates that better targeting of LPG subsidies by the Indian government would entail a saving of about US $1 billion. To examine the impact of MGNREGS on financial inclusion for India, following Ghosh (2016), we use the InterMedia data and exploit the staggered timing of implementation of MGNREGS across certain districts and estimate the following specification for household h in district d at time t as5:

SBFDhdt = α + β MGNREGSdt + γ X hdt + µ d + η t + ε hdt .

In the equation above, SBFD (Savings Bank Fixed Deposit) is the outcome variable of interest, alternately defined in terms of financial access and use and X is a vector of individual and household determinants such as gender (female vs. male), location (rural vs. urban), income profile (based on the Progress out of Poverty Index, PPI)6, work status and education status, marital status, holding of Aadhaar card, and receiving G2P payments in the account. We control for the non-random rollout of the program by including the interaction of the ‘backwardness’ index (BI) as devised by the Planning Commission (Government of India, 2003) with year dummies (Dasgupta et al., 2017). The index served as a basis for allocating districts to different phases of the program rollout. The district-level controls (μ) include domestic product per capita (DDP) and number of bank branches per 1000 persons as a proxy for financial infrastructure.

 The program was initially rolled out in 200 districts in February 2006 and subsequently in 130 districts in April 2007 and finally, in the remaining districts in April 2008. To understand the effect of the program on financial inclusion, we compare the impact of the implementation of MGNREGS in the first two sets of districts vis-à-vis the third set of districts. 6  The PPI index is made up of 10 questions on household size, assets, education and cooking sources, and can take a value of 0–100 (zero being the lowest). Households scoring less than 54 points are classified as Below Poverty Line (BPL) (living below USD 2.50). In 2015, the median (mean) score was 38 (39.7). 5

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Inclusive Finance: India Through the BRICS Lens 177 Table 11:   Impact of MGNREGS on financial access and use.

Dep. Var. MGNREGS

Access

Use

Dummy = 1 if Respondent Has SBFD Account, Else Zero

Dummy = 1 if Respondent Has Active (#) SBFD Account, Else Zero

(1)

(2)

(3)

(4)

0.121** (0.015)

0.101 (0.216)

-0.096** (0.016)

-0.115** (0.020)

MGNREGS * Female District controls

0.041** (0.019) YES

YES

0.043* (0.024) YES

YES

Household controls

YES

YES

YES

YES

Year fixed effects

YES

YES

YES

YES

No. observations

128615

128615

66232

66232

F-test (p-value)

248.3 (0.00)

240.7 (0.00)

80.6 (0.00)

79.3 (0.00)

Notes: # An account is defined as active if the respondent has conducted any financial transactions in the past 90 days. Standard errors in brackets. *p < 0.01; **p < 0.10.

The variable MGNREGS equals 1 if the program was implemented in district d (d = 1, 2) at time t, else zero (Imbert and Papp, 2015). The coefficient of interest is β, which estimates the impact MGNREGS on financial inclusion. Table 11 shows that access to SBFD account increases by 12.1 percentage points owing to the implementation of the MGNREGS in these districts. In addition, we find that MGNREGS did not perceptibly increase use; in fact, there is a decline in the likelihood of use of SBFD accounts. We also consider the interaction of MGNREGS * Female to ascertain the differential impact. The results show that access to finance increases by 4.1 percentage points in districts where MGNREGS is introduced early. To understand its economic significance, we look at a change in the average proportion of females from 0.49 (as in case of Rajasthan, the lowest in the sample) to 0.66 (as in case of Uttarakhand, the highest in the sample). The estimates in column 2 indicate that such a change leads to an additional 140 percentage point increase in the probability of access to bank account, quite a significant jump. In case of use, the magnitudes are a tad higher. Before we conclude, it would be worthwhile to mention two sets of studies which have a bearing on the G2P initiative. The first set of studies explore the relevance of public works program for financial inclusion in the presence of gender-related violence. To provide some examples, Amaral et al. (2016) show that Indian districts which implemented the MGNREGS program early witnessed an increase in

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domestic violence. Earlier to that, Chin (2012) had demonstrated that female labor force participation is associated with a reduction in domestic violence. More recently, Ghosh and Gunther (2018) showed that households in states with gender-related violence are less likely to own a bank account, notwithstanding the fact that districts in these states were early implementers of the public works program. The second set of studies examines the interface between public works program and left-wing extremism (LWE) violence and its interplay with financial inclusion. Employing an OLS framework, Barooah (2008) finds that LWE-conflict violence across districts increases with poverty and declines with literacy. Dasgupta et al. (2017) find that the effect of LWE-violence is mitigated by the roll-out of a large public works program (MNREGS) in Maoist-affected states. Using survey data, Ghosh (2019) shows that MGNREGS leads to an improvement in financial inclusion, notwithstanding the deleterious effects of higher LWE-violence. Our findings therefore suggest that public work programs do play a role in significantly influencing financial inclusion. Financial Literacy and Customer Protection Efforts at financial inclusion need to be strengthened on the demand side by ensuring significant investments in financial literacy. This assumes relevance if the poor are to make effective use of various initiatives towards fostering financial inclusion. This should include not only basic financial literacy, but also sector-focused financial literacy or, even for that matter, product-driven financial literacy so that the poor are not short-changed. Efforts to promote financial literacy need to start early and include both conventional (e.g. school curriculum, dedicated websites, self-help groups) and unconventional (e.g. time slots during high-impact TV programs, toll-free helpline) delivery channels. The funds set aside by various regulators for this purpose need to be seamlessly integrated as part of the overall agenda. Grievance redressal for customer complaints in banks also need imaginative thinking. Despite repeated exhortations, banks often penalize customers for minor violations, whereas any deficiency in service on their part are often not addressed expeditiously. The challenges in decoding and understanding the fine print from the large volume of convoluted information leads to an unequal relationship where the principal (i.e. the depositor) is actually far less powerful than the agent (i.e. the bank). The significant volume of complaints received by banks in regard to basic areas such as deposit accounts and even failure on non-observance and nonadherence to defined practices is ample testimony in this regard. As of end-March 2017, a total of 119678 complaints were received at Banking Ombudsman Office, of which 68 % pertained to public sector banks. Across ownership, issues relating

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to ATM/Credit and Debit cards were the most common, accounting for 13% of the complaints in public banks and 7% in private banks. The problem is all the more imposing for less sophisticated rural consumers, who are often unaware as how best to quickly and efficiently obtain a fair and cost-efficient solution to their grievances (Box 4).

Box 4: Consumer protection and financial literacy: What does global evidence suggest? In collaboration with FinCoNet, an international cooperation platform for supervisory agencies in the area of financial consumer protection, the World Bank in 2013 conducted a Global Survey on Consumer Protection and Financial Literacy for 114 economies. The Report was published in 2014. India was not included in the Survey. The survey covered four main areas: (1) legal and regulatory framework, (2) institutional arrangements, (3) disclosure practices, and (4) financial education. Regarding the legal and regulatory framework, five areas were addressed: whether a country has a general consumer protection (CP) law, whether the CP law has explicit reference to financial services, whether the country has separate financial consumer protection (FCP) law, whether CP regulations exist within the framework of financial sector legislation, and finally, whether there exists other FCP laws. While only 35% of the 114 countries had a separate FCP law, the overall evidence indicated that a basic legal framework for consumer protection was in place in most countries, although it might not be very pertinent in terms of its coverage of the issues relevant to financial services. As many as 29 items were included under institutional arrangements (Table). The evidence indicated that in countries with broad consumer protection legislation in place, the agency responsible for implementing this legislation also had the responsibility for consumer protection in financial services. The survey examined 28 facets of disclosure practices, including among others, general disclosure requirements at the account opening stage, regardless of account type, including: (1) plain language, (2) local language, (3) a standardized format for disclosure, and (4) disclosing recourse rights and processes. There were also questions on the annual rate or yield, the method of compounding, minimum balance requirements, fees and penalties, and early withdrawal penalties (for deposit services). For credit services, among the included categories were annual percentage rate, fees, and computation method regarding the average balance and interest. Overall, disclosure requirements at opening of loan and deposit accounts are focused on rates and fees, and to a lesser extent on the manner in which these rates and fees are computed. (Continued )

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Box 4: (Continued)

As regards financial education, a major focus was to understand whether there existed any dedicated agency to implement/oversee financial education. More than half (55%) of the countries had an agency that had the responsibility to implement/ oversee any aspect of financial education/literacy. The findings suggest that although some form of consumer protection legislation is in place in most countries, it does not necessarily include provisions specific to the financial services industry. Vast differences can be detected for the different income groups. Second, enforcement powers of supervisors are often limited, especially in lower middle-income and low-income countries. Third, regulations on financial consumer protections are of recent origin, and several countries of all income groups are pursuing this area with great vigor.

Item Countries

High Upper Lower Low Income Middle Income Middle Income Income 32

34

18

15

3

3

2

2

16

14

10

8

19

17

14

7

3

4

2

1

Legal and regulatory framework Sub-categories (5) Institutional arrangements Sub-categories (29) Disclosure practices Sub-categories (28) Financial education Sub-categories (6)

Notes: Numbers in brackets under each head indicate the number of included sub-categories. Numbers in each column indicate the number of countries complying with at least 50% of the subcategories.

We classify the countries based on their income as per the World Bank methodology. The analysis provides several insights. First, as one moves from high- to low-income countries, the proportion of countries compliant with the various subcategories declines. Second, while higher income countries have, on average, achieved a higher levels of consumer protection and financial literacy (measured in terms of coverage of all sub-categories), this does not necessarily imply a causal relationship. This calls for greater research in this area, particularly concerning which item is inducing higher levels of financial inclusion, in order to inform policymaking on financial inclusion.

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Although there is a lot of discussion on financial literacy in India, evidence on the ground is quite limited. The recent Financial Inclusion Insights (FII) survey of more than 45,000 respondents across 22 states in India provides some initial insights as to the status in this regard (Box 5).

Box 5: Financial literacy in India: What is the evidence? The Financial Inclusion Insights (FII) survey contains a section on financial literacy, although the survey focused mainly on access to finance and mobile money (Intermedia, 2014). The Survey focused primarily on financial knowledge (Panels A and B) and financial behavior (Panel C), but did not touch upon the issue of financial attitudes (see Box 6). Considering the expected divergence in the extent of financial inclusion in urban and rural areas, the analysis differentiates between the rural and urban areas. Panel A, which asks questions about basic knowledge of calculus that is needed for financial matters, indicates that India’s urban population performs slightly better as compared to their rural counterparts. Yet, people appear to be financially less literate when asked a three-fold set of questions on how interest rates impact their money over time, especially when taking into account the inflation aspect. Item

%

Panel A: Financial knowledge — Calculus Location Refused Division Calculation of interest rate Calculation of interest earnings Calculation of real interest rate

Incorrect

Correct

Rural

17.4

0.4

82.2

Urban

9.9

0.3

89.8

Rural

39.6

14.8

45.6

Urban

24.9

17.7

57.4

Rural

32.6

8.5

58.9

Urban

19.9

10.5

69.6

Rural

49.6

18.9

31.5

Urban

32.1

27.4

40.5

Panel B: Financial knowledge

Location Refused Don’t know

Know

Interest paid on current loan with a formal financial institution (Bank, MFI, Post Office Account etc.)

Rural

0.0

13.1

86.9

Urban

0.0

20.6

79.5

(Continued )

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Box 5: (Continued) Interest paid on current loan with a semiformal/informal financial institution (Lending and Savings Groups, Private Money Lender, Loan through Community)

Rural

0.0

36.3

63.7

Urban

0.0

43.4

56.6

Panel C: Financial behavior

Location

Always

Sometimes

I pay my bills on time

Rural

31.7

23.3

45.0

Urban

41.0

21.9

37.0

Rural

28.4

29.7

41.9

Urban

30.0

32.3

37.7

Set aside money for unplanned expenses/ emergencies

Rural

10.9

23.1

66.0

Urban

13.4

25.3

61.2

I make a plan for how to spend my income

Rural

21.6

34.4

44.1

Urban

25.4

35.1

39.5

I spend less many than I make each month

Rarely/ Never

Panel B enquires about financial knowledge by asking respondents who currently have a loan (formal or semi-formal/informal) whether they know what interest rate they pay. While the results could be driven by a rural bias in the data (69% of respondents are defined as rural dwellers), the interviewed rural population performs noticeably better. Informal financial services still seem to dominate, consistent with the AIDIS data. Finally, Panel C indicates that the surveyed urban respondents have adopted a slightly prudent financial behavior, or in other words, are better at managing income and expenses and take long-term financial considerations on board. This emphasizes the fact that access to finance in rural areas might not alone suffice but behavioral constrains also need to be considered in order to achieve greater progress on the financial inclusion front. Utilizing data from the survey, Gunther and Ghosh (2018) focus on evaluating financial literacy in India. They categorize financial literacy into three subcomponents — financial knowledge, financial attitude, and financial behavior — akin to the procedure followed by Atkinson and Messy (2011) in their cross-national study. The authors construct an index of financial literacy, which ranges from a minimum of zero (i.e. when the respondent does not provides a correct response to any of the questions) to a maximum of 15 (when the respondent provides a correct response to all the questions). The findings show that at the all-India level, the average (resp., median) financial literacy score is 6.8 (resp.,7), with large and significant variation across states not only in terms of overall financial literacy, but also in terms of its sub-components. (Continued )

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Box 5: (Continued)

15 12 9 6

FK Score

FB Score

FA Score

Bihar (11%)

Goa (13%)

Madhya Pradesh (11%)

Jharkhand (15%)

Uttar Pradesh (17%)

Chhattisgarh (17%)

Andhra Pradesh (20%)

Gujarat (21%)

Haryana (24%)

North East (25%)

Orissa (25%)

All India (26%)

Assam (27%)

West Bengal (31%)

Kerala (32%)

Rajasthan (32%)

Delhi (35%)

Maharashtra (32%)

Punjab (38%)

Karnataka (45%)

Tamil Nadu (48%)

Uttarakhand (55%)

0

Himachal Pradesh (77%)

3

FL Score

Since financial literacy comprises a mix of several attributes, being financially literate therefore does not necessitate a perfect financial literacy score. Based on this logic, we consider an adult as being financially literate if the literacy score is at or above the 75th percentile of the literacy distribution. Using this criteria, we find that 26.2% of the adult population is financially literate. To put it differently, nearly three-quarters of the adult population do not possess sufficient financial literacy competencies. Advancing the process further, a multivariate regression exercise is undertaken wherein for respondent i belonging to household HH in district D, the baseline regression is of the form: Yi ,HH ,D = α i + m D + β X i ,HH ,D + β Z HH ,D + ε i ,HH ,D ,



where Y is the normalized financial literacy score, mD are the district fixed-effects which absorb any variation at the district level that can impact financial literacy, x is a vector of variables that capture the respondent’s demographic and socio-economic characteristics such as gender, location, age, educational and employment status, z represent characteristics of the household to which the respondent belongs, and finally, ε is the random error term. (1)

(2)

Gender (Control: Male) Female

 

(0.001)

(0.001)

(5)  

(6)

(7)

 

-0.038***

-0.023***

-0.015***

-0.014***

(0.001)

(0.001)

(0.002)

(0.002)

(0.002)

 

 

 

 

-0.014***

-0.016***

-0.015***

-0.015***

(0.002)

(0.002)

(0.002)

(0.002)

-0.019*** -0.018*** (0.002)

(4)  

-0.056*** -0.056*** -0.057***

Location (Control: Urban) Rural

(3)

(0.002)

(Continued )

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Box 5: (Continued) Age Squared Age

0.011***

0.011***

0.011***

0.011***

0.011***

(0.000)

(0.000)

(0.000)

(0.000)

(0.000)

-0.0001*** -0.0001*** -0.0001*** -0.0001*** -0.0001*** (0.000)

(0.000)

(0.000)

(0.000)

 

 

 

0.025***

0.025***

0.024***

(0.003)

(0.003)

(0.003)

(0.003)

Standard 8

0.065***

0.064***

0.060***

0.058***

(0.002)

(0.002)

(0.002)

(0.002)

Standard 12

0.106***

0.105***

0.098***

0.094***

(0.002)

(0.002)

(0.003)

(0.002)

Tertiary education

0.134***

0.134***

0.125***

0.119***

(0.003)

(0.003)

(0.004)

(0.003)

0.028***

0.025***

0.026***

(0.003)

(0.003)

(0.003)

0.031***

0.029***

0.028***

(0.003)

(0.003)

(0.003)

0.005**

0.004

0.005**

(0.003)

(0.003)

(0.003)

-0.003

-0.002

0.006

(0.004)

(0.004)

(0.004)

0.002

0.003

0.005

(0.004)

(0.004)

(0.004)

0.004

0.006*

0.021***

(0.003)

(0.003)

(0.004)

0.029***

0.027***

(0.002)

(0.002)

Education (Control: Illiterate) Literate - no Edu

(0.000) 0.023***

Employment (Control: Housewife) Employed Self-employed Occasional work Looking for a job Not working Student Technological Aptitude (Control: No mobile) Owns mobile phone Indebtedness (Control: Savings never larger than debt) Savings > debt: Rarely

0.043***

Savings > debt: Sometimes

0.094***

(0.002) (0.002)

(Continued ) (Continued )

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Box 5: (Continued) 0.106***

Savings > debt: Never

(0.003) Intercept HH Characteristics District FE

0.237***

0.252***

0.223***

0.144***

0.162***

0.153***

0.127***

(0.013)

(0.013)

(0.014)

(0.014)

(0.015)

(0.015)

(0.014)

Yes

Yes

Yes

Yes

Yes

Yes

Yes

Yes

Yes

Yes

Yes

Yes

Yes

Yes

No. obs

42,696

42,696

42,696

42,679

42,679

42,679

42,679

R-squared

0.389

0.390

0.397

0.429

0.433

0.437

0.479

Notes: Standard errors in parentheses. ***, **, and * denote statistical significance at the 1, 5, and 10%, respectively

The findings point to large and statistically significant gender-, location-, employment-, education-, technology-, and debt-driven differences in financial literacy. To provide some examples, the coefficient on Female (in col. 1) indicates that female respondents display 5.6% lower financial literacy as compared with their male counterparts, and the finding is remarkably robust and consistent related research (Hsu, 2011; Lusardi et al., 2014). In column 4, when we include education as a control, it is observed that higher the levels of education, the greater the financial literacy. As we move up the education scale, the magnitude of the point estimates increases and they are statistically significant as well. Thus, respondents with tertiary education exhibit 14% increase in financial literacy, five times the number obtained from the lowest category (see, for example, Christiansen et al., 2008; Gerardi et al., 2013; Klapper et al., 2013). The final column looks at household debt profile. Debt literacy — defined as the ability to make simple decisions regarding debt contracts — has gained relevance in recent times, because individuals with inadequate understanding of such contracts are often found to engage in higher-cost borrowing (Calcagno and Monticone, 2015), sloppier financial behavior (Gathergood and Weber, 2017), or less advantageous financial contracts (Van Ooijen and van Rooij, 2016). On balance, our finding suggests that less indebted households are financially more literate as compared with those who are more indebted. This is in conformity with prior research (Lusardi and Tufano, 2010) and highlights the risk of potential ‘debt traps’ in the Indian context (Reserve Bank of India, 2017). To see this, note that the coefficient on Savings are larger than Debts: Never equals 4.3%, whereas that on Savings are larger than debts: Always is 10.6%, nearly two-and-a-half times as large.

Around the world, people with access to formal finance are being asked to assume greater responsibility for their financial well-being. With financial

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products and services becoming increasingly sophisticated, consumers are constantly challenged to read the fine print to decode the inherent risks embedded in financial products. Rules and conditions for credit cards, mortgages, lines of credit, and other vehicles for borrowing have significantly altered over time, substantially raising the risk exposure of customers. In this changed milieu, financial literacy is being increasingly advocated by regulators as a first line of defense for consumers (Box 6).

Central Banks and Financial Inclusion Our previous discussion suggests that while significant progress has been made on the supply side of financial inclusion, there is still distance to cover on the demand Box 6: Financial literacy around the world While stating the need for financial literacy is easy, it is often challenging to clearly define what constitutes financial literacy. Based on 14 countries across four continents, Atkinson and Messy (2012) surveyed the financial landscape with regard to consumer understanding of financial literacy. On average, 1000 adult individuals (i.e. age 18+), both male and female across different income classes, were interviewed face-to-face regarding their financial knowledge, financial behavior, and attitudes and preference towards finance, and the results were summarized and collated. The results indicate important variations across countries. Illustratively, in several countries, a larger proportion of the population achieved a higher knowledge score than a high behavior score, indicating that levels of financial literacy in these countries are higher in terms of knowledge than behavior. Conversely, in several others, financial literacy levels were observed to be higher in terms of behavior. The relevant questions are highlighted in the table below. Items

Refused

Don’t Know

Incorrect

Correct

Panel A: Financial knowledge Division Time value of money Interest paid on a loan Panel B: Financial knowledge Calculation of interest plus principal Definition of inflation

(Continued )

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Box 6: (Continued) Diversification Yes

No

Compound interest AND correct response to previous question Refused

Sometimes

Always

Never

Refused

Sometimes

Agree

Disagree

Panel C: Financial behavior Before I buy something, I carefully consider whether I can afford it I pay my bills on time I keep a close watch on my financial affairs I set long-term financial goals Panel D: Financial attitudes Money is there to be spent I find it most satisfying to spend money than to save it for the long-term I tend to live for today and let tomorrow take care of itself

side. This raises the question as to how far central banks have a role to play and how has it changed in the new milieu. It has been argued that financial inclusion is a means and not the end of economic development, and as a result, there is a need to clearly demarcate the relative roles of the central bank and the government in achieving this objective (Reddy, 2015). There are several reasons why increased financial inclusion may support the central bank’s task of safeguarding financial stability. First, consumers gaining access to the formal financial system are likely to increase aggregate savings and diversify the banks’ depositor base (Aghion et al., 2009). Any increase in savings has the potential to improve the resilience of financial institutions, given the stability of retail deposit funding, as was evidenced during the crisis (Ratnovski and Huang, 2009; Raddatz, 2010; Cornett et al., 2011). Second, by improving firms’ access to credit, financial inclusion can enable financial institutions to diversify their loan portfolios. Moreover, lending to firms that were previously financially excluded may also reduce the average credit risk of loan portfolios. Evidence suggests that an increase in the number of borrowers from small and medium-sized enterprises is associated with a reduction in delinquent loans and a lower probability of default by financial institutions (Bayoumi and Melander, 2008).

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Third, financial inclusion facilitates greater participation by different segments of the economy in the formal financial system. The presence of a large informal sector can impair the transmission of monetary policy as a significant segment of financially excluded households and small businesses make financial decisions independent of, and uninfluenced by, the monetary policy actions. As the share of the formal financial sector increases through greater financial inclusion, it yields an important positive externality by increasing the efficacy of the monetary transmission process. Financial inclusion also has important implications for the transmission of monetary policy. It helps consumers to smooth their intertemporal consumption pattern. This could potentially influence basic monetary policy choices, including which price index to target. Empirical research appears to suggest that inflation measures excluding food prices may be a poor guide to policy for economies with low levels of financial inclusion. This is the outcome of Engel’s law which states that at low levels of income, expenditure on food often dominates the budget of lowincome households. When food prices rise, these households, lacking access to the financial sector, do not save the extra income, but instead increase consumption, in turn raising inflationary pressures. Fifth, greater financial inclusion also strengthens the case for the interest rate channel of monetary policy. When financial inclusion is low, a large share of the money stock is typically accounted for by currency in circulation, with cash being the dominant mode of savings by households. As financial inclusion improves, consumers relocate their savings away from cash and into deposits. Given that the rewards for saving are affected by interest rates, greater financial access implies that a bigger share of economic activity comes under the purview of interest rates, making them a more potent tool for policymakers (Cecchetti and Kharroubi, 2012). As governments become more actively involved in the financial inclusion agenda, a key challenge is defining roles for government in creating the broader and interconnected ecosystem of market actors needed for safe and efficient product delivery to the poor. The IMF (2014) has identified three major roles that have the potential for significant impact: (i) promoting healthy competition (promoter), (ii) creating an enabling regulatory environment (enabler), and (iii) strengthening financial infrastructure and driver of transaction volume (developer). While each of these roles can have significant impact, the application of these roles in any given jurisdiction will depend on country-specific factors, such as customer demand, market structure and maturity, and government policies.

Concluding Remarks The goal of financial inclusion which is being currently pursued in India is a challenging one. Considerations of regulation, competition, and ownership in an

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integrated manner, enhanced oversight of financial markets, and a proactive focus towards financial infrastructure are all working together to help achieve the task of furthering financial inclusion in the country. At a broader plane, driven by manifold developments, including technological advancements, there has been a marked progress in financial inclusion in the BRICS. The progress is far more in regard to account ownership as compared with use. Some of the reasons are economic, while others are more structural in nature. Newer and innovative ways of addressing these challenges are emerging, which holds the promise of greater financial inclusion, going forward. The FINDEX 2017 notes that two-third of unbanked adults have a mobile phone. While this holds the promise of reaching out to the unbanked in a cost-effective manner, it also raises the possibility of cyber risks that can impede the financial inclusion momentum. Addressing the challenges involved while reaching out to the last mile holds the promise of a greener tomorrow for the unbanked populace.

Acknowledgments A part of the work was done when the author was working with the Centre for Advanced Financial Research and Learning, Mumbai, India. Useful suggestions from Partha Ray on an earlier draft are gratefully acknowledged. Needless to state, the views expressed and the approach pursued in the paper are strictly personal.

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CHAPTER 9

Gender, Education, and Programma Bolsa Familia in Brazil Aparajita Gangopadhyay Centre for Latin American Studies, Goa University, India

Introduction In Latin America, poverty and inequality run parallel. Every state in Latin America mirrors this reality. Also, the contours of inequality run broadly along racial and ethnic lines. Data on racial and ethnic minorities in Latin America are poor, and the criteria for classification of minorities vary. Estimates suggest that indigenous groups account for about for 10% (50 million) of the region’s population, while groups of African descent account for 30% (150 million).1 Indigenous and Afro-descendent people are, when compared to the ‘whites’, as a rule, are less educated, less healthy, and have lesser access to such basic institutions like the justice system. They face greater difficulties in transforming educational and occupational achievements into income, generally earning considerably less for the same number of years of schooling. Brazil is known for its striking levels of destitution and poverty. However, in the last few decades, democracy has promoted poverty alleviation and equity-enhancing  Indigenous people constitute a majority of the population in Bolivia and Guatemala and a significant minority in Ecuador and Peru. Afro-descendants are a majority in the Dominican Republic and Panama; they form 45% of the population in Brazil and more than 10% of the population in Colombia, Venezuela, and Nicaragua. 1

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reforms. Since, the initiation of the redemocratization process in 1985, voting rights have been restored to the ordinary people; the constitution of 1988 was one of the most progressive constitutions of Latin America and reflected the activism by the social movements in advocating the rights of the poor. The role played by the centerleft and left governments in Brazil since the late 1980s have extended such programs to previously excluded or marginalized peoples. They implemented new programs which were aimed at ensuring the most basic levels of social protection. Spending increased and the social protection programs have definitely reduced poverty, but the reduction is not commensurate with the resources spent. Socioeconomic equality remains acute; notwithstanding this, there have been modest improvements in income distribution over the last few years. However, reforms that systematically restructured the existing benefits toward equity enhancements have continued on in a laggard fashion over the years (Hunter and Sugiyama, 2009). Despite recent increases in financing for education, the population as a whole remains poorly educated, especially in relation to Brazil’s overall levels of development. Educational mobility is exceedingly low. Social mobility in Brazil remains closely tied to family background. Brazil’s high incidence of poverty, low educational achievement, and middling health indicators explain its low ranking in overall human development indicators (Hunter and Sugiyama, 2009, p. 32). The access to education, social security, healthcare, and housing are the core social sectors where the governments in Latin America, and Brazil, have tried to implement reforms for the marginalized. Of all the marginalized, the women suffer a kind of ‘double discrimination’.2 For instance, indigenous girls’ performance in school contrasts sharply with the rule that throughout the region girls do as well and even better than the boys. In Guatemala, for instance, indigenous girls complete fewer than two years of schooling on average. Indigenous girls start school later and drop out earlier. For Afro-Brazilian women in urban labor markets in São Paulo in the 1990s, a lower return in their education and age, compared with ‘white-men’, accounted for 50% lower overall wages (Naercio and Scorzafave, 2012). In regard to physical violence statistics, the World Health Organization (WHO) surveys of 1999 and 2000 indicated that, for instance, in Nicaragua 27% of women had reported being physically abused (in Quito, 37%; in Lima, 31%; in Colombia, 1 out of 5 in 1995, which has since risen to 27%) (Naercio and Scorzafave, 2012). Social surveys also show that for instance, in urban households in 1999, poor and younger women with fewer years of schooling were likely victims of domestic violence than wealthier, older, and more educated women. Each year of schooling reduced the probability of  Double discrimination is when a person or a group is targeted for more than one form of discrimination. In Brazil, women face discrimination for being women, poor, and/or being of say Afro-descent or belonging to the indigenous groups. 2

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victimization by 1.4% (World Bank, 2007). In order to deal with the issues related to race and identity, countries in the region, like Peru and Honduras, have established mechanisms for the promotion of racial and ethnic equality.3 In contrast, Panama, Venezuela, and Dominican Republic although having significant Afro-descendants have failed to advance policies and address racial discrimination. Indigenous representation rose in Bolivia, Ecuador, and, to a lesser degree, in Argentina and Colombia. By 2004, 11 countries had instituted quotas establishing a minimum level of representation (20–40%) for women in political parties. The overall quotas increased women’s presence in legislatures, but there was significant variation in the law. For example, whether it was obligatory, whether it only reserves a slot as in Brazil, or if it required a slot to be filled by a woman, or whether a woman must be placed in an electionable position, like in Argentina, also depended on the country’s electorate system (Htun, 2003). More than 15 countries have been collecting information on ethnicity through the census, but only a few, Brazil and Colombia, collect data on Afro-descendants. Peru and Guatemala follow the same for indigenous peoples. In Brazil, minorities like Afro-descendants account for 45%, Japanese 1%, and indigenous groups like Yanomami, Tukano, Urueu, Wau-Wau, Awa, Arara, Guarani (0.2–2.4%), and Jews 0.00056%. Brazil currently has 197 forest-dwelling indigenous groups (Telles, 2015). In Brazil, nearly 80% of Afro-Brazilians live below the nation’s poverty line compared to the ‘whites’. Only 4% of Afro-Brazilians between the ages of 18 and 24 are in universities, compared to 12% of the ‘whites’. Three-fourths of all AfroBrazilians have not completed secondary school, and 40% do not complete elementary school. In the UNDP’s Human Development Index, Brazil’s rank continued to stay at 79 among 159 odd countries (HDI Ranking, 2017). In 2007, Afro-Brazilians earned 50% less than the national average income. Afro-Brazilians suffer from the highest homicide, poverty, and illiteracy rates in the country. They are seriously under-represented in professional positions and in middle and upper classes and over-represented in prisons (56%). The situation is similar among the indigenous peoples in the region. FUNAI’s data (National Foundation for the Indigenous) showed that the indigenous people continue to suffer from disease, poor healthcare, loss of native culture, and recurring incursions, especially in rain forests (National Native News, 2017).  Judith A. Morrison in her article entitled “Behind the Numbers: Race and Ethnicity in Latin America” in the Americas Quarterly (2016) examines the conditions of the indigenous and ethnic groups from Latin America and the initiatives made by various organizations and governments to deal with them. She further delineates the success and the failures of these groups to find a voice for themselves within these countries. www.americasquarterly. com. 3

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Historical Antecedents of the Racial Issue Often contrasted with the United States, Brazilian post slavery race relations were said to be harmonious, tolerant, and devoid of prejudice or discrimination. The image of presumed equality was based primarily on Brazil’s unparalleled level of miscegenation among European, African, and indigenous peoples. Widespread intermixing of the population gave rise to a unique pattern of social differentiation in which, allegedly, ‘racial appearances’ (phenotype) rather than ‘origin was key’. Due to the resulting ambiguity of racial identity, many Brazilians denied the existence of race or racism in their country. Race relations in Brazil, as a result, received much less attention among social scientists in Brazil. However, recent empirical research has amply documented the persistence of racial prejudice and discrimination. Brazil’s image of racial equality has eroded greatly over the past two decades. Today, vigorous public debate over Brazil’s image of racial equality has displaced the ideology of ‘racial democracy’.4 The overwhelming evidence makes it clear that racial inequality, prejudice, and discrimination are Brazil’s social reality. Scholars have often argued that one of the basic determinants of contemporary racial inequality is the geographic polarization of Brazil’s economy and population  The term “racial democracy” refers to a certain pattern of race relations in Brazil. Specifically, it suggests that Brazilian race relations have developed in a tolerant and ­conflict-free manner, in contrast to the presumed hostile form of race relations that evolved in the United States. The concept of racial democracy had at one point received such widespread acceptance that it was regarded as an essential component of Brazilian national identity. Brazilians distinguished themselves as unique for having achieved a level of racial tolerance that few other societies had attained. The origin of the term racial democracy remains unclear. António Sérgio Guimarães, a Professor at the University of São Paulo, suggests that its usage goes back to the 1940s, when the Brazilian anthropologist Arthur Ramos and the French sociologist Roger Bastide employed the term to link this pattern of race relations to Brazil’s postwar democracy, which began to emerge at the end of the dictatorship of Getúlio Vargas (1937–1945). However, the concept is more generally associated with the work of Gilberto Freyre (1900–1987), who proposed the idea in the 1930s in a daring departure from the scientific racist thinking that had prevailed within Brazilian intellectual circles since the beginning of the 20th century. Freyre stood the scientific racist thinking of the day on its head by arguing that Brazil’s pervasive mixing of the races was not a factor in Brazil’s failure to develop, but instead was testament to the achievements of a Brazilian civilization that had encouraged a pattern of tolerant race relations that was unique in the world. Freyre urged Brazilians to take pride in this, as well as in the displays of Afro-Brazilian culture that were prevalent throughout Brazil. https://www.encyclopedia. com/history/encyclopedias-almanacs-transcripts-and-maps/racial-democracy-brazil. 4

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(Andrews, 1992, Figueiredo, 2015; Skidmore, 1992). Of the total population, it was found that Afro-Brazilians lived in the impoverished and underdeveloped Northeast, while the white population (52%) was concentrated in the industrialized Southeast (Instituto Brasileiro de Geografia e Estaistica, IBGE, 1996). Thus, because of locational disadvantages, Afro-Brazilians are said to be handicapped as they are concentrated in regions where there are fewer social and economic opportunities. Unequal regional development and population distribution has characterized Brazilian society since colonial times (Merrick and Graham 1979; Wood and de Carvalho 1988). Population and regional imbalances are the legacy of the boom and bust cycles of three colonial export commodities: sugar, gold/rubber, and coffee. The scarcity of labor to fuel sugar plantations during the 16th and 17th centuries was the impetus for importing African slaves into the Northeast. In the 18th century, with the discovery of gold/rubber and the concomitant decline in sugar production, the economic and population center of gravity shifted to central and southern Brazil. This shift left the once wealthy northeastern plantation economy in ruins, and from this point on development favored southern Brazil. It was the southern expansion of coffee exports during late nineteenth and early 20th centuries that led to the incipient industrialization of São Paulo, built first on slave and later subsidized European immigrant labor. Following the abolition of slavery in 1888, southeast coffee growers used the tax revenues from the great fortunes accumulated from coffee exports to provide the foundation to build São Paulo’s industrial economy and attracted roughly 3.5 million European immigrants. By the 1920s, São Paulo became the most advanced region of the country, and by the 1940s the state had the largest concentration of manufacturing in all of Latin America (Wood and Carvalho, 1988). The predominantly white regions of São Paulo and the southeast remained the nation’s locus of manufacturing and finance (Kowarick and Campanario, 1986). Over time, the consequence of such cumulative effects was the sharp spatial disparities. Continued growth and diversification of the Brazilian economy lessened but did not eliminate the unequal distribution of wealth and population. From the 1950s, industrialization in south-central Brazil lured Afro-Brazilian migrants from the Northeast and rural areas to the dynamic urban metropolises, especially São Paulo. This was accompanied by notable gains in Afro-Brazilian urban employment. Between 1950 and 1980, the proportion of individuals of African descent employed in cities rose from 36% to 62% (Oliviera et al., 1985). Yet, at the same time, the occupational structure moved toward more skilled jobs. As a result, in 1991, Afro-Brazilians continued to be disproportionately concentrated in agriculture, construction, and personal services, particularly domestic

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employment, and the lowest paid and most onerous jobs (Lovell, 1998). Brazil’s four decades of rapid economic expansion and substantial social and demographic change erased neither unequal population distribution nor unequal regional development. Sharp inequalities thus remained between the north and south and between the blacks and whites. In Brazil, affirmative actions have been more successful relatively when compared with Colombia. Nationally, the Federal Supreme Court, in its effort to reduce racial discrimination, established a 20% quota of job openings for Afro-descendants by service suppliers, in addition to another 20% of public service positions to be held by Afro-descendants in the Ministries of Justice, Culture, and Agricultural Development. Nevertheless, the issue has its shortcomings as equality by law is no guarantee of equality of opportunities for Afro-descendants; also, as there is a huge gap between what is decreed on paper and what is implemented.5 One of the most important sectors where the government in recent years has focused its attention has been on education. Ensuring high-quality mass public schooling, especially at the primary and secondary levels, historically has not been a central concern of the Brazilian governments, either democratic or authoritarian. For instance, according to the HDI statistics, the average mean years of schooling for women in Brazil is 8.1 years. The Gender Inequality Index places Brazil at the abysmal rank of 92 among 160 odd countries (HDI, 2017). Brazil spends a reasonable amount of its GNP on education. In comparison to its expenditure on education (primary and secondary schooling), Brazil ranks below that of most Latin American countries expenditure (Hunter and Sugiyama, 2009, p. 37). In the 1990s, after all other factors were accounted for, racial differences accounted for one-fourth of poverty and inequality. Brazil’s 1990s educational reforms were extending schooling rates for Afro-Brazilians between 7 and 13 years of age, which was more than for the ‘whites’. But Afro-Brazilian students continued to record a higher repetition and dropout rates. At school, their exams results were worse than that of the ‘whites’, highlighting the socio-economic variables in the society (Telles and Paixao, 2013). In an ongoing effort to provide equity in education, the Brazilian government recently introduced Affirmative Action Program that includes the use of quotas in public university systems and in new scholarship

 See the report by the Organization of American States in IACHR, The Situation of People of African descent in the Americas, OEA/Ser.L/V/II, Doc. 62, 5 December 2011, p. 76. In Human Rights in Latin America: The Case of Women and People of African Descent Robert Owoo http://www.e-ir.info/2016/07/19/human-rights-in-latin-america-the-case-of-women-andpeople-of-african-descent. 5

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programs designed to encourage low-income and marginalized students to enroll in public and private universities. In 2001, Racial Admission Quotas were introduced in 70 public universities. In the state of Rio de Janeiro, 20% was set aside for Afro-Brazilians who needed to pass the entrance exams. Also reserved was a further 25% for ‘social quotas’ for those students whose parents’ income is less than twice the minimum wage. Through its ProUniv Program, the Brazilian government also encourages private universities to offer scholarships to low-income students with a share reserved for Afro-descendants (especially women) and indigenous students, in exchange for tax breaks. The share allotted to each minority group is proportionate to its representation in the population of each state. On the issue of the ‘Race Quotas’ in 2012, the Supreme Court Tribunal of Brazil unanimously ruled that these quotas in public universities were constitutional. The Race Quotas were hotly debated and challenged the Brazilian ideal of ‘racial democracy’. These affirmative laws were aimed at combating discrimination and education for the historically marginalized Afro-Brazilian population (Telles and Paixao, 2013). It was an attempt to broaden opportunities for minorities in Brazil. In the case between Acao de DEM party vs. Cotas da UNB e no Brasil (Action of Brazilian Democratic Party vs. Quotas of the University of Brasilia) which reserved 20% of its enrolment spots for Afro-Brazilian, mixed races, and indigenous students, the Tribunal passed its judgment.6 The Tribunal of the Supreme Court stated that the quotas are the best methods to remedy the racial inequalities that were confronted after the abolition of slavery in Brazil in 1888 (Brazil was the last country in the Western hemisphere to abolish slavery). The racial quotas are the best transitory option to close the inequality gap in the realm of higher education. The Tribunal stated that the gap is a critical issue as a large section of the Afro-Brazilians continue to live in Favelas and earn a fraction of salaries enjoyed by the prominent Caucasian class.7  The Democratic Party claimed that this policy of the Universidade de Brasilia unconstitutional under Article 5 of the Brazilian constitution which protects equality of all citizens regardless of race. 7  The Tribunal claimed that the Brazilian policy is in accordance with Article 1 (a) and (b) which calls for implementing a national policy that promotes more equality in educational opportunities. Article 1 Section 4 on the Convention on Elimination of Racial Discrimination states race will not be the primary factor in determining access to higher education, but rather a factor taken into consideration, which complies with Article 13 Section 2 (c) of the International Covenant of Economic, Social and Cultural Rights. The Brazilian policy enables the universities to serve the most vulnerable groups without discrimination. 6

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On 29 August 2012, President Dilma Rousseff signed the Lei de Cotas (Law of social quotas) which instructed the federal universities in 4 years to ensure that half of the incoming class came from public schools. The spots reserved for the marginalized students will be in accordance with the percentage of the minority population in the state where each public university is located. Only 2.2% of the 70% of the AfroBrazilians living below the poverty line access higher education. The lower echelons of the socio-economic sectors of the country also receive poor education in public primary schools. Of late, Brazil boasts one of the largest increases in expenditure on education between 2000 and 2009 among the countries for which data are available. Even though Brazil’s spending on education as a percentage of GDP is below the OECD average, there has been a steady increase in the percentage of GDP invested in education, particularly between 2000 and 2014. Brazil increased public spending on education from 10.5% of total public expenditure in 2000 to 14.5% in 2005, and 16.8% in 2009 — one of the steepest rates of growth among the 33 countries for which data are available. Brazil ranks fourth in this out of the 32 countries for which data on public spending on education is available, and it is fairly above the OECD average of 13%. The next section will focus on female education, discrimination, and the visible success of the Programma Bolsa Familia (PBF) in approaching these multiple issues of gender, education, income, and equity.

Racial Identity, Women, and Education Demographic census and annual household surveys are the only sources of national level information on the color composition of Brazil’s population. According to estimates, the 1991 census reported that nearly half of the 147 million population was either ‘pardo’ or ‘preto’. This large proportion of Afro-Brazilians (pardos — were not necessarily blacks but could be referred to the Mulattos and pretos) was the result of the approximately 3.6 million Africans that were brought to the Portuguese colony during the three and a half centuries of the slave trade.8 The racial terminology of the census is a defined system of skin color and ethnic identity: branco (white), pardo, preto (blacks), amarelo (yellow), and indigena (indigenous). The color terminology used by the Brazilian census leaves no doubt that the categories reflect social definitions of skin color rather than ­biological definitions of race. There is controversy regarding the validity of the census bureau’s color classification scheme. The indigenous category was not used in the 1980  Brazil was the last country in the Americas to end slavery, and the Portuguese were the largest importers of slaves, bringing to Brazil 38% of the approximate 9,500,000 Africans forcibly transported to the Americas. 8

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census. Brazil, as a member of the UN, has repeatedly stated that it wanted to formally achieve the Millennium Development Goal of Universal Primary Education (UPE) by 2015. Fundamental education in Brazil is divided in two stages, Ensino Fundamental I (years 1–5) and Ensino Fundamental II (years 6–9). Enrolment rates are high, and Brazil seems to be speedily catching up with the average for OECD countries (OECD 2008). Many children are enrolled in pre-primary school facilities, including day-care facilities. This increased in 2007 to 70% of the 4–5-year-olds, of which 97.2% were girls (Klaveren et al., 2009). The net enrolment in primary education in 2000–2007 of children aged 5-to-14 was 94% overall, with 95% for girls, bringing girls to boys parity to 102% (WHO, 200920). For the last few years, a gender division of secondary education enrolment was unavailable. Though recent statistics are lacking, dropout rates of girls from public schools seem considerable. The increasing adolescent fertility rates are high, especially among the poorest sectors. One of the most cited negative consequences is low school attendance. It has been argued that the Brazilian educational system has no special programs for young women who become pregnant; therefore, if a pregnant student chooses not to abort, the most probable outcome is that she will quit, this likelihood being higher among the poorer classes. In 2000, the total enrolment rates of girls in school varied from over 95% of the population between ages 10 and 14 to nearly 50% of the 18–19-year-olds. By contrast, the enrolment rate of young mothers was 18–22 % in all age groups. Controlled by other factors, a childless girl was eight times more likely to be enrolled at school than a young mother with at least one child (Klaveren et al., 2009). The findings of Cardoso and Verner (2006) confirm that early parenthood has a strong impact driving teenagers out of school; they stress that extreme poverty is also lowering school attendance and that reducing the costs of school, such as transportation, could improve the record of school attendance. In addition, students must pass the vestibular, a public open entrance examination; competition is fierce for places in public universities, since education in these universities is totally free of charge. Female participation in regular tertiary education continued to exceed male participation by far. In 2007, 68% of all students enrolled in tertiary education were women, bringing the women to men parity in tertiary-level enrolment to 206% (Klaveren et al., 2009, n. 24). In the population aged 20–29, in 2006, 21% were still being educated. Among the population aged 30 and over, relatively many were — either full time or part time — enrolled in public and private institutions. This called for a serious introspection and suitable action on the part of the federal government in Brazil. Despite the enormous reforms made in the education sector, women continue to remain marginalized and discriminated in Brazil, especially those who are of

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Afro-descent or indigenous. The next section focuses on female education, discrimination, and the visible success of the social reform programs such as the PBF in approaching multiple issues of gender, education, income, and equity.

Female Education in Brazil: A Synoptic Overview The Brazilian colonial economy, founded on large rural properties and slave labor, paid little attention to formal education for men and none whatsoever for women. Isolation, social stratification, and patriarchal family relations favored a power ­structure based on the limitless authority of landowners. According to Ribeiro (2000), the Iberian cultural tradition, transposed from Portugal to its Brazilian colony, considered women as inferior beings who had no need to learn to read and write. The educational work of the Jesuits significantly contributed to strengthening male predominance; its priests had a liking for dogmatic forms of thinking and preached the maximum authority of Church and state (Heime, 1975). With the arrival of the Portuguese royal family in Brazil and Independence in 1822, Brazilian society began to have a more complex structure. International immigration and economic diversification increased the demand for education, which started being seen as an instrument for rising socially through the intermediary social strata (Beltrao and Diniz Alves, 2009). In this new context, the country’s ­leaders voiced their concern with female education for the very first time. The Empire’s first legislators established that primary school education should be the responsibility of the state and open to girls, who were primarily schooled by female teachers. But due to a lack of qualified female teachers and lack of interest in the parents, education did not reach a significant percentage of female students (UNICEF, 1982). In the first part of the 19th century, the first institutions aimed at educating women began to appear, although in a dual teaching picture, with clear gender specializations. Generally speaking, primary education, with its strong moral and social content aimed at strengthening the role of the woman as wife and mother, was meant only for females. Female high school education was largely restricted to teacher training, or in other words, preparing female teachers for the primary school courses. Women were still excluded from higher levels of education during the 19th century. The first school was set up in Niterói, in 1835, followed by another in Bahia, in 1836. Until the final years of the empire, normal schools were few in number and almost insignificant in terms of student enrolment (Hahner, 1981). If females found it difficult to have access to elementary education, the situation was more dramatic when it came to higher education, which was completely and unmitigatedly male dominated. Women were excluded from the first courses in medicine, engineering, and law that sprang up in the country. The imperial decree

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that gave women the right to enroll in a university course dates back to 1881. However, it was difficult to overcome these barriers because high school studies were essentially male-oriented, in addition to being expensive, and normal courses did not qualify women for entry to universities. It is important to note that during the 19th century and the first half of the 20th century female exclusion from high school courses made it unfeasible for women to enter university. So, duality and gender segmentation were present in the Brazilian educational system since the beginning, with women having lower literacy rates and restricted access to higher levels of education (Romanelli, 2001). The Brazilian Constitution of 1891 sanctioned the decentralization of education into a dualist scheme: the federal government was responsible for creating and controlling higher and secondary school educational institutions and the states were responsible for setting up schools and monitoring and controlling elementary education, as well as high-school-level professional education. It included normal schools for girls and technical schools for boys (Beltrao and Diniz Alves, 2009, n. 34). While the educational system expanded quantitatively at this time, there was little by way of qualitative change. The literacy rate of the Brazilian population grew during the Old Republic (1889–1930), despite the continuing high levels of illiteracy. Educational exclusion was obviously always greater for Afro-Brazilians (Beltrão and Novellino, 2002). The enrolment rates of Brazilian women in secondary and higher education increased at the beginning of the 20th century, but by much less so than those of men. For instance, between 1907 and 1912 in the Federal District, female presence in high school courses corresponded to less than a quarter of all students and in university courses it did not reach 1.5% (see Table 1). It is worth remembering that Rio de Janeiro had one of the best rates of education in the country (Beltrao and Diniz Alves, 2009, n. 34). The reasons why the level of Brazilian investment in education was low owes its origins in the primary products export-driven economic model that had been Table 1:   Number of people enrolled in high schools and universities in the Federal District — 1907–1912. High School Level

University Level

Year

Men

Women

% Women

Men

Women

% Women

1907

3,721

1,221

24.7

2,455

32

1.3

1909

4,596

1,460

24.1

3,323

39

1.2

1912

7,165

2,145

23.0

3,630

53

1.4

Source: Statistics of the 20th century, IBGE (2003).

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based on slavery. While the population remained in the countryside, with its archaic means of production, schools exercised no important role in qualifying human resources, being merely an agent for educating people on how to enjoy their leisure time or for preparing for self-employed professional careers, in the case of men, or for being primary school teachers or housewives, in the case of women (Beltrao and Diniz Alves, 2009). By redirecting Brazilian development toward the domestic market and to the urban, industrial sector, the Revolution of 1930 led to the first public policies for the masses, especially for those who lived in urban areas. The new demands made by industrialization and urban services had an influence on the content and expansion of education. But, as the expansion of capitalism was not homogenous all over Brazil, most of the expansion demanding for schools occurred in regions where capitalist relations were more advanced (Beltrao and Diniz Alves, 2009). During the period of the so-called Populist Pact (1945–1964), despite popular pressure for the democratization of education, the ‘aristocratic’ character of schools was maintained with the agreement of the ruling elite, making the expansion of schools occur in a manner that was unplanned and inadequately financed. It is important to point out that only in 1961, with the Guidelines and Bases of Brazilian Education Law (LDB) (Beltrao and Diniz Alves, 2009), was the equivalence of all high school courses guaranteed, thus opening up the possibility for women who were doing teacher training to sit for university entrance exams. So, it was from the 1960s that Brazilian women had a bigger possibility of attending university, and it was only in the 1970s that the reversal of the gender gap in university education began. As industrialization and urbanization in the country began to intensify, the educational system grew both horizontally and vertically. The military governments that came to power after 1964 drew their inspiration from the North American model. They took measures to meet the growing demand for places and professional qualifications, which was also in accordance with their international commitments. The alliance between military and techno-bureaucracy made it possible for large growth in the number of postgraduate courses. The objectives were to produce competent teachers for the universities themselves, stimulate development of scientific research, and ensure the formation of intellectuals who were qualified to respond to the needs of national development (Cunha, 2000). The expansion of education in Brazil continued with the process of redemocratization in the country, with installation of the ‘New Republic’ in 1985. In the 1990s, public policies were developed that were aimed at maintaining children in school (School Scholarship Scheme) and making an effort at providing universal basic education (Beltrao and Diniz Alves, 2009, n. 34). In the higher education sector, there was major growth in private universities, and the number of students enrolled in them greatly exceeded the number in public

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universities. This general expansion of places in Brazilian education particularly favored women. In the second half of the 20th century, women managed to reverse the gender gap in education at all levels. They knew how to take advantage of the opportunities created by the social transformations that were occurring in the country (Beltrao and Diniz Alves, 2009, n. 34). For instance, in 2007 53.3% of newly enrolled university students were women and 55% or more of first-year students had been women for the last 15 years. Therefore, all the levels of education sector were dominated by women who were in majority at every level in Brazil, and thus the average rate of schooling among Brazilian women became more than 1 year higher than that of men. However, women still earned 30% less than men for the same work, and even in the Brazilian congress they occupied less than 10% of the seats.9 The absence of gender equity had extended to education itself. School curricula, textbooks, and teaching methods reinforced stereotypes that devalued the role of women and confined them to the home and to low-status jobs and careers. It also projected ‘hard’ science and technology education at the universities to be a male domain. The non-governmental Human Development Network of Brazil pointed out that despite the superior education achievements made by women, it had no impact on their treatment on the workforce, where they continued to face major disadvantages when it came to employment conditions, negotiations, and promotions (Beltrao and Diniz Alves, 2009, n. 34). The Organization of American States (OAS) on its ‘Brazil Report’ in the framework of the Non-Sexist and Anti-Discrimination Education Campaign by the Acao Educativa Organization in collaboration with ECOS — Communication and Sexuality part of the reference Centre for the victims of violence of the Sedes Sapientiae Institute of Sao Paulo (CNRVV) coordinated by CLADEM (LAC Community for the Defence of Women’s Rights) — are attempting to deal with challenges of social gender relations in guaranteeing human rights in education. They are critical of the Brazilian state’s reports which speak of gender equity (between men and women) in education. These mostly emphasize the increasing literacy and better performance of women in education. The OAS Report puts forth the persistent inequalities among the Brazilian women. The progress in indicators of access and performance is marked by inequality among women according to income, race, ethnicity, and residence (rural/urban), especially Afro-Brazilian and indigenous women. These women also face unequal access to quality education and livelihood (Beltrao and Diniz Alves, 2009, n. 34). But above all, the reversal in the gender gap has been a triumph that resulted from a historical effort by the women’s movement as part of a more general struggle  Currently, they occupy about 10.38% of the seats.

9

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for equal rights between the sexes that involved countless social players. This did not only happen in Brazil, but was part of a worldwide change whereby the role of women in society was being redefined (Therborn, 2004). The introduction of the various social programs in education, employment, health, and housing by the government produced various levels of success. PBF is considered to be one of the most successful social initiatives undertaken by the successive governments of Cardoso, Lula, and Dilma.

Conditional Cash Transfers and Women’s ‘Empowerment’: Programma Bolsa Familia The presidencies of Henrique Cardoso and Ignacio Lula and their administrations along with that of Dilma Rousseff had embraced a more integrated approach by bundling disparate programs and targeting benefits to families in extreme poverty. Conditional cash transfers represented a modest share of overall government expenditure and reinforced the trend of incremental expenditure rather than substantial reallocation of public benefits. It began with the innovative program of Bolsa Escola in Brazil. Aiming to enhance educational attainment and alleviate poverty at the same time, the Bolsa Escola (School Income Subsidy) was introduced and was arguably one of the best programs. The Bolsa Escola gave a small income subsidy to needy families, provided that they kept their children aged 7–14 in school. The program’s design addressed the opportunity costs of education, discouraged child labor, and created a demand for education on the part of the parents. The Lula government subsequently folded the federal Bolsa Escola together with other poverty alleviation programs to form the Bolsa Familia, which is based on a single registry of poor families (Hunter and Sugiyama, 2009, n. 2, p. 46). Advocating the PBF, Wendy Hunter and Stugiyama point out, the Brazilian democracy has succeeded in adding new programs to the social agenda that provide minimal social protection. “These programmes further basic education and health among marginal populations as long as they are kept within reasonable financial limits and do not upset important stakeholders. A key factor in the Bolsa’s political appeal is that it does not challenge enshrined social protections to the upper and middle classes” (Hunter and Sugiyama, 2009, n. 2, p. 46). The Brazilian government’s strategy to positively impact on the lives of so many women through initiative such as Bolsa Familia, Brazil without Extreme Poverty, the National Documentation Program, My House, My Life, Brasil Carinoso, Light for All, Social Assistance Network, Pro-Gender and Racial Equality in Business Program, Continuous Loan Benefits, and through policies were geared toward population aging and care.

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The Brazilian representative for UN women, Nadine Gasman, expressed that the publication by the government of Brazil of “More equality for Brazilian Women: Pathways for Social and Economic Transformation” presented the Brazilian governments’ responses to women’s rights. She further added that although Brazil was a country with structural gender, racial, and ethnic inequalities, the positive experience of the Brazilian public administration needed to be amplified. These could be achieved by similar responses through the affirmation the rights of women, those of African descent, and the indigenous populations. According to the 2010 census, women constituted 51 % of the Brazilian population (Beltrao and Diniz Alves, 2009, n. 34). However, critical questions have been raised about the nature and methodology adopted for the conditional cash transfers. For instance, questions are raised as to whether the conditional cash transfers are an effective way to address poverty and build human capital in the long term, or if they allow governments to avoid making difficult decisions to restructure education and health in ways that would have a more fundamental and enduring impact (Hunter and Sugiyama, 2009, n. 2, p. 39). Other critics point out to the political dimensions that are in play here. Critics state that by handing over cash to such poor families, political parties like the PT (Workers’ Party) are building a strong political support base which will benefit the political party in the long run. Examples are forwarded of this, as support is continuously outpouring for the former president Lula who is in prison on charges of corruption. The poor in the cities and slums continue to support PT despite Lula’s jail term. The PBF, currently reaches approximately 13.8 million households, corresponding to 25 % of the poorest population of Brazil. Its primary goals remain efforts at fighting hunger and poverty; strengthening access to the public service network, especially education, health, and social assistance; promoting inter-sectoral integration and public policy synergy; and an anchorage-sustained empowerment of beneficiary families. The Ministry of Social and Agrarian Development (Mininsterio do desevnvolvimento social e agrario-MDSA), the governing body for the PBF at the federal level, uses three broad activities to try to achieve these goals: direct cash transfer, conditionalities in the areas of health and education, and coordination with other public policies that increase socio-economic opportunities for targeted families. In any case, federal efforts have been made to target public policies at PBF beneficiaries. In the context of the ‘Brazil without extreme poverty’ plan (Brasil seem Miseria-BSM) launched in 2011 and coordinated by the former Ministry of Social Development and Fight against Hunger (Ministirio do Desenvolvimento Social e Combate a Fome — MDS), various social programs began to prioritize

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assistance for these families. For example, The National Programme for Access to Technical Education and Employment (Pronatech), established in October 2011 was coordinated with the BSM, and openings in professional training courses targeted young people and adults under the PBF — with guidance from teachers and the adaptation of course material to promote learning among low-income populations. In this manner, called Pronatech BSM, 600,000 PBF beneficiaries enrolled in the courses, of which 66% were women. In case of extreme poverty, in 1992 the percentage of families of African descent in extreme poverty was 30%, approximately 15% in 2002, and reduced to 1.3% in 2014, which points to an important development in the reduction of inequalities for this social group. The Pronatech has broadened the opportunities for social inclusion, professional development, and incursion to former labor markets. Between 2011 and 2014, the program’s audience involved women, those of African descent, and youth for the most part. Of the population formally enrolled in education, 53% of the women were of African descent and 45% were between 18 and 29 years of age. As far as the Single Registry goes by 2014, 88% of all families registered in the countries social programs were run by female heads, 73% were families of African descent and run by women. In the context of housing, women represent about 80% of all contacts signed in the My House, My Life program (UN women).10 The design of the PBF determines that the cash be transferred preferably to women, which is the case for 12,677,749 (or 92%) of the targeted families. Although, this is not explicitly geared toward addressing the issue of gender roles, it produces a gender bias in the program. Thus, researchers have often sought to address whether (and how) the PBF influences gender relations. A closer examination reveals that 10 years after BF, Brazil more than halved its extreme poverty — 9.7% to 4.3% of its population. Income inequality has also fallen: BF reaches 14 million households — 50 million people or about one-fourths of the population — and is widely seen as a success story. Qualitative studies have shown that regular cash transfers from the program have helped promote the dignity and autonomy of the poor. And, importantly, women account for 90% of the beneficiaries. The modalities include a single registry called the ‘Cadastro Unico’ which covers 40% of the Brazilian population (the most vulnerable part) and has, since 2011, emerged as the axis of public policies focused on people living in poverty, used by more than 20 federal programs (Bartholo, 2016). The Cadastro Unico was the essential tool that allowed PBF to achieve these successes. It provided the basis of targeting PBF benefits, but is linked to numerous other social programs and services. It not only serves as the backbone for effective administration of the  See http://lac.unwomen.org/en/noticias-y-eventos/articulos/2016/05/mujeres-brazil.

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BF but also as a tool for coordinating social policy and facilitating rapid scale-up of additional efforts such as the Brasil Carinhoso program. PBF has also helped build the base for the ambitious programs such as Brasil sem Miseria and the Busca Ativa effort, include those who had been left out of these programs in the past (Wetzel and Economico, 2013). Primarily to the woman of the house, ‘the state tends to believe women are more reliable than men’ emphasized Sergio Faust, ex-Director, Instituto Fernando Henrique Cardoso (Bartholo, 2016, n. 55). By giving women a guaranteed paycheck, however meagre, the Brazilian government aims to help them break free of bad marriages or take charge of household decisions. ‘Money empowers women’ to more likely be involved in decision-making and grants them higher self-esteem. Less women feel like they are owned. The number of households headed by women is increasing, but Brazil is one of the lowest ranked countries on global female empowerment scales. In Bolsa Familia, more women make decisions regarding their children’s schooling and their own welfare. However, the broader question is: Is the PBF truly resolving poverty or fostering a culture of dependency? The success of the program in Brazil has led to its replication in Mexico and Colombia. Although the PBF and many other CCT programs do not explicitly focus on influencing gender relations, feminist criticism is often indicated that such programs tend to reinforce social roles traditionally played by the sexes — as the focus is on women as the primary person responsible for mediation between the program and the family, thus always stressing on their material responsibilities. This is claimed to result mainly from the definition of women as the grant holders, the conditionality requirement, and the programs’ inability to expand women’s individual choices (Molyneux, 2006; Bartholo, 2016, n. 55). In the context of the conditionalities, the feminist criticism tends to be based on the interpretation that when such conditions are met in the areas of health and education, it would lead to more time spent by women in caregiving activities, reinforcing, once again, the link between female identity and mothering (Molyneux, 2006; Bartholo, 2016, n. 55). Second, all compliance with the conditionalities is checked through the public system in each area, for example, public health and education, where officials in each municipality verify compliance and then record and send the data to the national level. Furthermore, there is no penalty for justified failure to comply, such as illness or lack of available transportation to get to school. Finally, the family will only be removed from the PBF after repeatedly failing to comply with the conditionalities, in a process that requires the municipalities’ public social assistance to follow-up with the family (Molyneux, 2006; Bartholo, 2016, n. 55).

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Therefore, as designed, the PBF does not exclusively set out to increase the amount of time women dedicate to their family as a result of the conditionalities, and there is no nationally representative data to identify to what extent this actually occurs. However, considering the effects of the PBF in reducing malnutrition and infant mortality, an alternative hypothesis is that women perceive the program as allowing them to devote less time to child care due to a possible decrease in children’s susceptibility to diseases. Additionally, such programs are concerned with keeping younger women in school, but not adult women. In particular, it is claimed that these programs provide no support for women to choose to dedicate time to more empowering productive work (Molyneux, 2006; Bartholo, 2016, n. 55). The PBF cannot evade the criticism that it uses women as mediators between the state and the family, but it seems reductionist to interpret it simply as a materialistic program that does not offer to choices to adult women. The structural improvement of the choices available to poorest women involves access to the PBF but is not limited to it. It requires the understanding that gender equality is a long-term process of change that depends on changing public policies in various areas. Moreover, perhaps the best that PBF can offer to improve women’s living conditions and choices is its social information platform, which includes identification data about the socio-economic characteristics of almost half of the country’s population. Any other responsibility attributed to the PBF to expand women’s choices seems to be beyond the scope of its goals and mandate (Bartholo, 2016, n. 55, p. 4).

By Way of a Conclusion PBF has substantially reduced the severity of the recipients’ poverty but brought comparably few Brazilians out of poverty completely. This is not surprising given the small amounts of money being transferred, but it represented a significant accomplishment on the path toward a Brazil that guarantees basic human needs. Bolsa Familia is cited widely as an exemplary social policy that illustrates Brazil’s commitment to social inclusion and expansion of citizenship rights (de la Briere and Rawlings, 2006). At the same time, conditional cash transfers exemplify the claim that the Brazilian democracy has succeeded in adding new programs to the social agenda that provide minimal social protection and that further basic education and health among marginal populations as long as they are kept within reasonable financial limits and do not upset important stakeholders. A key factor in the Bolsa’s political appeal is that it does not challenge enshrined social protections to the middle and upper classes. Although Brazil’s post-authoritarian governments have devoted new attention and resources to the social area, they have done little to

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narrow the stark differences in people’s effective access to public entitlements and social programs. One implication is that poorer groups with little political influence may be left without a strong political voice to defend the services or tracks that they alone occupy, while their better-off counterparts will have the means to defend their own spear of entitlements. For Brazil’s democracy, overcoming this historical division is an essential step toward providing meaningful citizenship to all.

References Andrews, George Reid (1992). “Racial Inequality in Brazil and the United States: A Statistical Comparison”. Journal of Social History, 26(2): 229–263. Bartholo, L. (2016). Bolsa Familia and Gender Relations: National Survey Results. Policy Research Brief No.55. Brasilia: International Policy Centre for Inclusive Growth. Beltrão, K. and M. S. Novellion (2002). Alfabetização por raça e sexo no Brasil: evolução no período 1940–2000. Rio de Janeiro: Ence, IBGE. Beltrao, K. I. and J. E. Diniz Alves (2009). “Reversal of gender gap in Brazilian education in the 20th century”, Cardenos de Pesquina, 39(136). Cardoso. A. R. and D. Verner (2006). School Drop-Out and Push-Out Factors in Brazil: The Role of Early Parenthood, Child Labour, and Poverty. Bonn: IZA, Discussion Paper No. 2515 [in Klaveren et al. (2009). An Overview of Women’s Work and Employment in Brazil, Decisions for Life MDG3 Project, Country Report No. 12, University of Amsterdam / Amsterdam Institute for Advanced Labour Studies (AIAS)]. Cunha, L. A. (2000). “Ensino superior e universidade no Brasil”. In E. M. T. Lopes and L. M. F. C. G. Faria Veiga (Eds.), 500 anos de educação no Brasil. Belo Horizonte: Autêntica, pp. 151–204. de la Briere, B. and L. B. Rawlings (2006). Examining Conditional Cash Transfer Programs: A Role for Increased Social Inclusion? Social Protection and Labor. Discussion Paper No. 0603. Washington, D.C.: The World Bank. https://openknowledge.worldbank.org/ handle/10986/20204. Figueiredo, A. (2015). “The work of Carl Hasenbalg and its importance for the study of the relations of racial inequalities in Brazil”, Society and State, 30(1). Hahner, J. (1981). A Mulher brasileira e suas lutas sociais e políticas: 1850–1937. São Paulo: Brasiliense. Heime, F.-W. (1975). “Education and politics in Brazil”, Comparative Education Review, 19(1): 51–67. Htun, M. N. (2003). “Women and democracy”. In J. I. Dominguez and M. Shifter (Eds.), Constructing Democratic Governance in Latin America. Baltimore: Johns Hopkins Press, pp. 120–121. https://malahtun.files.wordpress.com/2018/06/htun-2003-women-anddemocracy.pdf. Hunter, W. and N. B. Sugiyama (2009). “Democracy and social policy in Brazil: Advancing basic needs, preserving privileged interests”, Latin American Politics and Society, 51(2): 39.

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Klaveren, M., M. H. Williams, K. Tijdens, and N. R. Martin (2009). An Overview of Women’s Work and Employment in Brazil. Amsterdam: University of Amsterdam, Working Paper 09–83. Kowarick, L. and M. Campanario (1986). “Sao Paulo: The price of a world city status”, Development & Change, 17: 159–174. Lovell, P. A. (2000). “Gender, race, and the struggle for social justice in Brazil”, Latin American Perspectives, 27(6): 85–102. Merrick, T. W. and D. H. Graham (1979). Population and Economic Development in Brazil, 1800 to Present. Baltimore: Johns Hopkins Press. Molyneux, Maxine (2006). “Mothers at the Service of the New Poverty Agenda: Progresa/ Oportunidades, Mexico’s Conditional Transfer Programme”, 40(4): 425–449. Naercio, M. F. and L. Scorzafave (2012). Employment and Inequality in Brazil. https://www. oecd.org/employment/emp/42546065.pdf. National Native News (2017). http://nativenews.net/health-wellness-indigenous-way. Oliviera, L. E. et al. (1985). O “lugar do negro” na forca de trabalho. Rio de Janeiro: IBGE. Ribeiro, A. I. M. (2000). “Mulheres educadas na colônia”. In E. M. T. Lopes, L. M. F. Faria, and C. G. Veiga (Eds.), 500 anos de educação no Brasil. Belo Horizonte: Autêntica, pp. 79–94. Romanelli, O. O. (2001). História da educação no Brasil (1930/1973). Petrópolis: Vozes. Skidmore, T. E. (1992). Fact and Myth: Discovering a Racial Problem in Brazil. Notre Dame, Indiana: Kellogg Institute of International Studies. # Working Paper 173. Telles, E. and M. Paixao (2013). Affirmative Action in Brazil. LASA Forum, 44(2). Telles, E., R. D. Flores, and F. Urrea-Giraldoc (2015). “Pigmentocracies: Educational inequality, skin color and census ethnoracial identification in eight Latin American countries”, Research in Social Stratification and Mobility, 40: 39–58. Therborn, G. (2004). Between Sex and Power: Family in the World, 1900–2000. London: Routledge. Wetzel, D. and V. Economico (2013). Bolsa Familia: Brazil’s Quiet Revolution. Washington, D.C.: The World Bank. Wood, C. H. and J. A. M. de Carvalho (1988). The Demography of Inequality in Brazil. New York: Cambridge University Press.

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Index

A Aadhaar, 164–167, 170 Acao Educativa Organization, 209 Access to medicines, 115 Affirmative Action Program, 202 AIIB, 36 Alzheimer disease, 117–118 Apartheid, 131 Argentina, 175, 199 Asian Infrastructure Investment Bank, 35 Atal Pension Yojana, 144

Bolsa Familia, xxii, 9, 93, 147, 210, 213 Brasil Carinhoso, 213 Brazil, xvii, xix–xxii, 1, 4, 6–9, 11–12, 20–27, 29–31, 34, 79–80, 87–91, 93–95, 118, 120, 124, 127–128, 130, 134–135, 137, 147, 149, 151, 153, 155, 197–206, 208–212, 214 Brazilian Workers Party, 9, 13 Bretton Woods, 1 BRICS, xvii–xix, xxi–xxii, 1–4, 7, 9, 14, 19, 21–24, 29–30, 32, 34, 36, 39–40, 61, 73–74, 76, 79, 114, 116, 118, 121, 124, 128, 134, 136, 138, 149, 151, 154, 189 Britain, 4 Business Correspondents, 147 Business Facilitators, 147

B Bandhan Bank, 173 Banking Ombudsman Scheme, 148 Basic Savings Bank Deposit Accounts (BSBDAs), 146 Bernanke, Ben, 28 between-group inequality, 63–68, 70–71, 74–75 Bhartiya Mahila Bank, 161 Bill and Melinda Gates Foundation, 167 biodiversity, 99 bipolarity, 84 bipolarization, 83 Black Economic Empowerment, 6, 9 Bolivia, 199 Bolsa Escola, 93, 210

C Cadastro Unico, 212 Caixa Econômica Federal, 148 caste, 61–64, 67, 69 caste-based inequality, 87 Central Statistical Office (CSO), 80 Chile, 147 China, xvii–xxi, 1, 4–8, 11–12, 20–25, 27–31, 33–34, 36, 94, 118–121, 123–124, 128, 130, 134–135, 137, 151, 153, 155 Chinese Communist Party, 4, 12 CLADEM, 209 217

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class-based disparities, 91 class-based inequalities, 80, 87 climate change, 100 CNRVV, 209 Collateralized Debt Obligations (CDO), 160 Colombia, 199, 202, 213 Communist Party, 8, 12 conditional cash transfer, xxii, 93 Congress Party, 5 Construction Worker Welfare Boards, 93 consumption-led growth, 52, 54 corruption, 11–12, 125 current generations, 99 D da Silva, Luiz Inacio Lula, 9 Data Envelope Analysis (DEA), 103 decomposition, 64 de-coupling, 40 diabetes, 117–118 Dominican Republic, 199 E Earth Summit, 109 East Asia, 88 ecological footprint, 103 economic inequality, 61, 63, 69 ECOS, 209 Ecuador, 199 environmental crimes, 107 F Federal Mandatory Insurance Fund (FOMS), 130 Financial Inclusion Action Plan (FIAP), 158 Financial Inclusion Insights (FII), 181 Financial Inclusion Insights Survey (FIIS), 167 Financial Stability and Development Council (FSDC), 159

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FINDEX, 143, 155, 161, 189 Fiscal Policies, 28 Foreign Direct Investment (FDI), 30 Fourteenth Finance Commission, 137 France, 19, 30 FUNAI, 199 future generations, 99 G G7, xvii, 1–3, 14, 19, 22 G8, 20 G20, 1, 145, 158–159 GDP, 125, 132 general entropy class of measures, 65 Germany, 30 Gini coefficient, 9 Gini index, 94 global burden of diseases, 116 global financial crisis, 39 global inequality report, 7 Global Partnership for Financial Inclusion (GPFI), 158 global warming, 100 Goldman Sachs, xvii, xix, 20 governance, 100, 125–126 guanxi, 12 Guatemala, 198–199 H Head Count Ratio (HCR), 85 Health Sector Road, 131 HIV/AIDS, 116, 118, 131 Honduras, 199 Hong Kong, 29 horizontal inequality, 80 I IDFC, 173 IMF, xvii, 3, 26, 34, 188 Immediate Payment Service (IMPS), 172 inclusive finance, 145 inclusive growth, xxi income inequality, 11

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India, xvii–xxii, 1, 4–8, 11, 20–27, 29–32, 34, 36, 79–80, 91, 93, 114, 118–121, 124, 134–136, 138, 151, 153–155, 157 inequality, 79 inequality decomposition, 66–67 Innenpolitik, 2 inter-group inequality, 61, 63, 66, 69, 71 International Monetary Fund, 34 interpersonal inequality, 91 Italy, 19 J JAM, 164–165, 175 Japan, 19, 30 Jinping, Xi, 12 K Know Your Customer (KYC), 147, 166 L LAC Community for the Defence of Women’s Rights, 209 Latin America, 197–198 least developed countries, 8 Lei de Cotas, 204 Li Kequing index, 41 local government financial vehicles, 45 M Mahatma Gandhi National Rural Employment Guarantee Act (MNREGA), 92 Mahatma Gandhi National Rural Employment Guarantee Scheme (MGNREGS), 176–177 Malawi, 157 Medical Schemes Act, 132 Mexico, 94, 175, 213 Millennium Development Goal, 102, 205 Ministry of Health and Family Welfare (MOHFW), 133 Ministry of Labor and Employment (MOLE), 133

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MNREGS, 178 monetary policies, 24 Most Favoured Nation (MFN), 30 MSCI, 39 N National Foundation for the Indigenous, 199 National Health Act, 132 National Health Assurance Mission, 132 National Health Insurance (NHI), 131 National Health Mission (NHM), 132 National Programme for Access to Technical Education and Employment, 212 National Rural Health Mission (NRHM), 132–133 National Sample Survey Organization (NSSO), 81, 84, 88 National Strategy for Financial Education, 148 nation state, 100 natural environment, 101 Negotiated Service Delivery Agreement (NSDA), 131 neo-realism, 3 New Cooperative Medical Scheme (NCMS), 129 New Development Bank (NDB), xix, 21, 33–34, 36, 110 Nicaragua, 198 non-communicable diseases, 116 non-performing assets (NPAs), 50, 52 O OECD, 8, 130, 204–205 Office of Health Standards Compliance, 132 O’Neill Jim, 20 OOPS, 115–116, 121–123, 129–130, 132–133 OPEC, 19 Organization of American States (OAS), 209

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P PAHAL, 170, 176 Pakistan, 5 Panama, 199 Payments Bank (PBs), 174 Peru, 161, 199 Pesquisa Nacional por Amostra de Domicílios (PNAD), 88–89 Philippines, 147, 161 Ping, Deng Xiao, 5 Planning Commission, 91, 132, 176 political capture, 11 Portugal, 206 poverty, 79 Pradhan Mantri Jan Dhan Yojana (PMJDY), 144, 160, 163–169 primary health care, 115 primary health services, 115 private corporate sector, 45 Programma Bolsa Familia (PBF), 204, 206, 211–214 Progress out of Poverty Index, PPI, 167 Pronatech, 212 Putin, Vladimir, 14 R Racial Admission Quotas, 203 Rashtriya Swasthya Bima Yojana (RSBY), 132–133 real plan, 6, 24, 88 regulatory burden, 125 Relative Gini, 81 Reserve Bank, 144–146, 148, 159, 170, 174–175, 185 Rousseff, Dilma, 13, 204 rule of law, 125 Rural Cooperative Medical Schemes (RCMS), 129 Russia, xvii, xix, xxi, 1, 4, 7–8, 10–11, 20–23, 25, 27, 29–31, 33–34, 36, 118–121, 123–124, 129–130, 134–137, 151, 153, 155 Russian Constitution, 130

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S Sedes Sapientiae Institute of Sao Paulo, 209 Small Finance Banks (SFBs), 174 SME, 158–159 social groups, 61–64, 66–67, 70–74 social health insurance, 115 social progress index, 102 South Africa, xvii, xix, xxi–xxii, 1, 4, 6–9, 11–13, 21–32, 34, 116, 118, 120–121, 123–124, 131, 134–137, 149, 151, 153–155 South Asia, 88 Soviet Union, 3, 7, 10, 129 sustainable development, xx, 99 Sustainable Development Goals (SDGs), 102, 114, 119, 145 T taxes, 115 TB, 131 Tiananmen Square uprising, 10 tuberculosis, 116 U UK, 19 UN, xvii, 3, 113 UNDP, 199 UNDP Gender Equality Study, 8 Unified Payments Interface (UPI), 172 Unique Identification Authority of India (UIDAI), 166 United Nations Framework Convention on Climate Change (UNFCCC), 105 United States (US), 19, 30, 200 Universal Health Coverage (UHC), xxi, 113–116, 119, 121, 125, 128, 132, 134, 138 Urban Employee Basic Medical Insurance (UEBMI), 129 Urban Resident Basic Medical Insurance (URBMI), 129

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V Venezuela, 199 W Wealth inequality, 11 West Germany, 19

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Word Bank, 34 World Bank, xvii, 3, 34, 113, 143 World Health Organization (WHO), 113, 115, 198 World Health Report, 114 WTO, 4

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THE POLITICAL ECONOMY OF THE BRICS COUNTRIES  BRICS and the Global Economy

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THE POLITICAL ECONOMY OF THE BRICS COUNTRIES Editors-in-Chief

Edward D. Mansfield University of Pennsylvania, USA

Nita Rudra

Georgetown University, USA

 BRICS and the Global Economy Editor

Soo Yeon Kim

National University of Singapore, Singapore

World Scientific NEW JERSEY

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Published by World Scientific Publishing Co. Pte. Ltd. 5 Toh Tuck Link, Singapore 596224 USA office: 27 Warren Street, Suite 401-402, Hackensack, NJ 07601 UK office: 57 Shelton Street, Covent Garden, London WC2H 9HE

Library of Congress Cataloging-in-Publication Data Names: Abraham, Biju Paul, editor. | Ray, Partha, editor. | Kim, Soo Yeon, editor. Title: The political economy of the BRICS countries / editor-in-chief: Edward D Mansfield (University of Pennsylvania, USA) and Nita Rudra (Georgetown University, USA); edited by Biju Paul Abraham (Indian Institute of Management Calcutta, India), Partha Ray (Indian Institute of Management Calcutta, India), Soo Yeon Kim (National University of Singapore, Singapore) and Santiago López-Cariboni. (Universidad Católica del Uruguay, Uruguay). Description: New Jersey : World Scientific, [2019-] | Includes bibliographical references and index. Contents: v.1.BRICS: The quest for inclusive growth -- v.2. BRICS and the global economy - v.3. Political economy of informality in BRIC countries. Identifiers: LCCN 2019011951| ISBN 9789811202179 (set : alk. paper) | ISBN 9789811202186 (v. 1: hc : alk. paper) | ISBN 9789811202193 (v. 2: hc : alk. paper) | ISBN 9789811202209 (v. 3: hc : alk. paper) Subjects: LCSH: Economic development--BRIC countries. | BRIC countries--Economic conditions. | BRIC countries--Economic policy. | BRIC countries--Social policy. | BRIC countries--Foreign relations. Classification: LCC HD82 .P5485 2019 | DDC 330.9172/4--dc23 LC record available at https://lccn.loc.gov/2019011951 British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library.

Copyright © 2020 by World Scientific Publishing Co. Pte. Ltd. All rights reserved. This book, or parts thereof, may not be reproduced in any form or by any means, electronic or mechanical, including photocopying, recording or any information storage and retrieval system now known or to be invented, without written permission from the publisher.

For photocopying of material in this volume, please pay a copying fee through the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, USA. In this case permission to photocopy is not required from the publisher.

For any available supplementary material, please visit https://www.worldscientific.com/worldscibooks/10.1142/11330#t=suppl Desk Editors: Dr. Sree Meenakshi Sajani/Jiang Yulin Typeset by Stallion Press Email: [email protected] Printed in Singapore

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Editor’s Note and Acknowledgments

BRICS and the Global Economy is the brainchild of a book conference on the same theme held at the National University of Singapore in March 2017. It is part of a larger project — ‘From Emerging Markets to Rising Powers? Power Shift in International Economic Governance,’ funded through a Tier 2 Academic Research Fund Grant (MOE2014-T2-2-157) from Singapore’s Ministry of Education. I thank the colleagues who have contributed to this volume and travelled far to participate in the conference at the National University of Singapore. The larger project owes an intellectual debt to my collaborators on the report Global Shift: How the West Should Respond to the Rise of China (2011), co-authored with Daniel Deudney, James Goldgeier, Steffen Kern, Hanns W. Maull, and Iskander Rehman. It was supported by a fellowship from the Transatlantic Academy, led by Stephen Szabo and located at the German Marshall Fund in Washington, DC. I am most grateful to Giulia Mennillo for the extensive management not only of the preparation of this edited volume but also of the project overall. As the project’s postdoctoral fellow for 2 years, Giulia contributed important and innovative research on the rise of new credit rating agencies in China. Giulia also took on a key role in managing the various practical aspects of the project. From coordinating personnel to organizing workshops and talks, all the while pursuing her own independent research, Giulia has been an invaluable colleague, and I remain deeply grateful for her tireless efforts to bring the highest quality of academic scholarship and management to this project. I also thank the Editors-in-Chief of this three-volume project The Political Economy of the BRICS Countries, Ed Mansfield and Nita Rudra. They first approached me to undertake this project, and I am grateful for the opportunity they

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vi  Editor’s Note and Acknowledgments

have provided to gain greater visibility for this research project and to contribute to the advancement of knowledge about emerging markets and their roles in global economic governance. Thanks are also due to our very able Research Assistants from the National University of Singapore, who assisted with the preparation of this volume: Veronica Koh, Lam Wai Ni, Olivia Lim, Samuel Lim, and Jacelyn Tay. All are students from the Department of Political Science. Last but not least, the staff at World Scientific have been professional, patient, and prompt in bringing this volume as well as the other two volumes in this series to press.

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About the Editors-in-Chief

Edward D. Mansfield is the Hum Rosen Professor of Political Science and Director of the Christopher H. Browne Center for International Politics at the University of Pennsylvania. His research focuses on international security and international political economy. He is the author of Power, Trade, and War (Princeton University Press, 1994); Electing to Fight: Why Emerging Democracies Go to War (with Jack Snyder) (MIT Press, 2005); Votes, Vetoes, and the Political Economy of International Trade Agreements (with Helen V. Milner) (Princeton University Press, 2012); and The Political Economy of International Trade (World Scientific, 2015). He is also the editor of 14 books and journal special issues, and has published articles in the American Political Science Review, British Journal of Political Science, Comparative Political Studies, International Organization, International Security, International Studies Quarterly, Journal of Conflict Resolution, World Politics, and various other journals and books. The recipient of the 2000 Karl W. Deutsch Award in International Relations and Peace Research, Mansfield has been a National Fellow at the Hoover Institution and his research has been supported by grants from the Harry Frank Guggenheim Foundation, the Mershon Center, and the United States Institute of Peace. He is the co-editor of the University of Michigan Press Series on International Political Economy and was the Vice President of the International Studies Association. He has been a Term Member of the Council on Foreign Relations, a member of the Graduate Record Examination Political Science Committee, Associate Editor of International Organization, and Program Co-Chair for the 2001 annual meeting of the American Political Science Association. Mansfield received his BA, MA, and PhD from the University of Pennsylvania; and before joining the faculty there, he taught at Columbia University and Ohio State University. vii

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viii  About the Editors-in-Chief

Nita Rudra is a Professor in the Department of Government at Georgetown University. Her research interests include the politics of globalization, trade, foreign investment, development, democracy, inequality, taxation, and redistribution. Her works appear in the British Journal of Political Science, Journal of Politics, American Journal of Political Science, Comparative Political Studies, International Organization, and International Studies Quarterly. Her most recent book with Cambridge University Press is entitled Democracies in Peril. She has been a recipient of the Woodrow Wilson International Center for Scholars Fellowship, the Fulbright–Nehru Foundation Academic Fellowship, and the International Affairs Fellowship by the Council on Foreign Relations.

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About the Editor

Soo Yeon Kim is an Associate Professor and the Head of Department of Political Science at the National University of Singapore. She is a former Fellow of the Transatlantic Academy, based at the German Marshall Fund of the United States (Washington, DC), and of the Niehaus Center for Globalization and Governance, Woodrow Wilson School of Public and International Affairs, Princeton University. Soo Yeon Kim holds a Ph.D. in Political Science from Yale University and B.A. in Political Science and International Relations from Yonsei University. Her current research focuses on production networks, multinational firms, and the politics of free trade agreements in Asia; the politics of compliance in WTO disputes; and rising powers in the global economy. Soo Yeon Kim’s recent publications include “Global Value Chains and the Political Economy of WTO Disputes” (with Gabriele Spilker), The Review of International Organizations, 2019; “The Regime Complex for Investment Governance: Overlapping Provisions in PTAs and BITs” (with Clara Lee), in Manfred Elsig, Michael Hahn, and Gabriele Spilker, Eds., The Shifting Landscape of Global Trade Governance, (Cambridge University Press, forthcoming); and “Yin and Yank: Public Opinion in Europe Toward the United States and China” (with Sophie Meunier and Zsolt Nyiri), Comparative European Politics, 2016.

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About the Contributors

Gerda Asmus is a Ph.D. candidate in Economics at Heidelberg University, Germany. Previously, she has earned her master’s degree in Public Policy from Maastricht Graduate School of Governance. Her research centers around two fields. The first focuses on the analysis of international development finance. She is particularly interested in emerging donor countries, such as India and China. Her second field is devoted to the effects of historical events on regional differences in economic development. For both fields, she generates spatial data and makes use of modern spatial econometric techniques in her analyses. Thilo Bodenstein is an Associate Professor at the School of Public Policy, Central European University, Budapest and Vienna. His research interests are comparative and international political economy. He is the author of several papers and a book on the post-communist countries’ integration into the world market, on policies in the European Union and development studies. His area of expertise covers politics and economics of Central and East European countries, EU public policies and economic crisis management of EU member states, and public and economic policies in developing countries. Tanja A. Börzel is the Professor of Political Science and holds the Chair for European Integration at the Otto-Suhr-Institute for Political Science, Freie Universität Berlin. She is the Director of the Cluster of Excellence “Contestations of the Liberal Script”, together with Michael Zürn, as well as the H2020 Collaborative Project “EU-LISTCO — Europe’s External Action and the Dual Challenges of Limited Statehood and Contested Orders”. She also directs the Jean Monnet Center of Excellence “Europe and its Citizens”. Her recent publications include The Oxford Handbook of Comparative Regionalism (co-edited with Thomas Risse, Oxford xi

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xii  About the Contributors

University Press, 2016), Governance under Anarchy: Effective and Legitimate in Areas of Limited Statehood (with Thomas Risse, Cambridge University Press, forthcoming), and A Theory of Non-Compliance: Power, Capacity, and Politicization (Cornell University Press, forthcoming). Cristiane L. Carneiro is an Associate Professor at the International Relations Institute, University of São Paulo. She holds a Ph.D. in Politics (New York University), an M.A. in Political Science, and a B.A. in Law (UFPE). She has published on state compliance, with a focus on the WTO and human rights. Her most recent publication is an edited volume, The WTO Dispute Settlement Mechanism — A Developing Country Perspective (with Alberto do Amaral Junior and Luciana Oliveira, Springer, 2018). Andreas Fuchs is Professor of Development Economics at the Faculty of Business and Economics, University of Goettingen, Germany. His research analyzes the political economy of aid, trade, and investment using quantitative methods with a special focus on China and other emerging economies. Andreas Fuchs is one of the developers of AidData’s Global Chinese Official Finance Dataset. His research papers have been published in the Journal of the European Economic Association, Journal of Development Economics, Journal of International Economics, and the Journal of Conflict Resolution, among others. Before joining HSU Hamburg and IfW Kiel, Andreas Fuchs was a researcher at Princeton University and Heidelberg University. He defended his Ph.D. dissertation at the University of Goettingen in August 2012. Matteo Fumagalli is a Senior Lecturer in the School of International Relations at the University of St. Andrews in Scotland, UK. He previously taught at Central European University, University College Dublin, and the University of Edinburgh. Matteo’s interests lie at the intersection of the study of ethnic conflict and violence and the politics of natural resources, especially in authoritarian settings in Central and East Asia. He has published on various aspects related to energy politics and the international relations of natural resources, including the rise of resource nationalism in the small but resource-rich economies at China’s borders, and the resource nexus. His publications include articles in Democratization, East European Politics, the International Political Science Review, Ethnopolitics, and Asian Politics and Policy. Matteo’s most recent work revolves around the study of Asian inter-connectedness in the form of aid, logistics, trade and investment, across East-Central Asia and Northeast and Southeast Asia.

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About the Contributors xiii

Julia Gray is an Associate Professor of Political Science at the University of Pennsylvania. Her research focuses on international political economy and international organizations, with a particular focus on how institutions work in emerging markets. Her first book, The Company States Keep: International Economic Organizations and Investor Perceptions, won the 2013 Lepgold Prize. Yoram Z. Haftel is an Associate Professor and the Giancarlo Elia Valori Chair in the Study of Peace and Regional Cooperation in the Department of International Relations at the Hebrew University of Jerusalem. He received his Ph.D. from Ohio State University and had taught at the University of Illinois at Chicago. His research agenda touches on the sources, design, and effects of regional economic organizations and international investment agreements (IIAs). His recent work examines the relationships between international investment arbitration and state regulatory space in IIAs worldwide. He has published a book and numerous articles on this and other topics. Ayse Kaya is the Associate Professor of Political Science at Swarthmore College (in Swarthmore, PA, USA), where she also co-directs the Global Studies Program. She researches and teaches on globalization and international political economy, particularly multilateral economic institutions with a focus on the International Monetary Fund and the World Bank, the impact of the large emerging economies (BRICS) on the multilateral system, global inequality and poverty, and the international political ramifications of the 2008 global financial crisis, and more recently global environmental governance. She has published in a range of peer-reviewed journals, and her book on global economic institutions, Power and Global Economic Institutions, was published by Cambridge University Press (2015/2017). Rajesh Kumar works at the intersections of political theory, international political theory and political economy, and on citizenship and migration. He has been associated with the Rising Power and Emerging Markets project of the Department of Political Science, NUS as a graduate researcher, where he worked on India’s status as a rising power and as a member of the BRICS group. Currently, he teaches Political Science at the Delhi College of Arts and Commerce, University of Delhi. Andrew X. Li is an Assistant Professor of International Relations at Central European University, Budapest and Vienna. He earned a joint Ph.D. from National University of Singapore and King’s College London. Prior to joining Central European University, he worked as a research fellow at Nanyang Technological

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xiv  About the Contributors

University, taking part in a project on talent migration in Singapore. His research focuses on the political economy of international finance, migration and development as well as foreign policy (re)alignment and global power shifts. His works have been published in journals such as Economic & Politics, Journal of International Relations and Development, and Science and Public Policy. Giulia Mennillo is the Deputy Academic Convenor for the Global Studies Program and Visiting Fellow at the Department of Political Science at the National University of Singapore. Previously, she was a postdoctoral fellow for the research project “From Emerging Markets to Rising Powers? Power Shift in International Economic Governance” at National University of Singapore. Her research interests are in the interdisciplinary field of International Political Economy, particularly Global Finance. Her research agenda deals with credit rating agencies — private actors that play a fundamental role in the governance of today’s global financial markets. She holds a Ph.D. in International Affairs and Political Economy from the University of St. Gallen. She held research appointments at the Weatherhead Center for International Affairs at Harvard University, the Watson Institute for International and Public Affairs at Brown University, and the University of Warwick. Axel Michaelowa has a Ph.D. in Economics and works on international and national climate policy instruments and the UNFCCC process since 1994. He is a part-time researcher at the University of Zurich and senior founding partner of the consultancy Perspectives since 2003. Axel has written over 200 research articles and studies and consults private, governmental, and public institutions in over 50, mostly developing, countries on climate policy instruments, particularly market mechanisms. Axel was the IPCC lead author for the chapter on policies and measures in the fourth and fifth Assessment Report. Katharina Michaelowa is Professor of Political Economy and Development at the University of Zurich and at the Center for Comparative and International Studies (CIS), ETH and University of Zurich. Her research focuses on policies and politics in developing countries, international development cooperation, and international climate policy, and led to over 100 publications including several books and articles in journals such as International Organization, International Studies Quarterly, the Review of International Organizations, World Development, Climate Policy, and Climatic Change. Before joining the University of Zurich, she held positions at the Hamburg Institute of International Economics and at the OECD.

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About the Contributors xv

Angelika Müller is a Ph.D. candidate at Heidelberg University (Germany). She holds an M.Sc. in Environment and Development from the London School of Economics and a B.A. in Philosophy and Economics from Bayreuth University. Before starting her Ph.D., Angelika has worked in applied research with different international and non-governmental organizations, for instance, with the European Commission and the International Red Cross (IFRC). Her research focuses on the economics of financing sustainable development, including the question how the domestic political regime type affects the decision of countries to join the club of aid donors. Philip Nel is a Professor in the Department of Politics, University of Otago, Dunedin, New Zealand. He received his D.Phil. in Philosophy from the University of Stellenbosch, South Africa in 1984. He has been a visiting professor in Germany and Japan, and is a Professor Extraordinaire at the University of Stellenbosch, South Africa. Philip Nel was one of the founding editors of the International Studies Association journal Foreign Policy Analysis, and serves on the editorial boards of Global Society and Review of International Studies. His publications include edited and single-author volumes on income inequality in developing countries, South African foreign policy, rhetoric and the social sciences, Soviet politics, and a textbook on international relations, aimed at African students. Michal Parízek is an Assistant Professor of International Relations and member of the Peace Research Center Prague, Charles University, Prague, Czechia. His research focuses on the design and performance of international institutions and international administrations. Empirically, his research deals with the World Trade Organization and other global economic governance bodies as well as the United Nations system. His texts were recently published, among others, in The Review of International Organizations, New Political Economy, World Trade Review, Comparative European Politics, and Global Policy. Thomas Risse is the Professor of International Politics at the Otto-Suhr-Institute of Political Science, Freie Universität Berlin, Germany. His latest publications include the Oxford Handbook of Governance and Limited Statehood (ed. with Tanja A. Börzel and Anke Draude, Oxford University Press, 2018), Domestic Politics and Norm Diffusion in International Relations (Routledge, 2017), and the Oxford Handbook of Comparative Regionalism (ed. with Tanja A. Börzel, Oxford University Press, 2016). Risse received his Ph.D. in Political Science in 1987 from the University of Frankfurt, Germany. During his career, he has taught in the U.S. at Cornell, Yale, Stanford, and Harvard universities as well as the University of Wyoming, in Europe

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at the University of Konstanz, Germany, and the European University Institute, Florence, Italy. Matthew D. Stephen is an Interim Professor of International Relations and Regional Governance at the Helmut Schmidt University Hamburg and a Senior Researcher at the German Institute for Global and Area Studies (GIGA). His research focuses on the interaction between international power shifts, legitimacy, and international institutions. He has published in journals such as the European Journal of International Relations, Global Governance, the Chinese Journal of International Politics, and the Review of International Studies. He is the editor, together with Michael Zürn, of Contested World Orders, Oxford University Press, 2019. Ka Zeng is the Professor of Political Science and Director of Asian Studies at the University of Arkansas. Her research focuses on China’s role in the global economy, in particular Chinese trade policy, China’s role in global economic governance, and China-related trade dispute dynamics. Ka Zeng’s books include Trade Threats, Trade Wars (Michigan, 2004), Greening China (Michigan, 2011), and Global Value Chains and the Politics of Trade Liberalization (Michigan, under contract). She is also the editor or co-editor of China’s Foreign Trade Policy (Routledge, 2007), China and Global Trade Governance (Routledge, 2013), and Handbook on the International Political Economy of China (Edward Elgar, 2019). Ka Zeng is currently a senior research fellow at the Wong Center for the Study of Multinational Corporations.

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Contents

Editor’s Note and Acknowledgmentsv About the Editors-in-Chiefvii About the Editorix About the Contributorsxi xix

Introduction Part I  Understanding the BRICS Phenomenon

1

Chapter 1 Brazil as a BRICS Country Cristiane Lucena Carneiro

3

Chapter 2 Russia in Global Economic Governance Thilo Bodenstein

17

Chapter 3 India and Global Governance Rajesh Kumar

33

Chapter 4 China and Global Economic Governance Ka Zeng

55

Chapter 5 S outh Africa, BRICS, and Global Governance: How SA Tried to Change the World and Succeeded in Changing Itself Philip Nel

83

Part II  Regionalism and Foreign Aid

113

Chapter 6 E  merging Economies — But Regional Powers? The BRICS and Regionalism Tanja A. Börzel and Thomas Risse

115

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Chapter 7 BRICS and Foreign Aid Gerda Asmus, Andreas Fuchs, and Angelika Müller

139

Part III  Investment and Finance

179

Chapter 8 BRICS and the Global Investment Regime Yoram Z. Haftel

181

Chapter 9 Exchange Rate Policies of the BRICS Andrew X. Li

207

xviii  Contents

Chapter 10 He Who Pays the Piper Calls the Tune: And the “Relocation of the World’s Credit Rating Center” Goes To? Giulia Mennillo

229

Chapter 11 Treaty Shopping and Unintended Consequences: BRICS in the International System Julia Gray

259

Part IV  Climate Negotiations and Energy Governance

287

Chapter 12 BRICS in the International Climate Negotiations Axel Michaelowa and Katharina Michaelowa

289

Chapter 13 The BRICS, Energy Security, and Global Energy Governance Matteo Fumagalli

307

Part V  Representation, Fragmentation, and Legitimacy

335

Chapter 14 BRICS and the International Financial Institutions: Voice and Exit Ayse Kaya

337

Chapter 15 Th  e Representation of BRICS in Global Economic Governance: Reform and Fragmentation of Multilateral Institutions Michal Parízek and Matthew D. Stephen

361

Index391

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Introduction

Brazil, Russia, India, China, and most recently South Africa — collectively known as the BRICS countries — represent an emergent group whose actorness in the present and future global economy is a central point of debate. The BRICS label has been around since the beginning of the 21st century, but as a political force, the BRICS countries were catapulted to the center stage with the outbreak of the global economic crisis of 2008 and the subsequent emergence of the G20 as the “steering committee” for the global economy. While the BRICS countries remain at the core of this group, more broadly it includes other countries known as emerging market countries, which have exhibited strong economic growth and increasing voice in the international arena. Together, they are emblematic of the “rise of the rest” (Zakaria, 2011) and a tectonic shift in power in the international system toward greater inclusiveness of new actors from the developing world (Kahler, 2013). How have the BRICS, and more broadly the emerging market countries, shaped the functioning and governance of the global economy? This volume features our current state of knowledge concerning the BRICS and emerging markets in the discourses over global economic governance, rising powers in international politics, and the international political economy. We analyze the role of BRICS countries both as individual actors and interrogate their group dynamics in the governance of trade, investment, finance, the environment, and foreign aid. We also identify research frontiers that call for further scholarly attention.

From BRIC to BRICS: Origins and Evolution In 2001, Goldman Sachs’ chief economist Jim O’Neill (2001) introduced the BRIC acronym in the Goldman Sachs Global Economics Paper No. 66, “Building Better xix

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xx  Introduction

Global Economic BRICs” to highlight the economic dynamics of the larger emerging economies of Brazil, Russia, India and China. The paper proffered projections of the BRICs countries’ share of world gross domestic product (GDP) in the next decade, in which all four scenarios pointed to an upward trend with China taking up the lion’s share of this growth. The report’s projections on China were indeed borne out when in 2010, just 2 years after the outbreak of the global financial crisis (GFC), China overtook Japan as the world’s second largest economy. O’Neil’s paper also recommended an “upgrade” of the G7 group toward greater inclusiveness of the BRICs countries in global economic policymaking. While recognizing the economic heft and potential of these larger emerging market economies, the report noted the heterogeneity of this group and was markedly ambivalent on whether the BRICs countries would be inclined to join the G7 (or eight including Russia at this time) club of advanced industrial countries. The paper was prescient as it highlighted the political, economic, and social heterogeneity of this group of countries. It retained a strong skepticism about the willingness and compatibility of this motley group in joining the traditional leaders of the global economy. While the BRICs label originally included only the four countries, following the two BRIC summits in Russia in 2009 and in Brazil in 2010, South Africa in 2011 joined this group to form the BRICS at the summit in Sanya, China.1 South Africa’s participation in the BRICS Business Forum and the BRICS Banking Cooperation Mechanism on the sidelines of the summit solidified its position as a full-fledged member of this influential group of developing countries. The BRICS as five have since then continued on their path of cooperation and institution building.

Beyond BRICS Although the BRICS countries have been the most prominent actors among emerging markets (Narlikar, 2010), in recent years, the acronyms have gone beyond the BRICS to the N11 (Goldman Sachs, 2007), the MINT countries (Durotoye, 2014), and others found in academic and policy-related publications.2 These countries are visible as new actors transitioning from their previous roles as largely rule-takers to  South Africa’s joining of the BRIC group began in 2010 at the summit meeting in Brazil. It was formally invited to join this group in December 2010. Attending the third BRICS Summit in April 2011, South African President Zuma confirmed South Africa’s BRICS membership. 2  For a list of acronyms to describe emerging market country groupings, see: Amarendra Bhushan Dhiraj, “What’s Next: The List Of Catchy Acronyms For Emerging Market 1

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Introduction xxi

potential rule-makers that will shape the governance of the international economy. Moreover, their location in the developing world, i.e. outside the OECD group of countries, injects diversity and heterogeneity into the group of leading economies. This is likely to have ramifications for the functioning, regulation, and management of international economic exchange (Stewart, 2010). Existing scholarship suggests this is indeed a heterogeneous group of countries. They have taken different paths to power and influence in global economic governance (Hopewell, 2015), and they hold varying worldviews about their role in international politics (Nau and Ollapally, 2012). Some of these new groups have included the following: •• BICSAM (Outreach 5): This group includes the BRICS countries, excluding Russia but including Mexico. Brazil, India, China, South Africa, and Mexico, which were courted as the “Outreach 5” in the early 2000s by the G7 countries. Dialogue between these five countries and the G7 was extended beyond its initial 2 years and institutionalized as the “Heiligendamm Process” by 2009. •• BASIC: This group, formed in November 2009, includes Brazil, South Africa, India, and China. These countries organized to cooperate in international climate negotiations. •• BICS: Investors and analysts in the private sector employ this acronym, which is a variant of the original BRIC group. It includes Brazil, India, China, and South Africa as emerging markets, leaving out Russia. •• BRIICS: This grouping expands the BRICS group to include Indonesia. •• CIVET: This label includes countries that have been identified as potential second-generation emerging economies following the BRICS group. Coined by Robert Ward of the Economic Intelligence Unit, this group is comprised of Colombia, Indonesia, Vietnam, Egypt, and Turkey. •• E7: This grouping of seven emerging market economies includes China, Russia, India, Indonesia, Mexico, Brazil, and South Korea. Coined in 2009 by Price Waterhouse Coopers, these economies together are projected to surpass the G7 countries in economic size by 2020. •• Gulf Cooperation Council (GCC): A long-standing organization established in 1981 with six Middle Eastern countries, GCC is a regional intergovernmental organization and trade bloc. Members include Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates. The GCC was formed to promote political and economic cooperation among states in the Persian Gulf.

Economies”, CEO World Magazine, 14 October 2014, available online at: http://ceoworld. biz/2014/10/14/whats-next-list-catchy-acronyms-emerging-market-economies/.

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•• IBSA: The India−Brazil−South Africa (IBSA) Dialogue Forum brings together the three major democracies among emerging market countries to promote greater cooperation in the international arena. •• MINT: Coined by Fidelity Investments, this group includes Mexico, Indonesia, Nigeria, and Turkey. As the most populous non-BRIC countries among emerging market economics, they are regarded as potential economic powerhouses of the future. •• N-11: Jim O’Neill’s update in 2005 in a follow up paper, “How Solid are the BRIC?” featured the Next Eleven to follow in the ranks of the four original BRICs economies. The paper identified Bangladesh, Egypt, Indonesia, Iran, Mexico, Nigeria, Pakistan, Philippines, Turkey, South Korea, and Vietnam as having “BRICS-like potential” (7). Of these, the study argued that only Mexico and South Korea have the capacity to achieve global importance on par with the original BRICS countries.

Conceptualizations: BRICS as Emerging Markets and Rising Powers (with Rajeev Arumugam, Manali Kumar, and Florian Winkler) As indicated by the earliest formulation of the BRICS idea, the concept of the BRICS began in the private sector, positioned in the broader category of emerging markets as an investment category that has existed since the 1980s. Investment portfolios with emerging market equity and debt funds tapped fast-growing economies with prospects of strong investment returns. These countries included not only the BRICS but many others as well. Under the label of emerging markets, these investment destinations have captured the interest of private economic actors, such as investment firms, financial market index providers, and consulting firms. Private sector classifications of emerging market economies such as the BRICS, which vary widely in the level of transparency, breadth and depth of their classifications, are most clearly defined by emerging market index providers, whose publication of market classification matrices provide transparent and measurable criteria for identifying the countries that come under this label. Index providers include the Financial Times Stock Exchange (FTSE) Emerging Index, the Morgan Stanley Capital International (MSCI) Emerging Markets Index and the Standard and Poor (S&P) Emerging Broad-Market Index. FTSE, MSCI, and S&P indices measure equity market performance in emerging countries worldwide that are frequently adopted as benchmarks in the emerging market funds offered by investment firms. They combine a range of qualitative and quantitative indicators, including but not limited to economic factors such as the size of economy and market, credit ratings,

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and liquidity requirements but also political stability, property rights and the regulatory environments in these countries. International organizations have also contributed significantly to the definition and classification of emerging markets, going beyond the BRICS five. The International Monetary Fund (IMF) definition of emerging markets refers to “the capital markets of developing countries that have liberalized their financial systems to promote capital flows with non-residents and are broadly accessible to foreign investors”.3 The World Economic Outlook (WEO 2015) specified features, such as per capita income, export diversification, and level of global financial integration.4 The World Bank employs a classification of “Country and Lending Groups” based on income levels, which scholarship in economics has employed to identify emerging markets (Gimet, 2011; Rocha and Oreiro, 2013).5 The IMF definition and the World Bank’s classification of “low-income” to “middle-income economies”, in particular, provided the basis for Goldman Sachs, Deutsche Bank and Citigroup’s classification of emerging market countries. Banks such as Barclays include investability criteria and the presence of capital controls in addition to the World Bank and IMF classifications, while J.P. Morgan Chase’s Emerging Markets Bond Index Global (EMBI Global) also considers each country’s debt-restructuring history. Scholarship in economics has both engaged and problematized the classifications of international organizations. Frankel and Poonawala’s study (2010) employs the IMF’s classification of emerging markets in the WEO, emphasizing the inclusion of newly industrializing economies (NIEs). Cuadro-Saez et al. (2009) also adopt the IMF definition in its analysis, with the exclusion of Hong Kong and Singapore as these are more developed and their economies marked by greater financial market depth. Interestingly, Siddiqui (2010) notes that the IMF classification does not distinguish between emerging and developing economies, which suggests that all emerging market economies originate from the developing world and, perhaps more important, continue to be identified and affiliated with this group of countries. Liberalization: An important conceptual feature of emerging markets such as the BRICS countries is economic liberalization. Hoskisson, Eden, Lau, and Wright study (2010), for example, defines emerging markets as “low-income, rapid-growth countries using economic liberalization as their primary engine for growth” (249). Based on these criteria, a later study identifies 64 emerging market countries (Hoskisson et al., 2013). The studies by Hoskisson et al. (2010, 2013), developed further in Danis et al. (2011) and Chari and David (2012) emphasize liberalization  International Monetary Fund, “Glossary of Selected Financial Terms”, 2006.  International Monetary Fund, World Economic Outlook, 2015. 5  World Bank, “Country and Lending Groups”, 2016. 3 4

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as the adoption of pro-market reforms and/or the promotion of the private sector. Economic openness, more broadly, is a strong feature of these liberalizing economies (Choi and Williams, 2013). Transition: BRICS and other emerging market economies are also characterized by elements of transition, or movement from one state to another in economic governance and influence. This can refer to the transformation of the domestic economy from a centrally planned to a market economy in some cases (Freeman et al., 2012). More frequently, especially as concerning the BRICS countries with the exception of Russia, emerging markets are countries in transition between the developing and developed country groups (Zashev and Ehrstedt, 2010). The transitional nature of these economies indicates that the applicable pool of actors excludes the least developed countries (LDCs) and the advanced industrialized countries such as those of the G7. Rather, greater attention is drawn to low- and middle-income countries that either possess or have the potential for “emergence” in the global economy through economic liberalization and sustained high-growth. BRICS as Rising Powers The scholarship in International Relations provides an especially compelling examination of the BRICS and emerging markets and their role in the global economy. Studies on emerging markets problematize their role as “rising powers”, which overlaps with the existing scholarship in economics and also the features of emerging markets identified in indices originating from the private sector. The concept of ­“rising powers”, alternatively expressed as “emerging powers” (Hurrell, 2000) or “middle powers” (Dauvergne and Farias, 2012), is central to debates on the role of the BRICS and emerging markets in shaping economic governance. Studies that advance the concept of rising powers rely both on the material bases of these actors’ capabilities (Florini, 2011; He and Feng, 2012; Kahler, 2013) and, perhaps more important, the political will and ambition to affect outcomes in international politics. A consistent theme articulated in conceptualizations of rising powers is the combination of material capabilities to wield influence and a significant measure of political will or aspiration to do so. That is, studies suggest strongly that material factors alone do not qualify these new actors as rising powers. Cornelissen (2009), for example, refers to rising powers with attributes that include economic factors such as sustained economic growth and population size and also political factors such as their growing influence through new diplomatic alliances, their identity as a member of the global South, and growing state capacity through internal consolidation. Others point to the ability to exercise agency (Narlikar, 2010), aspirations toward greater international prominence (Erthal Abdenur, 2014; Hurrell and Sengupta,

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2012), and generally greater “influence and stature” (Mittelman, 2013: 24) in the shaping of the global order (Chu et al., 2015). Veto Players to Agenda Setters: Scholarship on BRICS and emerging markets as rising powers emphasizes the potential political strength of these emerging actors, which indicates the possibility for greater influence in international politics but that remains as yet unrealized. Subacchi (2008), for example, stresses the BRICS countries’ “potential to influence international relations” and “a belief in their entitlement to a more influential role in world affairs” (492−493). Indeed, the breakdown of the Doha Round negotiations in 2008 indicates that countries such as China and India can function as veto-players in international fora. At the same time, however, these emerging actors have yet to attain “agenda-setting power” (Narlikar, 2013: 561−562) that enables them to actively shape the international order in the way that major powers have done in the past. While Stuenkel (2013) argues that the BRIC group did collectively assert a role as agenda-setters in the wake of the global economic crisis of 2008, this claim does not find much corroboration. Rather, international relations scholarship more broadly emphasizes the relatively limited leverage and influence of these countries as “emerging” but not yet major powers (Hart and Jones, 2010). Providers of Global Public Goods: Another dimension to consider in conceptualizing the BRICS and emerging markets is their sense of identity as both leaders and great powers that are able to provide global public goods, and how much this aspect of their actorness is recognized by the international community (Lebow, 2010). Mielniczuk’s (2013) analyses of BRICS countries’ opening speeches at the United Nations General Assembly from 1991 to 2011 capture the transformation of these countries’ identities to rising powers and perhaps new leaders as they address the most pressing issues of international security in our time. Studies advance both criticism and skepticism about the political will of rising powers as stake-holders that are willing to contribute to the provision of global public goods (Pant, 2013; Lieber, 2014). Among the few studies that focus on BRICS countries participation to this end, Medcalf (2012) finds that both India and China are increasingly more active and involved in anti-piracy operations, humanitarian assistance, disaster relief, and peacekeeping. Nevertheless, scholarship is lacking that systematically examines the contribution of the BRICS countries and other emerging markets to global governance and does so in a large-scale study covering a wide range of issue areas. This volume is an effort to remedy this gap for the case of global economic governance. China and BRICS Leadership: Last but certainly not least, perhaps the most contentious and broad discussion of the role of BRICS countries and emerging markets in international relations is centered on China. India and Brazil also figure as important actors from the BRICS group; however, their potential and actual impact has received

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much less attention. India and Brazil’s democratic political systems are regarded as an important reason why the rise of these actors is less likely to pose a threat to the existing international order (Fontaine and Kliman, 2013) but rather figure, in Brazil’s case, as an “emerging soft power” (Bertazzo, 2012) or even peacekeeper (Kenkel, 2010). Studies frequently invoke power transition theory to examine the rise of China and its implications for global order (Schweller and Pu, 2011; Foot, 2014). Scholars also frame the debate in terms of whether China is a “status quo” actor that essentially benefits and therefore supports the current international order or a “revisionist power” that seeks to overturn it through reform or the formation of alternative institutions (Kastner and Saunders, 2012). The debate over the rise of China exhibits a clear divide between two contending views: China as a “threat” and “opportunity”, with policy prescriptions that stress, respectively, competition in the international arena or engagement (Etzioni, 2011) and socialization into the existing system (Johnston 2001, 2007). This volume is devoted to examining the BRICS as emerging markets and rising powers in the context of global economic governance. We focus on individual countries that make up the BRICS five: the domestic drivers of their identity and behaviors as emergent actors in the international arena; the extent of their leadership in their regional neighborhoods; and more broadly their influence in shaping outcomes in major international institutions for economic governance. We examine not only individual behaviors but also group dynamics, specifically the extent to which the BRICS countries, sometimes joined by other emerging market countries, can overcome collective action problems and advance unified and coherent positions.

Organization of the Volume The 15 chapters in this volume are the result of an international conference on “BRICS and the Global Economy” held in March 2017 at the National University of Singapore. The conference brought together specialists across countries and academic disciplines, all devoted to examining how this emergent group of actors are shaping governance in diverse areas of the global economy. The chapters, summarized below, are organized under four main sections, examining in turn the scholarship on individual countries of the BRICS group; and thematic areas including regionalism and foreign aid, trade and investment, and representation and legitimacy. These themes represent the balance of individual and collective interests of the BRICS countries as they navigate their paths in the global economy, especially in the areas in which they have been most visible and perhaps even influential in their actorness.

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Understanding the BRICS Phenomenon We begin our examination of the BRICS by looking at the individual countries. Individual chapters are devoted to Brazil, Russia, India, China, and South Africa. In each, authors focus on their respective country’s domestic politics, regional roles, and prospects for leadership in governing the international economy. In “Brazil as a BRICs Country”, Cristiane Lucena Carneiro characterizes Brazil, one of the original members of the BRICS club, as a “democratic, non-interventionist, middle power”. Within the context of the BRICS group, Carneiro discusses the importance of international trade and its governing institutions, in particular the World Trade Organization (WTO), on Brazil’s critical transition towards political, economic and social development between 1995 and 2015. Carneiro argues that Brazil’s commitment to multilateralism, combined with its self-identification as a middle power and non-interventionist democracy, provided a strong foundation for assertiveness in the WTO. In doing so, Brazil rose in prominence as a “southern hegemon” to represent developing countries’ disappointment with the Doha Round negotiations and the WTO system as a whole. According to Carneiro, Brazil’s engagement of the WTO has two main features: first, an assertiveness — participation that is both proactive and defensive — that involves heavy use of the WTO dispute settlement mechanisms’ third-party provisions and notifications of trade defense measures; and second, a selective approach to regional and preferential trade agreements that has clearly signaled Brazil’s preference for multilateralism. Together these features constitute evidence of a new set of beliefs in Brazilian trade diplomacy that emphasizes the role of the WTO in facilitating the country’s “critical transition” from a limited-access order to an open-access order (North et al., 2006). Thilo Bodenstein’s examination of Russia in the BRICS in the chapter “Russia and Global Economic Governance” emphasizes that Russia is a founding member of the BRICS and regards the BRICS as an important group for advancing its role in global economic governance (GEG). At the same time, Russia has only a middle range position in terms of global economic power compared to China. Also, Russia’s economic ties to its fellow BRICS members, with the exception of China, are weak. Since its independence, Russia has followed a double strategy for integration in GEG. It negotiated WTO membership for 19 years before it became a member in 2012 and it tried to integrate the post-Soviet countries into a regional free trade agreement (FTA), which became effective in 2015 with the creation of the Eurasian Economic Union (EAEU). Both integration attempts, however, have had only limited success in securing a place for Russia in GEG. The economic benefits of Russia’s WTO membership are small because of its foreign trade structure, which is based on commodity exports

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that do not fall under WTO law. At the same time, it faces economic sanctions over the conflict in Ukraine. The EAEU, on the other hand, currently falls short of its expectations, as it faces commitment problems from its smaller members that are reluctant to deeply integrate with Russia. Against this background, Russia’s close cooperation with the BRICS looks as a promising alternative to find its place in GEG, but Russia needs to further improve its global and regional role in GEG. In the chapter “India and Global Governance”, Rajesh Kumar challenges conventional readings of India’s position in global governance that present it as a reactive power, one which adopted a defensive attitude on economic and political issues since independence and until the 1980s. The low levels of economic growth, as well as India’s lack of initiatives in multilateral organizations for the same period, support this view. India’s pragmatic engagement with the world began 1990s onward, with its economic liberalization. Kumar argues, however, that this could be an incorrect reading because India has behaved as a self-interested and rational actor even during this period, for which its approach has been called inward looking. This chapter assesses India’s standing in global governance, with reference to the BRICS, by showing it as an intentional actor, playing the game to its own interests. This chapter notes the inconsistency between India’s projected power ambition and its current status in global political economy, and suggests bridging the gap by augmenting its material capacity through strategic alignments. Ka Zeng analyzes the scholarship on the most prominent country in the BRICS group in “China and Global Economic Governance”. Zeng describes China’s rapid ascent in the global economy and rising influence in multilateral economic institutions. These related phenomena have given rise to an increasingly large body of literature on the country’s role in global economic governance. Zeng’s chapter engages in an extensive review of this body of literature. In addition to outlining the major themes and arguments in the debate, it identifies emerging research agendas and areas for future research. It is argued that earlier analyses of China’s role in global economic governance tend to focus on the question of whether China is operating within the parameters of the postwar institutional arrangements or whether it has sought to challenge the established standards, rules, and norms underlying these institutions. These studies try to do so by documenting the evolution of the Chinese approach over time or assessing China’s position vis-à-vis both the existing players and other emerging powers. A second strand of literature probes in greater depth the sources of Chinese behavior to address such questions as domestic influences on China’s role in the global economy, the degree to which it is being socialized into adopting global norms and

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rules, and how key features of the existing regimes in turn affect China’s integration into the liberal international economic system. There seems to be a broad consensus that Beijing has not sought nor brought about significant changes to key global norms and rules in areas such as trade and investment, even though it seems to be increasingly challenging the status quo in other issues areas such as aid and development financing. Philip Nel’s chapter, “South Africa, BRICS, and Global Governance: How SA Tried to Change the World and Succeeded in Changing Itself ” traces the remarkable shift in South Africa’s ideological profile across its initial post-apartheid years to its present role as aspiring regional power within the BRICS group of states. From 1994, the country embraced rule-based multilateralism as the preferred means of growing out of the confines imposed by apartheid while simultaneously securing its interests in a rapidly-globalizing liberal economic order. Its ambitious journey of global economic integration has taken the form of abolishing protectionism, securing IFDIs (inward foreign direct investments), signing numerous BITs (bilateral investment treaties) and joining the World Trade Organisation (WTO). This chapter outlines how South Africa — in promoting a Western liberal approach towards global governance — initially developed a role for itself as a reform-oriented middle power and bridge-builder between the established powers of the industrial North and global South. In 2010, the country was invited to join the BRIC association. As this chapter details, the country has subsequently re-oriented itself towards a more inwardlooking, “sovereignist” trajectory that prioritizes South African national interests while challenging the Western approach to economic liberalism, human rights and governance. This exclusivist pivot has also been perceived as part of a bigger strategy to secure regional power status through alignment with other BRICS members against the dominance of a liberal order. Essentially, South Africa — in setting out to change the world — ended up changing itself when it became an attractive partner to emerging powers seeking to bring forth a new form of global change. Regionalism and Foreign Aid The following sections of this volume examine issue areas of particular importance and relevance to the BRICS countries in the global economy. These next two chapters take on the issues of regionalism and foreign aid. They consider the approaches and roles of the BRICS countries in the pursuit of regional leadership in their neighborhoods as well as in other regions through foreign aid, which often serves as an important instrument of economic statecraft and development policies. In “Emerging Economies — But Regional Powers? The BRICS and Regionalism”, Tanja A. Börzel and Thomas Risse focus on the roles of the BRICS countries as

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regional leaders and their influence in the creation and development of regional institutions. They argue that while Western dominance is eroding, the BRICS countries, in spite of the increasing economic capabilities, are not stepping up to fill the void. Rather, they appear to be concentrating their efforts on building up regional leadership and focusing on regional solutions for managing interdependence, political stability, and economic growth. Börzel and Risse provide in-depth examinations of each country’s role in shaping their respective regional organizations. While the BRICS acronym may suggest a certain solidarity, their analysis indicates more divergences than convergences in the approaches and forms of BRICS’ pursuit of regional leadership. In terms of explanation, the authors find that existing theoretical frameworks in international political economy such as hegemonic stability theory and economic interdependence provide at best weak insights into the variation of the BRICS’ countries regionalism approaches. Given that BRICS countries cannot together be taken as a unitary actor, the authors call for more comparative research to examine the sources of these divergent regionalisms. “BRICS and Foreign Aid”, by Gerda Asmus, Andreas Fuchs, and Angelika Müller, provides an overview of the small but growing literature on the bilateral foreign aid activities carried out by the five BRICS countries. While these so-called emerging donors are steadily gaining prominence in international development, they are certainly not new to the field, with foreign aid programs dating back as far as the 1950s. The recent increase in both the size and scope of their development activities around the globe is regarded by some as a threat to the international aid architecture dominated by the United States and its allies in Western Europe and Japan. What do we know about the size, scope and institutional design of the BRICS countries’ aid activities? What can we learn about these donors’ aid motives by analyzing the pattern of their aid recipients and focal sectors? Does the existing qualitative and quantitative literature allow us to draw conclusions about the effects of BRICS aid on economic growth, other development outcomes, governance and conflict in recipient countries? Moreover, how will BRICS aid affect the DAC-centered international aid architecture and the way the so-called traditional donors provide aid? This chapter examines existing scholarly work to draw some tentative conclusions, and the authors emphasize the considerable variation BRICS donors show in their aid approaches. The BRICS countries rarely act as a group in international development cooperation. As in the case of regionalism examined in the previous chapter, the BRICS, though originating mostly from the developing world, also pursue divergent policies, approaches, and possibly goals in their foreign aid activities.

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Investment and Finance The four chapters of this section analyze the behaviors of the BRICS countries in the areas of investment, monetary policy, credit ratings, and international economic agreements. The chapters examine, in turn, the role of the BRICS countries in the global investment regime (Haftel), their exchange rate regimes and levels of valuation (Li), China’s CRAs as counter-hegemonic institutions on the rise (Mennillo), and BRICS countries’ behaviors in treaty-shopping across investment and trade agreements (Gray). The chapters detail commonalities and differences across the individual countries comprising the BRICS and highlight their relative importance and weight in participation and determining outcomes in these governance areas. In “BRICS and the Global Investment Regime”, Yoram Z. Haftel examines the role Brazil, Russia, India, China, and South Africa (BRICS) play in the global investment regime and the policies they espouse. What accounts for the similarities and differences across these countries with respect to their approach to international investment agreements (IIAs) and investment arbitration? What are their implications for the future of this regime? Haftel’s study addresses these questions by situating emerging market economies in the persistent North−South divide that is endemic to the global politics of foreign direct investment (FDI). Surveying the policies of the five countries since the 1980s, it shows that all were initially motivated to provide foreign investors with protection against political risk in order to attract FDI. As their own position in the global economy has changed and the rules of the regime itself have evolved, the investment policies of the BRICS countries have transformed, albeit in distinct ways. China and, to a lesser extent, Russia appear broadly content with the current state of affairs. Brazil, India, and South Africa, on the other hand, seem to object to current rules, which they view as overly protective of foreign investors at the expense of host state regulatory space. Haftel argues and shows that two factors — the amount of FDI outflows and regime type — usefully account for the observed variation across BRICS’ international investment policies, but that more research is needed to fully understand this matter. Regardless of its sources, the diversity between the BRICS countries suggests that the prospects of them shaping the rules of the global investment regime, either individually or collectively, are rather bleak. In “Exchange Rate Policies of the BRICS”, Andrew X. Li reviews the global trends in exchange rate policies in the post-Bretton Wood era as well as the exchange rate policies of the five BRICS countries. His overall argument is that the exchange rate policies of the BRICS countries have converged to greater exchange rate flexibility

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and undervaluation of currencies, which are consistent with the global trend among developing countries. Li also reviews the existing literature on the causes and consequences of exchange rate policies and picks out the explanations applicable to the BRICS countries. Further, the author proposes a few possible directions and questions for future research in response to the call to develop the “third-generation” theories of the political economy of monetary institutions. In this connection, Li suggests research questions specific to the BRICS countries and discusses how the study of the BRICS may contribute to the “third-generation” agenda. Giulia Mennillo, in “He Who Pays the Piper Calls the Tune: And the ‘Relocation of the World’s Credit Rating Center’ Goes To’?” provides a thorough overview of the politics of credit rating agencies (CRAs). Mennillo’s study does so as follows: first, an analysis of the current CRA global landscape; then, an in-depth illustration of promising CRAs by the BRICS, in particular China; and finally, a discussion on challenges facing new CRAs. Offering explanations for why one would wish to challenge the hegemon, the discussion highlights the criticisms and deficiencies observed in the current CRA landscape. Mennillo also introduces the major players amongst Chinese CRAs. The chapter provides a comprehensive discussion of the roots of the deficiencies in the global CRA framework. It analyses the likelihood of the new CRAs’ compliance with the existing framework vis-à-vis their possible attempts at challenging the status quo. Mennillo’s analysis concludes by acknowledging that a counter-hegemon is not the solution to the flaws and challenges facing global rating landscape. The chapter is especially informative as a starting point for those who wish to deepen their knowledge and understanding of the politics of CRAs for developing future research. In “Treaty Shopping and Unintended Consequences: BRICS in the International System”, Julia Gray gives an overview of the various roles that different actors — firms and governments alike — in the BRICS countries have played in the “treaty shopping” landscape. Since the end of the Cold War, many countries such as the BRICS have turned to signing a wide range of economic agreements as a signal of their commitment to be part of the international community. The resulting rule overlap between BITs and PTAs in terms of substantive issue areas (shared investment chapters, overlapping rules of origin, etc.) as well as the overlapping jurisdictions created by multiple international tribunals are empirical realities that affect emerging markets around the world. It has created the ability for firms to treaty shop among tribunals that may not span their original jurisdictions, incorporating abroad to take advantage of differing dispute-settlement provisions. Gray argues that although this does not guarantee an outcome in favor of the firm, it does create further opportunities for litigation, which can be costly and

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time-consuming for states. This reality might benefit powerful firms more than less powerful ones in terms of the overall settlement. Thus, for the BRICS countries, the theoretical and empirical phenomenon of treaty shopping creates a mixed bag in terms of outcomes. Assessing whether the BRICS have been helped or hurt by treaty shopping requires looking both at state and non-state actors. While some governments and firms have been beneficiaries of treaty shopping, others have faced losses — at times even within the same country, as the Russia example illustrates. As the international system of treaties and agreements grows increasingly tangled, it becomes difficult to offer a clear assessment as to whether countries are better off integrating fully into it or opting out of part or all of it, as some of the BRICS have done. Climate Negotiations and Energy Governance This section features two chapters on areas of international political economy of increasing importance in recent years: governance of climate change and the politics of energy markets. Michaelowa and Michaelowa examine the lack of BRICS countries’ coordination in climate change negotiations. Fumagalli’s chapter focuses on the energy policies of individual BRICS countries, leading to similar conclusions that highlight the large and significant variations in individual preferences that preclude a coordinated BRICS-level position in energy governance. In the chapter on “The BRICS in the International Climate Negotiations”, Axel and Katharina Michaelowa argue that the BRICS countries have never collaborated in international climate policy as one negotiation group, mainly due to Russia having very different interests from the other four countries. Russian greenhouse gas emissions have declined substantially over the last 30 years together with the Russian economy while those of the other BRICS have multiplied several times. They have recently surpassed those of the OECD. In 2009, Brazil, China, India, and South Africa formed the “BASIC” negotiation group in order to prevent binding emission commitments for emerging economies being defined by the Copenhagen Conference. It was very successful, sidelining the EU in the final negotiations. However, since then BASIC has become less powerful. China uses various negotiation groups to further its interests. India often makes very principled stances regarding interpretation of “equity”. Brazil and South Africa, which until 2015 were the most progressive of the BRICS, currently suffer from domestic political and economic crises and thus their role has declined. Russia has become increasingly irrelevant since taking the Kyoto Protocol “hostage” between 2001 and 2004. It is thus unlikely that BRICS will speak with one voice in future global climate negotiations. Subject-specific collaboration may develop for certain periods, but will be taken up as per each country’s interest.

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Matteo Fumagalli’s chapter on “The BRICS, Energy Security, and Global Energy Governance” identifies energy security as one of the key global challenges of the 21st century. The global economy is changing rapidly, with population and economic growth shifting towards emerging markets, especially — though not exclusively — in Asia. In turn, such shifts are engendering critical changes in the energy diplomacy and energy security strategies of new energy players. Nowhere is this more evident than in the case of the BRICS. Fumagalli’s chapter uses the politics of energy to reflect on the rise, evolving role and impact of the BRICS on global energy governance arrangements and, more generally, dynamics of energy cooperation and competition. The BRICS’ economic weight has led to demands for greater voice in the international stage. As it reviews recent shifts in the global energy markets and the BRICS’ various contributions to global energy and environmental governance, the chapter advances different propositions. First, despite progress towards the institutionalization of the group, the BRICS remain a heterogeneous collection of countries, more the sum of their parts than a new coherent bloc, despite recent efforts at institutionalizing the group, a greater scope for energy cooperation and its participation in climate change negotiations. Second, they are responding to energy transitions and climate change in different ways, in some cases embracing them, in others shying away in the name of domestic political considerations. Third, progress towards global energy governance remains patchy in light of persisting contentious issues among the BRICS themselves, and between the group and advanced industrialized countries and other countries in the global South. While the BRICS may be dissatisfied with some aspects of global governance, especially in terms of the lack of representation and “voice”, thus far they have not articulated a shared vision of what an alternative may look like. Thus far, the BRICS have found the current global energy governance arrangements preferable to revisionist courses of action. Representation, Fragmentation, and Legitimacy This volume concludes with two chapters that focus on a central issue for BRICS countries’ participation and influence in governing the international economy: representation in major international institutions. Representation, which is strongly linked to legitimacy of the major international institutions that exercise economic governance, is problematized in the context of major institutions of global economic governance. Kaya’s chapter applies a “voice” and “exit” framework to analyze the BRICS countries’ participation in the IMF and the World Bank, and Parízek and Stephen look additionally to the WTO and the G7−G20 to draw out

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the consequences of contentious representation in these institutions. Together, they provide important insights especially into the motivations for forming new and alternative institutions, such as the Asian Infrastructure Investment Bank (AIIB) and the New Development Bank (NDB). “BRICS and the International Financial Institutions: Voice and Exit”, by Ayse Kaya analyzes the BRICS’ relations with the two international financial institutions (IFIs) with near-universal membership, the International Monetary Fund (IMF) and the World Bank. The chapter, following not just the literature on this topic but also the way actual events unfolded, examines BRICS’ “voice”, i.e., expressions of discontent with and efforts to reform the IFIs, and creation of pathways to “exit”, i.e. the beginnings of BRICS-led financial institutions, specifically the AIIB, the NDB, and the Contingent Reserve Arrangement. The chapter argues that explanations that draw in a detailed manner from specific institutional features and policies do a better of job of accounting for both partial successes with voice and what the new institutions mean for the postwar multilateral order. The chapter also charts possibilities for refining future research on this topic. In “The Representation of BRICS in Global Economic Governance: Reform and Fragmentation of Multilateral Institutions”, Michal Parízek and Matthew D. Stephen problematize the issue of representation of BRICS in Global Economic Governance (GEG) and the institutional consequences of their attempts to redress their underrepresentation in multilateral institutions. The authors start from the observation, shared by major International Relations theories, that multilateral institutions need to adequately represent all the important powers in the international system if they are to remain stable, effective, and legitimate. Parízek and Stephen discuss representation conflicts between BRICS and the established powers in four major GEG institutions: the G7−G20, the WTO, the International Monetary Fund, and the World Bank. For each case they identify the nature of the representation conflict and discuss the institutional outcomes of the conflict in terms of: (1) adjusting representation itself, (2) the impact on policy output, and (3) the emergence (or not) of institutional fragmentation. While in the G7−G20 case the authors observe a relatively successful case of increased BRICS representation and of rapid institutional adjustment, in the WTO case, the increased representation of BRICS is accompanied by policy deadlock and fragmentation. By contrast, the International Monetary Fund and the World Bank have responded to representation conflicts mostly cosmetically, leading to institutional fragmentation trends. The chapter argues that major GEG institutions face a double challenge in relation to the BRICS: they need both to accord new power through increased representation and to maintain policy performance. When institutions fail on either of these conditions, they open the doors to institutional fragmentation.

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References Bertazzo, J. (2012). “Brazilian security and defence policy under President Dilma Rousseff: Transition and initial challenges”, Critical Sociology, 38(6): 809–821. Chari, M. D. R. and P. David (2012). “Sustaining superior performance in an emerging economy: An empirical test in the Indian context”, Strategic Management Journal, 33(2): 217–229. Choi, S. K. and C. Williams (2013). “Innovation and firm performance in Korea and China: A cross-context test of mainstream theories”, Technology Analysis & Strategic Management, 25(4): 423–444. Chu, Y. H., L. Kang, and M. H. Huang (2015). “How East Asians view the rise of China”, Journal of Contemporary China, 24(93): 398–420. Cornelissen, S. (2009). “Awkward embraces: Emerging and established powers and the shifting fortunes of Africa’s International Relations in the twenty-first century”, Politikon, 36(1): 5–26. Cuadro-Sáez, L., M. Fratzscher, and C. Thimann (2009). “The transmission of emerging market shocks to global equity markets”, Journal of Empirical Finance, 16(1): 2–17. Danis, W. M., D. De Clercq, and O. Petricevic (2011). “Are social networks more important for new business activity in emerging than developed economies? An empirical extension”, International Business Review, 20(4): 394–408. Dauvergne, P. and D. B. L. Farias (2012). “The rise of Brazil as a global development power”, Third World Quarterly, 33(5): 903–917. Durotoye, A. (2014). “The MINT countries as emerging economic power bloc: Prospects and challenges”, Developing Country Studies, 4(15): 99–107. Erthal Abdenur, A. (2014). “Emerging powers as normative agents: Brazil and China within the UN development system”, Third World Quarterly, 35(10): 1876–1893. Etzioni, A. (2011). “China: Making an adversary”, International Politics, 48(6): 647–666. Florini, A. (2011). “Rising Asian powers and changing global governance”, International Studies Review, 13(1): 24–33. Fontaine, R. and D. M. Kliman (2013). “International order and global swing states”, The Washington Quarterly, 36(1): 93–109. Foot, R. (2014). “Constraints on conflict in the Asia-Pacific: Balancing ‘the War Ledger’”, Political Science, 66(2): 119–142. Frankel, J. and J. Poonawala (2010). “The forward market in emerging currencies: Less biased than in major currencies”, Journal of International Money and Finance, 29(3): 585–598. Freeman, S., L. J. Daniel, and W. Murad (2012). “Knowledge and network development for service firm entry into emerging Asian markets”, Asian Business & Management, 11(1): 101–122. Gimet, C. (2011). “The vulnerability of Asean+3 countries to international financial crises”, Review of International Economics, 19(5): 894–908. Goldman Sachs (2007). “Study of N11 nations”, Global Economics Paper, 153. Hart, A. F. and B. D. Jones (2010). “How do rising powers rise?”, Survival, 52(6): 63–88.

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He, K. and H. Feng (2012). “Debating China’s assertiveness: Taking China’s power and interests seriously”, International Politics, 49(5): 633–644. Hopewell, K. (2015). “Different paths to power: The rise of Brazil, India and China at the World Trade Organization”, Review of International Political Economy, 22(2): 311–338. Hoskisson, R. E., L. Eden, C. M. Lau, and M. Wright (2010). “Strategy in emerging economies”, Academy of Management Journal, 43(3): 249–267. Hoskisson, R. E., M. Wright, I. Filatotchev, and M. W. Peng (2013). “Emerging multinationals from mid-range economies: The influence of institutions and factor markets”, Journal of Management Studies, 50(7): 1295–1321. Hurrell, A. (2000). “Some reflections on the role of intermediate powers in international institutions, Paths to Power — Foreign Policy Strategies of Intermediate States”, Working Paper No. 244, Washington, D.C.: Woodrow Wilson International Centre: 23–41. Hurrell, A. and S. Sengupta (2012). “Emerging powers, North–South relations and global climate politics”, International Affairs, 88(3): 463–484. International Monetary Fund (2006). Glossary of Selected Financial Terms. International Monetary Fund (2015). World Economic Outlook. http://www.imf.org/ external/pubs/ft/weo/2015/01/ (accessed on 31 December 2017). Johnston, A. I. (2007). Social States: China in International Institutions, 1980–2000, Princeton: Princeton University Press. Johnston, A. I. (2001). “Treating international institutions as social environments”, International Studies Quarterly, 45(4): 487–515. Kahler, M. (2013). “Rising powers and global governance: Negotiating change in a resilient status quo”, International Affairs, 89(3): 711–729. Kastner, S. L. and P. C. Saunders (2012). “Is China a status quo or revisionist state? Leadership travel as an empirical indicator of foreign policy priorities”, International Studies Quarterly, 56(1): 163–177. Kenkel, K. M. (2010). “South America’s emerging power: Brazil as peacekeeper”, International Peacekeeping, 17(5): 644–661. Lebow, R. N. (2010). “The past and future of war”, International Relations, 24(3): 243–270. Lieber, R. J. (2014). “The rise of the BRICS and American primacy”, International Politics, 51(2): 137–154. Medcalf, R. (2012). “Unselfish giants? Understanding China and India as security providers”, Australian Journal of International Affairs, 66(5): 554–566. Mielniczuk, F. (2013). “BRICS in the contemporary world: Changing identities, converging interests”, Third World Quarterly, 34(6): 1075–1090. Mittelman, J. H. (2013). “Global bricolage: Emerging market powers and polycentric g­ overnance”, Third World Quarterly, 34(1): 23–37. Narlikar, A. (2010). New Powers: How to Become One and How to Manage Them, London: Hurst. Narlikar, A. (2013). “India rising: Responsible to whom?”, International Affairs, 89(3): 595–614. Nau, H. and D. Ollapally (2012). Worldviews of Aspiring Powers: Domestic Foreign Policy Debates in China, India, Iran, Japan, and Russia, New York: Oxford University Press.

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North, D. C., J. J. Wallis, and B. R. Weingast (2006). “A conceptual framework for interpreting recorded human history”, Working Paper 12795, NBER Working Paper Series. O’Neill, J. (2001). “How solid are the BRICs?”, Goldman Sachs Global Economics Paper 134. O’Neill, J. (2001). “Building better global economic BRICs”, Goldman Sachs Global Economics Paper 66. Pant, H. V. (2013). “The BRICS fallacy”, The Washington Quarterly, 36(3): 91–105. Rocha, M. and J. L. Oreiro (2013). “Capital accumulation, external indebtedness, and macroeconomic performance of emerging countries”, Journal of Post Keynesian Economics, 35(4): 599–620. Schweller, R. L. and X. Pu (2011). “After unipolarity: China’s visions of international order in an era of US decline”, International Security, 36(1): 41–72. Siddiqui, J. (2010). “Development of corporate governance regulations: The case of an emerging economy”, Journal of Business Ethics, 91(2): 253–274. Stewart, P. (2010). “Irresponsible stakeholders? The difficulty of integrating rising powers”, Foreign Affairs, 44–53. Stuenkel, O. (2013). “The financial crisis, contested legitimacy, and the genesis of intra-BRICS cooperation”, Global governance, 19(4): 611–630. Subacchi, P. (2008). “New power centres and new power brokers: Are they shaping a new economic order?”, International Affairs, 84(3): 485–498. Zakaria, F. (2011). The Post-American World: And the Rise of the Rest, New York: Penguin Books Limited. Zashev, P. and S. Ehrstedt (2010). “The first mover in new emerging markets: Balancing risks versus opportunities in the case of Belarus”, Journal of East-West Business, 16(3): 201–230.

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PART I

Understanding the BRICS Phenomenon

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CHAPTER 1

Brazil as a BRICS Country Cristiane Lucena Carneiro International Relations Institute, University of Sao Paulo, Brazil

Introduction When the term BRICs was coined, Brazil, Russia, India and China could arguably qualify as four countries that were on a path toward a critical transition that would ultimately transform these societies from limited-access orders into open-access orders.1 Open-access is a ubiquitous feature of what Douglas North and collaborators have coined social development (North et al., 2006). Fifteen years later, scholars argue that Brazil has embarked on this path toward a critical transition. The analysis claims that since the year 1994 “Brazil has been on a relatively virtuous path of economic and political development” (Alston et al., 2016: 20). Aside from the question as to how the other three countries evolved during these 15 years, a topic addressed by chapters in this volume, this chapter suggests that international trade institutions played a prominent role in the Brazilian case.2 The chapter proceeds to seize this relationship, with an emphasis on the WTO. Unlike South African latecomer membership in the BRICS group, Brazil was an original and important piece of the BRICs’ quadrangle. The sheer size of its  The term BRICs refers to the four original members (O’Neill, 2001). South Africa joined the BRICs in December 2010 although its membership was formally confirmed only at the third BRICS Summit in April 2011. 2  Another reason for limiting the analysis to Brazil is the fact that Russia and China joined the GATT/WTO system much later in time, in 2012 and 2001, respectively. 1

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population and economy guaranteed Brazil a place in any “club” organized along such cleavages as “emerging powers”,3 “rising powers”,4 or “middle powers”.5 Unlike the other three BRIC’s founding members — Russia, China, and India — Brazil is not a military power and privileges diplomatic over coercive means to achieve its foreign policy goals (Dauvergne and Farias, 2012).6 This singular characteristic would place Brazil in a special position with respect to the international development agenda. To that effect, Brazilian foreign policy has become increasingly assertive, not least but in the areas of global health promotion, South−South cooperation, and renewable energy (Dauvergne and Farias, 2012). Foreign policy scholars suggest that Brazil’s longstanding tradition of non-intervention and support for the peaceful resolution of international conflicts is behind Brazil’s successful initiatives vis-à-vis international development (Sotero, 2010; Cervo, 2010). Another area of influence that has attracted attention by scholars and policymakers is democracy promotion. Here, Brazil’s unique position stands out again amongst the other BRICs countries. For one, together with India, Brazil constitutes the “democratic half ” of the BRICs club. But unlike India, Brazil has embraced a more assertive role toward the promotion of democracy — most notably in Latin America (Stuenkel, 2013). The Brazilian role is particularly important nowadays because traditional actors in the realm of international democracy promotion efforts, such as the UK and the US, have given signs that they will fold toward a more inwardlooking agenda.7 Moreover, Brazil enjoys a privileged position to engage with other countries when it comes to promoting democracy. As a middle power, Brazil shares historical trajectories and contemporary challenges with other developing countries, which facilitates a constructive dialogue. On the other hand, Brazil has elected not to attach conditionality to its democracy promotion initiatives — in juxtaposition to American and European practices. For this reason, Brazilian efforts in this arena are often perceived as more legitimate and expected to yield better results  The terms “emerging powers” is frequently used by Andrew Hurrell, who sees these countries as essential for a thorough understanding of the global order in the 21st century (Hurrell, 2000). 4  Stuenkel privileges the term “rising powers” in his analysis of the role of Brazil and India in the promotion of democracy (Stuenkel, 2013). 5  The term “middle power” has a deep historic aspect, as it was first used in the mid-20th century (Dauvergne and Farias, 2012). 6  For more on the economic and social characteristics of Brazil and how they compare to the other BRICs countries see Armijo and Burges (2009). 7  To this effect, the decision of the UK to leave the European Union and the election of Donald Trump for the US Presidency are seen as evidence of this “pull-back” phenomenon. 3

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(Stuenkel, 2013). Along the same lines, scholars suggest that “being democratic helps inspire trust” (Armijo and Burges, 2009). It is in this capacity — as a democratic, non-interventionist, middle power — that Brazil engages with the international community. Brazil’s foreign policy agenda has yielded concrete results in the areas of South−South cooperation, public health, renewable energy, and democracy promotion. Underlying these efforts is a proactive international trade agenda. The remaining sections of this chapter will chronicle the Brazilian trajectory with respect to international trade, with an emphasis on Brazil and the World Trade Organization (WTO). Section two analyzes the growing importance of international trade for the Brazilian economy and elaborates on the role of international trade to boost the standing of Brazilian Presidents domestically. To that end, the analysis concentrates on the years 1995−2015, capturing the creation of the WTO and the outcome of 10 years of democracy in Brazil.8

Brazil and the WTO The Role of International Trade in the Brazilian Path toward a “Critical Transition” (1995−2015) International trade grew consistently, as a percentage of GDP, during the years after the entry into force of the WTO agreements (Figure 1). The growing relevance of international trade for the Brazilian economy can be explained, in part, by the availability of strong third-party enforcement through the Dispute Settlement Mechanism (DSM). The security of contracts rose and the risk of doing business with Brazil declined, because of the shadow of law associated with the WTO. It is also a fact that the high price of commodities, together with favorable exchange rate terms, played a key role in the international trade boom (Campello, 2015); nevertheless, I argue this effect would have been less expressive in the absence of WTO third party enforcement. Aside from the sheer economic benefits associated with the rise in international trade and its consequences for development, third-party enforcement also provided novel strategic tools for Brazilian trade diplomats. Thus, it comes as no surprise that Brazil features in the first case brought to the new DSM, a dispute challenging the legality of US import restrictions on gasoline.9

 1985 marks the Brazilian transition to democracy, with the first democratic elections for Congress in 20 years. Subsequently, a new Constitution was enacted in 1988, when free and fair elections for the President were held. 9  United States — Standards for Reformulated and Conventional Gasoline” (WT/DS2/AB/R). 8

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Figure 1:   International trade as a percentage of GDP (Brazil, 1995−2015). Source: World Bank (2016).

Brazil would use its expertise in international trade to head litigation efforts in the WTO with significant consequences for other developing countries. The sugar and cotton cases illustrate this strategy, once again.10 The sugar case against the EU and the cotton case against the US, both challenged the government subsidies offered to domestic cotton producers, in the US, and sugar producers, within former European colonies. Brazil argued that these subsidies violated GATT’s most favored nation clause and other WTO agreements, and could not be justified under GATT/ WTO exceptions. A number of other sugar and cotton producing countries had a direct interest in the outcome of this dispute, mostly developing countries, for whom these commodities accounted for an important share of international trade. Some of these countries joined the dispute as “third participants”, a status that — under the WTO regulations, grants the third participant the prerogative to take part in the proceedings and to submit its views on the dispute. The approximation with developing countries and the coordination efforts to pursue litigation in the WTO has helped to consolidate the Brazilian status as a tenured member of the BRICS club. Brazilian leadership was much more visible and prominent than one could make the case with respect to the other BRICS countries. The belief that Brazil had emerged to become the “southern hegemon” began to take root within international policy circles, what helped build the path toward a “critical  European Communities-Export Subsidies on Sugar WT/DS266/36, 9 June 2006 and United States-Subsidies on Upland Cotton WT/DS267/46, 2 June 2008. 10

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transition”. In addition, the imagery of Brazil as a “southern hegemon” also hardened within the Brazilian dominant networks.11 Beliefs held by the Brazilian dominant network had changed in fundamental ways between 1964 and 2014. The preference for developmentalism that marked the dictatorship years, evolved toward beliefs in social inclusion. The triggering mechanism for this first shift in beliefs was the democratization process, starting in 1985. One decade later, in 1994, there was a window of opportunity that led to yet another shift in beliefs. This time the dominant network’s beliefs centered around fiscally sustainable social inclusion (Alston et al., 2016). This chapter argues that beliefs at the international level also shifted. The Brazilian dominant network called for itself the new role of “southern hegemon”, and the WTO played a key part in the development of this new set of beliefs. In many ways, the growing importance of international trade for the Brazilian economy paved the way for the influential role of the WTO from 1995 onward. The notion of the WTO as a third party enforcer was key to this development, as argued above, but the Brazilian presence was in many ways singled out. Two characteristics ­distinguish the Brazilian presence in the WTO: (a) the broad spectrum of participation, going beyond the DSM itself to engage in other forms of participation which was labeled “assertiveness” elsewhere (Carneiro et al., 2016); and (b) the timid presence of Brazil with respect to regional trade agreements (RTAs) and preferential trade agreements (PTAs), henceforth referred to as PTAs. The paper elaborates on these two characteristics, which consistently marked the relationship between Brazil and the WTO between 1995 and 2015. I argue they constitute evidence of a new set of beliefs, within the Brazilian trade diplomacy, that crystallized the importance of the WTO for the Brazilian path towards a “critical transition”. Brazilian Assertiveness in the WTO The paper distinguishes between assertiveness and participation in the multilateral trade system. There is a large scholarship on participation in the Dispute Settlement Mechanism, but not much has been written on assertiveness. Our focus on assertiveness accounts for participation by states in the DSM, but it goes beyond that in order to account for state action that provokes the system but does not amount to disputatious behavior. One of the reasons for incorporating instances of assertive  Beliefs are central to the theoretical framework presented in Alston et al. (2016): “We label the set of perceived impacts of formal laws (a subset of institutions) on outcomes as core beliefs. The beliefs about how the world works guide the choices of the dominant network over which institutions to put in place to most likely get their desired outcomes (2016: 25).”

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behavior that are non-disputatious in nature is the fact that the states often face a trade-off between the costs associated with adjudication in the WTO and the likelihood of securing a favorable outcome. When the costs outweigh the benefits, we may still observe assertive behavior at the committee level, wherein states become more vocal within WTO committees (with an emphasis to the Committee on Sanitary and Phytosanitary Measures, SPS Committee, and to the Committee on Technical Barriers to Trade, TBT Committee), in spite of the absence of litigation. There is little to no scholarship on the notion of assertiveness. On the other hand, the literature on state participation in the WTO is prolific. This literature is dominated by large-N studies that uncovered challenging paradoxes and recurrent dynamics. There is a traditional view expressed in the literature that concentrates on international mechanisms and focuses on explaining state behavior as a consequence of power and economic dynamics. Early work by Horn et al. (1999) analyzes the rationale associated with disputatious behavior in the WTO. They observe that states with a diverse export sector and higher per capita GDP bring more disputes to the system. Recent work by Davis and Bermeo (2009) addresses a similar question, and concludes that the WTO remains heavily influenced by power asymmetries. This article also finds that the lack of legal capacity, as well as past experience with WTO disputes, constitutes one of the most important impediments for developing country participation in the DSM. Guzman and Simmons (2005) operationalize a power hypothesis and a capacity hypothesis, and conclude that low-income states tend to file against high-income states because there is more at stake in these disputes, as opposed to disputes between developing countries. Legal capacity is also at the center of research by Busch, Reinhardt and Shaffer (2009), which makes significant progress when it comes to measuring legal capacity. The authors present evidence from surveys, which reveal that developing countries fail to file complaints due to their lack of legal capacity in 67% of the cases covered by their study. Overall, developing countries have not secured better concessions under the WTO system, when compared to the GATT years (Reinhardt and Busch, 2003), and this is no less true for the case of Brazil. A subset of the scholarship on participation analyzes the impact that the institutional changes enacted in 1995, with the creation of the WTO, has had on participation — especially participation by developing countries. Brazil had an active voice during the Uruguay Round which culminated with the WTO framework. This presence sought to advance developing countries’ interests, with an emphasis on leveling the dispute settlement playing field. But these expectations were not fulfilled and international economic law scholars seem to agree that the new system has not substantively improved the position of developing countries vis-à-vis the resolution of trade disputes in the WTO. To that effect, work by Reinhardt and

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Busch (2003) compare the level of concessions to developing countries under the WTO, in contrast to those granted under the GATT. They conclude that because the WTO system is somewhat more averse to settlement during the consultations stage, and because developing countries are less apt to strike favorable compromises before a panel is established, these countries fail to secure more concessions in the new system. Earlier work by the same authors had already analyzed the consequences of increased legalism for bargaining (Reinhardt and Busch, 2003). This article discounts the implications of the major institutional reform of 1995 (and before that, the one of 1989), to report that the record of early settlement and the patterns of compliance did not change during the early WTO years, if compared to GATT’s record. This is important for developing countries, because of the power disparity and its consequences during the negotiation of a settlement. The analysis covers the period 1948−1999 and reveals that throughout this time, democracies remained less likely to comply with an adverse ruling.12 Brazil experienced first-hand these scholarly predictions. In both the sugar and cotton disputes, the Appellate Body’s decision acknowledged the majority of the claims advanced by Brazil, as a complainant, but compliance was delayed.13 On balance, the revised dispute settlement procedures that entered into force with the WTO have not substantively altered the set of ­incentives states confront; as a result, states disputatious behavior remained similar to the record during the GATT years and Brazil continued to encounter some of the same hurdles to advance its international trade agenda. This literature has exhaustively discussed the role of power and the impact of economic characteristics on states’ propensity to bring disputes to the WTO — or participation. A segment of this literature has also investigated whether the institutional context that emerged with the creation of the WTO has had any noticeable impact on patterns identified during the GATT years. The expectation that the WTO would have increased participation by developing countries in the dispute settlement mechanism was not borne by the data; similarly, the hopes that a legalized DSM would have translated into more favorable concessions to  Alter (2003) expresses a critical view of the same institutional reforms, and presents e­ vidence of the new system’s inability to resolve disputes with examples of protracted cases, such as the Beef Hormones and the Bananas disputes. 13  In the cotton subsidies case, against the US, Brazil had to file an Article 21.5 compliance procedure and receive authorization to retaliate, before the parties reached a mutually agreed solution, which happened only in 2014, 9 years after the final decision was circulated. In the cotton subsidies case, against the EU, Brazil filed an Article 21.3(b) compliance procedure, because the parties could not agree on the reasonable period of time for implementation of the Appellate Body ruling by the EU. 12

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developing countries did not materialize. Developing countries’ disappointment vis-à-vis the new system created a window of opportunity for Brazil’s greater role, as a “southern hegemon”. Given Brazil’s non-interventionist tradition and its preference for multilateral engagement, it was only natural that Brazilian foreign policymakers would seize the WTO stage to promote a greater role for Brazil, as a developing country. One observable trend in this respect is the level of Brazilian assertiveness in the system, as measured by the total number of requests for consultations, quasiadjudicatory measures (requests for panels, appeals, compliance procedures), and specific trade concerns (notifications within the SPS and TBT committees),14 as well as trade defense measures initiated by Brazil between 1995 and 2015. Assertiveness — in contrast to participation — has a proactive and a defensive aspect. For this reason, this chapter proposes two separate measures of assertiveness, in order to better sort out offensive vs. defensive measures. Thus, Assertiveness 1 = total number of requests for consultations, requests for panels, appeals, compliance procedures, notifications within the SPS and TBT committees; Assertiveness 2 = total number of anti-dumping, subsidies, safeguards and countervailing measure notifications.15 Figures 2 and 3 show the trend in assertive behavior for Brazil, India, and South Africa, the last two being the only other BRICS countries that are original WTO members. The Brazilian presence in the WTO, as expressed by the dotted lines for Assertiveness 1 and 2, grows even if unevenly along time. This growing presence constitutes evidence of the new role embraced by Brazil as a ‘southern hegemon. It is noteworthy how Brazilian assertiveness differs from India’s. Brazil is much more active in the DSM and at the committee level — the so called more offensive pattern of behavior (Assertiveness 1). India, on the other hand, has focused its efforts on defensive measures, such as safeguards, countervailing duties, and antidumping (Assertiveness 2). An offensive presence, or what we call Assertiveness 1,  Committee on Sanitary and Phytosanitary Measures and Committee on Technical Barriers to Trade. 15  Data comes from the WTO website and consists of a simple count of instances when a country presented requests for consultations, requests for panels, appeals, compliance procedures, and notifications within the SPS and TBT committees. These episodes are weighed equally and make up the measure of Assertiveness 1. Assertiveness 2 is the total sum of anti-dumping, subsidies, safeguards and countervailing measures notified to the WTO by the country who imposed these measures. The database is a panel that gathers country-year observations for every WTO member for the period 1995−2015. 14

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Assertiveness

14 12 10 8 6 4 2 0 1995

2000

2005 Year

Brazil

India

2010

2015

South Africa

Figure 2:   Assertiveness 1, Brazil, India, and South Africa (1995−2015). Source: Carneiro et al. (2016).

70 Assertiveness

60 50 40 30 20 10 0 1995

2000 Brazil

2005 Year India

2010

2015

South Africa

Figure 3:   Assertiveness 2, Brazil, India, and South Africa (1995−2015). Source: Carneiro et al. (2016).

is arguably more costly, both in terms of legal capacity as well as reputation. It is important to emphasize that Brazil is much more assertive than India when we look at Assertiveness 1 (Figure 2). This is mostly the result of Brazil’s massive recourse to the SPS and TBT committees, through the use of notifications. Conversely, with respect to trade defense measures, the Indian assertiveness is higher. Arguably, activism via trade defense measures is less confrontational (litigious) than requests for consultations, quasi-adjudicatory measures, and SPS/TBT committee notifications. This pattern of behavior by India could suggest a less aggressive engagement at the WTO, implicating lower reputational costs and fewer demands when it comes to technical capacity.

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Brazil’s Strong Preference for Multilateralism In order to fully capture the way Brazil has engaged with the WTO during the period under study, one needs to take note of the fact that Brazil has not fully embarked on the wave of PTAs that have been negotiated ubiquitously. PTAs are arguably at odds with the goal of equal treatment and most favored nation status encapsulated by the GATT/WTO agreements. Scholars have gone as far as to suggest that the new generation of PTAs that regulate nontariff barriers are in direct conflict with the GATT/WTO agreements — a view supported by a creative reading of the Appellate Body jurisprudence (Howse, 2015). Regardless of the legal standing of this widespread practice, for the purposes of the argument advanced in this chapter, Brazil has chosen to engage very selectively with the PTA bandwagon. The small number of PTAs notified to the WTO offers compelling evidence of this pattern. As Table 1 demonstrates, since the creation of the WTO in 1995 Brazil has entered into three PTAs. These were negotiated with trade partners that do not account for a significant share of Brazilian exports and who are peripheral for Brazil, as far as its regional influence is considered: Kazakhstan, Russia, and Turkey. Moreover, these agreements are embedded in a Generalized System of Preferences model, targeting developing countries; they do not carry enough specificity to impact terms of trade in any significant way. The picture with respect to RTAs is not much different. There are only three RTAs negotiated under the auspices of Mercosur — the RTA that was originally signed by Brazil, Argentina, Paraguay and Uruguay, in 1991, and later joined by Venezuela. Since its entry into force, Mercosur has had exclusive competence with respect to the negotiation and Table 1:   PTAs and RTAs to which Brazil is a member. Entry into Force

RTA Provider

Australia

PTA Provider

1/1/1974

Argentina – Brazil

Trade Partner

Entry into Force 1/1/2016

Japan

8/1/1971

Brazil – Uruguay

Kazakhstan

1/1/2010

MERCOSUR

India

(not in force) 1/6/2009

New Zealand

1/1/1972

MERCOSUR

Chile

10/3/2017

Norway

10/1/1971

MERCOSUR

Mexico

28/12/2016

Russia

1/1/2010

Switzerland

3/1/1972

Turkey

1/1/2002

United States

1/1/1976

Source: WTO (2017).

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signature of RTAs that involve any of its members. Therefore, with the exception of these three RTAs to which Mercosur is a member, Brazil has entered into only another two agreements — this time with other Mercosur country members: Argentina and Uruguay. In the case of the Brazil−Uruguay RTA, the agreement has not entered into force yet. Overall, Brazilian involvement with PTA/RTAs is very timid. This choice has obvious adverse consequences for the Brazilian economy (Thorstensen and Ferraz, 2014); I argue that there is a rationale for the Brazilian behavior, and it reflects preferences for a multilateralism that would grant Brazil the sought-after role of a “southern hegemon”. Aside from this untapped conjecture, the negotiation of PTAs has been the subject of a prolific scholarship. To fully understand the rationale and consequences of the Brazilian absenteeism, one needs to grasp PTAs in a more direct way. Scholars have seized the problematic relationship between the proliferation of PTAs and states’ behavior in the WTO head on. An initial effort to map PTAs negotiated by the EU and the US (Horn et al., 2010) was followed by a more direct analysis of the impact of PTA negotiation by the two major trading partners and the record of WTO disputes between each and their respective PTA partners (Mavroidis and Sapir, 2015). The authors conclude that the negotiation of PTAs after the creation of the WTO in 1995 has markedly reduced the number of disputes amongst countries that belong to the same trade agreement. The authors foresee several reasons to account for this phenomenon. Regardless of the rationale for the observed reduction in disputatious behavior in the aftermath of PTA negotiation, which Mavroidis and Sapir do not explore in their 2015 article, this empirical finding raises concerns for the WTO and for weaker parties — both within and outside PTAs (Mavroidis and Sapir, 2015: 361). Those that are PTA members will not benefit from the levelplaying-field structure that the WTO offers; those outside PTAs are still subject to the residual litigious initiatives by their trade partners. The PTA phenomenon has arguably set the stage for a greater role by Brazil, as a “regional hegemon”. The higher the density of PTAs, the greater the window of opportunity available for Brazil. The PTA bandwagon, together with the pattern of Brazilian assertiveness in the WTO, are two observable indicators of a new set of beliefs. These beliefs played an important role in consolidating the Brazilian path toward a “critical transition”. Aside from the empirical evidence presented here, which documents Brazilian assertiveness in the WTO together with the country’s skepticism towards PTAs, there are other noteworthy phenomena. Brazilian active role in the Doha Round as well as the increased presence of Brazilian public officials in the WTO cadres are two such instances. A rigorous investigation of these two phenomena is beyond the scope of this chapter, but future research could explore the role of Brazilian trade diplomats

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and scholars at large in the wheels that helped solidify the new set of beliefs within the dominant network. Along the same lines, the Brazilian government strategy and discourse during Doha has been consistent with this new set of beliefs — most importantly, with the notion of a lasting role for Brazil as a “southern hegemon”.

Concluding Remarks This chapter chronicles the evolution of Brazil, as a member of the BRICS club, between the creation of the WTO in 1995 until recently. The Brazilian position as a “southern hegemon” was consolidated during this time frame, mostly as a direct result of the country’s engagement with international trade. The chapter analyzes two aspects of this engagement, which follow from the growing importance of international trade per se for the Brazilian economy. First, the chapter takes notice of the strategies that Brazil has mobilized in the WTO, with an emphasis to Brazil’s presence in the Dispute Settlement System as well as its less studied efforts with respect to trade defense measures and committee behavior. Second, the chapter discusses Brazil’s skepticism toward and timid record of membership in PTAs. These two aspects of Brazilian engagement with the WTO arguably constitute a conscious effort to promote multilateralism, privileging non-interventionist and unconditional patterns of engagement — which are hallmarks of Brazilian foreign policy. The Brazilian pursuit of a greater role amongst countries in the South involved initiatives at the global level going beyond international trade per se, such as the ones in the realm of public health, renewable energy, South−South cooperation, and democracy promotion. This chapter engages with the literature on these initiatives to establish their importance in enabling Brazilian strategies within the multilateral trade regime. In the end, these four areas of international politics — coupled with Brazilian greater presence at the WTO, set the stage for a new relationship between Brazil and other developing countries. This relationship was key to Brazil coming full circle onto a path towards social development. The chapter singles out the Brazilian pattern of engagement with the WTO in even more assertive ways. The analysis of Brazilian assertiveness in the WTO includes a quantitative overview of nine indicators; it lends support to the conjecture of a greater presence. This presence is complemented by the prominence of international trade in the Brazilian economy, wherein significant externalities occur that play an important role in the Brazilian path toward a “critical transition”. Here, the chapter relies on the contribution of Alston et al. (2016), where the authors argue and demonstrate that Brazil has embarked on a sustainable path toward a “critical transition”. The road toward development presupposes substantive changes in beliefs held by the “dominant network”, or “elites”, to use the terminology in North et al.

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(2006). The argument advanced in this chapter suggests that international trade has played an important role in this process, between 1995 and 2015. In particular, the Brazilian decision to stay outside of the ubiquitous wave of PTAs reinforced the country’s preference for multilateralism. Along the same lines, Brazilian leadership during the Doha Round as well as the role of Brazilian public officials in the WTO, are consistent with the Brazilian pattern of engagement and invite a detailed analysis. These processes have played an important role in the Brazilian path toward a “critical transition”.

References Acemoglu, D. and J. A. Robinson (2005). Economic Origins of Dictatorship and Democracy, Cambridge, UK: Cambridge University Press. Alston, L. J., M. A. Melo, B. Mueller, and C. Pereira (2016). Brazil in Transition: Beliefs, Leadership, and Institutional Change, Princeton: Princeton University Press. Alter, K. J. and S. Meunier (2009). “The politics of international regime complexity”, Perspectives on Politics, 7(1): 13–24. Alter, K. J. (2003). “Resolving or exacerbating disputes? The WTO’s new dispute resolution system”, International Affairs, 79(4): 783–800. Armijo, L. E. and S. W. Burges (2009). “Brazil, the entrepreneurial and democratic BRIC”, Polity, 42(1): 14–37. Busch, M. L., E. Reinhardt, and G. Shaffer (2009). “Does legal capacity matter? A survey of WTO Members”, World Trade Review, 8(4): 559–577. Campello, D. (2015). The Politics of Market Discipline in Latin America: Globalization and Democracy, Cambridge, UK: Cambridge University Press. Carneiro, C., T. Nogueira, and F. Rezende (2016). Emerging Democracies and Assertiveness in the WTO — 1995 to 2015. Paper presented at the Annual Meeting of The American Political Science Association. Cervo, A. L. (2010). “Brazil’s rise on the international scene: Brazil and the World”, Brazilian Review of International Politics, 53: 7–32. Dauvergne, P. and D. BL Farias (2012). “The rise of Brazil as a global development power”, Third World Quarterly, 33(5): 903–917. Davis, C. L. (2009). “Overlapping institutions in trade policy”, Perspectives on Politics, 7(1): 25–31. Davis, C. L. and S. B. Bermeo (2009). “Who files? Developing country participation in GATT/ WTO adjudication”, The Journal of Politics, 71(3): 1033–1049. Greif, A. (2006). Institutions and the Path to the Modern Economy: Lessons from Medieval Trade, Cambridge, UK: Cambridge University Press. Guzman, A. T. and B. A. Simmons (2005). “Power plays and capacity constraints: The ­selection of defendants in World Trade Organization disputes”, The Journal of Legal Studies, 34(2): 557–598.

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Horn, H., P. C. Mavroidis, and A. Sapir (2010). “Beyond the WTO? An anatomy of EU and US preferential trade agreements”, The World Economy, 33(11): 1565–1588. Horn, H., P. C. Mavroidis, and H. Nordström (1999). Is the use of the WTO dispute settlement system biased? Paper No. 2340, CEPR Discussion Papers. Howse, R. (2015). “Regulatory cooperation, regional trade agreements, and world trade law: Conflict or complementarity?”, Law and Contemporary Problems, 78(4): 137–151. Hurrell, A. (2000). “Some reflections on the role of intermediate powers in international institutions”, Working Paper No. 244: Paths to Power — Foreign Policy Strategies of Intermediate States, Washington, D.C.: Woodrow Wilson International Centre, pp. 23–41. Mavroidis, P. C. and A. Sapir (2015). “Dial PTAs for peace. The influence of preferential trade agreements on litigation between trading partners”, Journal of World Trade, 49(3): 351–372. Narlikar, A. and D. Tussie (2004). “The G20 at the Cancun Ministerial: Developing countries and their evolving coalitions in the WTO”, The World Economy, 27(7): 947–966. North, D. C., J. J. Wallis, and B. R. Weingast (2006). “A conceptual framework for interpreting recorded human history”, Working Paper 12795, NBER Working Paper Series. O’Neill, Jim. (2001). Building Better Global Economic BRICs, Global Economics Paper no. 66. Goldman Sachs. Reinhardt, E. and M. Busch (2003). “Developing countries and the GATT/WTO dispute settlement”, Journal of World Trade, 37(4): 719–735. Schweller, R. (2011). “Emerging powers in an age of disorder”, Global Governance, 17(3): 285–297. Sotero, P. (2010). “Brazil’s rising ambition in a shifting Global Balance of Power”, Politics 30(1_suppl): 71–81. Stuenkel, O. (2013). “Rising powers and the future of democracy promotion: The case of Brazil and India”, Third World Quarterly, 34(2): 339–355. Thorstensen, V. and L. Ferraz (2014). O Isolamento do Brasil em Relacao aos Acordos e Megaacordos Comerciais, Brasilia, D.F.: Instituto de Pesquisa Economica Aplicada [IPEA]. Thorstensen, V. O. and I. T. M. O. Oliveira (2012). Os BRICS na OMC: Politicas Comerciais Comparadas de Brasil, Russia, India, China e Africa do Sul, Brasilia, D.F.: Instituto de Pesquisa Economica Aplicada [IPEA]. Wallis, J. (2011). “Institutions, Organizations, Impersonality, and Interests: The Dynamics of Institutions”, Journal of Economic Behavior and Organization, 79(1–2): 48–64.

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CHAPTER 2

Russia in Global Economic Governance T hilo Bodenstein School of Public Policy, Central European University, Hungary

Introduction Russia is a core member of the BRICS. It hosted the founding meeting of the BRICS on 16 June 2009 in Yekaterinburg and also the Ufa meeting in July 2015 jointly with the Eurasian Economic Union (EAEU) (Toloraya and Chukov, 2016). The BRICS is not only a venue for high level meetings, but it also aims to provide an alternative form of representation in global economic governance (GEG). In terms of substantial policy initiatives, Russia partakes in the BRICS Development Bank and in the BRICS Contingent Reserve Arrangement (CRA) — a monetary fund with a pool of US $100 million. It is also involved in plans for a future BRICS payment system and the creation of an optical fiber submarine cable system among the BRICS members (BRICS cable). Russia is thus an active member of the BRICS trying to shape the rules of the game of the future GEG (Toropchin, 2017). Despite increasing activities, the BRICS is remarkably heterogeneous in terms of economic power and integration in the global economy. For all its military capabilities, Russia is not an economic heavyweight within the BRICS. A few numbers exemplify this.1  Data on GDP, growth rate and export volume are retrieved from the World Bank’s World Development Indicators. http://databank.worldbank.org/data/reports.aspx?source=worlddevelopment-indicators (accessed 11 May 2017). Data on bilateral exports are retrieved from UNCTAD. http://unctadstat.unctad.org/wds/ReportFolders/reportFolders.aspx?sCS_ ChosenLang=en (accessed 11 May 2017). 1

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With US $1.37 trillion (in current prices) in 2015, Russia’s GDP is smaller than China’s GDP (US $11.06 trillion), India’s GDP (US $2.1 trillion) and Brazil’s GDP (US $1.8 trillion). Russia’s yearly growth rate from 2009 to 2015 was on average 0.5%, but growth slowed down to –2.8% in 2015. By contrast, China’s yearly average growth rate over the same period was 8.5% and India’s 7.5%. Russia’s total export volume is also dwarfed by China. Russian exports amounted to US $392 billion (in current prices) in 2015, while China’s export volume was US $2.43 trillion. Finally, only China is a major destination for Russia’s exports; it is Russia’s second largest export market after the Netherlands. Russian exports to China were worth US $28,335 million (current prices) in 2015. Its exports to Japan — its fifth important export market was still US $14,426 million. By contrast, Russian exports to India were US $4,549 million, to Brazil US $1,922 million and to South Africa merely US $274 million reflecting the limit economic exchange between both countries (see Chapter 5). Although the BRICS does not play a significant role in Russia’s global economic engagement, the group may still advance alternative forms of representation in GEG (see Chapter 15). In order to understand Russia’s engagement in the BRICS it is important to trace the country’s complicated history of integration into the global economic system. Finding a proper role has been a major challenge for Russia’s commercial diplomacy since its independence in 1991. Russia has followed a two-pronged strategy. In the early 1990s it decided to join the World Trade Organization (WTO) while at the same time it followed a strategy of regional economic reintegration in the post-Soviet region, starting with the creation of the Commonwealth of Independent States (CIS) to increase its political and economy weight in the global economy (Bratersky, 2016). Both initiatives turned out to be more complex than expected. The WTO negotiations went on for 19 years and Russia became a member only in 2012. Three years later the EAEU2 became effective — one of Russia’s major regional economic initiatives. But as of now, the EAEU is facing integration obstacles. The contribution traces Russia’s two main efforts to integrate in GEG through accession to the WTO and the creation of sustainable regional economic integration. The negotiation process to the WTO was initially slowed down by economic interest groups fearing to lose from WTO accession. The stalemate was overcome by an evolution of the interest group constellation, but accession was then again postponed by a decreasing engagement of the Russian government in economic reforms. The creation of the EAEU met few resistances by Russian economic lobby groups, as their losses through regional economic integration were small. The regional integration process, however, was mainly advanced by Russia’s geoeconomic interests. The final part reflects on potential venues for future research on Russia’s role in GEG.  The acronym EEC is sometimes also used.

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Russia and Global Governance: The WTO Russia saw several advantages from WTO membership. It is member of the IMF, the World Bank and the G20. Staying outside of the WTO would have prevented it from shaping the rules of the global trading system (Åslund, 2007). In more practical terms, its export industries faced constant protectionist threats. As a WTO member, it has access to the dispute settlement mechanism which provides for legally binding decisions and regulates penalties. Secure access to export markets, thus, was a key motivation. The sectors expecting to gain most from WTO membership were those which were frequently subject to trade discrimination, such as the steel, chemical and textile industries and especially agriculture. Studies estimated the potential welfare gains through WTO membership (Jensen et al., 2004; Rutherford and Tarr, 2006). The authors concluded that in the medium term Russia would be able to increase its consumption by an additional 7.2% and its GDP by an additional 3.2%. Long-term increase of consumption could amount to 24% and of GDP by 11%. The greatest gains through falling prices would materialize in the service sector where tariff protection was high. Åslund (2007) cites studies that estimated prices in the financial service sector to fall by one-third, in the air and maritime transport services by two-thirds, and in the telecommunications sector still by 20%. These economic gains would mainly result from increased Foreign Direct Investments (FDI) and improved resource allocation. Yudayeva et al. (2002) estimated that the increase in FDI could amount to at least US $4 billion per year. Another important aspect of WTO membership was its role as an anchor for market reforms, as membership would lock in undertaken reforms and make them non-reversible (Tarr, 2007). Conflicting commercial interests hampered the negotiation process. There was support by Russia’s steel and fertilizer industries, which were able to compete on the international market. These industries joined the Russian Union of Industrialists and Entrepreneurs (RSPP). Under the leadership of Aleksey Mordashov, owner of the steel company Severstal, the RSPP became an important advocacy group in favor of WTO accession. Hesitant in the beginning, the RSPP changed its strategy during the negotiations and argued in favor of WTO accession as a means to modernize Russia’s industry. But more importantly, the automotive sector signaled its qualified support for WTO membership. Russia’s automotive industry was hardly competitive with foreign producers and operated behind a wall of high tariffs. The initial resistance by the automotive industry was muted when Oleg Deripaska, owner of the car producer Rospromavto, received high import tariffs for the automotive industry, which in the final WTO agreement were phased out gradually (Åslund, 2007). The Russian Chamber of Commerce and Industry (RCCI), representing importcompeting industries that were seen as non-competitive on the world market and

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headed by former Russian Prime Minister Yevgeny Primakov, was outspoken against WTO accession (O’Neal, 2014). A highly contentious issue was branch banking by foreign banks in Russia (Tarr, 2007). Being able to run subsidiaries in a country is important for foreign banks to invest in a country, but this implied adjustment costs for Russian banks. Russia argued that its central bank might not be able to adequately supervise foreign bank branches, which would increase risk for depositors. Telecommunications was another area that met resistance. Russia was required to end the state monopoly of its Rostelekom and to create an independent supervisory body of telecommunication instead of the telecommunication ministry that used to be in charge of supervision of the telecommunication sectors (Tarr, 2007). It also had to open its insurance market for multinational life and non-life insurances. This met resistance from the insurance industry, as it considered itself less competitive than foreign insurers. Finally, the country also had to open its markets for business services, including such professions as accounting, law, health care, engineering, and advertising, among others. In these areas, foreign companies can operate as foreign owned entities. They can also engage in wholesale and retail activities (Tarr, 2007). Another pole of lobbyism against WTO accession was the agricultural sector, which feared the end of agricultural subsidies, but more importantly the end of Russian veterinary regulations, which were also widely used by Rospotrebnadzor — Russia’s consumer and public health agency — as non-tariff import restrictions (O’Neal, 2014). Some resistance came from the services sector, which was wary of enforcement of intellectual property rights, as electronic piracy was still an issue in Russia (Åslund, 2007). Despite resistance, the government under President Vladimir Putin was adamant to integrate the country into the WTO and acted accordingly. The old ministry of External Economic Relations was merged with other ministries into the new Ministry of Economic Development and Trade, headed by the liberal and reform-minded German Gref. The government’s working group on WTO accession included pro-WTO minded politicians — Finance Minister Aleksey Kudrin and Prime Minister Mikhail Kasyanov. Maxim Medvedkov, appointed by German Gref, became trade negotiator. The Custom Code and the Tax Code were also brought in line with WTO standards. Åslund (2007) assumes that, under this constellation, WTO accession could have happened already in 2003. The accession process, however, slowed down during Vladimir Putin’s second term as president (2004−2008). Domestically, Russia turned away from its liberal reform commitments and started to create what some observers called a “limited access order” (North et al., 2013; see Chapter 5). The trial in 2003 against and expropriation of the oligarch Mikhail Khodorkovsky, owner of the oil company Yukos,

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marked a turning point. The Duma elections in 2003 brought a loss to the liberal parties and secured a majority to Putin’s United Russia party (Sakwa, 2008). In 2004, Prime Minister Kosyanov was replaced by Mikhail Fradkov, who was known for his resistance to WTO membership. External circumstance also stood in the way of accession. The US Jackson−Vanik amendment, which subjected US–Russian trade relations to annual reviews regarding the right of Russian Jews to emigrate, was still in place and was repealed only in December 2012. Another obstacle was the confrontation between Russia and Georgia, during which Russia issued import restrictions on a range of Georgian products in 2006. The issues between both countries were settled only in November 2011 (Connolly and Hanson, 2012). Moreover, the global financial crisis (GFC) of 2007−2008 led to a fall in oil prices in 2008 from US $120 to US $40 causing an economic crisis and imposing constraints on the government budget. Russia reacted by postponing WTO negotiations for a year and by introducing trade measures — 132 trade measures were introduced between 2008 and December 2009 (Gerasimenko, 2012). Only when the oil prices started to increase to around US $90 by the end of 2010 did the Russian government relaunch the WTO accession process (Gerasimenko, 2012). Russia’s WTO experience since its accession in 2012 reflects those of other larger members in terms of involvement in dispute settlement. Until now Russia has been a complainant in five cases — four cases against the EU and one case against Ukraine. It has been respondent in seven cases — four with the EU, one with Japan and two with Ukraine as a complainant.3 Hofmann and Kim (2015) test whether dominant powers are more likely to escalate trade dispute with rising powers such as the BRICS. They find no empirical evidence for the “power transition theory” in WTO disputes and Russia’s disputes are no exception to this finding. However, the more problematic aspects of its membership are related to the war in eastern Ukraine and the accession of Crimea to the Russian Federation in 2014. As a consequence of Russia’s role in the Ukrainian crisis, the EU and the US imposed sanctions on Russia (Neuwirth and Svetlicinii, 2016). The EU issued visa bans and asset freezes, economic sanctions such as the prohibition of purchases and sales of bonds and other financial instruments, prohibition of arms sales covering “dual use goods” and equipment for deep water and shale oil exploitation. The US imposed similar measures on Russia, including more extensive restrictions regarding trade and business with Crimea. Russia retaliated by “counter-sanctions” comprising import bans on a wide range of agricultural products from the EU,  Retrieved from WTO. https://www.wto.org/english/tratop_e/dispu_e/dispu_by_country_ e.htm (accessed 14 May 2017). 3

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the US, Canada, Australia, and Norway (Neuwirth and Svetlicinii, 2016). Although the “counter-sanctions” caused shortages in some markets in Russia and the list had to be revised, the government lauded them in terms of import substitution policies that would allow the Russian agricultural industry to develop further. Notwithstanding, the “counter-sanctions” were also welcomed by business representatives. The sanctions and “counter-sanctions”, however, are potentially disruptive to WTO governance. Article XXI of the GATT mentions national security interests, but there is no jurisprudence that would allow Russian “counter-sanctions” (Neuwirth and Svetlicinii, 2016). The WTO has no clear procedures of how to deal with politically induced trade disputes. Thus, Russia’s WTO membership has, at present, the potential to become disruptive to the international trade order (O’Neal, 2014). To enhance Russia’s role in GEG, the WTO is currently at an impasse and may be an example of power-transition theory in WTO governance.

Russia and Regional Governance: The EAEU Russia’s accession to WTO was also delayed because, in 2009, it requested joint accession to the WTO by the Eurasian Customs Union (ECU), which comprised Belarus, Kazakhstan and Russia (Gerasimenko, 2012; O’Neal, 2014). Collective accession by a customs union was unprecedented and could not be solved within existing WTO regulations. But the request shows the importance Russia accords to the regional dimension of its global market integration strategy, similar to other BRICS states (see Chapter 6). The regional integration efforts resulted in the EAEU in 2015. But, as of now, the EAEU has not yet fulfilled the expectations of its largest member state. After the collapse of the Soviet Union, the first attempt to maintain economic and political ties between the newly independent post-Soviet states was the creation of the CIS in December 1991 (Saivetz, 2012).4 In the wake of the Soviet Union breakup, CIS’s main purpose was to hold together the economic space, including infrastructures for electricity, transport and communications that were threatened to disintegrate. As early as September 1993, the nine member states of the CIS signed a treaty on the creation of an economic union. This included a plan for progressive economic integration, starting with a multilateral free trade association, moving to a customs union, eventually comprising free movement of goods, services, labor and capital, and even finally leading to a monetary union. A first tangible step of  A comprehensive overview over regional integration in Eurasia is provided by Hancock and Libman (2016). 4

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the intention to form a closer union was an agreement to a free trade zone in April 1994, but it was Russia that failed to ratify it (Kembayev, 2016). The first steps toward deeper regional integration started in 1995 with a declaration of intent to form a customs union between Belarus, Kazakhstan and Russia (Kembayev, 2016). It was joined by Kyrgyzstan in 1995 and Tajikistan in 1997, but the agreement remained ineffective. A second move came in 1996 when Belarus and Russia formed the Union State of Russia and Belarus with the ambitious aim of not only economic integration, but the eventual unification of both countries. It became effective in January 2000, but never reached a stage of deeper integration (Kembayev, 2016). A major move toward regional integration happened in October 2000 when Belarus, Kazakhstan, Kyrgyzstan, Russia, and Tajikistan agreed on the formation of the Eurasian Economic Community (EurAsEC) (Saivetz, 2012; Tarr, 2016). This new organization became effective as of May 2001 and was joined by Moldova and Ukraine a year later and by Armenia in 2003. Between 2006 and 2008, Uzbekistan also participated in EurAsEC. The organization was given decision-making structures with an Interstate Council, a General Secretariat, an Inter-Parliamentary Assembly and a Court. EurAsEC had a far-reaching agenda of coordinating member states’ tax and budget policies, economic management, agriculture, industry, transport, border control, social issues and migration policy. Goals included the free movement of capital and the intent to form a common financial market, cumulating in a common currency.5 EurAsEC was also created with an eye on the WTO, as it was supposed to coordinate its members’ accession processes (Kembayev, 2016). Although little substance has been made in this respect, EurAsEC decisively contributed to regional integration by the launch of the ECU between Belarus, Kazakhstan, and Russia in January 2010 (Kembayev, 2016). Armenia and Kyrgyzstan joined the ECU in 2015. A common Customs Code entered into force in July 2010. Border controls between Russia and Kazakhstan were removed in July 2011 and between Russia and Belarus a year later. The second contribution of EurAsEC was the creation of the Common Economic Space (CES)6 (Kembayev, 2016). The agreement was signed in September 2003 in Astana by Belarus, Kazakhstan, Russia, and Ukraine, but Ukraine’s Orange Revolution put an end to the project. The CES gained new momentum with the action plan adopted by the Interstate Council of EurAsEC in December 2009. The CES, started in January 2012, aimed to implement free movement of capital, harmonization of economic policy (including the adoption of formal criteria for macroeconomic policy) and harmonization of labor, finance,  Decision of Interstate Council of EurAsEC, 9 February 2004.  Sometimes also referred to as Single Economic Space (SES).

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health and safety standards, in order to create a level playing field. In November 2011, the decision was made to transfer the work of the Commission of the Customs Union to the new Eurasian Economic Commission (EEC) located in Moscow. The final regional integration move was made with the creation of the EAEU on 1 January 2015. It is currently comprised of Armenia, Belarus, Kazakhstan, Kyrgyzstan, and Russia. The agreement to form the EAEU was declared by the Interstate Council of EurAsEC in November 2011. With the EAEU coming into effect, both ECU and CES were merged and the EurAsEC formally ceased to exist having served as a “parent” organization. The highest decision-making body of the EAEU is the Supreme Eurasian Economic Council (SEEC), which consists of the presidents of the five member states.7 It meets at least once per year and is in charge of strategic decisions regarding the development of the EAEU. The Eurasian Intergovernmental Council (EIC) includes the heads of governments and meets twice a year. It decides on issues that cannot be resolved by the EEC. The EEC is the main regulatory body where day-to-day work takes place. It consists of the Board of the Commission and the Council of the Commission, which was called Collegium during EurAsEC. One argument in favor of Eurasian regional integration was the disruption of economic ties that existed in the Soviet Union. But like the BRICS, the EAEU countries are dissimilar in terms of economic size and have low levels of trade interdependence (Borodin and Strokov, 2015). Russia’s GDP (in current prices, 2015) is more than five times bigger than all other countries combined, seven times bigger than the second largest economy (Kazakhstan) and 190 times bigger than the smallest economy (Kyrgyzstan). Trade patterns of the EAEU countries do not show a picture of integration (Myant and Drahokoupil, 2008; Borodin and Strokov, 2015). Export specialization patterns are partially similar with an emphasis on commodity exports. Fuel exports account for over 60% of merchandised exports for the two largest economies, Russia and Kazakhstan, while their share of foot export is only around 4 percent showing the structural similarity of their economies. Also, the share of manufacturing exports is above 40% only in case of Armenia and Kyrgyzstan. In Russia and Kazakhstan, manufacturing exports are below 20%. At the same time, high-technology exports remain comparatively small for all EAEU member states. Finally, Armenia and Kyrgyzstan have high shares of personal remittance due to labor migrants who mainly work in Russia. In addition, it is striking how little EAEU member states trade with each other. The two largest EAEU members Russia and Kazakhstan are not their most important   http://www.eurasiancommission.org/en/Documents/broshura26_ENGL_2014.pdf (accessed 6 February 2017). 7

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trading partners. Russia’s exports to Kazakhstan are only a quarter of its exports to the Netherlands.8 At the same time, Russia buys only slightly more than a third of what Italy buys from Kazakhstan. Kazakhstan’s exports to Belarus — its second most important trading partner within the EAEU — is only a fraction of exports to France. However, Russia is the most important export market of Belarus and Armenia with Kazakhstan playing a minor role. Only Kyrgyzstan, the tiniest of the EAEU economies, seems to be economically more integrated with other EAEU countries. Thus, the economic case for Eurasian regional integration or even a common market is puzzling and the general picture is that intraregional trade has significantly fallen over the past 20 years (Gurova and Efremova, 2010: 110). Regional economic integration, however, can be driven by concerns other than trade gains. Börzel and Risse (Chapter 6) observe that Russia is the only BRICS country that explicitly tries to secure a regional “sphere of influence”. Bratersky (2016) frames the long-term benefits of the EAEU in geopolitical terms. Sergei Glazyev, economic advisor to President Putin, stresses in his contribution on the Eurasian Union Russia’s Eurasian character as a “distinct, ideological, political, historical and cultural concept” (Glazyev, 2015: 84). He is not alone in this. President Putin also referred in a seminal newspaper contribution to the Eurasian Union as “a powerful supranational association capable of becoming one of the poles of the modern world…”, rallying the member states of the CIS around the Eurasian integration project (Glazyev, 2015: 88). The case for Eurasian integration is often framed in terms of geopolitics and geoeconomics in the Russian debate (Andronova, 2016; Bratersky, 2016). From a geoeconomic perspective, state agents control and use economic power to follow a mercantilist agenda. It is “the use of statecraft for economic ends; a focus on relative economic gain and power; a concern with gaining control of resources; the enmeshing of state and business sectors; and the primacy of economic over other forms of security” (Youngs, 2011, cited in Mattlin and Wigell, 2016: 128). Saivetz (2012) argues that geopolitical and economic goals cannot be separated in Russia’s policy toward its neighbors. From this perspective, the driving force of Eurasian integration has been Russia’s state officials. The concept of geoeconomics assumes that integration processes are driven by political elites, not necessarily by societal preferences or organized interest groups. In the case of Russia, both factors are rarely mentioned and barely observable. According to Krickovic (2014), public support for Eurasian integration is low and Russian nationalists even reject it. Tsygankov (2012) argues that Russia  Data on bilateral exports are retrieved from UNCTAD. http://unctadstat.unctad.org/wds/ ReportFolders/reportFolders.aspx?sCS_ChosenLang=en (accessed 11 May 2017). 8

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seeks to bind its neighbors into Russian dominated institutions to preserve its role as a “regional great power”. The dominant actors for regional integration are the political leadership and the elite (Krickovic, 2014). Elites focus on the perception of Russia’s decreased international influence and the need to restore its role as a “great power” (Trenin, 2011; Mankoff, 2009). Glazyev (2015: 85), for instance, reflects this thinking by arguing that Russia has power of attraction in Eurasia because “Russia is not just a country, but a civilization in its own right. Only China, India and Japan can claim the same.” Apart from great power instincts, the changing international environment affects Russia’s regional options. One concern of Russia’s political elites was EU expansion into the post-Soviet space via its European neighborhood policy, which was perceived as creating a “cordon sanitaire” around Russia, further isolating it (Krickovic, 2014). At the same time, political elites saw the decreasing global and economic influence of the West as a call to engage more in regional integration, in order to provide public goods that the West would not be able to provide anymore. A final motivation was the hope that Eurasian integration would help modernize Russia’s economy by becoming less dependent on Western markets and raw material exports (Krickovic and Bratersky, 2016). In the spirit of securing a sphere of influence, Russia’s negotiation style was not without coercive elements. Although Glazyev (2015: 94) states that “[u]nlike the EU or the US empire, which coerce other countries by force of arms and the power of their reserve currencies, Eurasian integration is a voluntary association of peoples […]”, Russia actually has frequently used its lever of energy subsidies to increase support of its neighboring country for regional integration (Krickovic and Bratersky, 2016). Russia’s use of energy prices and purchase of state assets in Belarus is a case in point (Korosteleva, 2015). Similar negotiation tactics were employed ­vis-à-vis Ukraine. Russia put pressure on Ukraine to merge its gas company Naftohaz with Gazprom (Saivetz, 2012) and tried to prevent it from signing the Deep and Comprehensive Free Trade Agreement with the EU. At the same time, the project of the EAEU cannot be fully separated from security concerns. The founding members of the EAEU are also members of the Collective Security Treaty Organization (CSTO). The organization’s main purpose is to maintain regime security, non-interference and state sovereignty. It has identified “separatism” as a common threat, as well as “information warfare” and “mass psychological brainwashing”, under which falls information that is “harmful to the spiritual, moral and cultural spheres of other states” (Jackson, 2014: 193). Armenia’s membership in the CSTO was a key motivation for joining the EAEU (Delcour, 2015). In a similar vein, Kyrgyzstan’s final decision to become member of the EAEU can be traced back to its growing security concerns over its citizens joining the ranks of Islamist groups (Krickovic and Bratersky, 2016).

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A final indicator that the EAEU may go beyond purely economic integration are statements by Kazakhstan’s president Nursultan Nazarbayev who warned against political integration of the EAEU as a threat to its country’s independence (Sultanov, 2015). In a similar vein, President Alexander Lukashenko of Belarus is opposed to creating additional supranational structures that would undermine political independence and sovereignty in Belarus (Sultanov, 2015). Geopolitical and economic consideration are closely intertwined. Interest group politics played a role in delaying Russia’s WTO accession. In the case of the EAEU, however, their impact on decision-making was limited. First, the EAEU founding states are authoritarian “limited access orders” with limited and selective influence of interest groups on political decision makers (Collins, 2004; Frear, 2013). Also, the preparation phase to the EAEU was short and largely driven by presidential administrations. The outcome of Russia’s WTO accession is another reason why Russian interest groups were hardly active regarding the EAEU. Russia’s external tariff has de facto become the external tariff of the ECU and later of the EAEU. This also implies that other EAEU members have to raise their tariffs (Hartwell, 2016). Thus, the EAEU is not a threat to Russia’s import competing industry. For instance, following the creation of the ECU, Russian car exports to Belarus and Kazakhstan have strongly increased. The EAEU is expected — as did its predecessor EurAsEC — to increase trade and investment among its member states and help modernize their economies. The organization is still fresh and it is too early to thoroughly assess its effects. Tarr (2016), however, estimates that the EAEU has trade-diverting rather than tradecreating effects. For example, although Russia’s WTO membership has phased in lower bound tariffs, which are also the external tariffs of the EAEU, the other member states were forced to almost double their external tariffs when entering the EAEU. Armenia’s unweighted average tariff rate was 3.5%, Kyrgyzstan’s 4.6% and Kazakhstan’s 6.7%. The common unweighted tariff rate of EAEU is expected to be 7.9% in 2020 (Tarr, 2016). This leads to a substantial increase of lower-quality imports from Russia and partially displaces imports from other countries. From a Russian perspective, this is an opportunity to expand its export markets, but on the whole, the ECU and EAEU do not seem to be trade-creating (Borodin and Strokov, 2015). A more serious problem is existing non-tariff barriers on goods that are reducing access to the Russian market, which appear as sanitary and phytosanitary regulations and technical barriers to trade. Russia’s GOST system effectively serves as the regulatory framework of the EAEU with approximately 20,000 applicable standards. GOST is the Soviet organization of industrial standards and now operates for all CIS member states (Tarr, 2016). The system of industrial standards has been highly centralized and has not only covered product standards, but also production

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standards. For instance, when producers want to adapt production processes due to market changes or technical innovation, this has to be negotiated with the regulators. Mutual recognition of standards does not happen and the EU solution of “negative regulation” — where a country’s regulations have to be accepted by all other EU countries — is unlikely to emerge in the EAEU. Trade facilitation, by contrast, has improved since the inception of the ECU (Tarr, 2016). The days it takes to export from Armenia has fallen from 20 days in 2009 to 16 days in 2015, from 16 to 15 days from Belarus, from 84 to 79 days from Kazakhstan and from 24 to 22 days from Russia. The numbers are similar for time it takes to import. Finally, commitment problems are still considerable. The members of the EAEU have been involved in mutual trade conflicts since the creation of the ECU and often non-tariff barriers were used for this purpose. For example, when the war in Ukraine escalated, Russia unilaterally imposed “counter-sanctions” on Western products. The other two members of the ECU, however, did not follow Russia’s “counter-sanctions”, undermining the sense of a customs union (Knobel, 2015). Russia accused Belarus of circumventing the “counter-sanctions” by transferring Western goods from Belarus to Kazakhstan and selling them on the way on the Russian market. As a consequence, it banned meat and dairy products from Belarus on grounds of health concerns, which was countered by customs checks on Russian vehicles entering Belarus. The latest row between the two countries happened in February 2017 when Russia reintroduced border controls with Belarus following a partial liberalization of Belarus’ visa regime.9 Commitment to EAEU rules is also questionable in the relationship between Russia and Kazakhstan. In March 2015, Kazakhstan stopped Russian imports of fuel and gas because of Russian trade surpluses (Tarr, 2016). In addition, Kazakhstan put a ban on meat products from Russia, arguing Russia violated safety standards. The move was matched by Russian counter-restrictions. The EAEU, thus, has become effective, but it is still far away from assuming a role as a regional economic block that can put its weight in the governance structure of the global economy.

Conclusion On 14−15 May 2017, China hosted the Belt and Road Forum (BRF) for International Cooperation in Beijing.10 It was dedicated to China’s Belt and Road initiative that promotes large infrastructure projects to establish trade routes from Asia to Europe,  Financial Times: “Belarus’s Lukashenko slams Russia over border controls.” https://www. ft.com/content/4eeeb5ca-ea1f-11e6-893c-082c54a7f539 (accessed 22 February 2017). 10  Financial Times: “China seeks to ease Belt and Road strategy concerns.” https://www. ft.com/content/ff13af84-395f-11e7-821a-6027b8a20f23 (accessed 27 May 2017). 9

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including countries of the EAEU. Among the 29 heads of states that attended was Russian President Putin. To ease Russia’s concerns about China’s engagement in its Eurasian turf, both countries agreed to a regional development cooperation investment fund, as China was initially reluctant to link its initiative more closely with Russia’s EAEU. The BRF reveals the limited impact of Russia’s regional initiatives on a broader scale, even in its own “sphere of influence”. Engagement with the BRICS has become Russia’s main strategy to find an ­alternative to the West (Johnson and Kostem, 2016) and to have a say in GEG. Common political initiatives, joint projects and a shared understanding of the key principles of GEG are supposed to make the BRICS work as a cohesive group (Toropchin, 2017). The underlying fundamental problem, however, is deep economic and political asymmetry among the BRICS states and lack of economic interdependence. Russia cannot match China’s economic — and increasingly political — weight (Kaczmarski, 2016). In order to increase its global economic weight, Russia has embarked on two major projects — WTO membership and Eurasian economic integration. The accession to the WTO took two decades. Support of key interest groups was lacking, and after securing support of economic actors, the Russian government shifted priorities and lost interest in the WTO. Eventually, Russia became a member of the WTO in 2012, but the crisis in Ukraine triggered economic sanctions against Russia and “counter-sanctions” by Russia. This reduced the usefulness of the WTO for Russia’s aim to influence GEG. The second project — regional integration in Eurasia — also took more than two decades to complete. The EAEU became effective in 2015. Although it is too early to assess the success of the project, the organization is faced with ongoing commitment problems by its members. To better understand the present and future of Russia’s role in the global economy and GEG, research should focus on various interrelated issues. Russia is trying to promote the role of the BRICS (Toloraya and Chukov, 2016), but it is unclear how economic and political heterogeneity has impacted on its cohesiveness. In the past, voting cohesiveness of the BRICS in the UN General Assembly has not increased (Hooijmaaijers and Keukeleire, 2016). Has political cohesiveness of the BRICS improved since then or does economic heterogeneity undermine it? Russia’s WTO membership is another field of investigation. How are the current economic sanctions reinvigorating import-competing lobby groups in Russia? How do Russian “counter-sanctions” affect the country’s role and position within the WTO? With respect to the EAEU, its future development depends both on its ability to tie the hands of the member states and on China’s Belt and Road initiative (Andronova, 2016). The initiative is attractive to the Central Asian states. To the extent that membership of EAEU may clash with full engagement in the Belt and

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Road initiative, the EAEU may become the less attractive option. Trade links within EAEU are only slowly increasing. The challenge of commitment problems is connected to this. These problems can only be credibly overcome if more supranational power is granted to the EAEU’s common institutions — a move that has been ruled out by Kazakhstan and Belarus thus far. It is important to understand how increasing economic interdependence may foster supranational governance in the EAEU. The WTO and the EAEU are the two institutional pillars that allow Russia to become part of GEG. If the BRICS want to influence the future rules of the global economy, Russia has to consolidate its current role in GEG first.

References Andronova, I. (2016). “Eurasian Economic Union: Opportunities and barriers to regional and global leadership”, International Organisations Research Journal, 11(2): 7–23 (in Russian). Åslund, A. (2007). “Russia’s accession to the World Trade Organization”, Eurasian Geography and Economics, 48(3): 289–305. Borodin, K. and A. Strokov (2015). “The Customs Union of the CIS”, Journal of Economic Integration, 30(2): 334–358. Bratersky, M. (2016). “Isolationism versus geopolitics: The dual role of the Eurasian Economic Union in global governance”, International Organisations Research Journal, 11(2): 58–70 (in Russian). Collins, K. (2004). “The logic of clan politics: Evidence from the Central Asian trajectories”, World Politics, 56(2): 224–261. Connolly, R. and P. Hanson (2012). “Russia’s accession to the World Trade Organization”, Eurasian Geography and Economics, 53(4): 479–501. Delcour, L. (2015). “Between the Eastern Partnership and Eurasian integration: Explaining post-Soviet countries’ engagement in (competing) region-building projects”, Problems of Post-Communism, 62: 316–327. Frear, M. (2013). Belarus: Player and pawn in the integration game, in R. Dragneva and Wolczuk K. (eds.), Eurasian Economic Integration. Law, Policy and Politics, Cheltenham: Edward Elgar, pp. 119–138. Gerasimenko, D. (2012). “Russia’s commercial policy, 2008–11: Modernization, crisis, and the WTO accession”, Oxford Review of Economic Policy, 28(2): 301–323. Glazyev, S. (2015). Russia and the Eurasian Union, in P. Dutkiewicz and R. Sakwa, (eds.), Eurasian Integration — The View from Within, London: Routledge, pp. 84–96. Gurova, I. and M. Efremova (2010). “Potentsial regional’noy torgovli SNG [The CIS’s regional trade potential]”, Voprosy Ekonomiki, 7: 108–122. Hancock, K. J. and A. Libman (2016). Eurasia, in T. A. Börzel and T. Risse (eds.), The Oxford Handbook of Comparative Regionalism, Oxford: Oxford University Press, pp. 202–224.

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Hartwell, C. H. (2016). “Improving competitiveness in the member states of the Eurasian Economic Union: A blueprint for the next decades”, Post-Communist Economies, 28(1): 49–71. Hofmann, T. and S. Y. Kim (2015). “Picking fights: Rising powers in WTO disputes.” Unpublished manuscript. Hooijmaaijers, B. and S. Keukeleire (2016). “Voting cohesion of the BRICS countries in the UN General Assembly, 2006–2014: A BRICS too far?”, Global Governance, 22(3): 389–407. Jackson, N. J. (2014). “Trans-regional security organisations and statist multilateralism in Eurasia”, Europe-Asia Studies, 66(2): 181–203. Jensen, J., T. Rutherford and D. Tarr (2004). Economy-Wide and Sector Effects of Russia’s Accession to the WTO, Washington, DC: World Bank. Johnson, J. and S. Kostem (2016). “Frustrated leadership: Russia’s economic alternative to the West”, Global Policy, 7(2): 207–216. Kaczmarski, M. (2016). “The asymmetric partnership? Russia’s turn to China”, Inter­national Politics, 53(3): 415–434. Kembayev, Z. (2016). “Regional integration in Eurasia: The legal and political framework”, Review of Central and East European Law, 41: 157–194. Korosteleva, E. (2015). Belarus between the EU and Eurasian Economic Union, in Dutkiewicz, P. and R. Sakwa (eds.), Eurasian Integration — The View from Within, London: Routledge, pp. 111–125. Knobel, A. (2015). “Evraziskij Ekonomicheskij Sojuz: Perspektivy razvitija i vozmozhnye prepjatstvija [Eurasian Economic Union: Prospects and challenges for development]”, Voprosy Ekonomiki, 3: 87–108. Krickovic, A. (2014). “Imperial nostalgia or prudent geopolitics? Russia’s efforts to reintegrate the post-Soviet space in geopolitical perspective”, Post-Soviet Affairs, 30(6): 503–528. Krickovic, A. and M. Bratersky (2016). “Benevolent hegemon, neighborhood bully, or regional security provider? Russia’s efforts to promote regional integration after the 2013–2014 Ukraine crisis”, Eurasian Geography and Economics, 57(2): 180–202. Mankoff, J. (2009). Russian Foreign Policy: The Return of Great Power Politics, Plymouth: Rowmann & Littlefield. Mattlin, M. and M. Wigell (2016). “Geoeconomics in the context of restive regional powers”, Asia Europe Journal, 14(2): 125–134. Myant, M. and J. Drahokoupil (2008). “International integration and the structure of exports in Central Asian republics”, Eurasian Geography and Economics, 49(5): 604–622. Neuwirth, R. J. and A. Svetlicinii (2016). “The current EU/US-Russia conflict over Ukraine and the WTO: A preliminary note on (trade) restrictive measures”, Post-Soviet Affairs, 32(3): 237–271. North, D. C., J. J. Wallis, S. B. Webb and B. R. Weingast (2013). In the Shadow of Violence: Politics, Economics, and the Problems of Development, Cambridge, UK: Cambridge University Press.

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O’Neal, M. (2014). “Russia in WTO: Interests, policy autonomy, and deliberations”, Eurasian Geography and Economics, 55(4): 404–421. Rutherford, T. and D. Tarr (2006). Regional Impacts of Russia’s Accession to the WTO, Washington, DC: World Bank. Saivetz, C. R. (2012). “The ties that bind? Russia’s evolving relations with its neighbors”, Communist and Post-Communist Studies, 45(3–4): 401–412. Sakwa, R. (2008). Russian Politics and Society. Fourth revised edition, London: Routledge. Sultanov, B. (2015). Kazakhstan and Eurasian integration, in Dutkiewicz, P. and R. Sakwa (eds.), Eurasian Integration — The View from Within, London: Routledge, pp. 97–110. Tarr, D. (2007). “Russian accession to the WTO: An assessment”, Eurasian Geography and Economics, 48(3): 306–319. Tarr, D. (2016). “The Eurasian Economic Union of Russia, Belarus, Kazakhstan, Armenia, and the Kyrgyz Republic: Can it succeed where its predecessor failed?”, Eastern European Economics, 54: 1–22. Toloraya, G. and R. Chukov (2016). “BRICS to be considered?”, International Organisations Research Journal, 11(2): 97–112 (in Russian). Toropchin, G. B. (2017). “From Goa to Xiamen. On some aspects of political cooperation within BRICS”, International Organisations Research Journal, 12(1): 174–188 (in Russian). Trenin, D. (2011). Post-Imperium: A Eurasian Story, Washington, DC: Carnegie Endowment. Tsygankov, A. P. (2012). “Russia and the CIS in 2011: Uncertain economic recovery”, Asian Survey, 52(1): 42–51. Yudayeva, K. V., Y. Bessonova, K. Kozlova, N. Ivanova, D. Sokolova and B. Belov (2002). Sectoral and Regional Analysis of Russia’s Accession into WTO: A Cost-Benefit Analysis, Moscow: Center of Economic and Financial Research at New Economic School (CEFIR) (in Russian).

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CHAPTER 3

India and Global Governance Rajesh Kumar Department of Political Science, National University of Singapore, Singapore

Introduction India’s standing in the global economy presents a paradox. In the 1770s, on the eve of the Industrial Revolution, India was the second largest economy in the world, with more than 20% of the world output. In the 1970s, this share fell to 3%. Economic stagnation of nearly two centuries due to colonial rule, an inward looking economy after independence in 1947, and an interventionist state are main reasons, according to a report by Goldman Sachs (Goldman Sachs Report, 2007: 11).1 The combined effect was decades of low growth, which is captured pejoratively by the phrase “Hindu rate of growth”. The Indian economy, however, began to catch up since the 1990s, when economic liberalization set up its integration into the world economy. And, since 2001, it has been one of the fastest growing economies of the world, which is also the reason it is part of the BRICS group. My purpose is to assess India’s position in the BRICS and in the global politicoeconomic governance. The question is whether India can sustain its growth given its problems, some of which like poverty, for example, have domestic as well as international dimensions. On the international stage, India’s behavior has seen a  One should note that India’s territorial extent was much larger in 1770s. But even if we adjust the territorial realignments that took place during the 18th through the 20th centuries, the paradox remains valid. The point is simply that its share in global economy has shrunk as compared to the past when it commanded the status of a major contributor. 1

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change — from the policy of “strategic restraint”, which it followed until the 1980s, to that of a policy of “strategic alignment”, which it has followed since the 1990s. The policy of “strategic alignment” is more prominent in political affairs than the economic, whereas India’s rise and its position in the global governance will depend on how successfully it can maintain balance between the two.

India in the BRICS BRICS is a coalition of emerging economies. Policy analysts have projected the coalition as the new “engine of growth” for the world economy, something like the G7 of the post-World War II global order.2 The significance of rise of the coalition is two-fold: first, it challenges the Western domination in setting the global governance agenda, and second, it brings hope for increasing cooperation among the countries of the South, and consequently for redistribution of power in the existing institutions that direct the global “idea and practice of planning” (Gorman, 2014: 471).3 If the BRICS agenda succeeds, we would witness rebooting of the institutions of “Washington Consensus”, namely, the United Nations, the International Monetary Fund (IMF), and the International Bank for Reconstruction and Development (World Bank). This would invite “a rethinking of power symmetries” with respect to global governance (Taylor, 2009: 46), and, incentivize establishing new institutions such as the Asian Infrastructure Investment Bank (AIIB), and the New BRICS Bank, all reflecting “alliance building” among the countries of the global South. And this would also mean some of the world’s most populous countries, such as China, India, and Brazil, would be taking the center stage at the global governance platform. Encouraging trends have backed these expectations. In 2001, a Goldman Sachs report projected that these countries would contribute to 10% of world GDP for the  A Goldman Sachs paper, “Building Better Global Economic BRICs” (30 November 2001) articulated the acronym, BRICs in 2001 (O’Neill, 2007: 5). Pele (2007: 4) traces the origin of the acronym to another 2003 paper by Goldman Sachs. South Africa joined the group in December 2010. Its membership was formally confirmed only at the third BRICS Summit in April 2011. 3  BRICs was promoted as an “investment” guide initially, by the economist Jim O’Neill of Goldman Sachs. The concept looked attractive because it brought together the largest emerging markets which showed promise of high growth and relative scale of consumptive power. These emerging markets were identified by their GDP (at purchasing power parity (PPP)) and by the productivity of their big populations. These countries began identifying with the concept politically, and their heads of government met for the first time in 2009, at Yekaterinburg, Russia. South Africa participated in the 2011 Summit meeting in China. It has emerged as a political economic grouping now, with the potential to alter the dynamics of global order and governance (see Beausang, 2012: 2; de Coning et al., 2015: 1). 2

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first decade of the 21st century. By 2007, the combined share was already 15% of the world economy. The coalition had approximately 3.5% share in the global capital market in 2001−2003; its per capita income ranged from about US $500−4500; and its annual average GDP growth rate exceeded 6% against a world average of 3.7%. This trend continued for a decade (Pele, 2007: 4−5; Goldman Sachs Report, 2003). The BRICS coalition is projected to overtake the combined GDP of the G7 by 2035 (Goldman Sachs Report, 2003; 2007).4 The projection may hold well if the coalition is able to sustain its current performance. Cary Huang (2015) notes that the BRICS economies drive global growth today, accounting for over 30% of the total. In 2014, the coalition registered a combined nominal gross domestic product of US $16 trillion approximately, which was about 20% of the global output. The corresponding share of the G7 countries dropped to less than 50% in the same period, from the previous share of 65%. BRICS countries hold US $4 trillion in foreign reserves, almost half of the global total, whereas G7 control only 20%, which would fall to just 8% if we exclude Japan’s share. Making a macro-level analysis, Cary Huang (2015) argues that these developments could mean “the significant tilting of gravity in the global economy”. The data from individual members of the coalition, however, may appear to be disappointing. China is currently growing at its slowest pace in 25 years, and its push for making BRICS a “free-trade” zone may not find support; the member countries are burdened by cheap Chinese imports, resulting in big trade deficits with China. Brazil, Latin America’s largest economy at US $1.35 trillion, had a dismal growth in 2015, and may contract about 3% in 2016. Russia is hit hard by Western sanctions and by the slump in oil prices. Its economy remains weak, its GDP shrank 3.7% in 2015. IMF predicts a further contraction of 0.8% in 2016 and a modest growth in 2017 for Russia. South Africa’s economy is the smallest among the BRICS coalition and is troubled also by a low credit rating, an unstable currency and steep unemployment rates (CNBC, 2016). India’s growth has followed a different trajectory in the last few years. Its US $2.38 trillion economy is growing at 7.5% annually, fastest of the five-member countries of the BRICS (CNBC, 2016).5 According to the Global Competitiveness Index 2016 of the World Economic Forum, India has become the second most  Projections of the period before 2010 do not include South Africa. But the average values for the period will not be significantly altered if we assume South Africa to be part of the coalition from the beginning. The current projections support this. 5  The Indian Government’s budget document of 2017 shares this view. It notes that the Indian economy has been robust to mild shocks and that, according to the IMF, it will be “one of the fastest growing major economies in 2017”. Source: http://indiabudget.nic.in/ ub2017-18/bh/bh1.pdf (accessed 27 December 2017). 4

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competitive BRICS economy, next to China. India’s competitiveness improved the fastest in 2015−2016, jumping 16 places to rank 39th among 138 countries on the index (The Economic Times, 2016). The report notes improvement in public institutions, in transparency of the financial system, and in goods market efficiency, business sophistication and innovation. Improved monetary and fiscal policies and lower oil prices have stabilized the Indian economy which now boasts the highest growth among G20 countries, and its growth may also help the BRICS story unfold as per the script. The Global Competitiveness Index 2016 report is significant for two reasons. First, the report indicates that the BRICS story may not depend on the growth of China alone anymore. Although China has remained top among the BRICS coalition at 28 rank, the gap with its peers is closing. India, ranked 39, has improved its performance, so have Russia and South Africa, moving two places up to 43 and 47, respectively. Brazil has shown a decline, falling six places to 81. Second, the report identifies international trade and openness to foreign investors as major factors for economic growth. This may induce cooperation on infrastructure and finance, as well as on energy, climate change, and sustainable development. India is quick to realize the importance of “cooperation”, and pressed for a New Development Bank (NDB) in 2012 at the New Delhi summit. The NDB and a BRICS Contingency Reserve Agreement (CRA) were institutionalized at the sixth BRICS Summit in Fortaleza, Brazil in 2014. India’s commitment to BRICS looks steady, but its fastest growing economy is also home to most poor people of the world, with nearly half of its 1.3 billion population living on less than US $3.10 a day (CNBC, 2016). Corruption, poor public health, inflation, and inefficient tax regulations could neutralize its economic gains. According to the Transparency International’s Corruption Index of 2012, India ranks 94th out of 176 countries. The Human Development Index of the UNDP places it at 136th out of 186 countries (Wulf and Debiel, 2015: 29). And, although India appears to be reaping benefits of high growth, which is largely attributed to its new export-optimism and economic liberalization, the policy itself is connected to factors that drive its domestic politics. India’s position in the global governance remains an open question.

India in the Global Governance: An Assessment India’s economic performance mirrors its political outlook. Two distinctive phases could be identified for assessing its role in global governance: (a) 1947−1990 (the Cold War years) and (b) 1991 onwards (post-Cold War years). The first phase, also a period of low growth for India, was the period when Jawaharlal Nehru’s idealism

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(1947−1964) and Indira Gandhi’s realism (1966−1977 and 1980−1984) determined India’s political and economic strategy. India followed a policy of non-alignment politically, guided by the belief that for securing its objectives, it needed to keep away from the “bloc” politics of the Cold War. The imperatives of a low growth economy could have also led to this policy. India presented a bleak picture in 1947, at the time of its independence. It accounted for less than 2% of global wealth, whereas it had to provide for 345 million people. The British rule had brought a degree of industrialization, but the levels of poverty also deepened during the same period (Malone et al., 2015). It is difficult to imagine that India accounted for 24% or 25% of global production in the 1700s, at the time when the British rule was expanding in India (Maddison, 2003; Washbrook, 2007). Maddison estimates that the United Kingdom’s GDP amounted to little more than 11% of India’s in 1700, but by 1947 it exceeded India’s by half. While India’s GDP per capita remained essentially flat during the 200 years of colonial rule, the United Kingdom’s GDP per capita increased five-fold (see Malone et al., 2015: 12). These conditions may not have favored J. L. Nehru, India’s first Prime Minister and his colleagues to take bold steps. Most studies have pointed out that India was forced to adopt a defensive stance, with an attitude for “export-pessimism” (Tellis, 2016; Baru, 2015). Yet, being non-aligned could be a choice of “strategic restraint”, less a defensive stance. The policy of non-alignment paid rich dividends. India enjoyed autonomy in matters of security and material well-being; it survived the Cold War without compromising on its territorial integrity; and, it established a good political standing among the “Third World” countries through the Non-Aligned Movement (NAM) — a position that largely forms the basis for claiming permanent membership of the UN Security Council today. On the economic front, India created impressive industrial and technological capabilities, while remaining by and large away from the global market (Tellis, 2016). There is another reason I characterize India’s behavior during the Cold War years as “strategic restraint”. There is evidence that it secured a latitude of maneuverability by being “non-aligned”. Michal Kalecki suggests that by the policy, India’s behavior was that of the “clever calf that sucks two cows” (Kalecki, 1993 (1964): 10; Baru, 2015: 330). India’s share of bilateral and multilateral aid increased during the Cold War years, but its usage was directed at different sectors. The US aid was focused on agriculture, while the Soviet aid was directed at creating public sector industry and defense manufacturing, and the World Bank aid was used for building capacities in irrigation and power. India’s “strategic restraint” was a self-interested behavior in response to its political and economic developmental needs. The decade of 1960s is particularly significant. India faced an acute food shortage in 1965−1966, when the monsoons failed and a war with Pakistan had depleted its

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foreign exchange reserves. India was dependent on food imports from the US, which expected India to open up its economy and devalue the Indian currency. At the same time, the US assisted India’s Green Revolution, with the objective of reducing India’s dependence on imported food. The 1967 devaluation of Indian rupee strained India’s relationship with the IMF and the World Bank, as India felt the US had not been supportive enough. Only a few years later, it entered into formal alliance with the Soviet Union, reoriented the NAM with the demand for a New International Economic Order, and began showing more interest in the G77, the largest forum of developing countries. Its reaction to policy recommendations of the Bretton Woods institutions, the IMF and the World Bank, which favored the debtors’ countries to reduce budgetary and fiscal deficits, privatize public-sector enterprises, and liberalize export−import policy turned hostile. It is true that India’s growth rate was an abysmal 3.5−4% until the 1980s, and its share in the world trade for the same period declined from 2% in 1950 to 0.5%. But there was no certainty that it could have been higher had it opened its economy with weak economic fundamentals. Politically, it could have gone the way other postcolonial countries in the subcontinent went, falling to military coups or becoming dependent regimes of the Cold War superpowers. But the decline of the USSR in 1989 altered the global context for India. India was induced more than ever toward competitive economic alliances, and this outlook was reflected in its policy of economic liberalization. The dominant view is that domestic and international compulsions forced India to open up its economy in 1991. With the collapse of the Soviet Union, India lost access to Eastern European markets, the rise in global oil prices inflated its imports bill, and due to Gulf War, over 100,000 Indians had to be repatriated from the Gulf region, disturbing remittance inflow into the Indian economy (Robinson, 2011: 2). The balance of payments crisis of 1991, which is cited as the main reason for economic liberalization, was “triggered” in part by shifts in the global balance of power and the refusal of the Organization for Economic Co-operation and Development (OECD) economies to help India overcome the crisis until it undertook major structural reforms (Baru, 2015: 332). India had to change its political and economic outlook. India reached out to the US, by moderating its views on the Afghanistan situation and the Iraq−Kuwait crisis. It changed its views on the Association of South−East Asian Nations (ASEAN), which it used to consider as a pro-US group, and sought to enhance economic cooperation with the group through what is known as its “Look East” policy. The alignments show commitment to address vulnerabilities in the unipolar world, and to counteract the Chinese dominance in South and Southeast Asia (Wulf and Debiel, 2015: 28). India also extended diplomatic recognition to Israel, which has since become a significant defense and strategic partner, besides building partnerships with the

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countries of the Middle East. One commentator notes that India’s curious relationship with the Middle East starts with calling it “West Asia”, as though it were trying to “leapfrog” the stagnant economies of Pakistan and Afghanistan, to connect to the vibrant Persian Gulf (Joshi, 2015: 322). India has important stakes in the region: the Persian Gulf alone is its largest trading partner, a source of India’s oil and gas needs, and home to 7 million Indians whose share of inward remittances constitute almost 50% of the total. Shashank Joshi notes that India’s posture in the Middle East has remained “broadly unchanged”, whose hallmarks may be understood as “reactiveness” and “incrementalism” (Joshi, 2015: 322). This may not be a correct view. In the 1990s, the Gulf War and the Oslo Peace process on Israel and Palestine, revealed divisions between the Arab Muslim world. This gave India diplomatic leeway in the region (Blarel, 2014). India changed its earlier stance of the 1950s and 1960s, when it regarded Egypt as the legitimate spokesman for Arab interests. The widespread Arab criticism regarding the Palestinian Liberation Organization’s (PLO) support of Iraq during the war and a series of Arab–Israeli peace conferences in 1991 mitigated the negative fallouts of India opening up to Israel. This also helped India move from a policy of quasi-privileged partnerships with a few local players in the Middle East, to a policy of multi-engagement with the region as a whole (Blarel, 2014). India has developed relations with each country bilaterally, showing “restraint” in taking sides in inter-Arab disputes, at the same time pursuing commercial interests with all actors in the region, showing commitment to its political and economic interests. Strong strategic partnerships have come up in the last two decades, with Iran, Saudi Arabia, the United Arab Emirates (UAE), and the Gulf Cooperation Council (GCC), with emphasis on cooperation in counter-terrorism and anti-piracy. While opening up its economy to foreign trade and investment, India reached out to both developed and developing countries, especially its immediate neighborhood. It adopted a principle of “non-reciprocity” with the SAARC countries, by which it committed to lower its tariff barriers for goods and services from the neighboring countries, without insisting for the same privilege in return. India placed its economic development at the center of the South Asia region by suggesting that the growth of India would benefit the neighborhood. The seed of this idea could be seen in the 1990s policies of the Narasimha Rao government which liberalized the Indian economy, but the idea got a systematic shape through what came to be known as “Gujral Doctrine” (Baru, 2015: 333). India also changed its views on the trade negotiations under the General Agreement on Tariffs and Trade (GATT), from opposing the Uruguay Round of negotiations to becoming one of the founder members of the World Trade Organization (WTO). Although India may have been “forced” to liberalize in 1991, it managed its integration with the world economy rather well. The Indian economy grew at the

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rate of around 5.5% from 1980 to 2000. This acceleration of growth was associated both with rise in domestic savings and investment rates and with an increase in the share of trade in India’s national income (Baru, 2015: 335). From 2000 until the transatlantic crisis of 2008, Indian economy grew at an average of 7.5% per year, with an all-time high of approximately 9% during 2003−2008. This acceleration of growth and the rise in India’s share of world trade, to around 1.5% by 2010, prompted it to conclude a series of Free Trade Agreements (FTAs) and furthering opening up to Foreign Direct Investments (FDIs). India’s policy of “strategic restraint” has now given way to what I have called “strategic alignment”, which may be noticed between the two phases of its political and economic performance. One can claim in hindsight, that India could have achieved a high growth rate in the first phase (1947−1980) had it not insulated its economy from the global market. This view is built upon the spectacular growth of 7.5–9% of the subsequent phase, which India registered after integrating its economy with the global economy. This view assumes that it was the balance of payments crisis that forced India to open up to the global market, and that it turned out to be a blessing in disguise for it brought high growth rates. This could only be partially true. Rahul Mukherji’s work shows that opening up in 1991 was as much a choice for India, as was deciding to remain insulated in 1966, when it faced a similar balance of payments crisis. Mukherji’s point is that “ideational” change in the state policy paradigm explains two different responses at different time periods to a similar situation. When the technocracy was averse to India’s globalization at the time of the 1966 balance of payments crisis, India refused to follow the dictates of the World Bank and “resumed the most severe version of autarky and economic regulation after 1969” (Mukherji, 2014: 461). In 1991, when the idea of liberalization and deregulation found favor with the policy technocracy, India did not hesitate to open up its economy.

India in the Regional Political Economy The regional dynamics of India’s engagements resembles a complex game, in which every actor seeks to advance its own interests. These dynamics involve India’s neighborhood, notably countries like Pakistan and China, with which it has fought wars over territorial demarcations, and the US, which was sympathetic to Pakistan during the Cold War years, but has been slowly getting closer to India in the last decade and a half. Kanti Bajpai characterizes the regional dynamics of India as that of a “protracted conflict”, and locates its cause in the “postcolonial sovereignty” of the actors (Bajpai, 2015: 21−25). In the case of India and Pakistan, the conflict ­originates in the respective “cartographic imaginations” of nationhood, through

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which India views Kashmir as a symbol of its secular nationalism, whereas for Pakistan, it remains a symbol of religious nationalism, as also a way for reaffirming the “two-nation theory” which formed the basis of its own creation. Kashmir, according to this theory, substantiates the view that Muslims in the northwestern part of the Indian subcontinent belong to a Muslim nation, and should be freed from Hindu domination. Pakistan’s irredentism over Kashmir follows this logic (Ganguly, 1995). Other scholars have viewed India’s claims as part of the problem (Varshney, 1991). Kashmir’s economic and strategic importance may also be debatable, and that India’s reaction may be exaggerated as well (Bajpai, 2015: 24). There is a territorial issue between China and India also, over the validity of the Johnson Line and MacMohan line, and over the status of Tibet, whose accession to China is questioned in the same way, as is Kashmir’s integration to India (Garver, 2001). India makes no irredentist claim on Tibet, but the Indian sense of responsibility towards Tibetans, especially giving political asylum to the Dalai Lama, raises concerns for China. China claims some parts of the northeastern Indian territory of Arunachal Pradesh and in the Aksai Chin region of Ladakh. Its “all weather friendship” with Pakistan raises suspicion in India, over its position on Kashmir, and on larger geopolitical issues of the region. The US involvement in the region dates to the Cold War years, when its stance on Kashmir was seen favoring Pakistan’s position. India viewed the US policies as “constraints” on its own regional maneuverability, as the threat of the American intervention in regional conflicts was always a possibility. India, Pakistan, and China are nuclear-enabled, which makes the region a potential negative sum game, where every actor feels that the other is benefiting at its cost. The conflicts are likely to remain “protracted”, because the conventional military weakness of one actor neutralizes the stronger actor’s capacity to make it a zero-sum by changing the territorial status quo to its advantage. Political solutions are desirable but look distant, given the domestic public’s emotions attached to the claims. Between India and its four other neighbors, such as Nepal, Bhutan, Bangladesh, and Sri Lanka, there exists asymmetry in territorial and population size, levels of economic growth and military capacities. India’s relation with them, with the exception of Bhutan, has been characterized by mistrust and suspicion until the 1990s, with brief periods of convergence of interests (Murthy, 2000: 1412). There was a fear in Nepal, governed by monarchy, and Bangladesh, under the military rule, that democratic India could influence similar elements in their societies. Anti-Indianism fashionably overlapped with their nationalisms. The ruling elite adopted anti-India policies and developed linkages with external powers to bolster their own position in the country and in the region. India saw this attitude as insensitivity to its own interests. India and Sri Lanka shared different perceptions on the Tamil ethnic crisis in Sri Lanka and over adopting measures for solving the crisis. With Bhutan, India’s

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relation has been relatively steady, with economic grant assistance from India for its 5-year plans, joint partnerships for hydroelectricity, and mutual appreciation of each other’s security concerns. Hydropower is seen as main economic activity in Bhutan that could make it self-sufficient, but growing and unsustainable trade imbalances, and setbacks in the hydro projects promised by India raises concerns for Bhutan (Langsam, 2017). The regional geopolitical dynamics affects economic engagements among the actors also. After the Indo-China war of 1962, trade between the two officially resumed in 1978 and the Most Favored Nation Agreement was signed in 1984, as Alka Acharya points out, but it was merely worth US $339 million in 1992. Once the two countries decided to enhance economic partnership, without prejudice to each other’s political positions on territorial boundaries for which special representatives were appointed, trade levels rose to US $8 billion by 2003. In 2004, India became China’s 11th largest trade partner, with the volume increasing up to US $13.6 billion. The trade target of US $20 billion by 2008 was reached 2 years ahead of schedule, and trade of US $60 billion worth was reported in 2010. The volume was expected to cross 100 billion in 2015. In 2000−2012, the trade between the two was fastest growing (Acharya, 2015: 364). The Indian export basket is however limited, comprising primary products mostly, and trade deficit for India has been rising since 2005−2006. India has been demanding market access to Indian pharma and IT where it has advantage over China, but the progress is slow on these accounts, as is the Indian efforts for improving its infrastructure and manufacturing. The political leadership of both countries has discussed creation of a China−India common market based on the model of European Union, which could be the largest economic system in the world, if realized, with a consumer base of 2.5 billion (Ambrose, 2017). Trade relations between India and Pakistan has been held hostage to the four wars (1947, 1965, 1971, and 1999). Both have fought over Kashmir and the liberation of Bangladesh. Localized and low intensity conflicts have been common, and Pakistan’s policy of cross-border terrorism continues to needle India. The low level of trade could be the result of Pakistan seeking to “protect” itself by keeping India at arm’s length (Basrur, 2015: 378). Trade between the two began to increase after the 2001−2002 crisis, when Pakistan realized that nuclear capability has made confrontation a negative game. Trade was a mere US $521 million in 2004−2005, which grew to US $2.35 billion in 2012, although the potential for growth is nearly ten-fold (Mehdudia, cited in Basrur, 2015). India−Sri Lanka economic linkages are growing with a big boost after conclusion of the India−Sri Lanka FTA in 2000. Trade has multiplied as much as 8 times, crossing US $5 billion in 2011−2012 (see Suryanarayan, 2015: 422). India’s economic engagements with Nepal include hydroelectricity projects, and trade in goods and

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services, with the Nepalese goods enjoying free access into Indian markets (Muni, 2015: 403). India accounts for nearly 60−70% of Nepal’s external trade, but Nepal has trade deficit problem. Indian FDI is reported to be almost 50% of Nepal’s total in 2013. Trade between India and Bangladesh has risen from US $1 billion in 2001 to $4.5 billion in 2012, of which Bangladesh’s share is US $0.5 billion (Datta and Srinivasan, 2015: 394). River water-sharing, illegal migrants from Bangladesh remain contentious and emotive issues, and rise of Islamic fundamentalism in Bangladesh poses a security challenge to India. India and Bangladesh adopted a land and boundary agreement in 2015, which could address border issues affecting trade between the two. The economic relationship of India with its neighbors is captive of the political climate and domestic public opinions. The lackluster performance of the South Asian Association for Regional Cooperation (SAARC), the South Asian Preferential Trading Arrangement, and the South Asian Free Trade Arrangement failed to break down trade barriers. The challenge for India, however, comes from the increasing Chinese influence in the region. China’s growing investment in Pakistan, construction of the Gwadar port, and supplying of civil nuclear plants in violation of the Nuclear Suppliers Group (NSG) rules are concerns for India. The Chinese presence and infrastructure building activities in the territory ceded to China by Pakistan in Pakistan Occupied Kashmir renews prospects of political conflicts between India and China (Garver, 2001; Acharya, 2015: 366). China’s investments in Sri Lanka, Bangladesh, and Nepal have been seen as challenging the traditional Indian influence in the region. Ashlyn Anderson and Alyssa Ayres note that over the past decade China has become a significant partner to the South Asian countries, forging ties through trade, diplomacy, aid, and investment (Anderson and Ayres, 2015). China overtook India as Bangladesh’s top trading partner in 2005, displacing many Indian goods in Bangladesh. China’s trade with Nepal and Sri Lanka still lags India’s, but the gap is not too wide. China’s Silk Road project is likely to enhance its influence in the region, which puts it in competition with India over “economics of influence” in South Asia. Christian Wagner argues that India’s position in South Asia, as compared to China’s, is disadvantageous, and blames the lack of clarity on the part of India to pursue its regional ambitions seriously (Wagner, 2016). Recent political skirmishes between India and China over Dokhlam, a Bhutanese territory which India considers strategically important and vital for geopolitical interests, may suggest toward the “politics of regional influence” also. China’s road construction in the region, which it calls its own, was met with resistance by India and Bhutan. A shrill propaganda by the Chinese state-controlled media followed, pointing to Indian “intrusion” in its territorial sovereignty, but China did not find much support from other powers of the world. The Indian and the Chinese troops

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decided to disengage after a standoff that lasted for more than two months. As BRICS members, however, both resolved at the ninth summit held in September 2017, for “healthy, stable” ties between China and India.6 The ninth BRICS summit discussed issues such as terrorism, trade and cooperation in agriculture, energy, environment, climate change, sports, and culture. Significantly, the Pakistan based terrorist groups were identified along with other organizations for the first time in the declaration expressing “concern” on the security situation in the region and violence caused by these outfits. One would notice that India’s “strategic alignment” policy would enable it to combine assertiveness of its role along with seeking convergence in other areas of cooperation, without allowing the political considerations to trump the economic ones.

Rising Power Ambitions and the Domestic Constraints India’s impressive economic growth during the last two decades, which continued above world average even during the slowdown of 2007−2008, has bolstered its ambition of becoming a “leading player”.7 Its “strategic alignments”, political and economic, are directed toward this object now. Consider South-East Asia, where India follows a policy of Act East now, as compared to the Look East policy of 1990s. In fact, it has proclaimed itself as a “new” player in Southeast Asia by making clear its intention in preserving freedom of navigation in the South China Sea. At the same time, it has intensified ties with the ASEAN to neutralize the growing Chinese assertiveness in the region. In a similar way, it has shown determination to secure its interests in the Indian Ocean Rim despite a new Chinese presence in these waters. It is a conscious decision on India’s part to invest in enhancing naval capabilities for power projection around the Indian peninsula. It is the same understanding which motivates India to build engagements with Iran and the UAE simultaneously, and make efforts to win over Saudi Arabia, long considered as Pakistan’s friend. India recognizes that Pakistan is likely to continue to pose intractable problems, through proxy means such as cross-border terrorism, or through China’s influence in global political economy where India is seeking “redistribution” and “recognition”. China has scuttled India’s membership to the Nuclear Suppliers  The Indian Express (5 September 2017) reports the Chinese President, Xi Jinping telling this to the Indian Prime Minister, Narendra Modi. 7  Although India’s foreign policy has been directed toward this goal for quite some time now, the Indian Prime Minister articulated India’s role as a “leading player” in his message to Indian Missions on 7 February 2015. The document can be accessed through this link: http://pib.nic.in/newsite/PrintRelease.aspx?relid=115241 (accessed 27 December 2017). 6

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Group (NSG) for now, ostensibly for evolving consensus over “fair” and “transparent” criteria for the non-NPT signatories w ­ illing to join the group. It is believed however that China acted to promote interests of its “all-weather” friend Pakistan and to block India’s rising influence. A similar motive guides its “technical hold” on India’s initiative in the UN Security Council to get Pakistan sponsored terrorists designated as global terrorists. India has refused to be distracted, rather has gone ahead in stabilizing the subcontinent with renewed outreach to its immediate neighbors. If SAARC could have no summit meeting in 2016 because of Pakistan’s support to cross-border terrorism, the Bay of Bengal Initiative for Multi-Sectoral Technical and Economic Cooperation (BIMSTEC) advanced the engagement among the neighboring countries, leaving out Pakistan. India wants to claim a leading role at the global stage. With this understanding, India reaches out boldly to create an intra-Asian balance against China. It has forged a new partnership with Japan. It maintains an even relationship with Russia despite the latter’s growing proximity with China and Pakistan. At the same time, it does not hesitate to engage China through trade and economic partnerships, and through a visiting membership to the Shanghai Cooperation Organization (SCO), considered as the zone of Chinese influence. Other important partners like France, Germany, the United Kingdom, and Israel get no less attention. The most remarkable partnership to have evolved in recent times is the one with the USA, which has put its weight behind India’s ambitions. There is a temptation to support India, a like-minded democracy as a counter-weight to the authoritarian China. The George Bush presidency began consciously to assist the growth of Indian power. China’s military buildup and modernization of its army, and its tactics of intimidating the smaller states in Southeast Asia on its claims over islands in the South China Sea has brought India and the US closer. The US has been a key destination for India’s skilled labor, it has supported India with capital and expertise, and it has declared its support for India as a permanent member of the UN Security Council. The US and India are partners for a civil nuclear cooperation arrangement. This agreement facilitated India’s entry into the Missile Technology Control Regime (MTCR), and help develop negotiations for India’s entry into the NSG. India has been actively seeking “democratisation” of the UN Security Council, as part of the G4 which includes Japan, Germany, and Brazil, because it believes that the Council should reflect the reality of the 21st century. All permanent members of the UN Security Council, including China, acknowledge in public that India should be playing a greater role in international affairs. One may note that India’s geopolitical strategy has been commendable. Consider India’s power projection in the Indian Ocean Rim, where China is also expanding its presence. Indian armed forces are large and perhaps adequate for frontier defense.

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Moreover, in view of the assessment that the days of full-scale wars are over, there is little incentive for India to increase its army’s strength. But if India has to play a bigger role in the Asia-Pacific, modernizing its armed forces is imperative. The current and prospective defense budget constraints imply that India has been unable to negotiate with its recalcitrant and inefficient bureaucracy. This consequently limits its capacity to provide the protective reassurance sought by many smaller states in the Asia-Pacific. To be sure, India spent US $10.5 billion between 2004 and 2007 on creating the world’s fourth largest military, and it was expected to spend more than US $45 billion on arms purchases between 2009 and 2013 to modernize its army (Robinson, 2011: 5). Its advanced missile technology makes it capable for planning long range ICBMs that could target China and the US But it must “court” the US for its objectives in the Indian Ocean (Berlin, cited in Robinson, 2011: 5). The US remains the key external actor in the region, with its military presence stretching from North and East Africa to the Persian Gulf and Arabian Sea, east to Singapore, and southwards to Diego Garcia. Experts noting India’s potential to become a global power do not doubt India’s growing political weight. The position of India in global governance is that of a “swing-state”, by which it is meant that India is not strong enough to be an independent pole, but its presence in any international grouping would strengthen that group significantly. The essence of being a “swing” state is merely being a balancing power. A balancing power does not command the same degree of autonomy as say, an independent pole like the US commands in the global polity today. As an independent pole, the US is a “system-maker”, whereas as a “swing” state India is only a “system-shaper”. As a “system-shaper”, India can influence various issues, but cannot determine outcomes against the core inclinations of the great powers. Clearly, it is the preferences and strategic objectives of the US which define the configuration of the global system, and this capability gives to it a preponderant position in global affairs. There is a clear “inconsistency” in India’s own projected role and its recognized status in the global affairs. Concerns are also expressed over its ability to sustain its economic growth. State power may be understood as a composite of the following: (a) material resources; (b) the ability of the state to extract these resources from its society and use them for defined political goals; and (c) influence over outcomes (see Tellis et al., 2001). The rising powers’ primary influence comes from managing its economic growth, which may help achieve outcomes sometimes disproportionate to its actual material power (Hart and Jones, 2010: 65−76). The first two attributes remain important for any state to maintain a degree of autonomy from domestic or foreign veto-wielders. But the Indian state is insufficient in both these attributes, even as it transiently shows promise with respect to the third attribute.

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Virmani (2005: 14) suggests that China and India will remain among the three to five fastest growing economies in the world during the next 20 years or so. Consistent with India’s own perception, contemporary projections out to 2050 also suggest that India will become a true pole by then (Tellis, 2016). China, the United States, the European Union, and India are projected to be the principal global entities dominating the international system in 2050. But, India’s share will be only 7% of global product against China’s 20%. The US and the EU are likely to contribute 17% each. The implication is that even if India becomes a true pole, or a “system-maker”, it will remain the weakest of the principal global players, and its rising power ambitions could be in serious jeopardy unless it acts upon expanding its capabilities. Domestic constraints however pose a challenge for India’s capability augmentation. There is a convergence among the Indian political elite over the security question. The plan for modernizing its army is likely not to face much resistance. But the policy of “strategic alignment” in economic affairs suffers because there is a tendency of resistance against moving away from the Nehruvian model of regulated economy. India’s reliance on its bureaucracy for redistribution of economic benefits aggravates the problem. Subsidy reduction, labor law reforms, and trade liberalization policies invite vehement opposition from civil society and from the vested interests within the state structure. Electoral competition sharpens social cleavages, and thus it constrains the Indian state for pursuing its rising power goals autonomously. Indian society must address the demands of social justice, but very often redistribution takes place keeping electoral prospects in mind rather than in accordance with sound fiscal policies. Corruption depletes the scarce resources the state earmarks for redistribution. The state is often curiously present in areas where it ought not to, for example, in producing private goods, and it is seriously deficient in areas where it has no substitute, such as administering law and order. The state capacity for resource extraction is poor and inadequate. India’s tax-toGDP ratios are among the lowest of G20 members and of the BRICS countries. India has low savings rate compared to its investment needs. Its high growth is “driven more by productivity increases than by factor accumulation”, which may not be sustainable over a long period (Tellis, 2016). It is necessary therefore that the rising India adopts structural transformation for the success of its growth story. It cannot become a “system-maker” or a “leading player” if it continues to follow a policy of economic isolationism. Foreign trade can create opportunities for its demographic profile, and address severe infrastructural limitations. Given domestic constraints however, trade pessimism is not easy to achieve. Gains from multilateral engagements like BRICS will be limited, at least in near future, given these limitations. India is highly dependent on energy imports; therefore, it cannot remain isolated from the world market, nor can it ignore securing shipping lanes for the

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transportation of oil, from Iran and Burma to as far as abroad as Sudan and Nigeria. Nearly half of the global sea-borne trade passes through the Indian Ocean, and almost 65% of the world’s oil and 35% of its gas reserves are found in the littoral states of the Ocean (Robinson, 2011: 4). By opening up to a trade-led growth regime, India cannot only secure its energy needs, but rather also augment its capacity to protect its interests in the Indian Ocean region. The Indian Ocean region today witnesses an increased Chinese presence, and frequent disruptions by non-state actors like organized pirates or terrorists. Besides, there is always a possibility that its supply chain could be disrupted at “choke points” such as the Strait of Hormuz, the Gulf of Aden, the Suez Canal, and the Strait of Malacca which may have serious consequences in case of war (Robinson, 2011: 4). If India sees itself as a potential global power, its strategic calculations should be completed by reaching out to the rest of the world. India’s “strategic alignments” are praiseworthy in political matters, but are found lacking on the economic front. Its ambition of becoming “a leading player” is limited by its current capacity.

Future Prospects BRICS presents an opportunity for “coexistence” of rising powers (de Coning et al., 2015). The coalition could rule the world by providing the engine of global growth, by influencing political decision-making of other countries according to its own interests, and by providing global knowledge and ideas. Francesca Beausang points out that the emerging markets or rising powers, in particular the BRICS group, lack the ability to innovate which threaten their economic domination also (Beausang, 2012: 10). In terms of organization, the members of the BRICS coalition have overlapping memberships in similar initiatives, in groupings such as, India, Brazil and South Africa (IBSA) and Russia, India and China (RIC). It will be worthwhile to assess the impact of multiple membership of the members on the effectiveness of BRICS. As BRICS has come up as a coalition of countries which are bound together by a colonial past, with a shared aspiration to challenge the Western domination in the global affairs, it remains to be seen how each member’s strategic interest does not overshadow the shared aspiration. The key will be to strike a delicate balance between what they hope for themselves individually and collectively. What is at stake here is whether forming issue-based coalitions would translate into a capacity for shaping global rules, given that their interests do not always align (see Chitalkar and Malone, 2015: 588). Both India and Brazil aspire for a permanent seat on the UN Security Council, for example, which does not find favor with both Russia and China.

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Energy is an emerging field where all BRICS members have substantial interest in competing with each other. Africa’s resources have already invited Chinese and Indian investments, and the Chinese influence in Africa is already being talked about as a “neo-colonial” project (see Larmer, 2017). It will be interesting to examine whether India and China cooperate over this agenda, or project it as part of their rising power ambitions which could take the form of a zero-sum game. Where will this leave South Africa, Brazil and Russia? The BRICS coalition members are not united over WTO negotiations, much less do their views converge on climate change commitments. Most arbitration complaints in the WTO are from the member countries against each other. This is not a sign of “coexistence”. Will the coalition succumb to the varied interests of the members?

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CHAPTER 4

China and Global Economic Governance Ka Zeng Department of Political Science, University of Arkansas, USA

Introduction China’s rapid ascent in the global economy and rising influence in multilateral economic institutions have given rise to an increasingly large body of literature on the country’s role in global economic governance. This chapter engages in a preliminary review of this body of literature. In addition to outlining the major themes and arguments in the debate, it will identify emerging research agendas and areas for future research. It will be argued that earlier analyses of China’s role in global economic governance tend to focus on the question of whether China is operating within the parameters of the postwar institutional arrangements or whether it has sought to challenge the established standards, rules, and norms underlying these institutions. These studies try to do so by documenting the evolution of Chinese approach over time or assessing China’s position vis-à-vis both the existing players and other emerging powers. A second strand of literature probes in greater depth into the sources of Chinese behavior to address such questions as domestic influences on China’s role in the global economy, the degree to which it is being socialized into global norms and rules, and how key features of the existing regimes in turn affect China’s integration into the liberal international economic system. There seems to be broad consensus that Beijing has not sought nor brought about significant changes to key global norms and rules in areas such as trade and investment, even though it seems to be increasingly challenging the status quo in other issues areas such as aid and 55

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development financing. Studies that fall into this line of inquiry cull evidence from a wide range of global governance institutions, including those in the areas of trade, finance, aid, intellectual property rights, and climate change. They are also characterized by considerable methodological diversity to include not only qualitative studies based mainly on case studies, but also increasingly quantitative analyses that utilize a large-N research design to assess the main research questions. Driven by China’s more recent efforts to create new institutions outside of the existing institutional infrastructure such as the Asian Infrastructure Investment Bank (AIIB) and the New Development Bank (NDB), a nascent body of literature extends the previous analysis to examine the drivers of these moves, the opportunities and challenges for the successful implementation of these projects, and the extent to which these efforts to promote alternative multilateral arrangements could seriously undermine the liberal international economic order. The prevailing view that emerges from these studies seems to be that China is generally operating within the parameters of the existing system, even though it is at the same time pushing for modest and incremental reforms in certain issue areas. The rest of this chapter first outlines three major phases in the evolution of scholarly discourse on China’s involvement in the global economic system. It will then address a set of additional questions that are relatively understudied but are capturing growing scholarly attention. The chapter concludes by reflecting on gaps in the existing literature and identifying directions for future research.

Earlier Assessment of China’s Behavior in Global Economic Governance China’s growing participation in international institutions has captured considerable scholarly interest starting in the 1990s. Earlier literature on China’s rising influence in the global economy tends to focus on the conditions that facilitated its global economic ascendance (Lardy, 2002), the progress and problems of China’s integration into the international economy (Economy and Oksenberg, 1999), China’s early experience with multilateral economic institutions such as the World Bank, the International Monetary Fund (IMF), and the General Agreement on Tariffs and Trade (GATT) and its successor, the World Trade Organization (WTO) (e.g. Jacobson and Oksenberg, 1990), or how to manage the integration of China into the established multilateral economic institutions (Johnston and Ross, 1999; Pearson, 1999). The growing interest in China has also been a broader trend in the academic literature that examines the increasingly active multilateral engagements of rising powers in the global economy. Starting in the early 2000s, a growing number of books and articles (Hogue, 2004; Friedman, 2005; Prestowitz, 2005) have started

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to caution about the disruption that the rise of emerging powers posed to the international economic system and the “global power shift” from the West to the East. This body of work additionally looks at the distinctive characteristics of this group of countries and the strategies they have adopted to promote their interests in international institutions and to push for change in the global economy. For example, Narlikar (2002, 2010) examines the successful bargaining strategies that China, along with other emerging powers such as Brazil and India have adopted in the international economic system. In particular, she emphasizes how developing countries and rising powers can enhance their bargaining power through the effective use of strategies. Studies in this tradition focus on developing country bargaining positions and power, as well as the tactics and strategies they use to promote their interests. However, the empirical focus of these studies tends to be on developing countries as a whole rather than on China specifically. At the same time, the progressive growth in China’s influence has inspired an increasingly large body of literature on the question of whether China is a cooperative player in the global economy. These studies tend to focus on China’s early experience in international economic institutions such as the WTO, emphasize Beijing’s “learning” experience in the organization, or assess China’s participation record against those of other emerging powers. Pearson (2006), for example, argues that far from mounting a direct challenge to its key rules and principles, Beijing has been a cooperative player under the WTO’s institutional rubric. Citing China’s support for the trade liberalization agenda of the Doha Round multilateral trade negotiations and China’s broad adherence to the rules of the organization, the study contends that, with the exception of Chinese behavior on Taiwan, there is little indication that Beijing is challenging the rules and norms of the WTO. Kennedy (2008: 5−6) examines China’s participation in the WTO and two standards-setting organizations, concluding that as a new WTO member with a relatively steep “learning curve”, China has at best played a modest role in the WTO. He emphasizes that while China is generally playing by the rules of the regime, its relative inexperience, the weak capacity of Chinese economic diplomats, and “inadequately institutionalized channels” of government-business consultation on international economic policy have prevented Beijing from effectively promoting its interests within the organization. In a similar vein, Wang and French (2014) examine China’s behavior in global economic governance, concluding that while the country is generally an active player, its level of participation is not commensurate with its status as the second largest economy in the world. The study further attributes such a gap to Beijing’s pragmatic economic interests. Through an examination of China’s involvement with the G20, Ren (2015) reaches a similar conclusion that while China has actively participated in the G20 process and generally accepts prevailing international rules

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of the game, it remains a reform-minded status quo power which at the same time seeks opportunities to enhance its institutional power and push for constructive changes within the existing system. Still other works address the question of whether China is a responsible stakeholder or a system transformer through detailed studies of China’s performance in such areas as multilateral trade negotiations (Gao, 2012, 2015; Gao and Lewis, 2005), global climate change negotiations (Zhang, 2012), energy security (Chan et al., 2012; Li, 2012), global health (Chan, 2011), and G20 cooperation (Kirton, 2016). Overall, a relatively large body of literature addresses the question of whether China has sought to change the rules of the global order. There also seems to be a preoccupation with Chinese “learning” over time across different areas of global governance institutions. The predominant view that emerges from these studies is that while there are areas where Beijing is not entirely content with the existing rules and norms such as in the area of financial regulation, it is generally comfortable with and an advocate of the status quo. Furthermore, even though Beijing has sought modest, incremental changes in certain areas, these moves cannot be construed as efforts to rewrite the rules of the global governance system.1 Substantial change in Chinese behavior in a more active and reformist direction would therefore depend on major changes in both the Chinese domestic economy and in the relationship between Beijing and the dominant leaders of the existing international system.

Sources of Chinese Behavior While the above literature tends to focus on how to “manage” the integration of China into the global economy or assess the extent to which Chinese behavior challenges the “rules of the game”, more recent studies place increasing emphasis on the drivers and sources of Chinese behavior. In addition to characterizing China’s position vis-à-vis the status quo powers, these studies further investigate the sources of Chinese behavior, paying particular attention to the constraining influence of norms, domestic politics, and international institutions. Socialization and Normative Influences One strand of the literature has sought to explain China’s behavior in global economic governance from the perspective of socialization and normative influences. This approach suggests that frequent interactions between Chinese actors and their  For an example of a study that expresses this view, see, for example, Kennedy and Cheng (2012). 1

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foreign counterparts generate a dynamic social learning process, whereby international norms become increasingly internalized. From this perspective, through increased interactions, China has gained a better understanding of how the system works and, as a result, has developed a greater stake in the maintenance of the status quo. In other words, engagement with multilateral institutions has exerted a gradual socialization effect, leading to behavioral changes which are generally system conforming. Kent (2007) provides a detailed treatment of such socialization processes through an examination of China’s interactions with leading international organizations such as the IMF and the United Nations Environment Programme. Harpaz (2010) applies the above insight to explain China’s evolving approach toward the WTO dispute settlement mechanism (DSM). Specifically, she finds that while China has been a conciliatory defendant and reluctant complainant in its earlier engagement with the DSM, its approach has gradually evolved into a more aggressive one that is more amenable to international adjudication. She further attributes such changes to the socialization effect of the country’s intense participation in the DSM. Li (2012) reaches similar conclusions, suggesting that normative, rather than material constraints, are crucial to explaining China’s inactivity in the initial years of its WTO membership. Harpaz (2016) further adopts a norms-driven approach to explain China’s profile in international economic governance, finding that as a result of socialization, China is becoming more entrenched in the existing system and, as a result, is likely to continue to uphold the status quo even as it pushes for modest and incremental reforms in certain areas. In the area of China’s international financial relations, Ferdinand and Wang (2013) make a similar argument that the history of China’s engagement with the IMF illustrates how China has been socialized into prevailing global governance norms, even though continuing concerns about potential overdependence on the organization has led it to seek alternative ways of enhancing its own leverage and influence such as through Asian regional financial cooperation. Overall, most authors seem to concur that, with some exceptions, frequent interactions with multilateral economic institutions have led China to align its interests with prevailing international norms and to develop a stronger stake in the perpetuation of the status quo. Domestic Sources In spite of its authoritarian political structure, scholars have increasingly recognized the growing pluralization of China’s political process and its influence on Chinese foreign policy. As a result, a growing stream of work increasingly turns to the domestic drivers of China’s role and behavior in the multilateral economic system,

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emphasizing in particular the constraining effects of leader cost-benefit calculations, domestic interest groups, and political institutions. Leadership Preferences Given China’s highly centralized decision-making structure and its complex and often opaque decision-making process, some of the studies that approach China’s role in the global economy from the perspective of domestic politics adopt a rationalist approach to emphasize the cost-benefit calculations of the top leadership. Such a rationalist, leader-oriented cost-benefit framework emphasizes both the tangible and intangible economic and political interests underlying the calculations of top elites that influence China’s foreign economic policy.2 In analyzing the policy preferences of domestic actors toward international cooperation, such a framework stresses how, in spite of the proliferation of societal interests and their growing ability to influence the decision-making process in an authoritarian regime such as China, top elites are nevertheless uniquely positioned to defend the country’s economic interests, including industrial policies (Blanchard and Ripsman, 2008). As top elites in China seek to enhance the country’s economic and technological competitiveness, promote further market liberalization, and boost long-term economic growth potential,3 it is reasonable to expect that they will continue to use the instruments at their disposal to influence China’s foreign economic relations in ways that enhance the country’s wealth and power, as well as influence in global economic governance. Applying a leader-oriented cost-benefit model to China’s accession negotiations to the WTO, Blanchard (2013a) argues that such a model best explains the country’s arduous and prolonged accession processes, its strong push for membership in the second half of the 1990s, and its willingness to accept stringent accession terms. Blanchard (2013b) further applies this model to examine the variation in China’s compliance with its commitments to the Trade-Related Investment Measures (TRIMs) across different issue areas. Specifically, he argues that Chinese leaders are more likely to comply with their TRIMS obligations when the benefits, measured in terms of access to foreign capital, technology, and global markets and job creation outweigh the costs, measured in terms of potential dependence on foreign suppliers, foreign pressure, the potential for WTO disputes against China, and an  For studies that emphasize the key theoretical propositions of the rationalist approach to international institutions, see Keohane (1988), Harsanyi (1969), Hasenclever et al. (2000), Martin and Simmons (1998) and Hudson and Vore (1995). 3  For studies that emphasize such elite motivations, see, for example, Blanchard (2013a) and Wang (2005). 2

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unfavorable trade balance, and vice versa. As such, the analysis highlights how domestic considerations may limit the extent to which the WTO can influence or transform Chinese behavior. In his study of China’s role and position in the Doha Round trade negotiations, Tu (2013) attributes Beijing’s inability to adopt more cooperative stances at the WTO to the lack of strong leadership interests and control over the negotiation process. In a similar vein, a recent study by Harpaz (2016) analyzes the variation in China’s performance across three global governance areas — trade, investment, and development aid — and yields some support for a rationalist state-centric approach. In both areas of international trade and investment, the Chinese leadership has not sought to rewrite the rules as the benefits from preserving the system far outweighs any potential costs. As integration into the global trading system promises to promote trade and hence economic growth which is critical to regime survival, it has adopted an approach that is generally supportive of the maintenance of the existing system. Furthermore, the fragmented international investment system also enabled the Chinese leadership to successfully secure access for its outward foreign direct investment (FDI) and promote inward FDI. This provides a sharp contrast to China’s approach to the international development aid regime where it has sought to more aggressively pursue its own development financing model in order to gain access to the natural resources and markets that are vital to the country’s long-term economic growth. A state-centric, leader-oriented cost-benefit framework has also been utilized to explain China’s approach to international monetary policy. Germain and Schwartz (2015) examine the limits to RMB internationalization, arguing that Chinese domestic elites are unlikely to adopt unpopular policy measures to support the RMB as an international currency, such as increasing imports and moving away from investment and export production to domestic consumption due to the potentially negative implications of such measures for political stability and regime survival. This would in turn dampen the prospect that the RMB could rival the US dollar as an international reserve currency. He (2015) examines the domestic forces behind China’s push for the use of the RMB globally, emphasizing in particular how the desire to promote domestic economic reforms represents an important motivation behind the People’s Bank of China (PBoC)’s push for the internationalization of the currency. Taken together, the above studies emphasize how top leaders in China are often able to override domestic pressure in order to defend their key foreign policy and national interests. To the extent that the benefit from international economic integration outweighs its costs, this approach would predict continued Chinese support for key regime norms, rules, principles, and decision-making procedures.

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Interest Groups In addition to emphasizing the strategic role of top elites in defining China’s key foreign policy interests, scholars have increasingly recognized the growing ability of domestic interest groups to influence China’s international economic policy. Underlying such an approach is the recognition that even though leaders in an authoritarian regime such as China may be less sensitive to domestic audiences than in a democracy, the deepening of China’s economic reform in the past decades has substantially opened up the policy space to allow for greater input of domestic interest groups, bureaucratic institutions, and non-governmental organizations.4 Studies following such a line of inquiry thus increasingly devote attention to how support or resistance from key domestic interest groups has shaped China’s approach to global economic governance. For example, it has been argued (Chin and Stubbs, 2011; Jiang, 2008; Ravenhill and Jiang, 2009) that domestic interest group opposition plays an important role in explaining the exceptions and carve outs in China’s free trade agreements (FTAs) such as the China−ASEAN or the China−Australia FTA. Pressure from domestic industries has also been found to be an important factor influencing China’s WTO dispute settlement and FTA strategy (Liang, 2007a). The role of domestic politics has also been recognized in studies of China’s global investment, financial, and monetary policy. For example, Shi (2015) adopts a domestic political economy approach to the study of China’s outward FDI (OFDI) and develops an argument that emphasizes the interaction between state preferences and state-owned enterprises (SOEs)’ profit incentives. From this perspective, the symbolic relationship between Chinese political elites and SOEs enabled the latter to take advantage of the preferential policies provided by the state to take on excessive risks in their investment decisions. This helps to explain the puzzle as to why Chinese OFDI is frequently drawn to developing countries with a risky investment environment. In the area of international monetary policy, Steinberg and Shih (2012) highlight how the preferences of domestic interest groups, in particular those of the tradable industries, visibly influenced China’s exchange rate policy. Steinberg (2015) suggests that China’s current financial policies emphasize the retention of capital controls and continued government intervention in the foreign exchange market. As the political balance generated by such policies is tilted in favor of the winners from the current policies at the expense of the losers, this should dampen the prospect for substantial policy change in the absence of political reform. In a similar vein,  On this point, see, for example, Lampton (2000); Mertha (2009).

4

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scholars have emphasized the importance of domestic political divisions for Chinese foreign exchange reserve accumulation (Steinberg, 2014), China’s engagement with international macroeconomic policy surveillance (Walter, 2014), Chinese leaders’ preference for monetary bilateralism (Jiang, 2014), the move toward capital account opening and RMB convertibility (Volz, 2014), and Beijing’s use of economic power as a tool for realizing the country’s strategic foreign policy interests (Norris, 2016). An important finding that emerges from these studies is that the political cleavages in China surrounding foreign exchange and monetary policy are unlike those found in other countries. Policy outcomes often reflect the Chinese policymakers’ parochial political interests and competing interests of domestic interest groups. In other words, one can apply the conventional political economy approach to understand China’s international monetary policy, even though the specific configuration of forces underlying China’s international monetary policy may be different from that in most other states. Political Institutions While pressure from domestic interest groups influence the demand for international economic cooperation, political institutions play an important role in aggregating these preferences and shaping the policy outcome. Consequently, scholars have devoted some attention to the influence of domestic institutions on China’s ability to engage in either regional or multilateral economic cooperation. For example, Liang (2007b) emphasizes how changes in domestic institutional arrangements brought about by the government restructuring in the late 1990s altered the preferences of domestic ministries, thus facilitating the negotiation process leading to China’s accession to the WTO. Pearson (2010) highlights the domestic institutional constraints on China’s leadership in East Asian economic cooperation mechanisms, arguing that a fragmented decision-making structure, a heavy reliance on top level decision-makers who tend to attach relatively little attention to regional economic cooperation, and the lack of autonomy of negotiators have impeded Beijing’s ability to play a greater leadership role in the region. Going beyond specific institutional configurations, the influence of China’s distinctive economic structures of state capitalism has also received some scholarly attention. For instance, Wang (2014) points to the constraints that salient institutional features of China’s state capitalism place on Beijing’s ability to address the country’s large external imbalances. Wu (2016) stresses the challenges that the so-called “China Inc.” model poses to the WTO legal system, arguing that while the WTO system has so far been effective in handling a number of China-related trade issues, it faces continuing challenges in effectively designing a set of predictable and fair legal rules in order to address thorny issues arising out of the close

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relationship among the government, the Party, and domestic firms as well as the country’s non-market economy status. Overall, studies that approach China’s role in the global economy from the point of view of domestic politics emphasize that despite continued control by the central government, the policy making process has gradually become more porous to allow for a wider range of domestic interests and voices. This contrasts with still another approach discussed below which puts greater weight on the influences of the international system. Influence of International Institutions While studies mentioned in the above sections primarily locate the sources of Chinese behavior at the domestic level, still another body of research emphasizes how the character of the existing international system, with its prevailing norms, rules and principles, may affect the prospect of China’s smooth integration into the liberal international order. Starting from the premise of an inevitable power shift between the US and China, Ikenberry (2008) suggests that as China has benefited significantly from its increasing engagement with international institutions based on the principles of non-discrimination and reciprocity, this should reduce the likelihood of major provocations during a period of great power transition. In Ikenberry’s words, the existing international order is based on a dense set of rules and institutions that are “hard to overturn and easy to join” (24). If the Chinese leadership were to adopt a more confrontational stance that seeks to challenge the status quo, then it is likely to face the resistance of not only the US, but also a coalition of countries in the West and this should in turn provide a safeguard to the interests of established powers. While Ikenberry emphasizes how the overall characteristics of the postwar liberal international order affects the integration of China into that order, others examine how specific features of the post-war international economic institutions may influence Chinese behavior. For example, based on a case study of China’s compliance with its WTO obligations in the telecommunications sector, Kobayashi (2013) suggests that as a result of the ambiguities of the WTO agreements and commitments themselves, China has been able to engage in “creative compliance” with its treaty obligations whereby it engages in creative interpretation of the law without explicitly breaching the “black-letter law”. Harpaz’s analysis of China’s WTO commitment in the banking sector (2013) similarly points to how the ambiguities inherent in the General Agreement on Trade in Services (GATS) leave room for countries to engage in flexible interpretations of their obligations. Harpaz cautions that this should complicate compliance and lead us to lower our expectations of

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what compliance and liberalization are capable of achieving in China. Another study by Harpaz (2016) explores how the variation across the international trade, investment, and aid regimes affects China’s policy in each of these areas. Specifically, she finds that as the WTO’s inclusive, consensus-based decision-making process provides the Chinese leadership with veto power over rules change, this has enabled the Chinese leadership to take advantage of the organization’s constraining effect to achieve its own policy objectives. In the area of investment, the fragmented nature of the regime with no one dominant power also generally facilitates Chinese cooperation. However, the above patterns contrast with that in the global aid regime where the dominance of a small number of countries has increased the difficulties for the system to accommodate China’s rising aspirations, leading China to promote its own alternative aid model outside of the existing institutional framework. In sum, the progressive increase in China’s global influence has led scholars to go beyond simply documenting and characterizing China’s involvement in the global governance system to probe the domestic, international, and normative influences on Chinese behavior. These studies are generally of the view that the above forces tend to constrain China from using its growing influence to reshape the rules and institutions of the international system to serve its own interests. As Harpaz (2016) puts it, “China’s national interests, the constraining effect of the institutions in the liberal international economic order and China’s ongoing socialization will drive it towards upholding the status quo albeit with some modest and incremental reform from within.”

Toward Two-Way Socialization in International Economic Institutions If scholarly interest in China’s role in global economic governance in the middle phase of the development of the literature focuses on the question of whether China is a rule follower or a rule breaker in the international economic system (e.g. Li, 2011; Kennedy, 2018), then more recent studies, driven by Beijing’s more active moves to create alternative institutions outside of the existing institutional framework, increasingly go beyond this debate to focus on the two-way interactions between China and multinational organizations. Another related question is whether and how China is seeking to shape and influence the diffusion of international norms to become a rule maker in the international system. Importantly, in view of China’s growing influence in global economic governance, scholars are increasingly directing attention to the degree to which multilateral organizations are making institutional adjustments to accommodate the interests and aspirations of rising states. Chin (2010) and Grabel (2011), for example, suggest

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that partly in response to policy proposals made by rising states, including China, the IMF has made adjustments to its lending policy to increase the flexibility and rate of turnover of its lending practices and provide countercyclical financing to countries confronted with financial difficulties in order to weather the storm of the Global Financial Crisis (GFC). Other studies (e.g. Woods, 2008; Chin and Heine, 2014; Chin, 2015) examine the extent to which multilateral development institutions have made policy changes to accommodate China and other rising powers’ growing role in the provision of development finance. Strand et al. (2016) address a similar question through an examination of China’s relationship with the World Bank and Asian Development Bank (ADB). However, the study reaches the less sanguine conclusion that these existing multilateral organizations have failed to adequately adjust their internal governance mechanisms to account for rising Chinese influence. A couple of chapters in this volume further shed light on this question. For example, Kaya (2018) examines the engagement of large emerging economies (BRICS), including China, with international financial institutions (IFIs) such as the IMF and the World Bank. Drawing on the “voice” and “exit” framework developed by Hirschman (1970), she argues that the BRICS have not only achieved some success in voicing their preference with regard to both the distribution of voting power within the institution and certain policies of key concern to them, but have also been able to credibly threaten to exit from the existing institutions through the creation of the NDB in 2014 and the AIIB in 2015. She further explores the variables that influence the BRICS’ successful exercise of these strategies such as the particular features of institutions, the BRICS’ effective negotiation strategies, domestic politics, and “counter-hegemonic” desires evinced by countries such as China. Parízek and Stephen (2018, Chapter 15) highlight growing conflicts over representation in international economic institutions, showing how institutional stickiness and the established powers’ reluctance to make concessions may result in greater institutional fragmentation, which may in turn raise key questions about the legitimacy and performance of existing institutions. Underlying the above studies is a growing recognition that the socialization process for rising powers may be evolving from the “one-way socialization” seen in the early phase of the rise of a new power, whereby its priority is in seeking integration with the existing norms to the so-called “two-way socialization” whereby the emerging power begins to more actively “shape the environment without directly confronting the hegemon”, promote new solutions to global problems, and take on the role of a “norm-shaper” instead of a “norm-taker”. Subsequent studies examine how changes in exogenous conditions induced by hegemonic decline have provided opportunities for the transition from “one-way” to “two-way” socialization, thus enhancing rising powers’ ability to shape global norms (Chin, 2012). They also

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consider in detail how such “two-way” socialization is taking place in China’s relationship with major ­multilateral organizations such as the World Bank (e.g. Chin, 2010, 2012)5 or the WTO (e.g. Zeng and Liang, 2013).6 Another way in which recent studies are breaking with the older debate about whether China is acting as a stakeholder in global economic governance is in considering the variation in Chinese behavior across issue areas, rather than relying on assumptions about its disposition or “type”. For example, Foot and Walter (2010) identify three factors that shape Chinese behavioral consistency with global norms across issue areas, namely, the compatibility between global and dominant domestic norms; procedural legitimacy and material distributional fairness; and actor perceptions of the implications of their own and other actors’ behavior for the global power hierarchy. According to these authors, the salience of the issue area domestically in turn plays an important role in determining the relative importance of these variables. On issues of macroeconomic surveillance and climate change, for instance, China has demonstrated a lower degree of behavioral consistency with global norms due to the inconsistencies between domestic and global norms, questionable legitimacy, and significant consequences for the global power hierarchy. Harpaz (2016) examines the variation in Beijing’s role and behavior across the issue areas of trade, finance, and development aid, emphasizing how rationalist state-centric, domestic politics, and normative approaches complement one another in explaining such variation. Kastner et al. (2016) question the utility of an approach that emphasizes the importance of “disposition”, or domestically-rooted values, ideology, and interests, in explaining China’s approach. Instead, these authors call our attention to the importance of the strategic context of the issue under consideration and, specifically, Beijing’s outside options and the degree to which it is viewed by outside powers as indispensable to effective and sustained cooperation within the regime to explaining its approach in a given issue area. Thus, in international financial governance, China has pursued a so-called “hold up” strategy which predicates Chinese cooperation on other actors’ concessions, both due to its favorable outside options and general perceptions of the country’s importance to global financial governance.  Chin (2012) presents a case study of the new partnering arrangement between the World Bank and China Eximbank as evidence of Beijing’s growing ability to shape global development financing norms. 6  Zeng and Liang (2013)’s co-edited volume on China’s first decade in the WTO includes substantial discussion of China’s behavior in the evolving structures of the WTO and gives implicit recognition of how ongoing institutional changes within the global trade regime have opened the way for China to assert its influence within the organization. 5

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Kennedy (2018) further examines the variation in Chinese participation in a wide range of international regimes, including those governing trade, finance, intellectual property rights, climate change, public health, labor, and technical standards. The contributors collectively argue that China has made further advancement on the learning curve and become more skillful in navigating the complex regime rules and promoting its own interests in those regimes that focus on the needs of industrial producers, but has not made the same progress in those regimes that primarily address issues of concern to other actors such as labor or tackle other problems such as climate change. Webster (2014) articulates a theory of “paper compliance” to characterize the variation in China’s compliance with international institutions. The theory suggests that Beijing selectively complies with the norms and rules promulgated by international institutions depending on the feasibility of obeying them.

Research Frontiers The above discussion outlines three major streams of work that have dominated the discourse on China’s relationship with established powers in the global economy, namely, studies that provide an empirical assessment of China’s role in global economic governance; explore the sources of Chinese behavior; or emphasize the growing “two-way” interaction between China and global economic institutions. It should be noted that outside of these main research areas, there also exists a growing body of literature that analyses the power dynamics associated with the country’s rapid economic ascendance, the relative influence of political and economic forces in shaping the country’s foreign economic policy, and the political, social, and economic implications of China’s growing global influence. These studies complement the works mentioned above in providing a more comprehensive account of China’s role in governance regimes. Power and Economic Statecraft While less studied, the use of power in China’s foreign economic policy and Beijing’s economic statecraft has attracted growing scholarly interest. Earlier studies focus on China’s use of “direct power”, defined as either “the ability of one state to get another state to do what it would not otherwise do, either by persuasion or coercion” or “the ability of one state to avoid direct pressure from another state to do what the former would not otherwise do” (Chin, 2014: 184−185). Setser (2008) and Drezner (2009), for example, represent earlier attempts to examine the question of whether China has been able to convert its large holdings

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of US debt into policy influence. Drezner, in particular, is skeptical of China’s ability to translate its creditor state status into political power, suggesting that while China’s financial power may increase its ability to resist US demands, it does little to enhance Beijing’s ability to compel or coerce the US to change its policies. Cohen (2012) surveys the various strategies China used to promote the internationalization of the RMB and probes the strategic intentions behind the use of these policy instruments. Another study by Cohen (2008) emphasizes Beijing’s passive, instead of active use of monetary power, suggesting that Beijing has been able to take advantage of its huge foreign exchange reserves to forestall external pressure for policy adjustments. Chin goes beyond the emphasis on direct power to examine China’s exercise of structural power, which includes both its first face, or a state’s “power to shape or determine the broader context within which other states and market actors have to operate”, and its second face, or the “capacity to expand the range of choices open to others” (Chin, 2014: 185). Specifically, he argues that China is increasingly able to exercise the second face of structural power in the international monetary system by promoting reserve diversification and thus expanding the range of reserve currency options available to both governments and market actors. At the same time, to the extent that such efforts may exert a disciplining effect on US economic policy and constrain the “exorbitant privilege” of the United States, it also allows Beijing to exercise the first face of structural power. Echoing the above studies’ concern with the use of power in China’s international economic policy, recent studies have also devoted some attention to China’s use of economic statecraft. For example, Katada and Sohn (2014) suggest that moves toward financial regionalism in East Asia in recent years may be viewed in terms of the governments’ use of financial statecraft as both a shield and a sword. Specifically, by promoting financial regionalism, major regional governments have sought to promote a counterweight strategy designed to create supplementary or alternative regional institutions in order to both shield the domestic economy from adverse conditions in international financial markets and to enhance their influence in global financial governance by introducing the option of potential defection from international financial governance regimes. Overall, however, studies of China’s financial statecraft (e.g. Armijo and Katada, 2014) find that efforts by China and other emerging powers to promote South−South cooperation and deepen regional ties to reduce dependence on the global financial system are far from systemchallenging and have not been particularly effective in enhancing these countries’ leverage vis-à-vis established players. The relative importance of political considerations vs. economic interests in shaping China’s international footprint has also received growing scholarly attention.

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For example, Liao and McDowell (2016) conjecture that de facto trade and direct investment interdependence enhance the ability of the PBoC to negotiate bilateral currency swap agreements (BSAs) with foreign central banks both by providing firms with insulation from international liquidity shocks and reducing the transaction costs of cross-border exchanges. De jure economic integration via preferential trade agreements (PTAs) and bilateral investment treaties (BITs) further reinforce this dynamic. Another study by the same authors (Liao and McDowell, 2014) in turn emphasizes the role of political, instead of economic considerations, in influencing foreign countries’ demand to adopt the RMB as a reserve currency. Specifically, as a state’s preferences for international order, as measured by voting in the United Nations General Assembly (UNGA), move away from the US-led status quo and toward the Chinese alternative, the likelihood that it will add the RMB to its reserve portfolio also increases. A more recent study by Dreher et al. (2016) seeks to untangle the relative influence of foreign policy considerations and economic interests in shaping Chinese aid, arguing that while the former dominates Chinese Official Development Assistance (ODA), the latter plays a more important role in the distribution of commerciallyoriented sources of state financing that tend to be less concessionary. In pointing to the potential similarities in the underlying motives of Chinese and Western official finance, these and other studies (Dreher and Fuchs, 2015) therefore help to debunk the myth that foreign aid from China should be considered as “rogue aid” driven solely by self-interest. In analyzing China’s approach toward FTAs, Zeng (2016) makes a similar suggestion that economic interests about enhancing market access abroad or securing essential supplies of raw materials may have taken a back seat compared to foreign policy interests of enhancing China’s international influence in shaping China’s FTA diplomacy. Overall, the above studies emphasize the dynamic interactions between China and the partner country and point to the importance of shared links, either politically or economically, in shaping Beijing’s trade, aid, and investment strategies. As such, they should help to illuminate China’s foreign economic strategy and deepen our understanding of the potential for cooperation between China and its partner countries in the international economic system. The Political, Social, and Economic Implications of China’s Economic Ascent In addition to examining the drivers of China’s international economic initiatives, recent studies also increasingly analyze the political, social, and economic implications of China’s rising influence in the international economic system. Research in

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this stream explores reactions to China’s growing trade and investment activities in host countries and the effect of China’s commercial diplomacy on its foreign relations or host country development. First, China’s evolution from being mainly a capital importer to a capital exporter has generated growing interests and reactions in developed countries to Chinese outward foreign direct investment (COFDI). Tingley et al. (2015) focus on political reactions to the mergers and acquisitions (M&A) activities of Chinese firms in the United States, finding that although national security concerns provide an important ground for the erection of legal barriers to foreign M&As, considerations about economically distressed domestic industry and reciprocity also play a role in explaining political opposition to Chinese investment in the US. The study thus helps to shed light on some of the important causes of friction in the US−China economic relationship. Studies (e.g. Meunier et al., 2014; Meunier, 2014) have also examined the political fears that the substantial increase in COFDI has g­ enerated in European countries and its potential economic and political consequences. Second, the foreign policy consequences of China’s growing trade and investment activities represent another promising area of research. Based on an empirical analysis of China’s trade relations with developing countries in Africa and Latin America, Flores-Macías and Kreps (2013) find that countries that trade more with China are also more likely to converge with it on foreign policy issues. This implies that expanding trade relations may potentially enhance China’s foreign policy influence vis-à-vis the partner country, which may in turn increase the difficulty for the United States to attract allies in the international arena. Kastner (2016) yields slightly different conclusions, finding that increased trade dependence on China may increase the country’s ability to elicit the partner country’s cooperation on economic, but not necessarily on political issues. Kaplan (2016) examines the political consequences of capital flows from China. Through a comparative analysis of two of China’s largest debtors — Brazil and Venezuela — in the periods both before and after the introduction of Chinese financing, the study finds that increases in the share of Chinese state-to-state financing in total external public financing tend to be associated with larger government budget deficits in these countries. In doing so, the study sheds light on the conditions under which growing economic interdependence affects the policy autonomy of governments in developing countries as well as the conditions under which deviations from Western governance models are likely to occur. However, not all scholars are of the view that growing COFDI and other forms of financial flows are effective in reshaping host country policies. For example, some recent studies (e.g. Blanchard, 2016) suggest that Chinese foreign direct investment

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and other economic ties with Latin America did relatively little to tilt the host country’s foreign policy toward Beijing. Conversely, cordial political relations may not help to boost COFDI. The political, social, and economic consequences of Chinese foreign aid represent yet another burgeoning area of research. The Asmus, Fuchs, and Müller chapter in this volume (see Chapter 7) provides a rather comprehensive review of the existing literature dealing with this question, suggesting that there is little systematic evidence that Chinese aid has been effective in promoting economic growth and other development outcomes in recipient countries, is appreciated by the general public in recipient countries, is directly linked to recipient country institutions such as democracy or corruption, or has a direct impact on the recipient’s labor or environmental standards. Running through the above studies is a common concern with the potential for China to export its domestic governance models through its global economic activities. The degree to which the Chinese leadership can translate its growing economic clout into political and economic leverage, influence partner country governance in areas such as labor and the environment, and more generally promote the country’s global influence will therefore likely remain a major area of scholarly interest in the future. China’s Emerging Institutional Statecraft and Its Implications for Global Economic Governance While the above analysis suggests that China is generally playing by the rules of the game and also has interests in seeing the system work, more recent developments also suggest that subtle changes may be taking place beneath the surface. In particular, China’s push for regional trade agreements (RTAs) such as the Regional Comprehensive Economic Partnership (RCEP) in response to the growing trend toward the so-called mega RTAs such as the US-led Trans-Pacific Partnership (TPP), along with the development of a set of financial institutions and other arrangements (such as the AIIB, the NDB, and the “One Belt, One Road” (OBOR) initiative) designed to enhance a China-centric pattern of trade, investment, and infrastructure development in the region raise important questions about Chinese preferences and motivations as well as the potential consequences of these new initiatives. Do these recent developments represent efforts to weaken or overhaul the existing system? Or can they be considered as useful supplements to the existing structure that can help increase the effectiveness and legitimacy of established institutions and so can be considered as system-preserving? In light of Beijing’s recent activism in promoting these new policy initiatives that may potentially present a forceful

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challenge to the existing institutional structure, a growing number of studies have turned attention to the nature and drivers of these more recent developments. For example, Strand et al. (2016) examine the motivations behind the creation of the AIIB and the implications of the institution for China’s global leadership. While the authors consider the creation of the AIIB as being driven by China’s dissatisfaction with the pace of change in global governance institutions, they do not view the move as mounting a direct challenge to the system dominated by the United States. Wang (2017) engages in a similar analysis of the motivations behind the creation of new multilateral development banks such as the AIIB and the NDB and the risks and challenges they pose to global governance. According to her, these new institutions arise out of the desire to stimulate infrastructure investment which is critical to long-term domestic economic growth; develop an additional channel for raising capital relatively inexpensively; create impetus for reform of the existing global financial governance system; and reduce dependence on the US dollar. While pointing to the benefits of these new financial institutions, the study also points to their potential risks, including enhanced Chinese influence and the challenge they pose to traditional models of development financing. The tentative view that emerges from these studies is that these China-backed arrangements represent part of a recent trend toward a more activist foreign policy by the Chinese leadership and should not be construed as a threat to the existing international financial order or a major departure from China’s existing approach. A more recent study by Ikenberry and Lim (2017) focus on China’s recent moves to create new, potential rival institutions. In doing so, the authors emphasize the importance of not only placing these actions within the wider context of the country’s engagement with regional and global institutions, but also of realizing the variation in China’s orientation toward three different aspects of the “existing international order”, namely American hegemony, liberal internationalism, and the “deeper systemic foundations of sovereignty and primacy” (Ikenberry and Lim, 2017: 2). Based on this delineation of the complex interactions between a rising power such as China and the international order, they identify a spectrum of strategic choices faced by China that ranges from a “status-quo stakeholder” that seeks to participate in existing rules and practices on the one hand to “outright opposition to or non-participation” in existing institutional arrangements on the other. In between these two extremes are a few other middle options such as being an “authority-seeking stakeholder” that seeks to enhance its voice and influence in existing institutions through redistributive decision-making authority; engage in “institutional obstruction” whereby a rising state operates from within the institution to play a spoiler role or to alter or impede the application of specific rules, norms, practices; undertake “external innovation” to create new international institutions

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or regimes; or pursues outright “opposition to or non-participation” within an existing institutional framework. Focusing on the AIIB as a specific case of “external innovation”, the study concludes that there is no strong evidence that the AIIB’s operation embodies a strong counter-hegemonic logic and undermines the existing order as the institution’s underlying norm of multilateralism and the reliance on international financial markets to fund multilateral development loans should constrain the degree to which the institution can be used for political purposes. In light of the flurry of activities by Beijing to create new institutions, the challenge remains for the scholarly community to sort out the implications of these moves for the global governance system.

Conclusion As the preceding discussion shows, the unprecedented economic rise of China has brought about a significant shift in scholarly interest from earlier concerns about how to “manage” China’s rise to efforts to better understand both the domestic and international factors that shape the country’s international economic policy at a time when the traditional powers have diminished influence. While the above review of scholarly literature yields no evidence that Chinese behavior has worked to undermine the existing system, recent developments call for more careful analysis of the complex interplay of domestic and international factors that may influence China’s orientation in the global economic system in the years to come. In particular, China’s increasingly active push for the creation of new institutional arrangements at a time of declining support for multilateralism and international institutions in the US has accentuated the need for us to develop a better understanding of the motivations and objectives of Chinese policy, as well as the constraints on Beijing’s ability to exercise a more proactive role in global economic governance. If, as Ikenberry and Lim (2017) have pointed out, China’s strategic choice will likely feature a mixture of cooperation and opposition, then greater attention to the potential constraining influence of domestic politics, international economic integration, and prevailing international norms may be necessary in order for us to better make sense of Beijing’s policy choice. At the same time, in light of the country’s increasingly prominent role in the global economy, it may also be necessary for us to examine in greater detail China’s coalition-building strategies in global governance negotiations as well as the incumbent powers’ counter-strategies. During the past decades, China has both sought to form coalitions with other large emerging economies to advance its interests in the global governance structure and actively embrace regional agreements and institutions in order to expand its leverage at the global level. For example, China has worked closely with Brazil and India in the deadlocked Doha

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Round trade negotiations in 2008. However, although Beijing tends to portray itself as a link between developing and developed countries in the negotiations, its independent national power and diverging trade interests with major developing world agricultural producers have made it difficult for Beijing to effectively play such a role. In addition, China has actively promoted a series of regional economic cooperation initiative such as the ASEAN Plus Three (APT) and the East Asia Summit. In response, the incumbent powers have pursued their own counterstrategies, including both cooptation and efforts to weak emerging powers’ move to create outside options that would enhance their bargaining power (Kahler, 2013). How these strategies and counter-strategies will play out against the background of China’s continued embracement of free trade and the US’ declining support for multilateralism and international institutions may therefore deserve greater attention in future research. Lastly, in addition to focusing on China’s potential contribution to new multilateral arrangements, future scholarly work could engage in more detailed examination of the consequences, both positive and negative, of China’s growing economic engagements for governance models and developmental coalitions in other developing countries. Recent research (Adolph et al., 2017), for example, points to the possibility of a “Shanghai Effect” whereby African countries that primarily export their products to China are increasingly converging with the lower labor standards in China. The study has also shown that such an effect is likely to be particularly large if Chinese exports are displacing exports to high, instead of low standard countries. Similar questions could be asked about the impact of China’s growing economic influence on environmental standards, domestic governance, and development coalitions in other developing countries. In analyzing the above questions, it would also be helpful if researchers could employ multiple methods, including both qualitative studies that examine a given issue in detail through primary field research or secondary sources and quantitative analyses utilizing a large-N design in order to better illuminate Beijing’s motivations and preferences as well as the consequences and ramifications of the country’s expanding global economic reach.

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CHAPTER 5

South Africa, BRICS, and Global Governance: How SA Tried to Change the World and Succeeded in Changing Itself Philip Nel Department of Politics, University of Otago, New Zealand

Introduction South Africa (SA) was invited to join the BRIC group of states on 23 December 2010 by the Minister of Foreign Affairs of the People’s Republic of China, Yang Jiechi (Besada et al., 2013). This followed extensive lobbying by South African President Jacob Zuma during 2009 and 2010 (Stuenkel, 2013) among the other BRICs, Brazil, India, and Russia. The invitation came just a year into the first term of President Jacob Zuma, who was elected President by Parliament in 2009, and can be regarded as a major foreign policy success of the Zuma era. This chapter argues that it was more a mixed blessing than an unqualified success, though. On the plus side, it allowed South Africa to join an important agenda-setting and operational club of emerging global and regional powers, thus providing a new outlet for South Africa’s long-standing ambition to make a difference to global governance. In the process, two costs were incurred. The first and most important is that BRICS membership has not, as hoped for by the Zuma government, contributed to “the radical transformation” of the South African economy in favor of a more inclusive, state-led development-focused growth model. In fact, developments since South Africa joined BRICS have deepened the exclusivist, limited-access nature of the South African economy. A number of structural weaknesses, some of which are leftovers from the apartheid era, but reinforced 83

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by policy choices made since 1994, prevent South Africa from achieving the dream of a non-racial, inclusive open-access that is promised in the 1996 Constitution. The net effect of these weaknesses is that a large segment of the South African population, about a quarter to a third, find themselves systematically excluded from the benefits of a modern industrialized economy. To combat this, the Zuma government embraced the notion of “radical economic transformation”, to be achieved through a state-led industrial development project that would enhance Black participation in the economy and would lead to the elimination of poverty by 2030. If anything, exclusion has worsened since 2010, despite the commercial opportunities that BRICS membership brought, and South Africa’s increasing commercial presence in Africa. By perpetuating and deepening South Africa’s dependence on primary commodity extraction, the close association with China in particular has not brought South Africa closer to halt the relative decline of its manufacturing sector, and has done little to reverse the education and employment disparities that are some of the worst legacies of apartheid. It would be wrong to blame BRICS membership exclusively for the continuation of the structural and institutional weaknesses of the South African economy. Most of the blame rests with the way in which President Zuma has developed a strong neo-patrimonial hold on key levers of the economy, particularly State Owned Enterprises (SOEs) and the organs of state procurement and fiscal management. These instruments have been used, often in ways that disregard constitutional rules and constraints, to create and capture rents for him, his closest allies, and segments of the Black business elite. BRICS membership provided some means to oil this rent-creation machine, through a range of commercial and infrastructural deals between South African authorities and BRICS members. The second cost of BRICS membership has to do with South Africa’s foreign policy orientation and its current contributions to global governance. Most significantly, BRICS membership provided legitimacy for, and a means through which, the Zuma government could make its mark as the leading regional power in Africa. Despite a range of ambiguities, South Africa’s original post-transition foreign-policy orientation was predominantly that of an emerging middle-power and bridge-builder (Schoeman, 2000; Jordaan, 2003). Post-apartheid South Africa embraced multilateralism as a vehicle to link the legitimate development concerns of poorer states and the opportunities provided by a globalized liberal economic order. By 2017, this orientation has not completely disappeared. Gradually, and significantly so since 2010, a second aspiration, that of being a regional power, has become prominent (Qobo and Dube, 2015). This orientation represents an alternative approach to globalization than the middle-power approach, and aims more explicitly at securing regional hegemony, both for the sake of prioritizing domestic development, but also as a means to join in the establishment of alternative centers

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of what Carmody calls “gregional power” in global governance, capable of challenging “Western” hegemony (Carmody, 2012). South Africa was invited to join BRICS largely because of its economic preponderance and leadership ambitions in Africa, and BRICS membership both legitimated and provided additional means for South Africa to secure its status as a regional hegemon. This reorientation of South Africa’s external role was accompanied by a much more inward-looking reprioritizing of “the national interest” (see below), and a more instrumental appreciation of how the rest of Africa could contribute to South Africa’s well-being. On the global stage, and, as a corollary to the inward looking regional-power orientation, South Africa is more willing today than in the early post-apartheid era to support the anti-liberal “sovereignist” agenda also favored by other BRICS members. The story of South Africa’s membership of BRICS is thus a tale of how South Africa, by originally setting out to change the world for the betterment of itself and of its continent, ended up recalibrating its domestic development and its global orientation, and not necessarily for the better. In what follows, I relate this story in three parts. The first shows why South Africa and the then four BRICs states found each other attractive to start off with, and why the active diplomacy of the Zuma presidency had a favorable reception. The second episode focuses more directly on how BRICS membership shaped latent and emerging tendencies in South Africa’s domestic and foreign policy orientations. A third part looks at how, despite the expressed desire of President Zuma, BRICS membership has coincided with a weakening, not an improvement, of the capacity South Africa to become an inclusive social order. A final section concludes by situating the preceding episodes in the context of a conceptual typology that notes a fundamental isomorphism shared by all the BRICS members, South Africa included.

South Africa as “Another BRIC in the Wall” (Carmody, 2012) Being invited to join BRICs in 2010 was an important event for South Africa. It did not only reflect successful diplomatic efforts on the part of the Jacob Zuma administration, but also cemented South Africa’s reputation as an emerging regional power with global standing. The SA government hoped to exploit the commercial and diplomatic opportunities that membership offered to support and deepen the “New Growth Path” (NGP) — announced in 2010, and since then replaced by the National Development Plan (NDP) as the long-term political plan aimed at eliminating poverty and halving inequality by 2030 (see Table 1 for a South African Timeline). In promoting the NGP, and the NDP, the growth trajectories and experiences of Brazil, China, and India were regarded as analogous to that of, and as models for, South Africa. It was also projected that South Africa, in partnership with the

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Release of Nelson Mandela and other political prisoners.

1991

Start of multi-party talks. President De Klerk repeals remaining apartheid laws, international sanctions lifted.

1994

First democratic SA election. Nelson Mandela elected president. International sanctions lifted. SA takes seat in UN General Assembly. Launch of the Reconstruction and Development (RDP) economic programme.

1996

Truth and Reconciliation Commission begins hearings on human rights crimes committed by former government and liberation movements during apartheid era. Parliament adopts new constitution. Adoption of Growth, Employment and Redistribution (GEAR) macroeconomic strategy.

1998

SA hosts Non-Aligned Movement (NAM) Summit.

1999

General elections. Thabo Mbeki becomes second President of post-apartheid SA, after Mandela declined to stand for a second term. SA joins G20 as a founding member. SA hosts Commonwealth Heads of Government Meeting.

2000

SA hosts UN AIDS Conference.

2001

SA hosts UN World Conference Against Racism. New Partnership for Africa’s Development (NEPAD) launched and accepted by the African Union.

2002

SA hosts World Summit on Sustainable Development.

2003

6 June 2003, Yashwant Sinha (External Affairs Minister of India), Celso Amorim (Foreign Minister of Brazil) and Nkosazana Dlamini-Zuma (Foreign Minister of SA) formalize the India–Brazil South Africa (IBSA) Dialogue Forum by signing “Brasilia Declaration”.

2004

Ruling ANC wins landslide general election. Thabo Mbeki begins a second term as president.

2005

President Mbeki sacks his deputy, Jacob Zuma, due to charges of corruption. GEAR macroeconomic programme replaced by Accelerated and Shared Growth Initiative for SA (ASGISA).

2006

Former deputy president Jacob Zuma acquitted of rape charges, reinstated as deputy leader of ANC.

2007

Zuma elected chairman of the ANC. SA elected for first of two terms on UN Security Council (2007−2008). SA hosts the G20 Secretariat.

2008

President Mbeki resigns over allegations that he interfered in Zuma’s corruption case. ANC deputy leader Kgalema Motlanthe chosen by parliament as president.

2009

Jacob Zuma elected president. Economy goes into recession for first time in 17 years.

2010

SA hosts the World Cup football tournament. New Growth Path replaces ASGISA as macroeconomic program.

2010

SA invited to join BRICS group of states.

2011

President Zuma attends the third BRICS Summit in Sanya, China. COP 17 (United Nations Climate Change Conference) held in Durban. SA elected for second term on UN Security Council (2011–2012). Fifth IBSA Summit hosted by SA in Durban. (Continued )

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Police open fire on striking workers at platinum mine in Marikana, killing 34, injuring 78, and arresting 200. President Zuma re-elected as leader of the ANC. Nkosazana Dlamini-Zuma, ex Health and Foreign Affairs Minister elected as Chairperson of African Union Commission.

2013

Nelson Mandela passes away. SA hosts the fifth BRICS Summit in Durban. Government introduces a new macroeconomic program, the National Development Plan (NDP)-2030.

2014

SA’s fifth democratic election. President Zuma elected for second term.

2015

Government receives unwelcome international attention over allegations of bribery to disgraced international footballing body FIFA to secure 2010 World Cup, and allowing Sudanese President Omar al-Bashir to visit despite International Criminal Court arrest warrant over genocide and war-crimes charge.

2016

Supreme Court rules President Zuma violated the constitution by not repaying public money used to improve his private residence. SA announces intention to withdraw from the International Criminal Court (ICC).

2017

SA revokes decision to withdraw from ICC after court declares it “unconstitutional and illegal”. President Zuma dismisses widely-respected Finance Minister Pravin Gordhan, leading to the country’s credit rating being cut to “junk” status by some CRAs.

BRICs, could contribute to and benefit from the growth potential of Africa. Zuma, in contrast to Mbeki who was skeptical about China’s goals in Africa, was impressed by the commercial opportunities that China (and other BRIC members) held, and saw BRIC countries as crucial partners in cementing South Africa’s place in Africa, in promoting agendas for global change, and in enhancing Zuma’s own particular domestic agenda (Zuma, 2013). By 2010, China was already South Africa’s main trading partner, taking 8.8% of its merchandise exports, mainly ores, slag and ash, and iron and steel. At that stage, the USA took 7.6% of SA’s exports, and Japan 6.9%. China accounted for 13.9% of all merchandise imports into SA, mainly electrical machinery and appliances, footwear and clothing. India also featured as one of SA’s top 10 export destinations (taking 2% of total merchandise exports), and as one of its five most important suppliers. In contrast, Brazil and Russia took only 1% and 0.4% of SA’s exports, respectively (SACU, 2012; Brand South Africa, 2012). Expectations were high that membership of BRICS would enable South Africa to explore its comparative advantages in increasing exports to all of these markets, specifically in fruit and related products, ores, and machinery (IDC, 2012). Inward foreign direct investment (IFDI) from China and India into South Africa grew noticeably since 2003, and India became one of the top five sources of IFDI to South Africa between January 2003 and July 2015

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(Sanchez, 2015). By the end of 2011, South Africa — in terms of stock — had become the eighth largest recipient of Chinese outward foreign direct investment (OFDI). In return, by 2011 a fifth of South Africa’s stock of OFDI was in the BRIC countries, mainly China. This share was slightly more than the total stock of South Africa’s OFDI to Africa in 2011 (UNCTAD, 2013). Hence, and obviously, growing commercial relations between South Africa and some of the BRICs (mainly China and India) did play a role in the invitation that the BRICs extended to South Africa to join the group. In addition, South Africa’s proven track record as a supplier of mineral commodities, and its leading role in the development and provision of mineral-related services, made it an attractive partner for the commodity-hungry China and India. The total value of South Africa’s mineral reserves is estimated at $2.5 trillion. South Africa leads the world in the mining of platinum, chrome, vanadium, and manganese, is the world’s third-largest producer of gold, and excels in the provision of mining-related services (BRICS, 2011). This, coupled with the sophistication of South Africa’s service delivery in the fields of personal and corporate finance, and in telecommunications, stimulated BRICs interest. However, it was not only the size of the South African market or the degree of economic exchange between South Africa and the BRICs that secured SA a place at the BRICS table in 2010. SA is a midget compared to the other members. In 2016, SA held only the 30th position in GDP measured in constant 2005 international dollars, factoring in purchasing power), and at $736 billion (in constant international dollars) its total output was less than 4% of China’s, about 9% of India’s, 20% of Russia’s, 24% of Brazil’s, and 0.6% of total world output (IMF, 2016). Also in terms of trade, South Africa was a small player in 2010, providing only 4% of imports into India, just over 1% into China, 0.4% in the case of Brazil, and 0.2% into Russia (IDC, 2012). Despite its relative smallness, South Africa was attractive as a future BRICS member because of a mix of a number of factors, additional to its growing commercial links with some of the existing members. It is difficult to place these in a strict rank order of importance, but there is good reason to believe that South Africa’s aspirations to be “the gateway to Africa” played the most significant role. In addition, South Africa’s credibility among a variety of actors as a global bridge-builder and reform-minded participant, made it an attractive partner for a group who saw itself as the core shapers of an alternative global order that would not challenge liberal globalization tout court, but aimed at making globalization work more to the benefit of the likes of emerging markets and their partners in the Global South. The perception of South Africa as the gateway to Africa, and as a credible and respected reform partner were based on the way in which it reintegrated with the global, and African, economy after 1994, the moral weight of its own domestic transition, and its proven role as bridge-builder in global governance in the 1990s and early 2000s.

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On the most basic level of identity conception, the SA leadership embraced and cultivated the notion that its transition from apartheid to non-racial inclusive democracy was an exceptional moral achievement. And, indeed, it was. SA was eager, and was encouraged, to carry its message of peaceful change, rule-bound justice, and reconciliation onto the world stage, and a distinct idealism centered around these themes could be observed in its foreign policy right from the start (Becker, 2010). Over time this was translated into a global reformist élan: the pursuit of a more equitable distribution of power and privilege on the global stage, and the celebration of rule-based multilateralism as the preferred means to secure the interests of developing countries in a globalizing world economy. The notion that South Africa’s transition from apartheid was exceptional and that it is thus entitled or honor bound to help to make the world more just and protect the weak, continues as an implicit identity-driver in its foreign policy up until today. The most recent White Paper on South Africa’s Foreign Policy (DIRCO, 2011) and the glossy 20 Year Review — South Africa 1994−2014, published by the SA Presidency (2014), emphasize South Africa’s “unique approach to global issues” and its commitment to carrying the principle of “ubuntu” (the virtues of other-directedness, non-confrontation, and compassion) to the world. Underlying this idealized self-conception are some material interests, but it would be wrong to not also appreciate how this self-conception shaped South Africa’s behavior during a large part of the post-1994 years. As far as the material interests are concerned, South Africa’s most immediate post-apartheid desire was to fully integrate with the global political economy as a means to grow out of the confines that apartheid imposed and invited. This implied an acceptance of the liberal principles underlying the global economy, an ideological price that was offset by a commitment to global reform and the promotion of an agenda that would favor the dispossessed and marginalized globally (Nel et al., 2001; Jordaan, 2012). In stark contrast to the protectionist/isolated years of 1985−1990, post-apartheid South Africa embarked on an ambitious program of economic liberalization — a dramatic “gamble on investment” as one commentator aptly described it (Nattrass, 1996; Nel, 2002). This was a program of rapid liberalization of external economic relations, coupled from 1996 onwards with a liberal domestic macroeconomic policy (titled the “Growth, Employment, and Redistribution” — GEAR program) that combined prudential state budgeting, conservative monetary policy, privatization, and broadening of the participation black South Africans in private economic ownership and management (so-called Black Economic Empowerment — BEE — changed to BBBEE — Broad-based Black Economic Empowerment — in 2003). Many, but not all, of the protectionist mechanisms used by the embattled apartheid state were abolished, South Africa embraced the results of the Uruguay Round of GATT trade

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negotiations, and joined the WTO. South Africa was forced to join the WTO as a “developed economy” and not as a developing economy. This implied deeper tariff cuts and fewer developmental concessions. Deeper integration of South African business into the global economy also implied the relocation of headquarters of South African multinational firms, ostensibly to exploit the opportunities that internationalization brought. South African imports and exports, as a percentage of GDP, increased from a 5-year average of 39 in the period 1990−1994 to 60 in the period 2005−2009 (World Development Indicators, 2015). South Africa committed under the GATT Uruguay Round to bind all but 2% of all its tariff lines and replace non-tariff barriers with transparent tariffs (Edwards, 2015). By 2010, the mean applied weighted tariff rate on all South African products was a third of what it was in the early 1990s (World Development Indicators, 2015; Department of Trade and Industry (DTI), 2010). On a regional level, South Africa joined the Southern African Development Community (SADC), initiating a SADC free-trade area that came into effect in 2008 (Sandrey, 2013). Not qualifying for membership of the Lomé Convention and its preferential treatment of African, Caribbean and Pacific (ACP) states, South Africa (as part of Southern African Customs Union which also includes Botswana, Lesotho, Namibia, and Swaziland) negotiated an extra-regional Trade, Development and Cooperation Agreement (TDCA) with the European Union, signed in 1999 (Krapohl et al., 2014), and also a FTA with the European Free Trade Association states (Iceland, Liechtenstein, Norway, and Switzerland) that came into effect in 2008. It also benefitted from the African Growth and Opportunity Act (AGOA), passed into law in 2000 by the US Congress. AGOA provides quota- and duty-free entry of some African goods to the US market, and contains trade preferences that are more favorable for African states than those contained in the WTO’s Generalized System of Preferences (Prinsloo, 2016). Compared to the large divestments from South Africa in the 1980s, the next two decades was a boom time for IFDI, leading to a tenfold increase in the value of IFDI stock, reaching an average value of US $111,570 million in the period 2005−2009 (UNCTAD, 2016). This represented an increase from just over 8% of GDP in the period 1990−1994 to close to 40% in the period 2005−2009. The stock of OFDI by South African institutions constituted an average of 5% of its GDP in the period 1990−1994 (Verhoef, 2011). By 2010, it had increased to 25% of GDP (UNCTAD, 2012). One of the most important tools through which post-apartheid South Africa secured IFDI was the signing of a large number of bilateral investment treaties (BITs) that made extensive provision of third-party arbitration in the case of investor-state disputes. During the immediate post-apartheid period (1994−1998)

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South Africa entered into 15 BITs, mostly with European countries, and by 2005 had signed 41 such treaties, some of them also with other developing states (Peterson, 2006). By 2009, 42 BITs were in place. While it was clearly part of an aggressive strategy to reinternationalize as quickly as possible by providing assurances to risk-averse investors, there is also evidence that the South African authorities entered into these without much thought about the range of issues that could lead to investor-state disputes, and the implications of these agreements for national policy autonomy (Poulsen, 2014). We will see how South African attitudes towards this essential liberal instrument of global integration changed dramatically by the time that South Africa joined BRICS. Regional integration was a very important component of global economic reintegration, and provided the basis for the notion that South Africa acts as a “gateway” to Africa. Such status is largely self-assigned, and not necessarily popular in the rest of Africa (Alden and Schoeman, 2013; Obi, 2015), but it was instrumental in persuading the original BRICs members to invite South Africa to join. For many observers, economic integration with the rest of Africa amounted to malign economic penetration by South African companies, resulting in deindustrialization in certain industries, the squeezing out of local retail, the dissemination of liberal economic norms, and contradictorily, the imposition of non-tariff trade and other barriers on neighboring states (Daniel and Bengu, 2009; Southall and Comninos, 2009; Carmody, 2012). The mining, retail, beverages, telecommunication, and banking sectors in South, made extensive use of the pro-Africa focus of the Mbeki era (see below) to expand their foreign investment stock across the continent. By 2011, South Africa was the fifth largest holder of FDI stocks in Africa, and the second largest developing-country investor in Africa (after Malaysia) (UNCTAD, 2013). Although driven by different domestic agendas, and following different sequencing schedules, there was close symmetry between South Africa’s post-1994 drive to liberalize and the global integration programs of the BRIC members. All five BRICS members experienced a deepening of integration into the global economy in the 1990s and 2000s, albeit from different baselines. Both India and Brazil instituted programs of trade and international financial liberalization that coincided South Africa’s in the early 1990s, albeit from lower levels of existing integration than South Africa. Noticeably, South Africa was already relatively deeply embedded in the global economy, compared to the other BRICS, by the time of the first fully inclusive democratic election in South Africa in 1994. This was due to its role as supplier of highly-valued mineral commodities, including gold and platinum, and the fact that its financial institutions had important international linkages. By the time that it joined BRICS, South Africa had increased its exposure and was the most economically globalized of all the BRICS. Axel Dreher’s 100-point index of

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economic globalization, which incorporates both de facto capital and trade flows, as well as the depth of existing de iure restrictions on such flows, provides a useful guide to measure a state’s integration with the global economy (Dreher, 2006). Taking 5-year averages, the relative scores of the five BRICS in the period 1990−1994 (with the score for 2010−2014 in brackets) were: Brazil 46 (51), China 40 (50), India 24 (42), Russia 31 (53), and South Africa 51 (65). Global reintegration, and extensive penetration of the African continent was good for the South African economy, in real terms, South Africa’s GDP was 77% larger by 2012 compared to 1994. In per capita terms, this translated into real growth of 31% (World Development Indicators, 2015). South Africa also had a significant impact as a “mobilizer” (Vom Hau et al., 2012) of the African region, in particular to get the region to look for ways in which it could benefit from integration into the liberal world economy. It also persuaded the rest of Africa to be more forthcoming in accepting standards of good governance as defined by Western powers and the International Financial Institutions (IFIs), such as the World Bank and International Monetary Fund. Aligning Africa closer with global liberal norms, in return for better economic access to Western markets and deep Official Development Assistance (ODA) pockets, turned out to be the main legacy of the Mbeki Presidency (1999–2008). Mbeki personally invested in and provided ideological justification and organizational capacity for the NEPAD (the New Partnership for Africa’s Development) program, which became the flagship of Africa’s program of rebirth and accelerated economic and political modernization (Taylor and Nel, 2002). In 2002 NEPAD became an official African Union project, with headquarters in Johannesburg, South Africa, and aimed at enhanced economic cooperation within Africa and between Africa and its international donors and wellwishers, based on infrastructural modernization, trade and investment facilitation, and improving corporate and public governance on the continent. Although China was by 2010 already significantly involved in a large number of African states, Brazil, India, and Russia were especially encouraged by SA’s proven capacity to influence Africa’s agenda and its economic successes in Africa to embrace South Africa’s self-appointed status as “gateway” to a continent whose economic prospects looked particularly rosy in 2010 (Taylor, 2014). South Africa’s commitment to a liberal (open) global economic order, and its willingness to take the lead in persuading the rest of Africa that this order could also benefit them, was balanced by a desire to assist in enlarging the development opportunities for poorer states, and to do so in terms that would echo South Africa’s own domestic commitment to justice and non-discrimination (Jordaan, 2012). By 2010, post-apartheid South Africa’s contribution to global governance, and in particular its commitment to represent a “South’ agenda in the existing institutions of global governance, were well established. Highlights include its membership (as the

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only African member) of the G20 since its founding in 1999, the first of two stints on the UN Security Council (2007−2008, and again in 2011−2012), and privileged participation in the so-called Heiligendamm process launched by Germany in 2007 in which the G7 group of industrialized states interacted with China, India, South Africa, Brazil, and Mexico on a systematic basis, leading to the enhanced globaleconomic role of the G20 in 2009 (Vickers, 2008). South Africa’s enhanced status and global ambitions also contributed to the formation of the India−Brazil−South Africa Dialogue Forum (IBSA) in 2003 (Nel and Stephen, 2010). This enhanced South Africa’s role in the arena of South−South cooperation and led to important policy initiatives, including the BASIC (Brazil, South Africa, India, and China) alliance that was formed in the lead-up to the 2009 Copenhagen Conference of the Parties to the United Nations Framework Convention on Climate Change (UNFCCC). The timeline in Table 1 provides additional evidence of the prominent role that South Africa played both in institutions of the Global South, and in hosting global policy conferences in which it could hone its capacity to influence the agendas of the Global North. The 2000s turned out to be the high-point of this middle-power, bridge-building role, especially in the context of negotiations in the World Trade Organization (WTO), and in the G20 processes. As Stephen (2013: 97) notes, South Africa’s negotiation strategy in the WTO has been less confrontational and more integrative than either of its close ideological partners in IBSA (Donna Lee, 2006; Nel and Stephen, 2010). Since the creation of the WTO’s Dispute Resolution Mechanism in 1995, South Africa has not been a complainant in a single case, although it has been a respondent in five, and a third party in seven. In contrast, India has been a complainant in 23 and Brazil in 31 (WTO, 2017). As a bridge-builder, South Africa was influential in pushing the industrialized countries to live up to their own liberal principles, in particular as far as liberalization of agricultural trade is concerned, and to accept a developmental agenda in such contentious matters as intellectual property rights and in the Doha Round of WTO negotiations that kicked off in November 2001. In turn, South Africa has used its influence to keep developing countries engaged in global trade negotiations after the famous African walk-out at Cancun in 2003 (which South Africa joined), and to accept (at least some of) the so-called “new” trade issues, such as trade facilitation, trade and investment, and trade facilitation that industrialized states wanted to impose (Lee, 2006; Jordaan, 2012). Straddling the distributionally polarized agendas of the South and the industrialized states means that South Africa’s role was (and remains) often ambiguous, and that it is sometimes perceived as having moved too closely to a position where it not only provides legitimacy to a global neoliberal agenda on trade and development, but has been co-opted by the major powers (Bond, 2004; Jordaan, 2012; Lee, 2006).

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South Africa’s middle-power bridge building diplomacy also supported d ­ ifferent revisionist/reform attempts in other fora of global governance. These included attempts to balance/block the power of the North in climate-change negotiations, pursuing institutional reforms such as a revision of voting rights in IFIs and expanded permanent membership of the UNSC, and influencing the agenda of the G20 to be (Stephen, 2013; Nel, 2010). South Africa was widely perceived and valued as an emerging reform-orientated middle power (Schoeman, 2000; Jordaan, 2003), committed to multilateral, rule-based global governance, and well placed to challenge Western dominance, but also to bridge divides between the established powers of the industrial North and the global South. This fitted the global reformist interests of the BRIC nations very well.

South Africa as a BRICS Member: From Bridge-Builder to Regional Power BRICS membership coincided with important changes in the foreign and domestic policies of South Africa. Some of these had a long gestation, dating back to the middle of the 2000s and cannot be attributed exclusively to the effect of BRICS membership. However, BRICS gave it a certain momentum, focus, and longevity. Two important trends stand out. First, and in contrast to the almost helter-skelter manner in which South Africa embraced global economic integration on liberal terms between 1994 and 2007, there has been a distinct national-interests-first reorientation in economic development outlook, and trade and foreign policy in general. Secondly, South Africa has become more explicit in challenging some of the universalist and interventionist principles that underlie Western liberalism’s approach to human rights, good governance, and humanitarian intervention, prompting some observers to speak of a “sovereignist turn” in South Africa’s orientation. By enumerating these changes in what follows, I do not want to create the impression that South Africa has turned its back totally on the policies of the 1990s and 2000s that stood it in reasonably good stead. Middle-power bridge-building is not dead, and neither is South Africa’s basic commitment to a global economic order integrated on liberal precepts. However, by the time that Jacob Zuma became President in 2009, criticism of the failings of these policies had become much more prominent, and the process of looking for alternatives was well-under way. Three processes/documents were crucial signposts of the changes that would come to fruition after Zuma took over the presidency of the ANC in 2007, and became President of the country in 2009. The one was the work of the National Planning Commission (NPC) from 2010 to 2013, including a “Diagnostic Report” — a comprehensive review of strengths, weaknesses, and opportunities

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facing South Africa. The Diagnostic Report formed the basis of the eventual National Development Plan, and was quite critical of the lack of achievement in a number of areas, including employment, broad-based quality education, and socio-economic and spatial inequalities (National Planning Commission, 2013). To overcome these shortcomings, the NDP proposed that government policies be geared toward turning the South African state into a capable, strong, and accountable developmental state, associated with explicit industrial and labor-market policies that aim at decent job creation and lifting per capita income levels across the board. Foreign policies and external economic relations should support these goals, and the range and sequencing of external liberalization and integration with the global economy must be made dependent on domestic industrial and redistributive goals. Chapter 7 of the NDP made it clear that foreign relations, including projects focused on shaping global governance and cementing South Africa’s position in Africa, in future had to serve one and only one purpose: promoting the national interests of South Africa, conceived in terms of overcoming the shortcomings cited above, and identifying the key global partners that could assist in this: The shift of global power towards developing countries provides South Africa with an opportunity to maximise its regional and international influence over the next 20 to 30 years. Policy making should be driven by the objectives set out at the inaugural meeting of the National Planning Commission in May 2011: to grow the economy, reduce poverty and improve the quality of life of all South Africans. In other words, government’s global and regional policy-making stance should be South Africa-centric. Policy-making should improve the country’s functional integration in the region, on the continent, among developing countries — ­especially with key states like Brazil, India, and China — and in the world, with measurable outcomes.

The 2010 South African Trade Policy and Strategy Framework produced by the Department of Trade and Industry (DTI, 2010) pointed out that while South Africa had been quite successful since the early 1990s at liberalizing trade by reducing tariffs and canceling them altogether on more than 50% of imports, this had not assisted South Africa to give full effect to its industrial development plans and diversification of exports. To align trade and industrial development better, it argued, a strategic developmental approach to tariff policy had to be introduced — analogous to the managed trade policies followed by “successful developing economies” — meaning China, in particular. The third document that clearly heralded the realignment towards a domestic developmental agenda was the 2011 White Paper on Foreign Policy issued by the renamed Department of International Relations and Cooperation (DIRCO, 2011).

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Titled Building a Better World: The Diplomacy of Ubuntu, the White Paper ­continued to frame foreign policy in terms of the unique and exceptional “South African experience”, normatively couched in the universalist terms of “Ubuntu”. Beyond this normative veneer, though, the White Paper is quite hardnosed in its explicit commitment to the promotion of national interests, conceived of in the same domestically-orientated terms that the NDP uses. While the themes of protecting multilateralism, and promoting cooperation to secure “a just, humane, and equitable world order of greater security, peace, dialogue and economic justice” receive fair hearing, the White Paper repeatedly emphasizes that the goal of South Africa must be to “build an environment in which it can realize its national socio-economic agenda as well as its political and security interests” (DIRCO, 2011: 10). As was the case with the Diagnostic Report mentioned above, and in Chapter 7 of NDP, the White Paper contained an implicit critique of the universalistic role of bridgebuilding middle-power that was associated with South Africa’s foreign policy under Mandela and Mbeki, now replaced with a solid commitment to pursue a narrow range of national interests above all else. By the time of the fifth BRICS Summit in 2013, the first held in South Africa, the conception of national interests as defined in terms of a developmental approach to domestic and internationally-focused policy making was firmly established as the distinctive trademark of the Zuma era in South African politics (Zuma, 2013). This reconceptualization of national interests — manifested in these various documents and other policy declarations (Qobo and Dube, 2015) — and the policy and behavioral changes to be reviewed below, can be seen as manifestations of a distinct “sovereignist” turn on the part of South Africa. “Sovereignist” here refers to a normative preference for domestic and international arrangements that create maximum room for national autonomy protection of sovereignty — shared by all the BRICS, what Miles Kahler calls “maximum policy discretion to deal with the effects of globalization” (Kahler, 2013). As Laïdi (2012: 614) argues: The BRICS form a coalition of sovereign state defenders. While they do not seek to form an anti-Western political coalition based on a counter-proposal or radically different vision of the world, they are concerned with maintaining their independence of judgment and national action in a world that is increasingly economically and socially interdependent. They consider that state sovereignty trumps all, including, of course, the political nature of its underpinning regimes.

By the time of the fifth BRICS summit (held in South Africa) in 2013, such a sovereignist approach became a distinguishing feature of the Zuma era. It is no coincidence that BRICS’s most important sovereignist initiative to date — the

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NDB, was agreed to at the fifth Summit, followed by the announcement of a Contingent Reserve Arrangement at the sixth Summit 2014 (in Brazil). More recently, the idea of a new CRA, aimed against the dominance of the established “Western” agencies, has also been floated. Although hardly explored in the literature on a developmental state in South Africa (see the edited volume Edigheji, 2010), there is a close association between the notion of the protection of sovereignty/national autonomy and the pursuit of national development strategies in an era of (and in reaction to) economic globalization (Polidano, 2001). In addition, the aspiration to be recognized as a regional power, in contrast to the role of middle-power bridge-builder, also presupposes a change of priorities. Bridge-building uses the strategy of issue entrepreneurship to carve out the policy space in which the developing world — including Africa — can benefit from economic globalization. The regional-power approach, in contrast, relies on organizing and mobilizing the region to guarantee that the regional power secures its national interests first and foremost (Vom Hau et al., 2012). In turn, the regional power undertakes to provide regional public goods, such as the provision of peace-making and peace-keeping resources, protection against foreign intervention, and representing Africa in global governance fora (Hentz, 2008; Vickers, 2013). The national-interests-first sovereignist turn in South Africa’s interaction with the world is reflected in three significant policy innovations during the years of BRICS membership. Two relate to domestic development priorities, while a third is reflected in South Africa’s voting behavior at the UN. Domestically, a distinct counter-movement against perceived restrictions on national autonomy grew in intensity from 2009 to 2010 onwards. The specific context was a review of the 42 BITs that South Africa entered into since 1994 (DTI, 2009). As explained above, this formed part of a “gamble on investment” which characterized the first decade of the post-apartheid era (Peterson, 2006). BITs have been interpreted as a crucial dimension of the legalization of world politics. Abbot et al. (2000) describe legalization as a form of institutionalization that is characterized by heightened obligations, greater precision in rules and, perhaps most crucially, the delegation of rule interpretation and enforcement to third parties. It is this later feature of the BITs that South Africa had entered into that precipitated a rethink on its part, initiated by a case brought by Italian investors (with a holding company in Luxembourg). The plaintiff claimed that the stipulations of the Mineral and Resources Development Act of 2002 (MPRDA) constituted an infringement of their property rights and that it was unlawful as due process was allegedly not followed. What the plaintiffs found particularly damaging were the stipulation of the MPRDA that South Africa maintains

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national-control of mineral resources, and that all companies had to embark on programs of Broad-based Black Economic Empowerment (BBBEE) (see Piero Foresti, Laura de Carli and Others vs. Republic of South Africa, ICSID Case No. ARB(AF)/07/01). The claim was settled in 2010 (mining rights were exchanged for a 5% Black empowerment arrangement), but the case triggered a comprehensive review of the potential implications of BITs for the national policy autonomy of the South African state. This culminated in the rescinding of a number of BITs with European states from 2012 onwards (Norton, 2014; Bosman, 2016). By the end of 2015, a new South African “Protection of Investment Act” came into effect, offering investors protection in national courts, mediation, recourse to stateto-state arbitration, but ruling out third-party investor-state arbitration. South Africa was not alone in questioning the wisdom of bargaining away national policy autonomy for the sake of IFDI, and the issue of state-investor arbitration became a major bone of contention in debates about mega-regional trade agreements (RTAs) such as TTIP and the TPP. UNCTAD also devoted considerable attention to generating new guidelines on sovereign-friendly investment regimes (UNCTAD, 2016, Chapter 3). A second manifestation of the inward-looking national-interests-first change in South African policy comes in the form of increasing policy “warnings” that South Africa in future will tie its tariff policy much more closely to its development needs. In an implicit criticism of the rapid and deep liberalization of South African trade in the 1990s, the Department of Trade and Industry (DTI) has started issuing warnings that “South Africa will be resolute in using tariffs to defend domestic industry and support industrial development” (cited in Creamer, 2017; see also Dube and Gus, 2012). In his pronouncements on this matter (February 2017) the DTI Minister did add that South Africa cannot afford to become “overly protectionist”, but pointed out that South Africa will no longer be a push-over when it comes to trade policies and trade remedies” (cited in Creamer, 2017). Above, I noted that South Africa has as yet not been a complainant in a single WTO dispute resolution proceeding. Judging by the Minister’s words, it would seem that from 2017 onwards, South Africa will be ready to resort to that type of remedy if it deems its own industrial interests to be at stake. Part of this can be regarded as South Africa’s response to growing global protectionist trends that came to a head with the BREXIT vote in the UK and the election of President Trump in the USA. However, the decision to align tariff policy closer with national industrial policy dates back to 2012−2013 (DTI, 2013). The third manifestation of South Africa’s sovereignist turn is a pattern of voting in the UN that shows an increasing hesitancy to criticize states for behavior that

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could be construed as breaches of human rights and other international liberal norms. Again, this sovereignist turn did not originate with the Zuma presidency, but had gradually been gestating in the 2000s in contrast with South Africa’s early commitment to the promotion of human rights, which the Mandela presidency elevated to a specific aim of the new South Africa’s foreign policy. In 1998, South Africa’s National Plan of Action for the Promotion and Protection of Human Rights (NAP) was submitted to the UN’s Office of the High Commissioner for Human Rights and emphasized that all human rights were “universal, indivisible and interdependent” (cited in Graham, 2016: 63). Over the next decade, South Africa’s approach to the matter increasingly became ambiguous (Jordaan, 2014). As Graham (2016) shows, South Africa’s policy on the international promotion of human rights continues to be an evolutionary learning process, in which a broader range of interests/forces came to the fore than in the heady, single-mindedness of the early post-apartheid days of the 1990s. South Africa continues to be quite consistent in voting for and promoting thematic human rights concerns in various UN bodies, including the right to development that has become a theme of its membership of the Human Rights Council (HRC; member since 2014). However, in both its terms as non-permanent member of the UNSC (2007−2008; 2011−2012), and in its voting behavior in the UN General Assembly Third Committee and the HRC, South Africa is increasingly hesitant to support country-specific resolutions that could be construed as interference in the domestic affairs of member states, or that manifest a broad interpretation of the “interventionist” terms of Chapter 7 of the UN Charter. South Africa’s policy aims at squaring competing values: promotion and protection of human rights to give effect to the normative exceptionalism that the country continues to claim, and at the same opposing attempts by Western nations to weaken norms pertaining to non-interference, territorial integrity and sovereignty. Human rights remain a bone of contention in the UN system, and while this battle is not of South Africa’s making, its very legitimacy as a spokesperson for, and its aim of becoming a permanent UNSC member on behalf of Africa, are dependent on its credentials as an opponent of liberalism of the interfering kind (Jordaan, 2012). As far as the latter is concerned, South Africa (for most of the time) consistently found common ground with the BRICs (Ferdinand, 2014). Its decision in 2016 to withdraw from the Rome Statute that established the International Criminal Court (ICC), in line with a general African disquiet about the perceived anti-African bias of the ICC, should also be interpreted as a manifestation of South Africa’s growing enthusiasm for a sovereignist approach to global affairs. The decision to leave the ICC was rescinded in 2017, though, after a South African court found it to be unconstitutional and illegal (Torchia, 2017).

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How Successful Was the BRICS Experiment? The previous section argued that South Africa’s profile domestically and in terms of global governance has changed markedly in the last decade, away from that of a middle-power that embraces liberal economic policies and attempts to build bridges between established industrialized states and aspiring industrializing states. In its place has emerged an aspiring regional power, focusing on how its role in Africa and the world can contribute to the consolidation and deepening of the developmental state model of national development. BRICS membership was intended to contribute to securing South Africa’s status as Africa’s regional power, and to assist in the restructuring of the South African economy. Since 2014, the latter goal has increasingly been couched in terms of a new slogan, namely, “radical economic transformation” (Bhorat et al., 2017). What this means is as yet not clear, but there is evidence that points to a coordinated attempt by the Zuma Presidency to secure, both through legal and dubious means, a form of patron−client control over crucial state-owned enterprises (in particular the Electricity Commission — ESKOM, and the railways — Transnet), state procurement channels, and strategic parts of the mining sector. Zuma has also been staffing the state sector with a number of preferred clients, while getting rid of opponents, such as the highly-respected Minister of Finance (Pravin Gordhan) who was unceremoniously sacked in April 2017. Ostensibly, all of the above is done in order to promote Black ownership of and participation in the national economy, but for some observers it is clear that it actually is geared towards benefiting a select group of cronies around Zuma, and a small section of the emerging Black business class in South Africa. The degree to which BRICS membership plays into this strategy of “state capture” (Bhorat et al., 2017) is not fully transparent, but it is obvious that the BRICS connection was instrumental in “securing” a large and lucrative nuclear energy deal with the Russians. One of the reasons that the President had a falling out with his previous Minister of Finances was that the latter was strongly opposed to this type of dubious “deal making”. Although Mr. Gordhan finds himself in the political wilderness (in May 2017), his opposition to the nuclear deal has been vindicated by a court ruling that instructed the President to follow transparent tender procedures and submit the allocation of the right to build new nuclear reactors in South Africa to Parliament (Cotterill, 2017). Six years is not a long time in the development trajectory of a country, and it is too soon to draw any firm conclusions about the longer-term effects of BRICS membership, and the sovereignist turn described above, on South Africa’s domestic situation. There are indications, though, that the trends traced above have not assisted in ­making South Africa a more inclusive social order, despite all the words that have been spilled on this elusive goal since the late 2000s. I rely on the notion

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of inclusiveness as defined by Ranieri and Ramos (2013). They make a distinction between inclusiveness of participation and the inclusiveness of sharing in the benefits of economic growth. The first can be traced by the International Labor Organization’s indicator of the employment-to-total (available) labor force, expressed as a percentage. The second can be measured as the head-count poverty rate, that is, the portion of the population that find themselves in poverty as a percentage of the total population. In addition, a measure of income inequality can also be used to trace the second dimension of inclusivity. By the time that South Africa joined the BRICS, the economy grew at a rate that kept pace with population growth, and recorded a GDP per capita growth rate of 1.5% in 2010 (after the slump in 2009 due to the global financial crisis (GFC)), and 1.7% in 2011. Since 2012, this growth rate has contracted markedly and has been negative since 2015 (see Table 2 for available summary economic statistics). As a result, the unemployment rate has crept up to beyond 26% by 2016. Young South Africans are particularly affected by persistent high levels of unemployment. According to Moody’s (Laing, 2017), unemployment amongst the 34-year old and younger amounted to 48.6% in the third quarter of 2016, and 65.5% among those younger than 24 years (excluding students). Festus et al. (2016) find that the largest concentration of the unemployed is among young, poorly-educated black residents of rural Gauteng, which is the mining and industrial heartland of South Africa. Unemployment also signals that a sizeable portion of the black population remains excluded from suitable education that would prepare them for formal employment. However, educational imbalances are not the only determinant of unemployment. High unemployment in post-apartheid SA is related to: (a) the continual shrinkage of the non-mineral tradable sector and manufacturing in particular (see Figure 1 and Table 2, and Rodrik, 2008), and (b) to the rigidities of the labor market. Manufacturing, as a percentage of GDP, has declined from around 20% in the mid-1990s to about 13% in 2015. This places a structural constraint on the ability of the economy to absorb newcomers to the labor force. Other labor-market rigidities include the role of organized labor and of business management. The former is a labor aristocracy, and one of the alliance partners of the ruling ANC, and keeps upward pressure on wages, including the (likely) introduction of a minimum wage. Management/business responds to rising wages by increasing productivity and shedding unskilled labor, thus exacerbating unemployment (Seekings and Nattrass, 2015: 232). BRICS membership exacerbated the imbalances captured by Table 2 — primarily by increasing South Africa’s long-term structural vulnerability and inhibiting job creation/employment growth in the non-mineral tradable sector. Minerals account for about a quarter of total South African merchandise exports, up from about 10% in the mid-1990s. This dependence on mineral exports, and South Africa’s exposure

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Table 2:   South Africa: Selected social economic indicators 2008–2017.

Inward FDI, % of GDP

Metals and Ores as Unemployment Gross Contribution of Percent of Contribution Gini of Rate (% of Government Manufacturing Merchandise of Services to Disposable Potential Debt to GDP Exports GDP Income Workforce)

2008

3.2

1.8

-7.2

3.44

27.2

15.9

29.1

65.5

2009

-1.5

-2.9

-4.1

2.58

31.6

15.0

29.3

66.6

2010

3.0

1.5

-2.0

0.98

35.3

14.4

28.3

67.2

2011

3.2

1.7

-2.3

0.99

38.8

13.3

31.0

67.5

22.7 63.1

23.7

69.0

24.7

24.7

2012

2.2

0.7

-4.0

-5.0

1.17

41.0

13.1

27.7

67.9

25.0

2013

2.2

0.6

-3.9

-5.7

2.24

44.0

13.2

29.9

67.8

24.6

2014

1.5

-0.1

-3.7

-5.4

1.65

46.9

13.3

25.9

68.0

25.1

2015

1.3

-0.4

-3.9

-4.3

0.48

49.8

13.5

24.0

67.8

25.4

13.2

2016

0.1

-1.6

-3.7

-4.1

51.5

2017

1.1

-0.6

-3.6

-4.8

52.6

68.7

26.1 26.7

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Year

Real Real GDP GDP Per Capita Growth Growth

Current Account Overall Fiscal Imbalance Balance (% of GDP)

Note: Figures for 2017 are projections. Sources: World Development Indicators (2017); IMF (2016b).

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Figure 1:   The decline of manufacturing and unemployment in South Africa, 1990−2015. Source: World Development Indicators 2017.

to China, are points of vulnerability, not strength. China takes 10% of South African exports, and is the country’ largest single export market. Global demand for South Africa’s commodity exports is also largely determined by China. 60% of all South Africa’s commodity exports to BRIC countries in 2015 were minerals, and two-thirds of those went to China alone. It is no surprise, therefore, that shrinking Chinese demands for commodities reduced imports from South Africa by a quarter from 2014 to 2015, and at US $30 billion was lower in 2015 than it was in 2011, having grown by a factor of eight between 2006 and 2011 (BRICS, 2016: 193). Exposure to SSA, the basis of the “gateway to Africa” selling point, adds to this vulnerability. SSA accounts for 30% of South Africa’s exports, and most of its FDI assets held outside China. It is an open question whether the BRICS’s NDB and CRA would be able to compensate for these vulnerabilities. South Africa’s lack of inclusivity is reflected dramatically in the high, and rising, income inequality levels (Anand et al., 2016). Consumption (income) inequality has increased from 57.8 on a 100-point Gini scale in 2000 to 63.1 in 2009. The consumption share of the lowest quintile shrunk from 3% to 2.7%, and the share of the middle class — the next three quintiles — also shrunk by about 4%. The consumption share of the top quintile increased from 62% to 68%. The most recent income survey of 2011 records a Gini of 69 for disposable income (DI), and a staggering 77 for market income inequality (MII = income before tax and transfers). The income share of the lowest

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quintile was 1.54% (DI) and 0.30% (MII), and the share of the top quintile 74.5% (DI) and 81.4% (MII), respectively (income surveys reported in UNU-WIDER (2016); see also World Bank (2014). It is clear that South Africa is having success in reducing net (after tax and transfer) inequality, but that the structural factors that determine MII (before tax and transfer) inequality contribute to keeping South Africa amongst the group of most unequal states in the world (Woolard et al., 2015; World Bank, 2014). Thanks to a range of fiscal interventions, in the form of social assistance cash transfer programs, poverty rates have declined markedly since 1994. Most of these have their origins after 1996 when the state compensated for its turn to an orthodox neoliberal macroeconomic strategy (GEAR — see Table 1) by increasing cash transfers to vulnerable groups, reaching as many as 17 million South Africans in 2017, at a cost of more than ZAR 10 billion per month. Such social assistance is the main source of income for the majority of poor households in the country. Fiscal redistribution — stimulated by democratization (Seekings and Nattrass, 2015) has been a success, and by 2011 (which was when the last census took place) lifted almost 4 million people out of poverty. Between 2006 and 2011, the percentage of households whose income fell below the national poverty line decreased from 57% to 46% (Seekings and Nattrass, 2015) on different poverty measures and findings. In 2011 alone, fiscal transfers reduced extreme poverty (income below US $1.25 a day) from 35% (market income) to 17% (disposable, after tax and transfer income) (World Bank, 2014). Whether such fiscal largesse is sustainable is an open question, though a long-term study by the South African Treasury warns that a growth rate of at least 3% is required to continue paying for it (Ferreira, 2015). As Table 2 shows, South Africa last achieved that rate of growth in 2008. Currently, the state is running a fiscal deficit, state borrowing is increasing, and there is a long-term currentaccount imbalance. This is set to worsen in view of the downgrade of South Africa sovereign credit rating to junk status by CRAs Fitch and Standard and Poor’s in April 2017, with Moody’s contemplating a similar move. In the absence of sustained and inclusive economic growth based on renewed industrialization of the South African economy (Jonas, 2017), more than the current 17 million South Africans (out of a total of 52 million) will be dependent on cash transfers just to maintain a basic standard of living, and there is no guarantee that the state will be able to afford it.

Conclusion Brazil, China, India, Russia, and South Africa form an exclusive club, but not in the sense that they will never want to spoil a good acronym by allowing other states to join. Rather, they are exclusivist, in the sense that the overall configuration of their political, social, and economic institutions systematically excludes or marginalizes

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significant segments of their populations, each in their own way (but see Alston et al., 2016 on Brazil). Using a typology popularized by a recent prominent strand of neo-institutionalism, they are “mature limited access orders” (North et al., 2013). Limited access orders are characterized by elite rent-seeking pacts, which serve to co-opt those with the capacity to violently challenge the status quo. As elite pacts, they limit the access of non-elites to existing institutions, and new organizations are allowed only to the extent that they serve to maintain or strengthen the elite pacts. Politics, and a range of patron−client relations determine access. In mature limited access orders, the dominance of an elite-based overall political arrangement coincides with some seemingly inclusive institutions and norms, such as competitive elections, a market economy, functioning legal systems and relatively free media. Overall, and due to the specific ways in which some seemingly inclusive institutions operate, they continue to marginalize sizeable sections of their populations. In South Africa, despite the exemplary liberal democratic credentials of its 1996 Constitution, a strong independent media and legal system, and a diversified market economy, social and labor-market institutions conspire to exclude systematically as many as a quarter to a third of the population from the material and psychological benefits enjoyed by the more fortunate. This chapter argued that the exclusivist credentials of post-apartheid South Africa have become more evident in recent years, and that this trend has largely coincided with South Africa’s membership of the BRICS group since 2010. It also coincides with a “sovereignist” turn in South African foreign political and economic relations in which important dimensions of the global liberal order are challenged in favor of an emphasis on national development priorities and resistance to some liberal cosmopolitan values and practices. I deliberately used the term “coincide” to link these domestic and foreign policy trends to avoid assuming causality while the mutual influences of events and trends are diffused, dispersed, and subject to feedback loops. Nevertheless, there is enough evidence to sustain a coherent tale about a country that originally set itself the goal of contributing to global change, and thus becoming an attractive (for various reasons) partner for others who also have an interest in global change. It then hitched its own fortunes and specifically the fortunes of a favored elite around the figure of President Zuma, to those other “emerging powers”, and found itself changed in the process. South Africa gained considerable respect in the 1990s and early 2000s as a global mediator and champion of the cause of the developing South, although ambiguity was not absent from that role (Jordaan, 2012). By 2017, though, this respect is dissipating as it becomes clear how the aspirations of being a regional power, combined with declining governance standards domestically, is transforming this BRICS member. Whether this makes South Africa less attractive as a member to the other BRICs, remains to be seen.

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Want to Know More? Three recent contributions to the literature on South Africa are highly recommended. The first is a report by the “State Capacity Research Group” under the title “Betrayal of the Promise: How South Africa is Being Stolen” (Bhorat, 2017). It reveals the murky world of the patron−client network that President Zuma and his cronies have constructed in an attempt to undermine the Constitutional state in South Africa and to redirect state capacities for their own sectarian purposes. Mzukisi Qobo and Prince Mashele’s book The Fall of the ANC: What Next? (Qobo and Mashele, 2014), analyzes the weaknesses that have beset one of Africa’s oldest and previously most respected national liberation movements, the African National Congress. Given the prominence of the ANC in South African politics, where it has ruled unchallenged since 1994, the fortunes of the country are closely linked to those of this movement/party. Current signs of a rot, spreading from the top, bode ill for the future. Jeremy Seekings and Nicoli Nattrass’ “Policy, Politics and Poverty in South Africa” (Seekings and Nattrass, 2015) is the best available account of poverty in South Africa, how policy initiatives have aimed at dealing with it, and how the labor market, and actors in the labor market, contribute to excluding a large part of the population from participating fully in a modern diversified economy.

References Alden, C. and M. Schoeman (2013). “South Africa in the company of giants: The search for leadership in a transforming global order”, International Affairs, 89(1): 111–129. Alston, L. J., M. A. Melo, B. Mueller and C. Pereira (2016). Brazil in Transition: Beliefs, leadership, and Institutional Change, Princeton: Princeton University Press. Anand, R., S. Kothari and N. Kumar (2016). “South Africa: Labor Market Dynamics and Inequality”, International Monetary Fund Working Paper, WP/16/137. Becker, D. (2010). “The new legitimacy and international legitimation: Civilization and South African foreign policy”, Foreign Policy Analysis, 6(2): 133–146. Besada, H., K. Winters and E. Tok (2013). “South Africa in the BRICS: Opportunities, ­challenges and prospects”, Africa Insight, 42(4): 1–15. Bhorat, H., M. Buthelezi, I. Chipkin, S. Duma, L. Mondi, C. Peter and M. Swilling (2017). Betrayal of the Promise: How South Africa is Being Stolen, State Capacity Research Project, Public Affairs Research Institute. Bond, P. (2004). Talk Left, Walk Right: South Africa’s Frustrated Global Reforms, Pieter­ maritzburg: University of KwaZulu-Natal Press, pp. 83–84. Bosman, K. (2016). “South Africa: Trading international investment for policy space”, Stellenbosch Economic Working Papers, 04/16.

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PART II

Regionalism and Foreign Aid

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CHAPTER 6

Emerging Economies — But Regional Powers? The BRICS and Regionalism Tanja A. Börzel and T homas Risse Otto Suhr Institute for Political Science, Freie Universität Berlin, Germany

Introduction The rise of the BRICS (Brazil, Russia, India, China, and South Africa), has certainly changed the international political landscape. Yet, we are still a far cry from a multipolar world. Multi-polarity is a concept that belongs to the 19th century, because it fails to capture globalization, i.e. the inter-connectedness and interdependence that characterizes the 21st century. The Western dominance in global governance is certainly fading. At the same time, however, the BRICS have not filled the void. Rather than assuming a leadership role in global governance, they have focused on the regional level to manage problems of interdependence that threaten their political stability and economic prosperity. How important is regionalism to the BRICS? Do they champion different forms of regionalism? How is the BRICS’ engagement in regionalism going to affect the global economy and the global order more broadly? This chapter argues that the BRICS may have the economic resources to become global leaders and to make a difference internationally. Yet, they still lack a vision for the global order and the political will to use their capabilities to pursue it. So far, the BRICS’ appetite for global leadership appears to be limited. Rather, they seek to shape the order of the region in which they are embedded. Since the end of the Cold War, Brazil, South Africa, and India have increasingly acted as regional 115

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powers seeing regionalism as a way to pursue their national interests. They have engaged in regional institution-building to contain the influence of external actors or to prevent and manage threats to the regional stability, such as massive human rights violations, coup d’états, and natural disasters. More recently, China and Russia have also become more active in seeking the cooperation of their neighbors. Still, the commonalities of the BRICS in engaging in regionalism are outweighed by the differences between them. Explaining these differences is a challenge for theories of comparative regionalism. This chapter is organized in three parts. The first part compares how the BRICS have engaged in regionalism. While all five countries play an increasingly active role in their respective regions, they differ greatly in the approach they take and the impact they have on regional institution-building. Second, we explore the extent to which main approaches to regionalism help us explain this variation. The third part concludes the chapter by putting the regionalism approaches of the BRICS in the broader context of their (potential) role as leaders in the global economy. We argue that economic power per se is not sufficient to affect the international order. With the possible exception of China, the emerging economies have not put forward an alternative vision and still largely follow the practices of Western democracies. And even China appears to work mostly within Western-led multilateral institutions attempting to shape its policies. Finally, we end with some reflections on avenues for future research.

Towards a Regional Leadership? The IPE literature discusses regionalism as both stepping stones and stumbling blocks for global (economic) governance (Preusse, 2004; Musila, 2005). Irrespective of its effect on global trade and investment, regional leadership plays a key role in the creation and prevalence of regional organizations (Gilpin, 1987; Yarbrough and Yarbrough, 1992; Lake, 1993; Mattli, 1999b). Emerging economies have sufficient capabilities to act as regional leaders. Besides realizing economies of scale or avoiding and managing policy externalities, they could use regional institutions to challenge or circumvent global governance regimes (Frazier and Stewart-Ingersoll, 2010). Indeed, students of comparative regionalism have expected emerging economies and rising powers to engage with their region and take on leadership in creating and developing regional institutions (Nolte, 2010; Burges, 2008). Others have cautioned that regional powers may have the capabilities but lack the purpose and practice of regional leadership (Schirm, 2010; Prys, 2010; Krapohl et al., 2014). Moreover, if they choose to lead, their leadership is not necessarily benevolent but can take the form of coercive domination (Destradi, 2010).

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Initially, the BRICS were rather reluctant to engage systematically in regionalism. Yet, in the past years, they have played an increasingly active role in (re)building regional governance institutions. Brazil: Post-Hegemonic Regionalism Brazil has been ambivalent towards pushing regional institution-building in Latin America (Spektor, 2010). On the one hand, its neighbors have complained about Brazil’s lack of commitment and unwillingness to provide regional leadership. On the other hand, the economic integration between Argentina and Brazil, which started in 1986, formed the basis for the Southern Cone Common Market (MERCOSUR) created in 1991 (Krapohl et al., 2014). The establishment of and institutional support for MERCOSUR marked a reorientation in Brazilian foreign policy towards using regionalism as a means to consolidate Brazil’s leadership in the region (Lazarou, 2013; Teixeira, 2011). The Treaty of Asunción of 1991 aimed at fostering the international competitiveness and national development of Argentina, Brazil, Paraguay, and Uruguay, through regional trade liberalization. The democracy clause established with the Ushuaia Protocol in 1998 was to help stabilize democracy in Paraguay (Ribeiro Hoffmann, 2012). The establishment of MERCOSUR resulted in a significant increase of intraregional trade in the 1990s, particularly between the two major economies. Some have interpreted MERCOSUR as a bargain between Argentina and Brazil of ­“preferential access into the Brazilian market in exchange for Argentinian support for Brazilian international trade strategies” (Bouzas et al., 2002 quoted in Malamud, 2012: 170). While the Argentinian crisis at the end of the millennium reversed the trend, Brazil used MERCOSUR as a platform to mobilize opposition against the US Free Trade Area of the Americas initiative (Lazarou and Luciano, 2015). It also launched the South American Presidential Summit in 2000 as an alternative venue to promote trade and security in the region. The financial crisis of 2008 increased the demand for trade and development cooperation at the regional level. Economic and political integration had stalled in MERCOSUR despite the attempts of Brazil and Argentina to relaunch the project in 2003. The creation of the Permanent Review Court in 2004, the MERCOSUR Parliament (Parlasur) in 2006, and the Fund for Structural Convergence in 2005, 70% of which Brazil pays for (Lazarou and Luciano, 2015), were to strengthen the social and citizen dimension of regional integration. Yet, they did not change MERCOSUR’s intergovernmental or inter-presidential character. The strong role of the presidency in Latin American politics is mirrored at the regional level where

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member states seek to protect rather than transfer their sovereignty (Malamud, 2003). Regional organizations in Latin America are dominated by state leaders and involve low degrees of pooling and delegation of authority (Bianculli, 2016). To provide a continental umbrella for regional cooperation, Brazil spearheaded the creation of the Union of South American Nations (UNASUR) in 2004 (Burges, 2007).1 UNASUR is the first South American integration scheme bringing together the Andean Community (CAN) and MERCOSUR as the two major economic blocs in the region. It compromises the 12 independent South American states and centers on social policy, infrastructure, energy, and security rather than trade. Similar to MERCOSUR, UNASUR shall also promote democratic stabilization. With its focus on development and democratic stabilization, Brazil has promoted UNASUR as a counterbalance to the US and the Organization of American States (OAS; Mera, 2005; Tussie, 2009). UNASUR is to tie in Venezuela while keeping out Mexico and its Pacific Alliance partners (Colombia, Peru, and Chile), which favor regional trade liberalization over regional development (Burges, 2008; LinkeBehrens, 2015: 15−16; Lazarou and Luciano, 2015). Finally, UNASUR serves Brazil as platform to establish interregional relations within the Global South, e.g. the Africa-South America Summit (ASA) or the Summit of Arab-South American countries (ASPA). Brazil also supported the creation of the Community Latin American and Caribbean States (CELAC) in 2010. CELAC unites the Rio Group of Latin American states, which had existed since 1986, with the Latin American and Caribbean Summit (CALC). Similar to UNASUR, Brazil’s engagement has been motivated by its post-liberal regional agenda and its ambition for the region to develop a common voice to increase its influence at the global level (Lazarou and Luciano, 2015). While UNASUR and CELAC are considered the centerpiece of post-hegemonic regionalism in Latin America (Briceño-Ruiz and Ribeiro Hoffmann, 2015; Riggirozzi and Tussie, 2012), the two regional organizations reflect the declining relevance of US-led Pan-Americanism as much as Brazil’s aspirations to promote its post-liberal agenda at the regional level. Overall, Brazil has increasingly used its regional power to promote regionalism in South America and to boost its image as a rising power (Malamud, 2012; Lima, 2008). MERCOSUR and UNASUR have served its interest to offset the influence of the US and the OAS, which Brazil perceives as dominated by the US. Together with CELAC, MERCOSUR and UNASUR also help promote Brazil’s global ambitions for changing international institutions towards giving the Global South a greater voice  The South American Community of Nations (SACN) founded in 2004 was renamed in UNASUR in 2008. 1

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(Lazarou and Luciano, 2015; Vigevani and Ramanzini Júnior, 2011; Gratius and Saraiva, 2013; Burges, 2009). At the same time, the effectiveness of regional institutions in Latin America has been weak (Bianculli, 2016) which limits their use as a “springboard for Brazilian leadership” (Malamud, 2012: 171). Moreover, members of MERCOSUR, UNASUR and CELAC are reluctant to let Brazil represent them at the global level (Malamud, 2012). Argentina, for instance, was one of the strongest opponents of Brazil’s campaign for a permanent seat in the UN Security Council. Nor was MERCOSUR able to agree on a joint candidate for the post of Director General of the WTO in 2005 as a result of which Brazil competed with Uruguay (Malamud, 2012: 171−172). The lack of support and outright rivalry by Venezuela and Bolivia have made Brazil turn to the other BRICS countries to advance its global agenda (Malamud, 2012). Russia: Competitive Regionalism Russia is the only regional power that developed an explicit strategy of using regionalism to secure its sphere of influence in its “near abroad” and to control it neighbors. This strategy predated the Putin era (Tsygankov, 2006; Saivetz, 2012; Molchanov, 2016; Krickovic, 2014). The Commonwealth of Independent States (CIS) was designed to “hold together” the former Soviet Republics after the Soviet Union had collapsed in 1991 (Libman and Vinokurov, 2012). It was supposed to help Russia regain political control over former Soviet states and stress its claims to regional hegemony. While the CIS set out to mimic monetary and economic integration in the European Union, it has largely remained a “paper organization” (Obydenkova, 2011). Russia therefore initiated a series of other regional institutions, including the Customs Union of 1995 with Belarus, Kazakhstan, the Kyrgyz Republic, and Tajikistan, which later transformed into the Eurasian Economic Community (EurAsEC), or the Collective Security Treaty Organization (CSTO), a common defense alliance created in 2002 (Obydenkova, 2011; Wirminghaus, 2012; Hancock and Libman, 2016). The 2008 global financial crisis (GFC) resulted in renewed efforts of Russia at regional institution-building. The export of natural resources had failed to turn Russia into an “energy superpower” (Tsygankov, 2016). Rather than bringing all postSoviet countries under one common institutional roof, Russia started to diversify its approach setting up relations with smaller sub-groups (Vinokurov, 2007; Krickovic and Bratersky, 2016). The Eurasian Economic Union (EAEU) inaugurated in 2015 is the most recent of Russia’s ambitions of integrating former Soviet Republics into a regional organization that is to fend off the EU’s attempts to draw its “Eastern neighbors”

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closer by offering deep and comprehensive association and free trade agreements (DCFTA; Wirminghaus, 2012; Frazier and Stewart-Ingersoll, 2010: 743; Dragneva and Wolczuk, 2013; see also Chapter 2). Post-Soviet states have to choose between joining the EAEU and signing a DCFTA with the EU. Besides making Eurasian and European economic regionalism mutually exclusive, Russia pursues a form of “plutocratic regionalism” (Hancock, 2009) in which it provides substantial benefits to other members (e.g. lower gas prices, market access). In return, smaller states delegate authority to Russia to make and implement decisions. Russia’s agreement to “supranationalise” the Eurasian Economic Commission (EEC), the executive body of EAEU modelled after the European Commission, appears to undermine claims about Russia using regionalism to control its near abroad. The EEC has the power to initiate and draft policies, adopt decisions, monitor the implementation of international treaties, frame strategic plans and may even conclude international treaties on behalf of the EAEU (Treaty on the EAEU 2014). More importantly, it takes decisions by qualified majority. However, the highest organ of the EAEU is the Eurasian Supreme Council, which still decides by consensus. Thus, the EEA imposes a weak form of “voluntary restrictions of its (Russia’s, TAB/TR) sovereignty” (Molchanov, 2016: 129). It could as well-increase Russia’s leverage by making it appear less threatening to its neighbors (Krickovic, 2014) and promote its image as a “benevolent hegemon” rather than a “neighborhood bully” (Krickovic and Bratersky, 2016). Russia feels increasingly encircled by rival powers. It has used regionalism to counter external influence and intervention by providing its neighbors with access to Russian markets, also for labor migrants, to finance and to cheaper energy, as well as by helping authoritarian regimes deal with internal and external security threats (Krickovic and Bratersky, 2016). By making states join comprehensive regional agreements which are competitive rather than complementary to European forms of economic regionalism, Russia seeks to tie its neighbors into Russia-led regional institutions asserting what is sees as its traditional sphere of influence (Gast, 2017) and counter its economic and geopolitical decline as a former super power (Wilson, 2017). Declining oil prices, the plunge of the Russian ruble and Western sanctions have considerably undermined the economic incentives Russia can offer to make membership in regional institutions attractive. As a result, Russia increasingly relies on its role as a provider of security and stability in the region stepping up its troop deployments and military aid (Krickovic and Bratersky, 2016). Interestingly, this is done bilaterally rather than using the regional structures of CSTO (Wilson, 2017). Arguably, Armenia forewent a Deep and Comprehensive Free Trade Agreement with the EU to join the EAEU, not because of the greater economic benefits but in return for Russian security guarantees in the conflict with Azerbaijan over Nagorno Karabakh.

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More recently, Russia started to seek the cooperation of China to promote the economic development in the post-Soviet area. The EEU signed a memorandum of understanding with the Chinese Silk Initiative (OBOR, see below) in 2016, which may indicate a policy reversal in Russia’s approach to regionalism in Central Asia moving away from containing and countering the growing influence of China towards a division of labor, in which Russia guarantees security and China promotes economic development in the region (Krickovic and Bratersky, 2016; Wilson, 2017). For Belarus and Kazakhstan, this division of labor provides an opportunity to decrease their economic dependence on Russia, which may eventually undermine the EAEU and Russia’s role as regional hegemon more broadly. At the same time, with China using “One Belt, One Road” (OBOR) rather than the Shanghai Cooperation Organization (SCO) for pursuing economic development projects in Central Asia (see below), Russia seeks to use SCO for boosting its global role by expanding its membership (Wilson, 2017: 15). In 2016, SCO approved the accession of Pakistan and India. India: Selfish Regionalism India has increasingly shown aspirations for regional leadership in the South Asian network of institutions such as the South Asian Preferential Trade Area (SAPTA), the South Asian Association for Regional Cooperation (SAARC), and the Bay of Bengal Initiative for Multi-Sectoral Technical and Economic Cooperation. Two of its main foreign policy doctrines inform India’s approach to regionalism: First, the “Look-East Policy” involves a stronger focus on East Asia and ASEAN, in particular. The ASEAN-India Free Trade Area (2010), for instance, serves India to increase its influence in South-East Asia and position itself as a main competitor to China (Wang, 2010). Second, India’s relations with SAARC members are guided by “asymmetrical responsibility”, where it makes concessions, such as preferential market access, without insisting on reciprocity particularly with regard to the least developed countries, including Nepal, Bangladesh, and Bhutan (Jain, 2005). SAARC was established as early as 1985 to support the socio-economic development of India, Pakistan, Nepal, Bangladesh, and Bhutan through collective self-reliance (Jain, 2005). Ten years later, the member states decided to develop SAARC into a Free Trade Area (SAFTA) and create a South Asian Development Fund (SADF) to finance infrastructure projects. While India has become more active in region-building, it has refrained so far from developing a vision for how to create stability in the conflict-ridden region (Destradi, 2012). Its previous policy of regional interventions was not intended “to make friends but to establish its hegemony” (Tripathi, 2016: 148).

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Its neighbors regard with suspicion India’s preponderant power and lasting conflict and ­competition for leadership with Pakistan. Bangladesh−India−Myanmar− Sri Lanka−Thailand-Economic Cooperation (BIMST-EC), for instance, has been designed to exclude Pakistan from free trade agreements (FTAs) of which India is part (Jain, 2005; Wang, 2010). Despite its commitment to non-reciprocal treatment, India, which accounts for 80% of the region’s GDP, has benefited most from regional trade cooperation. While overall regional trade has remained low, India’s exports in other member states has grown exponentially; its imports, by contrast, have remained low (Jain, 2005: 70; Juhos, 2015: 472). India continues to rely on an ad hoc and country-by-country approach towards economic and security cooperation with neighbors, also in trying to counter the growing influence of China in the region. China’s trade with and foreign investments in the SAARC members are higher than India’s (Juhos, 2015: 472−473). Similar to Central Asia, Beijing is using OBOR to establish bilateral infrastructure and development projects with India’s neighbors. While India has declined the invitation to participate in the Silk Road Initiative, China has observer status in SAARC and seeks full membership. Conflict and rivalry with Pakistan in particular has largely impaired economic integration and intra-regional trade in South Asia, which are the lowest in Asia (Dash, 2012). India’s attempt to move beyond its immediate neighborhood by looking East, West, and North (Juhos, 2015: 471) makes countries in the region reluctant to accept India’s emerging regional leadership (Tripathi, 2016). They perceive India as a “selfish hegemon” abusing its power to exploit its weaker neighbors and use regional cooperation as a “launching pad” for its global power ambitions (Juhos, 2015: 470; Behuria et al., 2012: 231). Last not least, India still lacks the diplomatic capacities to play a major role in regional governance (Behuria et al., 2012). China: Regionalism with “Chinese Characteristics” China used to be hostile towards Asian regionalism. It considered ASEAN as a tool of Asian countries allied with the West to fight communism (Narine, 1998). It had a clear preference for bilateral relations (Dent, 2008). After the end of the Cold War, however, China increasingly developed a more positive approach towards regionalism to foster trade and security with its neighbors and to support its export-driven development strategy (Wang, 2011b). On the one hand, China has sought to participate in and further develop existing institutions. It joined the Asia-Pacific Economic Cooperation forum (APEC) in 1991 and the Asia-Pacific Trade Agreement (APTA) in 2001. Beijing also became a formal observer to the SAARC in 2005. On the other hand, China has launched a number of new initiatives, including the SCO in 2001, the East Asian Summit in 2005, the China−Japan−Korea FTA negotiations in 2012,

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the Regional Cooperation Economic Partnership (RCEP) agreement in 2011, and the Asian Infrastructure Investment Bank (AIIB). These regional engagements notwithstanding, China has focused on its bilateral relations with ASEAN (ASEAN+3; ASEAN Regional Forum) to develop its role in the region (Wang, 2011b). In 2002, China and ASEAN started to negotiate a China-ASEAN FTA (CAFTA), which came into effect on 1 January 2011. CAFTA covers goods, services and investments; it also provides a formal mechanism to solve disputes on trade and investments. By population, CAFTA is the largest free trade area in the world and the third largest in terms of value (Wang, 2011a, 2011b). The OBOR project launched in 2013 seeks to extend China’s bilateral relations with Asian countries. It reflects the strategy advanced by China’s leader Xi Jinping to promote a new type of regionalism that seeks to go beyond trade and expand geographically beyond East Asia by building a wider Asian community “of common destiny” based on infrastructure links, essentially projects financed by the AIIB, and historical and cultural linkages (Zhang and Li, 2016). Interestingly, the Silk Road Economic Belt Initiative aimed at engaging Central Asia circumvents the SCO where Russia has sought to limit China’s attempts to use the regional organization for its economic development projects (Wilson, 2017: 14−15). The 21st Maritime Silk Road Initiative, by contrast, is complementary to South-East Asian regionalism since the latter focuses on trade rather than development. So are the China−Pakistan Economic Corridor and the Bangladesh−China−India−Myanmar Corridor, due to India’s reluctant engagement in SAARC (see above). China’s approach to regionalism “with Chinese characteristics” (Zhang and Li, 2016; Beeson and Shaomin, 2016) is open and non-exclusive. It experiments with diversified forms of regional cooperation characterized by low levels of formality and obligation, weak centralized institutions, and consensus-based decision-making (Kahler and MacIntyre, 2013). While being hardly legalized, China’s regionalism endorses global norms, such as multilateralism and open markets (Kolmas, 2016; Wang, 2011a). At the same time, China’s approach remains distinctively bilateral. Unlike Brazil, South Africa or Russia, China does not play a leading role within regional institutions but seeks to build Asian regionalism through strengthening its bilateral, predominantly economic ties with them. Overall, regionalism serves the broader international goal of China’s “peaceful rise” and the “building of a harmonious world” (Wang, 2011b: 206) establishing its position as a regional and global power (Wang, 2016). This is also reflected in China’s engagement with other regions and regional organizations, particularly in the Global South, including the Forum for East Asia-Latin America Cooperation (FELAC, 1999), the Forum on China-Africa Cooperation (FOCAC, 2000), the

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China-Community of Latin American and Caribbean Countries Forum (ChinaCELAC, 2014; Ribeiro Hoffmann, 2016), as well as regional trade agreements (RTAs) with the Gulf Cooperation Council and the South African Customs Union (Wang, 2011a). South Africa: Self-Interested Regionalism During the times of colonialism and apartheid, South Africa pursued a similar approach to regionalism as Russia using the Southern African Customs Union (SACU) as a means to dominate its neighbors, get access to cheap labor, and create a market for its internationally uncompetitive products (Flemes, 2009). The post-apartheid governments declared their willingness to employ South Africa’s reboosted economic power to exercise regional leadership (Flemes, 2009). South Africa was instrumental in creating the New Partnership for Africa’s Development (NEPAD) and the African Union (AU). It also used its economic leverage to actively shape SACU (Soko and Balchin, 2016). South Africa’s role within Southern African Development Community (SADC) has been more ambivalent, though (Amos, 2010; Lorenz-Carl, 2013; Muntschik, 2013). On the one hand, Pretoria successfully integrated the country into the organization, which its neighbors had created to counter-balance South Africa during apartheid (Amos, 2010). It pushed through the creation of a free trade area set up in 2008. On the other hand, the South African government undermined the conclusion of an Economic Partnership Agreement between SADC and the EU by going for a strategic bilateral partnership with the EU (Amos, 2010; Krapohl et al., 2014). South Africa did not play a prominent role in managing the various crises in the region either. Angola, Rwanda, and Uganda helped remove Mobutu Sese Seko from his autocratic rule over the Democratic Republic of Congo in 1997. And it was the former president of Botswana who negotiated the transition after Laurent Kabila had been ousted from power in 2002 (Clark, 2016). Finally, South Africa did not prevent the dismantling of the SADC Tribunal instigated by Zimbabwe in 2010 (Hulse and van der Vleuten, 2015). In recent years, South Africa has lost some of its global standing, which undermines its aspirations for regional leadership (Soko and Balchin, 2016). Its economic and military capabilities have declined (Hulse, 2016). Suspicion and distrust of its neighbors have further undermined South Africa’s regional power. Rather than implementing the FTA, for instance, SADC countries have concluded bilateral FTA with each other in order to prevent what they see as a takeover of their markets by self-interested South Africa (Lee, 2003; Hulse, 2016). Zimbabwe has championed the Common Market for Southern and Eastern Africa (COMESA), which competes with SADC (Hulse, 2016).

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Similar to India, South Africa’s neighbors perceive it as a “self-interested, almost coercive actor” (Hulse, 2016: 3). They have also criticized South Africa’s Western orientation and commitment to liberal democracy and economic liberalism (Flemes, 2009). To be fair, South Africa has provided some “co-operative hegemony” (Flemes, 2009), e.g. when it agreed to opening its markets first while giving the economically weaker members of SADC more time. However, these attempts at “benevolent leadership” (Krapohl et al., 2014) have been overshadowed by its unilateral extraregional trade policies, such as the bilateral Trade, Development and Cooperation Agreement (TDCA) with the EU, which entered into force in 2000. Beside some asymmetrical trade liberalization, the TDCA comes with substantial development aid. Overall, South Africa has been “a reluctant and conflicted regional power” (Clark, 2016), which has largely failed or at best underperformed as regional leader promoting and abandoning regionalism depending on what serves its economic and security interests best.

Same Same But Different: Explaining BRICS’ Role as Regional Powers The BRICS have played an increasing role as regional powers, yet in very different ways. India and South Africa are rather selective in their regional engagement. Brazil and Russia have consistently engaged in regional institution-building. So has China, however, less by dominating regional organizations but by strengthening its bilateral ties with them and other Asian countries. With the exception of Russia, none of the BRICS appears to have a clear vision of regionalism and their role in it. They differ, however, in their preferences for institutional design. China and India have resisted deeper forms of regionalism. Brazil, Russia, and South Africa have been more open to formalized cooperation but have been equally reluctant to pool and delegate national sovereignty in practice. The BRICS also share common features in their approaches to regionalism. First, to the extent that they foster regional cooperation, they do so in order to maximize their short-term interests. None of them — with the possible exception of China and only most recently — pursues a long-term strategy of regional integration. Second, and related to the first point, most BRICS are very reluctant to support supranational integration schemes that might constrain their own freedom of action. They mostly prefer regional intergovernmentalism (except maybe for Russia and the EAEU). How can we account for the differential approaches the BRICS have taken towards regionalism? In the following, we discuss power-based approaches (balancing behavior and regional hegemony), (economic) interdependence (managing

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conflict and negative externalities, promoting value chains), as well as domestic politics (regime type and locking-in of domestic reforms). We also compare the BRICS to other regional as well as external powers. Power-Based Approaches Power-based approaches such as neorealism assume that in the absence of a central enforcement power (anarchy), cooperation is risky for states which are concerned about the equal distribution of power among them (Baldwin, 2013; Grieco, 1988). To explain regional cooperation, hegemonic stability theory points to powerful states within the region or outside, which are willing to and capable of acting as “regional paymaster, easing distributional tensions and thus smoothing the path of integration” (Mattli, 1999a: 56; Gilpin, 1987: 87−90; Grieco, 1997). For example, the US played a key role as external hegemon in the creation and prevalence of the European Community and ASEAN by mitigating the security dilemma in the region (Gruber, 2000; Acharya, 2014). Germany is often portrayed as regional paymaster and “reluctant hegemon” in the EU (Bulmer and Paterson, 1996; Bulmer and Paterson, 2013). Conversely, the ineffectiveness of regionalism in the Middle East or East Asia is often blamed on the absence of a regional or external hegemon (Fawcett and Gandois, 2010; Hemmer and Katzenstein, 2002). Powerful states facilitate the emergence of regionalism for different reasons. The US, China, Russia, South Africa, or Nigeria supported and engaged in regionbuilding for geostrategic and economic reasons to strengthen military alliances, promote stability in neighboring countries, or secure access to new markets, cheap labor, water and energy resources (Antkiewicz and Whalley, 2005; Gowa, 1995; Clarkson, 2008; Coleman, 2007: 155−184). Brazil has championed MERCOSUR and UNASUR to establish itself as a regional power and to counter-balance US influence in Latin America (Mera, 2005; Tussie, 2009; Teixeira, 2011). Likewise, Russia has built EEA and CSTO to protect its near abroad against the influence of the EU and NATO (Obydenkova, 2011; Hancock and Libman, 2016). More generally, the similarity among the BRICS as short-term utility maximizers in their approaches to regionalism is largely consistent with power-based approaches in international relations theories. So is their reluctance to pool or delegate sovereignty. However, power-based approaches have a hard to time to explain the variation among the BRICS as well as the variation over time. While hegemonic leadership may help initiate and promote regionalism, powerful states are not always willing to act as hegemons (Destradi, 2010). The only regional power, which has played a hegemonic role as paymaster of its region is Russia, at least to some extent. China has been rather reluctant to use its regional power to shape regionalism and has

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only started recently assuming a more active role (Zhang and Li, 2016). Moreover, it has been undecided for quite a while whether to play regional bully or paymaster (on the distinction between benign and malign hegemony see Gilpin (1981)). Most recently, the Trump Administration, by giving up TTP, has handed China a major victory regarding its aspirations to create the Regional Comprehensive Economic Partnership (RCEP). Brazil has been ambivalent towards pushing regional institution-building in Latin America (Spektor, 2010). India appears to have aspirations for regional leadership but so far refrained from developing a vision for how to create stability in the conflict-ridden region (Destradi, 2012). South Africa has used its economic power to actively shape the Southern African Customs Union (SACU) but has played a more ambivalent role within Southern African Development Community (SADC; Lorenz-Carl, 2013; Muntschik, 2013). A similar and inconsistent picture emerges for regionalism as a way to balance external powers. Russia’s efforts can be read as an attempt to counter the EU in its near abroad, while Brazil and China have tried to balance the US in Latin America and Asia, respectively. Yet, balancing behavior against external powers does not explain India’s regional policy or that of South Africa. With regard to intra-regional power rivalries, they have often contributed to preventing efforts at regional institution-building. Examples include the competition between China and Japan in East Asia (Beeson, 2006; Dent, 2012; Grimes, 2008), between India and Pakistan in South Asia (Dash, 2012), between Brazil and Venezuela in South America (Burges, 2007), or between South Africa and Nigeria in Sub-Saharan Africa (Francis, 2006). (Economic) Interdependence International Political Economy (IPE) approaches emphasize welfare enhancing effects of cooperation, which tend to be greater among geographically proximate states. These include reduced transaction costs, economies of scale, technological innovation due to greater competition, more foreign direct investments, and greater economic and political weight in international markets and institutions (Mattli, 1999b: 46−47; Hancock, 2009: 25−29). Accordingly, globalization becomes a major driver for economic regionalism since global markets entail increased trans-border mobility and economic linkages, and trade issues are less cumbersome to deal with at the regional than at the multilateral level (Schirm, 2002). Coping with negative externalities, such as diversions of trade and investment, provides another rational to pursue economic regionalism. States may either seek membership in regional institutions generating the external effects as many European countries have done in the case of the EU and some of the South American countries do with NAFTA (Mattli, 1999b: 59−61). Or they create their own regional group. NAFTA can be

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interpreted as the US reaction to the fortification of the Single European Market and the emerging economic regionalism in Asia (Mattli, 1999b: 183−185). A similar “domino effect” (Baldwin, 1995) was triggered by the US turn towards regionalism which has contributed to the proliferation of regional preferential trade agreements (PTA), since states perceived the US as no longer capable of or willing to ensure the stability of the global trading system (Mansfield, 1998). Variation among the BRICS might be explained by the higher degree of economic interdependence fueling the demand for regional institutions to settle resulting conflicts (Mansfield, 1998; Mansfield and Milner, 1997; Mattli, 1999b; Moravcsik, 1998; Stone Sweet and Caporaso, 1998). Economic interdependence plays a prominent role for Russia’s efforts at regional institution-building in Eurasia (Hancock and Libman, 2016). At the same time, East Asia is by far the most economically integrated region (next to the EU) among those considered here. However, China has only recently begun to invest in regional institution-building. In this context, the IPE literature has argued that value chains and economic production networks are a main driver of regionalization in Asia. They link investment and intra-firm trade across multiple countries (Wang, 2011b). Intra-regional ties have grown not only in terms of trade but also advanced infrastructure, communication, and movement of people have grown rapidly and link to the regional trade and investment strategies of China (Weidenbaum and Hughes, 1996; Peng, 2002). Transnational production networks work as functional equivalents to formal regional institutions (Katzenstein, 2005; Ravenhill, 2009). With regard to South America, Southern Africa, and South Asia, however, economic interdependence is comparatively low and, thus, cannot explain the variation in the regional approaches of Brazil, South Africa, or India. As a result, IPE approaches focusing on economic interdependence produce mixed results at best with regard to explaining the behavior of the BRICS toward their respective regions. Regime Type and Domestic Politics Geographic proximity and democracy seem to increase the intensity of economic exchange between countries, and hence foster regional cooperation (Mansfield et al., 2000). An important body of research on the political economy of PTA formation and implementation has focused on the compatibility of political institutions in partner countries. To the extent to which “homophily” prevails among trading partners with similarities in their political institutions, these countries are also more likely to form a PTA (Hurrell, 1995: 68−71). This line of research emphasizes the influence of two institutional features on PTA formation: regime type and veto players (Mansfield and Milner, 2012; Mansfield et al., 2002, 2007).

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On regime type, the main argument is that democratic leaders have an incentive to sign PTAs because they provide information about leadership and performance. The premise is that it is difficult for voters to distinguish between the government’s poor performance in managing the economy and events that are beyond the government’s control. In order to avoid a scenario in which voters may vote a government out of office for reasons beyond its control, governments have an incentive to sign PTAs because these agreements offer reliable information to voters about the behavior of the home government and the governments in PTA partner countries. PTAs thus provide democracies with the institutional mechanism to make information available to voters. In non-democracies, however, governments have less incentive to enter into PTAs because electoral imperatives are far less pressing. Democracies are thus more likely to enter into PTAs than autocracies. Governments of democracies can increase political support through PTAs, while autocratic governments have less incentive to do so. The literature on international democracy promotion established a link between the democratic quality of states and their membership in regional organizations (Pevehouse, 2005, 2016). States use regional organizations to “lock in” democratic developments through deeper forms of regional cooperation and integration, entailing judicial litigation and sanctioning mechanisms. A prominent example often referred to in the literature is the post-communist countries of Central and Eastern Europe that sought membership in the European Union after their transition. Locking in domestic reforms may also work for authoritarian governments; they instrumentalize their membership in regional organizations to boost the sovereignty and legitimacy of their regimes (Levitsky and Way, 2010; Söderbaum, 2004). Institutional lock-in at the regional level is not only about committing successor governments to domestic reforms, democratic or otherwise. It can also provide a signaling device by which incumbent regimes seek to publicly commit themselves to certain institutions that external donors or investors care about. Domestic and regional stability are important for attracting capital and technology. After all, autocratic rulers often rely on economic prosperity for their domestic legitimacy (Solingen, 2008). How do these arguments score with regard to the BRICS? As to the propensity of democracies to engage in regional cooperation and integration, three of the five BRICS are democracies (Brazil, India and South Africa), but their behavior has varied quite substantially and over time. Moreover, only one region of those under consideration here is populated by democracies, namely, South America. Yet, regional integration in MERCOSUR has stagnated for quite some time. Regime type as such does not seem to explain the behavior of the BRICS.

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What about “lock-in” effects and “regime boosting”, irrespective of regime type? First, Eurasia as well as the SCO come to mind here as regional institutions encompassing various autocratic regimes. Russia’s efforts to boost regionalism in its near abroad, as well as China’s engagement in SCO are roughly consistent with the regime-boosting argument. Second, Brazil’s initial and strong support for MERCOSUR as well as post-Apartheid South Africa’s backing of SACU and SADC are also consistent with the arguments about democratic “lock-in”. The same holds true for Brazil’s later support for UNASUR as an association of left-wing South American governments. Third, China’s more recent attempts to foster regionalism in Asia are at least partially motivated by efforts to back up domestic economic reforms through the conclusion of multiple FTAs (Jetschke and Katada, 2016). Last not least, India’s selective regionalism is also consistent with the argument here, since it has little to gain domestically by boosting regional institutions in South Asia. In sum, power-based approaches can explain similarities among the BRICS, particularly their pursuit of short-term interests with regard to regionalism and their preferences for intergovernmental institutional designs of regional organizations. At the same time, hegemonic stability theory which emphasizes the long-term interests of (regional) hegemons in (regional) cooperation to maintain order and stability, is largely disconfirmed by the behavior of the BRICS. Moreover, powerbased approaches cannot account for the variation in the BRICS’ approaches to regionalism. In a similar vein, (economic) interdependence does not seem to provide much leverage in explaining the variation among the BRICS. In contrast and over time, domestic lock-in effects and “regime boosting” arguments are at least partly consistent with the empirical evidence. Yet, regime type is irrelevant as an account for the variation among the BRICS.

Conclusions: From Regional Powers to Global Leaders? We have argued in this chapter that, at best, the BRICS pursue regional policies which are geared toward short-term utility maximization. None of them is prepared to foster regional integration in a similar way as the US in the post-World War II period. Nor do they assume roles as regional “benign hegemons” who maintain regional order and are prepared to pay the costs of regionalism. While all BRICS are similar in this regard, the differences among them are also remarkable. Russia has created and dominates a whole new set of regional organizations, while China largely works through existing institutions. Brazil, Russia, and South Africa have assumed regional leadership roles, at least to some extent, while India pursues

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extremely selective regional policies. Last not least, China exerts leadership not through regionalism, but through bilateral relations in a “hub and spoke” system. What does this tell us about the future role of the BRICS as potential global leaders? Are the BRICS transforming themselves from regional to global powers? If we take our cues from the regional performance of the BRICS, they have a long way to go. They certainly command the economic and military capabilities to pursue both regional and global leadership roles. Their economic performance is indeed remarkable, the only exception being Russia (Molchanov, 2016), which looks more like a rent-seeking than an emerging economy. Russia, China, and India rank among the top military powers of the world — after the US, which is still the lonely number 1. China’s defense budget is not even a quarter of the size of what the US spends on its military. If it was only about military capabilities, Brazil and South Africa would have little potential for becoming a global power any time soon. However, how important is military power for shaping the global order? Material resources as such, be they military or economic, appear at best a necessary condition. What it takes to influence, not to mention shape the global order in the 21st century is, first, a vision, and second, the strategic capacity to put “your money where your mouth is”, i.e. deploy your capabilities to pursue your vision. The BRICS seem to lack both vision and practice so far. With the possible exception of Russia, none of them has so far developed a vision of regional order and put it into place. Moreover, none of the BRICS has so far developed clear ideas on how to revise the global (economic) system. Russia and China are permanent members of the UN Security Council, but they have shown little enthusiasm for changing the global governance structures. Brazil and India, together with South Africa (IBSA), call for a new economic world order that reflects the interests and needs of the Global South (Hurrell, 2006; Alden and Vieira, 2005). But they have failed to present their vision of how such a new order would look like and how existing norms, practices, and outcomes of global governance would have to be revised (Narlikar, 2013). At best, the emerging markets seek a redistribution of power. This is justified by the need to give the Global South a greater voice (Nel, 2010; Kingah and Quiliconi, 2016). The reform of IMF quotas and the inclusion of China’s renminbi in the basket of SDR currencies are indicative of changes within existing institutions to accommodate the global shift in power. As such, they play to the theme of continuity in international institutions and raise questions concerning the factors affecting institutional change and development. The BRICS have pushed the formation of alternative institutions for economic governance: the BRICS Bank and, more recently, the AIIB. These new institutions essentially replicate the functions of existing institutions but give the BRICS a greater say.

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International institutions created or dominated by the BRICS certainly have the potential to drive global economic governance in a more competitive direction, offering alternative forms of governance from the traditional leading economies. Yet, similar to their approaches to regionalism, the BRICS neither seem to have a vision nor do their interests always align. In conclusion, this chapter on the BRICS role in shaping regionalism has demonstrated that that they cannot be treated as a unitary actor, as the acronym implies. While having similar weight in their respective region and equally pursuing self-interested policies, the variation with regard to their practices is probably greater than the similarities. Major international relations theories have a hard time accounting for these similarities and the differences. Our survey has also revealed a lack of comparative research about the BRICS. Single case studies about individual regional powers and their policies toward their regions abound. Little they tell us, however, about how unique the BRICS’s engagement in regionalism is, also when compared to other emerging economies, and how best to explain it.

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Tsygankov, A. P. (2006). “If not by tanks, then by banks? The role of soft power in Putin’s Foreign policy”, Europe-Asia Studies, 58(7): 1079–1099. Tsygankov, A. P. (2016). Russia’s Foreign Policy: Change and Continuity in National Identity, Plymouth: Rowman & Littlefield. Tussie, D. (2009). “Latin America: Contrasting motivations for regional projects”, Review of International Studies, 35(S1): 169–188. Vigevani, T. and H. J. Ramanzini (2011). “The grounding of regional integration for Brazil: Universalism, Sovereignty and elite perception”, Global Society, 25(4): 449–468. Vinokurov, E. (2007). “Russian approaches to integration in the post-Soviet space in the 2000s”, in M. Katlijn, V. Lien and V. Evgeny (eds.), The CIS, the EU, and Russia: Challenges of Integration, Houndmills: Palgrave Macmillan, pp. 22–46. Wang, J. (2010). “The role of China and India in Asian regionalism”, in M. Sornarajah and J. Wang (eds.), China, India and the International Economic Order, Cambridge, UK: Cambridge University Press, pp. 333–386. Wang, J. (2011a). “China and East Asian regionalism”, European Law Journal, 17(5): 611–629. Wang, Y. (2011b). “China, economic regionalism, and east Asian integration”, Japanese Journal of Political Science, 12(2): 195–212. Wang, Y. (2016). “The complexity of the relations among leading states and following states: The case of east Asian regional integration”, in S. Kingah and C. Quiliconi (eds.), Global and Regional Leadership of the BRICS Countries, New York: Springer, pp. 189–208. Weidenbaum, M. L. and S. Hughes (1996). The Bamboo Network: How Expatriate Chinese Entrepreneurs are Creating a New Economic Superpower in Asia, New York: Simon and Schuster. Wilson, J. L. (2017). “The Russian pursuit of regional hegemony”, Rising Powers Quarterly, 2(1): 7–25. Wirminghaus, N. (2012). “Ephemeral regionalism: The proliferation of (failed) regional integration initiatives in post-Soviet Eurasia”, in T. A., Börzel L. Goltermann and K. Striebinger (eds.), Roads to Regionalism. Genesis, Design, and Effects of Regional Organizations, Aldershot: Ashgate, pp. 25–44. Yarbrough, B. V. and R. M. Yarbrough (1992). Cooperation and Governance in International Trade: The Strategic Organizational Approach, Princeton: Princeton University Press. Zhang, X. and X. Li (2016). “China’s regionalism in Asia”, The Asan Forum, 5(6). http://www. theasanforum.org/chinas-regionalism-in-asia/#3 (accessed 26 December 2017).

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CHAPTER 7

BRICS and Foreign Aid Gerda Asmus*, Andreas Fuchs†, and Angelika Müller* *Alfred-Weber-Institute for Economics, Heidelberg University, Germany † Faculty of Business and Economics, University of Goettingen, Germany

Introduction At their annual summit in the Brazilian city of Fortaleza in July 2014, the five leaders of the so-called BRICS countries (Brazil, Russia, India, China, and South Africa) launched the New Development Bank (NDB) to support the funding of infrastructure projects in developing countries. At the time this chapter is in print, the bank has been equipped with an initial subscribed capital of US $50 billion, it has opened its headquarters in Shanghai, and the Indian national K.V. Kamath has assumed his role as the Bank’s president. Together with the newly established Asian Infrastructure Investment Bank (AIIB) and the planned Shanghai Cooperation Organization (SCO) Bank, the NDB is seen as a challenger of the international aid architecture dominated by the United States and its allies in Western Europe and Japan. Unsurprisingly, the United States opposes such initiatives that question its global leadership (Desai and Vreeland, 2015; Stiglitz, 2015), but it is astonishing that

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30,000 25,000 20,000 15,000 10,000 5,000 0

Figure 1:   Annual gross disbursements of ODA in millions of US dollars (2010−2014 average). Note: Estimate for Brazil is based on 2010 data due to lack of data for other years. Source: Own figure based on data from OECD (2017b).

many Western countries have jumped on the China-led bandwagon and become members of the AIIB.1 These young multilateral initiatives led by BRICS countries add to the long-standing and impressively growing bilateral aid activities of these five states. Brazil, Russia, India, China, and South Africa are all not new to the aid business, in spite of which they often receive the label “new donor” or “non-traditional donor” (Manning, 2006; Kragelund, 2008). China, for example, started its aid activities in 1950, while Brazil, the “youngster” among the BRICS, became an aid donor in 1969 (Fuchs and Müller, 2018). Today, the combined aid budget of the five BRICS is still small compared to the total amount of aid provided by the club of established donors organized in the Development Assistance Committee (DAC) of the Organization for Economic Co-operation and Development (OECD). The rapid pace with which the BRICS’ aid activities have grown in size and scope, however, has drawn significant public attention (e.g. Naím, 2007; Woods, 2008; Walz and Ramachandran, 2011). Figure 1 shows the average annual gross disbursements of Official Development Assistance (ODA) by all G7 and BRICS countries over the 2010−2014 period in millions of US

 On the proliferation of development banks, see Pratt (2017). On why many countries choose to join the AIIB, see Wang (2016). 1

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dollars.2 The United States is the world’s largest provider of ODA, followed by Japan and Germany. Following strict OECD definitions, BRICS aid appears to be small compared to G7 aid but such statistics hide the considerable amounts of official nonODA financing that the emerging powers provide to developing countries. India’s aid commitments, for example, would rise from an annual average of US $588 million to $1.56 billion if loans by the country’s Export−Import Bank were added to the aid projects provided by the Ministry of External Affairs (Asmus et al., 2017). Similarly, less than one quarter of the US $350 billion in official finance commitments from China to the developing world between 2000 and 2014 is classified as “ODA-like” according to AidData’s Global Chinese Official Finance Dataset (Dreher et al., 2017). Despite the BRICS’ long track record as aid donors, until recently scholarship has devoted almost exclusive attention to foreign aid provided by both the member countries of the DAC and the big international financial institutions (IFIs), mainly the International Monetary Fund and the World Bank. Scholars have scrutinized in depth these donors’ aid allocation (e.g. Alesina and Dollar, 2000; Kuziemko and Werker, 2006; Hoeffler and Outram, 2011). They also investigated whether and under which conditions it is effective in promoting economic growth and other developmental goals (e.g. Burnside and Dollar, 2000; Clemens et al., 2011; Galiani et al., 2017), and examined the side-effects of these flows (e.g. Kono and Montinola, 2009; Bjørnskov, 2010; Nunn and Qian, 2014). Unsurprisingly, several survey studies try to help researchers cut a swathe through the thicket of the aid literature (e.g. Doucouliagos and Paldam, 2008, 2011; Milner and Tingley, 2013; Fuchs et al., 2014).3 On the contrary, academic research on emerging donors outside the DAC is scarce.4 There are at least two main reasons why foreign aid from BRICS countries has largely flown under the radar in social sciences research. First, these countries’ bilateral aid flows have not always been sizeable. This is particularly true for the 1990s, i.e. after the end of the Cold War and the abolishment of the apartheid regime in South Africa. Second, the aid activities of all BRICS donors are much more opaque compared to those of the DAC donors and the big international financial  According to the OECD, ODA are “those flows to countries and territories on the DAC List of ODA Recipients and to multilateral institutions which are: (i) provided by official agencies […] or by their executive agencies; and (ii) each transaction of which: (a) is administered with the promotion of the economic development and welfare of developing countries as its main objective; and (b) is concessional in character and conveys a grant element of at least 25% […].” 3  More recently, a growing number of scholars work with geo-referenced aid data to explore aid allocation and effectiveness at the subnational level (e.g. Strandow et al., 2011; Öhler and Nunnenkamp, 2014; Dreher and Lohmann, 2015). 4  See Dreher et al. (2013) for a literature review on non-DAC donors more generally. 2

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institutions, preventing researchers from conducting thorough empirical analyses. Tellingly, China, the largest BRICS donor, ranks second to last in the annually published Aid Transparency Index.5 Recent advances in the availability of unofficial data on BRICS aid (e.g. Tierney et al., 2011; Asmus et al., 2017; Dreher et al., 2017; Strange et al., 2017; Brandt, n.d.) have helped to fill this research gap. A better understanding of BRICS aid is important. Woods (2008: 16) describes the rise of non-DAC donors as “[a] silent revolution [that] is taking place in the development assistance regime”. The five BRICS countries are not members of the OECD, let alone the DAC, and thus do not have to abide by the organization’s ­standards. They are thus less constrained in the way they provide aid and may follow their political and economic self-interests and strategic considerations to a greater extent than DAC donors (Sato et al., 2011; Fuchs and Klann, 2013). The BRICS donors have common ground insofar as they seek to challenge the prevailing international aid architecture through reforms or the establishment of new institutions (Tierney, 2014). Their growing bilateral aid budgets, the joint construction of new multilateral development organizations, the often-promulgated rejection of aid conditioned on policies and institutions, and a focus on aid tied to goods and services from the donor economy are said to undermine the dominance of DAC donors in the world of international development cooperation.6 This chapter aims to provide a comprehensive overview of the small but growing literature on the bilateral foreign aid activities carried out by the five BRICS countries around the globe. It aims to answer the following questions: What do we know about the size, scope and institutional design of the BRICS countries’ aid activities? What can we learn about these donors’ aid motives by analyzing the pattern of their aid recipients and focal sectors? Does the existing qualitative and quantitative literature allow us to draw conclusions on the effects of BRICS aid on economic growth, other development outcomes, governance, or conflict in recipient countries? Moreover, how will BRICS aid affect the DAC-centered international aid architecture and the way the so-called traditional donors provide aid? While our examination of previous scholarly work allows us to draw some careful conclusions, it also reveals the heterogeneity of the five BRICS’ aid activities. Based on our findings, we highlight major avenues and challenges for future research. We proceed as follows. The second section provides a brief discussion of the major differences between the aid policies of BRICS donors and those of the ­so-called traditional donors. The following five sections introduce each BRICS donor,  Publish What You Fund (2016) evaluates China’s Ministry of Commerce, which is the country’s leading aid agency. Only Saudi Arabia ranks lower among the 45 rated aid agencies. 6  See Bunte (2013) for arguments why recipient governments may or may not prefer unconditional over conditional aid. 5

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summarize the existing research on their aid activities, and sketch avenues for future research. The final section summarizes the chapter.

What Is Different About BRICS Aid? There are several theoretical reasons why BRICS aid should differ from DAC aid. First, BRICS donors are not bound by the regulatory framework of the DAC or similar rules. Second, the BRICS countries are large in terms of population and the size of their economy but still clearly below the level of economic development of DAC donors, which may affect their aid motives. Third, the BRICS differ from (the typically Western) DAC donors since their aid philosophies — with the exception of Russia — have been anchored in the Non-Aligned Movement (NAM) and, more specifically, in the framework of South−South Cooperation, including the principle of non-interference in domestic affairs. In what follows, we briefly discuss each of these three points and highlight what sets the BRICS apart from the so-called traditional donors. First, by operating outside the DAC, BRICS donors have not committed themselves to align their aid efforts with the DAC’s principles and regulations. Their actions do not have to undergo a regular peer review by the DAC (Ben-Artzi, 2017). The DAC has established a lengthy set of principles, standards, and procedures by which member donors govern their relations with recipient countries. Most notably, the 2005 Paris Declaration on Aid Effectiveness lays out principles on how to make aid more effective.7 Although Russia was negotiating its OECD membership and the OECD has run “Enhanced Engagement” programs with the other BRICS countries since 2007, none of the BRICS countries abides by DAC aid principles. It rather seems that most BRICS nations’ aid modalities resemble the aid practices of the DAC donors a couple of decades ago (Kragelund, 2010). Sato et al. (2011: 2097) argue that the absence of “collective institutions for self-restraint” provides non-DAC donors  Although the BRICS donors have signed the Paris Declaration, it is commonly understood  that they did so as recipients and not as donors of aid (e.g. Chaturvedi, 2008; Bräutigam, 2009). The declaration includes the following five core principles: “(1) Ownership: Developing countries set their own strategies for poverty reduction, improve their institutions and tackle corruption. (2) Alignment: Donor countries align behind these objectives and use local systems. (3) Harmonisation: Donor countries coordinate, simplify procedures and share information to avoid duplication. (4) Results: Developing countries and donors shift focus to development results and results get measured. (5) Mutual accountability: Donors and partners are accountable for development results.” See https://www.oecd.org/ dac/effectiveness/parisdeclarationandaccraagendaforaction.htm (accessed 13 February 2017). Evidence in Minasyan et al. (2017) suggests that aid effectiveness improved for those donors that enhanced their quality of aid giving after the Paris Declaration.

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with “a certain level of freedom to pursue their own short-term national interests through their aid activities”. For example, the BRICS donors’ decision to tie their aid deliveries to goods and services from the donor economy stands in sharp contrast to DAC principles (Kragelund, 2008). This is of concern both from a development perspective as tied aid typically reduces its value for the recipient (Knack and Smets, 2012) and from the perspective of businesses in OECD countries as it provides BRICS donors with commercial advantages vis-à-vis DAC donors. Moreover, the low share of budget support in the BRICS’ aid portfolios should also be of concern if one attaches a value to the principle of country ownership. Second, the BRICS countries’ lower levels of income provide another ­argument why BRICS aid should follow self-interests more than that of DAC donors. Fuchs and Vadlamannati (2013) hypothesize that self-interest is a particularly important driver of aid from the perspective of poorer donor countries. Given the developmental challenges that a “needy” donor country faces domestically, its population’s support for altruistic development aid activities is arguably weaker.8 Altruistic aid can be understood as a “luxury good” (Dudley, 1979). Governments of poorer countries are therefore more likely to emphasize the expected benefits that accrue to the donor country from engaging in foreign aid. To this effect, Naím (2007: 95) holds an extreme view, arguing that “rogue aid providers [China, Iran, Saudi Arabia and Venezuela] couldn’t care less about the long-term well-being of the population of the countries they ‘aid.’” Analyzing the results of the existing aid allocation literature on non-DAC donors, Dreher et al. (2013: 407) conclude that, “aid allocation by ‘new’ and ‘old’ donors appears to follow similar rules” — in the sense that both donor groups follow their geopolitical and commercial interests. Nevertheless, DAC donors seem to allocate aid towards recipient needs to a slightly higher degree than non-DAC donors (Dreher et al., 2011; Fuchs and Klann, 2013; Fuchs and Vadlamannati, 2013). However, the observed differences between DAC and non-DAC donors are not as sharp as to “justify branding non-DAC donors as ‘rogue donors’” (Dreher et al., 2013: 407). Third, with the exception of Russia, BRICS aid is associated with the principles of South−South Cooperation.9 Mwase and Yang (2012) list the objective to achieve mutual benefits (rather than poverty reduction), the lack of policy conditionality, and the focus on microsustainability of individual projects (contrasting the DAC’s attention to long-run debt sustainability) as the key differences in the BRICS’ philosophies compared to the group of DAC donors. These key differences could “be traced  In line with this idea, Cheng and Smyth (2016) find that support within China for outgoing aid is lower in the country’s poor provinces. 9  Russia, a country of the North, closely cooperates with the global South and shares its views on creating a multipolar world, non-conditionality in development cooperation, and non-interference into domestic affairs (Larionova et al., 2016). 8

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back to the South−South Cooperation discussions, which emphasize principles of equality, solidarity, and mutual development and complementarity” (Mwase and Yang, 2012: 4). Similarly, Mawdsley (2012) identifies four characteristic features of the “symbolic regime” of Southern donors that sets them apart from “traditional” aid giving. One, Southern donors call on a “developing country identity” which they would share with recipient countries. Two, they highlight their expertise in development appropriate to the context in recipient countries.10 Three, they oppose hierarchical donor−recipient relations. For example, they avoid the term “aid donors” and typically label themselves as “partners in South−South Cooperation”. Four, they emphasize the mutually beneficial relationship between partners. Mutual benefit is an important leitmotif of their aid giving. Their public rejection of aid conditioned on policies and institutions is said to undermine the dominance of DAC donors. While Western donors, at least on paper, reward countries with good policies and institutions, emerging donors allegedly “provide aid without any strings attached” (Dreher et al., 2013: 405). Authoritarian leaders of recipient countries that are hostile towards aid tied to democratic institutions or the respect of human rights may view this as an advantage. Indeed, Bermeo (2011) provides empirical evidence that supports the claim that the source of aid matters for its impact on institutions. The BRICS countries’ principle of non-interference also affects the selection of projects within countries. In line with the Bandung principles, Southern donors claim not to interfere in the internal affairs of recipient countries or to exert pressure; their aid projects are said to solely emerge from the requests of the recipient governments. As Bräutigam (2011: 761) points out, “[T]he Chinese emphasis on local ownership can lead to ‘prestige’ projects that do not appear to be poverty-reducing: a new government office building, a sports stadium or a conference center.” Dreher et al. (2019a) identify some adverse effects of this “demand-driven” aid approach. It appears that significantly more Chinese aid flows into the birth regions of African leaders, which tend to be richer relative to the country’s average. At the same time, Dreher et al. (2019a) do not find comparable effects for the World Bank. In light of these substantial differences vis-à-vis the still dominant DAC donors, the BRICS’ aid activities are perceived as challenges to the prevailing international aid architecture. Their initiatives to reform the existing multilateral development organizations and the setup of new institutions further magnify this perceived threat (Tierney,  For example, India’s Ministry of External Affairs claims that it “possess[es] skills of manpower and technology more appropriate to the geographical and ecological conditions and the stage of technological development of several developing countries”. As quoted on several websites of Indian embassies, e.g., the Indian embassy in Azerbaijan. Available at http:// www.indianembassybaku.in/eoi.php?id=Itec (accessed 12 February 2017).

10

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2014). However, the BRICS have not yet attempted to develop a joint development strategy (Gu et al., 2016). Moreover, the extent to which BRICS donors work differently compared to the club of established donors varies among the five countries. Russia, for example, was not exposed to the South−South Cooperation discourse as it was not part of the so-called Third World and the related institutions such as the G77. It was even considered close to the DAC regime until the country’s OECD accession negotiations were put on hold in 2014. While we discussed a couple of common theoretical expectations on the BRICS countries’ aid activities, the lack of a joint aid framework makes a separate analysis of the B, R, I, C, and S in foreign aid more appropriate. The following sections provide an overview of the current state of research on each BRICS donor and discuss how each of them departs from the established DAC paradigm, highlighting differences within the group of BRICS donors.

Brazil Brazil’s development cooperation dates back to the 1960s with the provision of modest technical cooperation to other developing countries (Inoue and Vaz, 2012; Muggah and Hamann, 2012).11 From 1978 onwards, following the launch of the Buenos Aires Plan of Action for Promoting and Implementing Technical Cooperation among Developing Countries, Brazil’s technical cooperation increased steadily (Inoue and Aoki, 2007). In 1987, the growing administrative burden gave rise to the establishment of the Brazilian Cooperation Agency (ABC), which is located within the Ministry of External Relations (Cabral and Weinstock, 2010). Finally, the inauguration of President Luis Ignacio Lula da Silva in 2003 marked its recent emergence as an internationally recognized aid donor: Lula’s administration prioritized social issues in its foreign relations agenda (Soares De Lima and Hirst, 2006). From this time, Brazil’s aid activities increased significantly in both size and scope. ABC’s annual spending increased from US $0.24 million in 2004 to US $21.5 million in 2010 (ABC, 2017). According to OECD estimates, 2010 marked the first year that incoming and outgoing aid projects were of comparable size (OECD, 2017). Under Lula’s successor, President Dilma Rousseff, both incoming and outgoing aid decreased (IPEA, 2016; OECD, 2017). In contrast to Lula, the Rousseff administration put higher priority on domestic social issues. Between 2010 and 2013, she reduced Brazil’s aid budget by more than 30% and reoriented Brazil’s international development policy towards domestic commercial interests (Costa Leite et al., 2014;  For a general overview of Brazil’s development cooperation and the debates surrounding it, consult Vaz and Inoue (2007); Cabral and Weinstock (2010); Inoue and Vaz (2012); and Costa Leite et al. (2014). 11

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Younis et al., 2014; IPEA, 2016). Nevertheless, Brazil’s total aid remained well above pre-Lula-period levels. According to the latest available estimate, Brazil spent around US $397 million on aid in 2013 (IPEA, 2016).12 Brazil’s institutional framework for development aid is decentralized and suffers from loose coordination (Vaz and Inoue, 2007; Cabral and Weinstock, 2010). While the ABC is the main executive body mandated for technical cooperation, several other governmental institutions provide development cooperation independently from the ABC. The Ministries of Health, Agriculture, Education, and Science and Technology are all involved in Brazil’s aid activities without the obligatory involvement of the ABC or the Ministry of External Affairs. This institutional complexity obscures Brazil’s aid activities and makes them difficult to assess. The official estimate states that only 7% of Brazil’s aid budget is spent on bilateral technical assistance, while 58% is channeled through international organizations (Inoue and Aoki, 2007). Both the Brazilian government and third parties have undertaken first attempts to render the country’s aid activities more transparent. For example, the Institute for Applied Economic Research, a government-run think tank, has published three reports to quantify Brazil’s development cooperation (IPEA, 2011, 2014, 2016). These reports are the only official data sources on Brazil’s total aid flows. They cover the years 2005−2013 and report aggregate numbers by year and sector. Due to the lack of a central accounting system, the reports rely on survey data and do not cover all aid institutions and types of financial cooperation (Costa Leite et al., 2014; Bry, 2017). Brazil’s lack of aid transparency may not only be due to bureaucratic overload but also a lack of political will. Brazil’s refusal to sign the 2005 Paris Declaration and the 2008 Accra Agenda for Action in 2008 (Cabral et al., 2014; Semrau and Thiele, 2017) highlights the country’s unwillingness to implement standards established by the DAC. An alternative data source for Brazil’s aid activities is the AidData database, which tracks individual development finance projects by both OECD and nonOECD donors (Tierney et al., 2011). The available data cover 1,097 projects between 1998 and 2010, with an average annual commitment amount of US $159,354. However, those data are limited to the ABC’s aid activities and do not include projects after 2010, when the ABC stopped providing project-level information (Semrau and Thiele, 2017). Given the absence of an official aid database, future research could entail initiatives to construct a comprehensive database from a multitude of official and unofficial data sources, including media reports.13  For a comparison with OECD countries, peacekeeping expenditures must be excluded, which results in US $386 million. 13  See Strange et al. (2017) for a comparable initiative for Chinese aid. 12

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The AidData database allows analysts to obtain a clearer — albeit ­incomplete — picture of Brazil’s aid engagement. The geographic focus of Brazil has historically been Latin America and the Lusophone countries (Semrau and Thiele, 2017). Although the number of recipient countries has significantly increased, totaling 159 in 2013 (IPEA, 2016), Latin America and the Lusophone world remain the priority. This can also be seen from Table 1, where we provide a list of the top 10 recipient countries of aid from Brazil (and the other BRICS donors) over the 2005−2010 period (data from Tierney et al., 2011). In terms of sectors, contrasting China’s and India’s focus on economic infrastructure, Brazil prioritizes agriculture and social sectors such as health and education (Younis et al., 2014; Bry, 2017; Semrau and Thiele, 2017). These priorities align with the country’s domestic social agenda. A recent econometric study sheds light on Brazil’s aid motives by analyzing its aid allocation across countries (Semrau and Thiele, 2017). The study focuses on three aspects: recipient institutions, recipient need, and Brazil’s own strategic interests. Starting with the role of recipient institutions, Brazil claims that its aid initiatives respect the national sovereignty of the recipient countries (De la Fontaine and Seifert, 2010; John de Sousa, 2010), which should imply that recipients’ institutional

Table 1:   List of BRICS donors’ most important recipient countries. Brazil 2005−2010

Russia 2010−2015

India 2006−2010

China 2005−2014

South Africa 2005−2010

1. Mozambique

1. Cuba

1. Bhutan

1. Russia

1. DR Congo

2. Haiti

2. Kyrgyzstan

2. Sri Lanka

2. Pakistan

2. Guinea

3. São Tomé & P.

3. North Korea

3. Afghanistan

3. Angola

3. Zimbabwe

4. Timor-Leste

4. Nicaragua

4. Nigeria

4. Ethiopia

4. Lesotho

5. Guinea-Bissau

5. Serbia

5. Ethiopia

5. Sri Lanka

5. Comoros

6. Cape Verde

6. Tajikistan

6. Nepal

6. Laos

6. Liberia

7. Angola

7. Syria

7. Cote d’Ivoire

7. Venezuela

7. Sudan

8. Paraguay

8. Armenia

8. Mozambique

8. Turkmenistan

8. Uganda

9. Algeria

9. Zambia

9. Sudan

10. Senegal

10. Guinea

10. Syria

9. Ecuador 10. Brazil

9. Burundi 10. Seychelles

Notes: The list of China’s most important recipient countries covers both ODA and OOF projects. The list of India’s most important recipient countries is based exclusively on flows from the country’s Ministry of Foreign Affairs and Exim Bank. The list of Brazil’s most important recipient countries is based exclusively on flows from the Brazilian Cooperation Agency (ABC). The list of South Africa’s most important recipient countries is based exclusively on flows from the African Renaissance Fund. Source: AidData’s Global Chinese Official Finance Dataset (Dreher et al., 2017), OECD Dataset: DAC2a (OECD, 2017a), AidData Research Release 3.0 (Tierney et al., 2011).

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characteristics should not affect aid giving. Yet, some scholars argue that, as a democratic country, Brazil might ultimately favor values similar to those of the OECD countries (John de Sousa, 2010). In line with the former idea, Semrau and Thiele (2017) find that neither the recipients’ level of corruption nor their regime type influence project allocation via the ABC. Semrau and Thiele’s findings are thus in line with Brazil’s lip service to the principle of non-interference, which is also dominant in China’s and India’s foreign aid programs.14 Turning to recipient need, there is evidence that Brazil’s aid allocation is needsdriven. Semrau and Thiele (2017) show that countries with a lower GDP per capita have a higher probability of receiving Brazilian aid.15 Zondi (2013) sees the needsbased approach supported by the fact that Brazil wrote off the debt of 12 African countries to support their endogenous growth. Finally, potential political and commercial benefits to the Brazilian government are subject to a wider debate. The focus of Brazilian aid on Latin America and the Lusophone world seems to support the claim that Brazil is trying to bolster its status as a regional power and a leader for certain regions of the developing world (Cabral et al., 2014). A case study by Bry (2017) suggests that Brazil’s emphasis on mutual benefits and non-conditional aid indeed succeeds in creating a positive image among recipients. Although Semrau and Thiele (2017) show no quantitative evidence that Brazil favors its important export markets as recipients, other scholars discuss in detail how Brazilian aid seeks to promote national firms accessing new markets (e.g. Magnoni, 2010; Burges, 2014). Given these inconsistent findings on the drivers of Brazil’s aid allocation pattern, more research is required — not only on the motives behind Brazil’s aid activities. If Brazilian aid continues to grow in size and scope, the effects of Brazil’s aid on the recipient countries deserve closer investigation. This could include evaluations of single aid projects at the micro level and analyses of the effects on macro-indicators of economic development such as GDP growth. Future research should also address the data gaps if official data remains scattered and incomplete.

 On the contrary, an earlier study by Dreher et al. (2011) finds a statistically significant negative effect of the control of corruption on the likelihood of receiving aid from Brazil. Both studies use AidData’s project-level datasets (Tierney et al., 2011), but Semrau and Thiele use a more recent version. In addition, Dreher et al. (2011) do not control for Lusophone countries, which could also explain the different results. 15  Again, the earlier study by Dreher et al. (2011) finds different results. In their study, poorer countries do not receive more ABC aid flows, but the study does not control for Brazil’s bias towards Latin America and Lusophone countries. 14

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Russia Russia, as the legal successor of the Soviet Union, is unique among the BRICS donors. Strictly speaking, it is neither emerging nor re-emerging but rather it has been reborn as a player in the global donor community. Beginning with the aid and trade program in 1953 (Berliner, 1959), Soviet support rapidly reached a peak of US $1 billion in 1960 — a level comparable to the US’ aid effort in terms of gross national product at the same time (Goldman, 1965). Soviet aid was mainly allocated to the Middle East and South Asia. Between 1966 and 1977, for example, the largest recipients were Afghanistan, Bangladesh, Egypt, Iran, Iraq, Pakistan, Syria, and Turkey (Rai, 1980). Main areas of support were technical assistance and academic programs: “by 1978, more than 26,000 [third-world students] were [educated] in the USSR” (Brun and Hersh, 1990: 148). The construction of the steel plant at Bhilai in India and a highway program in Afghanistan, both celebrated successes, emphasized the Soviet determination to be seen as a powerful leader in the field of development cooperation (Goldman, 1965). Another well-known example is the construction of the Aswan dam in Egypt, for which the Soviet Union won the competitive bid by offering larger loans with lower interest rates than the US and the United Kingdom (Goldman, 1967). Soviet relationships with developing countries focused on countries that share their communist ideology. A shared discontent over (Western) colonialism and the rise of capitalism provided a foundation for development cooperation (Jaster, 1969). In a quantitative analysis of Soviet aid during the Cold War era, Rai (1980) finds correlations between Soviet aid and UN General Assembly (UNGA) voting alignment, suggesting that aid was used to reward or punish recipient countries for their foreign-policy positions. Other early studies find that the Soviet Union achieved policy concessions through foreign aid.16 In a recent study, Bueno de Mesquita and Smith (2016) argue that the size of policy concessions received from a recipient in exchange for aid depends, among others, on the presence of a competing donor country. For the Cold War era, they find that the US spent much more on aid while receiving less security concessions once the Soviet Union entered the scene as a “rival” donor in the mid-1950s. Russia’s rapid economic decline following the dissolution of the Soviet Union implied that the country found itself on the other side of development cooperation  For example, Roeder (1985) finds that “Soviet aid […] can […] induce compliant behavior indirectly through the creation of trade dependence” and notes that Soviet aid was mostly tied to Soviet products. Lundborg (1998) models a gift exchange theory and shows that more US aid leads to more US support, while such support decreases if Soviet aid increases. 16

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during the 1990s (Larionova et al., 2016). Only after spending about a decade as a net recipient, did the country slowly begin to recreate a development program in the mid-2000s (Gray, 2011). In 2007, Russia, under the presidency of Vladimir V. Putin, adopted a concept note on development assistance, which builds on the Millennium Development Goals (MDGs), as well as Russia’s National Foreign Policy Concept and the National Security Concept (Ministry of Finance, 2007). The official goals include poverty reduction, disaster relief, and the development of trade and economic partnerships. Other goals are “to influence global processes with a view to establishing a stable, fair and democratic world order”, “to create a belt of good neighborliness along the Russian national borders”, and “to strengthen the credibility of Russia and promote an unbiased attitude to the Russian Federation” (Ministry of Finance, 2007: 6). Moreover, the government strived for cooperation with the OECD, which led to accession negotiations in the same year (OECD, 2007).17 Russia reinforced its intentions to integrate with the OECD aid community through reporting its ODA statistics from 2011 onwards (Ministry of Finance, 2012).18 However, in the course of increasing tensions over Ukraine, the planned referendum on Crimea’s secession, and Russia’s critical role in those events, the OECD member states decided to suspend the accession process in March 2014.19 In April 2014, a successor to the 2007 aid strategy concept was adopted (Ministry of Finance, 2014; Ministry of Foreign Affairs, 2014). While it clearly builds on the previous strategy, new emphasis is put on an increase of Russia’s institutional capacity, a growing bilateral aid budget, and aid transparency.20 Between 2010 and 2015, Russian ODA disbursements have more than tripled from US $520.9 million to US $1.7 billion. As a point of reference, its contribution in 2015 amounts to 36% of Italian aid. While the transition economies in Eastern Europe and Central Asia as well as Latin America have been the focal regions of Russian aid initially, Africa is gaining in importance. According to latest OECD data, Russia contributed on average US $44.6 million to Africa annually between 2010 and 2015, which is twice the amount of aid towards Eastern European countries (US $22.8 million). However, the former is still far from its contributions to Asia, and Central America, with these receiving US $284.8 million and US $170.8 million,  See Davis (2016) on why countries (do not) seek membership in the OECD.  Reported numbers begin in 2010. 19  Nonetheless, as of today, Russia still reports aid information to the OECD. 20  In 2014, around 75% of Russian aid is provided bilaterally, while multilateral aid contributions, especially via the World Bank Group, the United Nations and, to a much smaller extent, regional development banks and other organizations, account for the remaining 25% (Ministry of Finance, 2007; OECD, 2016). 17 18

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respectively (see also Table 1). Examples for projects in 2014 include budget s­ upport for the Kyrgyz Republic, agricultural machinery supply in Nicaragua, delivery of Russian trucks for humanitarian operations in Afghan remote areas, assistance in Guinea to prevent the spread of Ebola, and humanitarian and food aid to Syria (Ministry of Finance, 2014). The majority of Russian aid projects are in the education, health, food security, and public finance sectors. Additionally, debt relief and debt-for-development swaps are offered (Ministry of Foreign Affairs, 2014; OECD, 2016). The Ministries of Finance and Foreign Affairs are mainly responsible for the framing of Russian foreign assistance and overseeing its implementations (OECD, 2016). Many more agencies add to the assistance structure, which complicates coordination (Larionova et al., 2016). Although Moscow reports aid data to the OECD, project-level information is not made available and thus one cannot draw a detailed picture of Russia’s development cooperation. Finding comprehensive and structured information on Soviet aid is also challenging. A useful data source for Soviet economic aid is the replication data for Charles Dannehl’s 1995 book, which comprises information on aid to non-communist developing states for the 1955−1989 period (Dannehl, 1995). Scholars may also resort to reports produced by the United States’ Central Intelligence Agency, containing information on economic and military aid (e.g. CIA, 1974). However, such sources are not in line with OECD reporting standards, which complicates comparisons to other aid providers at the time. A complete account on Soviet and Russian development aid is yet to be produced and will probably only be possible in the wake of an official release of documents by the Russian government or an opening of its archives to the public.21 While many studies on Soviet aid have explained Moscow’s motives during that era, Russia’s aid strategy today is not well understood. In the 2007 concept note, Russia refers to itself as a superpower with the responsibility to contribute to international development efforts (Ministry of Finance, 2007). It would be worthwhile to evaluate whether Russian aid sticks to its official developmental goals or rather follows the purpose of extending its sphere of influence. Russia further claims that its development cooperation aims to “foster democratic processes, development of market-oriented economies, and observance of human rights in recipient countries” (Ministry of Finance, 2007: 6). Whether Russia indeed follows these goals in its allocation decisions should be subject to scrutiny. In the spirit of Rai’s (1980) analysis of the link between Soviet aid and recipients’ UNGA voting behavior, scholars could analyze the political benefits that accrue to Russia from its foreign aid program.  Researchers interested in a thorough analysis of Russia’s aid distribution could also consider AidData’s TUFF methodology (see section on China below).

21

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India With more than US $4.5 trillion received between 1960 and 2015, India has been the world’s largest recipient of foreign aid (OECD, 2017a). At the same time, India has run its own outward development assistance since the early years of its independence (Nehru, 1958).22 India’s economy and presence in the international community have grown significantly over the past two decades and its development cooperation has evolved in tandem — both in its geographic scope and sectoral coverage. India started to identify itself as a donor rather than as a recipient in the early 2000s. In the 2003−2004 budget speech, India’s Minister of Finance announced that India would only accept untied aid and reject new aid offers from most bilateral partners. At the same time, India planned to cancel debt for Highly Indebted Poor Countries (HIPCs) and to expand its grants and project assistance under the so-called India Development Initiative (Singh, 2003). Some observers find it puzzling that a country that continues to be comparatively “needy” increasingly provides foreign aid (Fuchs and Vadlamannati, 2013).23 Others argue that the growing aid budget is simply the result of an emboldening economy coupled with a long history as a provider of development assistance (Mukherjee, 2015). Indian development programs were initially fragmented and decentralized. The Indian Technical and Economic Cooperation Program (ITEC), created in 1964, represents India’s first step towards organizing its foreign assistance and remains the flagship program to date. Together with the Special Commonwealth African Assistance Program (SCAAP), it reaches 161 countries globally through personnel training, consultancies, expert exchange, study programs, equipment donations, and humanitarian aid (Mawdsley, 2010; MEA, 2013). In January 2012, India’s Ministry of External Affairs (MEA) established the Development Partnership Administration (DPA) to handle the increasing outflow of aid projects, combat fragmentation, and further the institutionalization of its aid efforts. Placing the DPA within the MEA highlights the close ties of India’s development cooperation to its foreign policy. Today, another increasingly important arm of India’s aid policy is the Department of Economic Affairs (DEA) within the Ministry of Finance. Among other initiatives, the DEA provides interest-equalization support to India’s Export−Import (Exim)

 For an overview of the early history of India’s foreign aid, see Dutt (1980).  In the early 2000s, 38.2% of India’s population still lived on less than US $1.90 a day (World Bank, 2017). Although the most recent data show that the share almost halved until 2011 (21.2%), poverty is still very high compared to Brazil (11%), Russia (0.1%), China (7.9%), and South Africa (16.6%). 22 23

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Bank, which in turn provides concessional loans to developing countries (Arora and Mullen, 2016). Approximately 54% of MEA’s 2016−2017 budget was committed to grants, loans, and training towards foreign governments (US $1.314 billion), accounting for 0.46% of the government’s total budget. This represents a slight decrease in development cooperation allocated by the MEA compared to the previous budget year. At the same time, foreign assistance through the DEA has doubled (Ministry of Finance, 2017). Until 2015, 226 LoCs amounting to US $16.9 billion were allocated to developing countries, about 50% of which went to African states (MEA, 2015a). Most of such credits are comprised of a grant element of at least 25% required to qualify as ODA by OECD standards (Hubbard and Sinha, 2011). Some scholars, however, question whether these flows would indeed qualify as ODA as they are mainly geared towards export promotion rather than recipient development (Hubbard and Sinha, 2011). Around 85% of these LoCs are tied to goods and services provided by Indian firms. They are designed to facilitate Indian firms entering African markets and mostly involve infrastructure, transportation, IT, energy, and agricultural projects (Sinha, 2011). Hence, a substantial part of India’s development assistance is intended to benefit both sides of the transaction. India prioritizes two geographic regions: South Asia and Africa. The main recipients in South Asia are Bhutan, Sri Lanka, Afghanistan, Nepal, and Bangladesh (see Table 1), with a majority of aid allocated towards the sectors Energy Generation and Supply, Transport and Storage, Industry, as well as Water Supply and Sanitation (Tierney et al., 2011). Energy and infrastructure related projects in particular enable India to benefit from its cooperation efforts in the long-term (Agrawal, 2007). Recent schemes include the Terai Road Project, which links the Terai region in Nepal with neighboring Indian regions, or the Punatsangchu Hydroelectric Project in Bhutan, which contributes to energy exports to India (MEA, 2015b). Many aid projects in Nepal and Bangladesh are also seen as a strategy to counter Chinese influence (Mullen and Ganguly, 2012). It is worth noting that not all aid provided to its neighbors is perceived positively. For example, despite India’s claim that it follows Nepalese demands, the Nepalese population views India as strategic, following its own political agenda, while lacking transparency and accountability (Adhikari, 2014). Turning to Africa, India enhances its cooperation with all countries on the continent through the India−Africa Forum Summit (IAFS), a platform for African− Indian relations held every 3 years.24 Its development projects in Africa mainly focus on personnel training (civil servants and engineers), loans for Indian equipment and  The IAFS resembles China’s Forum on China−Africa Cooperation (FOCAC) in its ­institutional design (Taylor, 2012). 24

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services, as well as education and IT (Mawdsley, 2010). One of the most prominent projects is the Pan-African E-Network with a budget of US $125 million. This ambitious endeavor seeks to connect 53 member states of the African Union both with each other and with India to enable access to tele-education and tele-medicine (Pan-African e-Network Project, 2011). India’s traditional link to Africa is mainly on account of its support for the African decolonization process and fight against apartheid, its active role in the Commonwealth, and its diaspora particularly in Eastern Africa (Muni, 1991; Adam, 2015). India’s aid activities in Africa appear to be part of a larger strategy and can be seen as part of a cooperation package. Within Africa, it has strong trade ties, invests in businesses, and is one of the largest providers of UN peacekeeping forces (Naidu, 2008). Cheru and Obi (2011) connect India’s aid activities to resource security and the development of new market opportunities. This manifests in India’s growing engagement in West Africa since the 2000s, where it has increased investments in the energy sector of resource-rich countries (Beri, 2008; Mawdsley, 2010). Officially, Indian aid allocation is demand-driven, unconditional, and, within the horizontal South−South Cooperation framework, based on the idea of mutual assistance (George and Samuel, 2016). Quantitative results in Fuchs and Vadlamannati (2013) show that Delhi also follows commercial and political self-interest: recipient countries that align their votes in the United Nations General Assembly (UNGA) with the Indian government and those that have strong trade ties with India receive significantly more aid. Since India is a relatively poor donor country with a longstanding democratic system, it appears to be easier for the Indian government to justify its expenditures vis-à-vis its electorate if it is provided in a more self-interested manner (Fuchs and Vadlamannati, 2013).25 While most emerging donors lack an official aid database, India at least provides project-level information in the annual reports of the MEA and press releases on LoCs by the Exim Bank. AidData made this information available in an easily accessible format for the 2006−2010 period (Tierney et al., 2011). Asmus et al. (2017) are currently extending and geo-referencing the data to allow for geospatial analysis of Indian aid worldwide for the 2006−2014 period. With the growing availability of detailed and structured data, researchers can evaluate Indian aid allocation and its effects on various outcome variables. For example, future research could analyze whether Indian aid to Africa is indeed a combination of developmental goals and commercial partnerships, and whether India is competing with China and other countries in a bigger scramble for the continent (Cheru and Obi, 2011). Likewise,  For an interview- and media evaluation-based analysis on the domestic perception of Indian development cooperation, see Mawdsley (2014). 25

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the role of the widespread Indian diaspora in its aid allocation decisions is yet to be explored. Turning to India’s neighborhood, it would be interesting to assess whether energy projects serve India’s energy supply more than they support the bordering countries economies. Researchers could also examine whether and to what extent China’s and India’s involvement in development cooperation in South Asia affects their respective power statuses.

China Despite being labeled as a “new donor”, China’s foreign aid program is almost as old as the People’s Republic itself.26 Egypt was Beijing’s first aid recipient in Africa in 1956, when it received its first aid tranche worth US $4.7 million (Bartke, 1989). Using historical aid data, Dreher and Fuchs (2015) analyze the main drivers of Chinese project allocations during the history of China’s aid program. They find that political considerations, such as Beijing’s demand for international recognition, were dominant during the initial phase of China’s aid giving. After 1978, with Deng Xiaoping’s economic reforms, China opened to the West and economic considerations gained significant weight in China’s aid policy. After the Tiananmen Square protests in 1989, China actively sought diplomatic support in the developing world, which once again put political motives at the center of its aid-giving considerations. Finally, the results in Dreher and Fuchs (2015) show that after the 1995 aid reform, which introduced market principles into the aid system, China’s aid policy and practices became increasingly guided by commercial interests. A complex network of institutions administers China’s aid activities.27 The Ministry of Commerce (MOFCOM) is the coordinating agency and is directly responsible for the provision of humanitarian assistance, most grants, and interestfree loans (e.g. Bräutigam, 2009). The Ministry of Finance leads the budgetary process, is responsible for China’s contributions to international organizations, and oversees the Export−Import (Exim) Bank of China, which is the main provider of concessional loans and export credits. The Ministry of Foreign Affairs ensures that China’s aid policy is in line with its foreign policy objectives, leads the network of China’s embassies worldwide and organizes the Forum on China−Africa

 See Davies (2007), Bräutigam (2009), and Kobayashi (2008) for thorough summaries of the history of China’s foreign aid. 27  Kobayashi (2008), Bräutigam (2009), and Corkin (2011) provide overviews on the institutional setup of China’s aid administration. See Rudyak (2017) for a summary of the recent debate on institutional reforms. 26

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Cooperation (FOCAC).28 Other ministries and agencies provide aid in various areas. For example, China’s Ministry of Health is responsible for parts of China’s medical aid (Grépin et al., 2014). China considers its aid “as a sensitive area, a state secret” (Bräutigam, 2009: 2). This is underscored by the withdrawal of lists containing all completed aid projects from MOFCOM’s yearbooks in 2006 (Dreher and Fuchs, 2015). An official and comprehensive aid database is not available. The few remaining official sources of information on aid projects are scattered. The White Papers on China’s Foreign Aid (State Council, 2011, 2014) only provide values at a very high level of aggregation. To obtain a grasp of the universe of Chinese aid, researchers rely on unofficial estimates. Kitano and Harada (2016) estimate China’s gross foreign aid at US $5.1 billion over the 2010−2014 period, of which 8% was provided as multilateral aid.29 According to these statistics, China was the world’s sixth largest donor in 2014. The OECD (2017b) estimates China’s average annual gross ODA disbursements at US $3.0 ­billion over the 2010−2014 period (see again Figure 1). These values are smaller than Kitano and Harada’s estimates as they do not cover disbursements of concessional loans. AidData was able to track Chinese aid projects from various official and unofficial sources and the resulting database suggests that total Chinese official finance commitments to the developing world amounted to an annual average of US $23.6 billion over the 2000−2014 period (Dreher et al., 2017).30 However, less than a quarter could be identified as ODA under DAC definitions.31 Overall, estimates of Chinese aid vary widely and the debate boils down to the question of what should count as aid (e.g. Lum et al., 2009; Bräutigam, 2011; Wolf et al., 2013; see Strange et al., 2017 for a discussion).  The FOCAC meetings are China’s official forum to engage with Africa. The first meeting took place in Beijing (2000) and was followed by summits in Addis Ababa (Ethiopia, 2003), Beijing (2006), Sharm el-Sheikh (Egypt, 2009), Beijing (2012), Johannesburg (South Africa, 2015), and Beijing (2018). 29  Note that China counts only the interest-rate subsidy, not the value of the loan. Debt relief is not included in China’s definition of foreign aid. 30  All values throughout this chapter obtained from the 1.2 Research Release (see http:// aiddata.org/china, accessed 27 November 2017). AidData’s China in Africa dataset uses the so-called Tracking Underreported Financial Flows (TUFF) methodology. Applying a “ground-truthing” approach, Muchapondwa et al. (2016) provide support for the reliability of the dataset and methodology. See also data-gathering initiatives by Brant (n.d.) for Chinese aid in the Pacific and by Gallagher and Myers (2016) for Chinese loans to Latin America. 31  According to ECOSOC (2008), the grant element (assuming a 10% discount rate) varies between 24.2% for some China Exim Bank loans to 75.1% for Chinese government loans. 28

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China’s aid differs from DAC aid in many respects. First, it is largely tied to goods and services from China. While aid projects provided through China’s Ministry of Commerce are principally tied to Chinese companies and products, any project can be granted an exception to this rule if deemed necessary (Bräutigam, 2009). Regarding the tying status of the Exim Bank loans, its official guidelines state that at least 50% of all procurement should come from China. Second, China rarely provides aid in the form of budget support and most bilateral activities come as project aid. Third, China’s aid is similar to the request-based system in early Japanese development assistance (Bräutigam, 2009; Kragelund, 2010) and, in striking contrast to DAC donors, lacked country development strategies until very recently. According to Bräutigam (2009: 308), China prefers experimentation to explore what works. Almost every developing country in the world is a recipient of some form of Chinese aid. Only countries that maintain diplomatic relations with the government in Taipei (Taiwan) rather than Beijing are typically excluded.32 Figures published by the State Council (2014) for 2009 suggest that most Chinese aid goes to Africa (45.7%), followed by Asia (32.8%), and Latin America (12.7%). On the African continent, AidData could track the largest amounts of Chinese development finance in Angola, Ethiopia, and Sudan over the 2000−2014 period (Dreher et al., 2017). Estimations of the volume of China’s aid allocation across recipient countries suggest that China’s ODA is mainly driven by Beijing’s foreign-policy interests (Dreher et al., 2018). It shows no robust link with natural resource endowments (Dreher and Fuchs, 2015). On the contrary, less concessional flows, such as export credits, correlate with economic variables such as recipients’ debt burden, access to oil, and bilateral trade volume with China (Dreher et al., 2018). Not only is China’s geographical reach almost all encompassing, the same holds true to the sectoral composition of Chinese aid. While public attention focuses on large infrastructure projects and prestige projects, such as the construction of stadiums and government buildings, China is active in virtually all sectors. While social infrastructure projects, such as the provision of hospitals and government buildings, dominate in terms of project numbers, economic infrastructure projects, mainly in the areas of transport and energy, are the heavyweights in terms of financial values (Dreher et al., 2017). Although AidData was not able to track a single project on environmental protection at the time of their first study in 2013 (Strange et al., 2013), China has recently started activities in this area and began

 There are few exceptions to this rule such as humanitarian aid after severe catastrophes (e.g. Tubilewicz, 2012). 32

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listing “Strengthening Environmental Protection” as one of its goals in a recent White Paper (State Council, 2014).33 The question as to whether Chinese aid has been effective in promoting economic growth and other development outcomes in recipient countries is largely unexplored. Critics voice doubts that Chinese aid is geared towards economic development given that China is engaged in so many prestige projects, such as government buildings and stadiums, that are not directly linked to economic growth or poverty reduction (Lum et al., 2009; Will, 2012). Others praise China for its focus on infrastructure (Bräutigam, 2009). According to results from panel growth regressions in Busse et al. (2016) for the 1991−2010 period, Chinese aid and foreign investment have no robust effect on economic growth in African countries. Using georeferenced aid data, Dreher et al. (2019b) examine the effects of Chinese development projects on development at the subnational level. Their results suggest that Chinese aid is successful in promoting regional development as measured by nighttime light emissions. At the country level, Dreher et al. (2017) find positive growth effects of Chinese ODA but not of less concessional and more commercially-oriented types of official finance. Given the short time in which Chinese aid flows are substantial and the long time lags that some types of aid require to show effects, this question should be reinvestigated as more data become available. In contrast to Western donors and the big IFIs, China does not link its aid to conditions that relate to recipients’ political systems or their human rights records. The Chinese government emphasizes that it “never uses foreign aid as a means to interfere in recipient countries’ internal affairs” (State Council, 2011).34 Bräutigam (2009: 285) notes that “China’s rise has clearly given dictators additional financing options”, but also points to Western donors’ aid provisions to authoritarian regimes. Even if China’s aid allocation was not biased towards autocratic recipient countries, recipient countries might turn to emerging donors like China to circumvent conditions linked to their institutional setup and human rights record. Several papers explore these links between Chinese aid and recipient institutions. A series of papers (Dreher and Fuchs, 2015; Broich, 2017; Dreher et al., 2018) finds that the cross-country allocation of Chinese ODA does not respond  AidData lists seven projects in the environmental sector in Africa over the 2013−2015 period. See http://china.aiddata.org/ (accessed 4 February 2017). 34  This principle of non-interference, also enshrined in Indian aid, dates back at least to the Final Communiqué of the 1955 Bandung Conference. It became part of the “Eight Principles of China’s Foreign Aid to Developing Countries” laid out in 1964, and has been reiterated continuously since then. 33

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to the quality of institutions in recipient countries, in line with China’s principle of non-interference with recipients’ internal affairs.35 In a more direct analysis of the effects of Chinese aid on institutions, previous research provides some support for the raised concerns. In a quantitative analysis of democracy in developing countries, Kersting and Kilby (2014) find eligibility for Chinese aid to be negatively linked with democracy.36 Bader (2015), however, does not find that Chinese aid stabilizes autocracies, but such an effect does follow Chinese trade flows. Concerning corruption, in her response to the critique that China is favoring countries with corrupt regimes, Bräutigam (2009) emphasizes that China is very active in Africa’s best-governed countries such as Botswana, Mauritius, and South Africa. However, first studies show that Chinese aid worsens corruption within countries. Using Tanzanian survey data, Kelly et al. (2017) provide evidence suggesting that Chinese aid activities undermine a corruption-reducing effect of World Bank aid projects. Similarly, Isaksson and Kotsadamm (2018) find increased levels of corruption around active Chinese project sites but no such link for World Bank project locations. The supposedly lax environmental and labor standards of China’s development finance are subject to criticism (see Bräutigam, 2009 for a discussion). Kurlantzick (2006: 5), for example, is concerned that “Chinese investment could contribute to unchecked environmental destruction and poor labor standards, since Chinese firms have little experience with green policies and unions at home, and some African nations have powerful union movements”. Strange et al. (2013) list several instances of crackdowns on Chinese activities out of environmental concerns in Gabon and Sierra Leone. They also refer to a report by Human Rights Watch (2011) on labor abuses, including poor health and safety standards in Chinese state-owned copper mines in Zambia. While to date there is no systematic study on the effects of China’s aid activities on labor standards, two quantitative studies analyze their environmental impact. In the first, BenYishay et al. (2016) show that exposure to Chinese-funded infrastructure projects slows forest loss in Cambodia, but speeds it up in Tanzania. They conclude that “China’s development activities need not lead to widespread environmental damage when nearby ecosystems are appropriately protected, but domestic environmental governance plays a crucial role in shaping these outcomes” (24). In the second, Hsiang and Sekar (2016) could not link a sudden increase in the production of illegal ivory through elephant poaching to  The picture is different for other official flows, such as commercial loans, which appear to flow over-proportionally to more corrupt countries (Dreher et al., 2018). 36  This is in line with Bermeo (2011) who shows that recipients of aid from a­ uthoritarian sources are less likely to democratize than countries that receive aid from democratic donors. 35

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greater Chinese influence through aid. These two papers form an exception and there remains much room for further research on the environmental consequences of China’s development activities. There is little systematic evidence on the extent to which recipient populations appreciate Chinese aid. Using representative survey data, Eichenauer et al. (2018) find no evidence that inflows of Chinese aid, trade and investment improve or deteriorate attitudes towards China among Latin American individuals. Findley et al. (2017) conduct a large field experiment in Uganda and find some evidence that citizens prefer aid from the United States compared to Chinese aid. Chinese aid is often criticized for the high number of Chinese staff involved in its aid projects (e.g. Alden, 2005). This is of concern as it may prevent human capital spillovers to the local population. According to Bräutigam (2009: 154), however, “the idea that the Chinese always bring over planeloads of their own workers and [do] not employ Africans is wrong.” Her own non-representative collection of project information suggests that the share of local workers in Chinese projects ranges between 0 and 96% with a median value of 83% (Bräutigam, 2014). Similarly, Davies (2007) cites the results of a survey by the British Department for International Development (DFID), according to which the local labor share in Chinese construction and infrastructure projects in four selected African countries amounted to 85−95%, comprising mostly, but not exclusively, low-skilled labor. Nevertheless, more systematic data gathering efforts and analyses are warranted to shed more light on local human capital spillovers. Research on China’s gains from its aid program is still scarce. Is China successfully buying foreign-policy support in international fora such as the United Nations Security Council? Do Chinese companies benefit from their government’s aid efforts and does the aid engagement have distributional consequences within the Chinese business community? In a similar vein, scholarship should investigate the effects of China’s aid on the way the established donors provide aid. Results in Granath (2016) already suggest that, in response to growing Chinese aid activities in recipient countries, DAC donors increase their own aid. In a pioneering study, Hernandez (2017) finds that countries with a larger influx of Chinese aid receive less severe conditions from the World Bank. Further avenues of research could be the effects of Chinese aid on the sectoral composition and the concessionality of “traditional” aid. There is also little research on whether Chinese aid harms the effectiveness of Western aid. An exception is Li (2017). He finds that the democratizing effects of DAC aid to Sub-Saharan Africa have been reduced with the emergence of Chinese aid. On the positive side, the results in Strange et al. (2017) suggest that sudden withdrawals of “traditional” aid are less likely to translate into violent conflict if recipient countries have access to funding from China. The extent to which Chinese aid hampers Western aid effectiveness with respect to development outcomes and

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the West’s ability to buy political support from developing countries also deserves close attention.

South Africa South Africa is the newest BRICS member, joining the group in December 2010.37 As an aid donor, South Africa is said to have a comparative advantage as a result of its geographical, cultural and political knowledge of Africa, and its own recent experience in building a democracy. Its aid contribution is far from reaching the volumes of the other BRICS countries (see again Figure 1). Thus, it is not surprising that South Africa’s aid initiative is largely unexplored. The total volume of South Africa’s development aid is difficult to assess. There is no central accounting of South Africa’s bilateral aid and hence a lack of reliable data. According to one source, South Africa’s aid in 2004 amounts to approximately US $1.6 billion, which would be less than 0.01% of South Africa’s GDP (Alden and le Pere, 2010: 5). Others cite relatively high numbers of 0.7−1% of the country’s GNI (around US $6 billion) (Grimm, 2011a; Besharati, 2013a), according to which South Africa would be one of few countries in the world that achieve the United Nation’s target for international aid. However, these estimates include peacekeeping activities and multilateral contributions which are not counted under OECD definitions (Tjønneland, 2013). In fact, just about 10% of its contribution from 2005−2009 went to bilateral assistance (Yanacopulos, 2013). For instance, South Africa channels substantial amounts through organizations such as the South African Customs Union (SACU), the Southern African Development Community (SADC), and the African Union (AU). Bilateral flows via the African Renaissance Fund are currently estimated at US $183 million (Figure 1), which should be a better approximation of the actual number of all bilateral flows. The history of South Africa’s development aid reaches back to the apartheid era. As Braude et al. (2008) point out, assistance to other countries emerged as an instrument to gain foreign political support. In 1968, the Economic Cooperation Promotion Loan Fund was installed as a financial instrument for South Africa’s cooperation (Besharati, 2013a). Until the 1980s, South Africa steadily expanded its bilateral assistance to more countries but kept its focus on the African continent (Vickers, 2013).38 In general, foreign policy under the apartheid regime was  South Africa’s BRICS membership was formally confirmed only at the third BRICS Summit in April 2011. 38  As Braude et al. (2008: 5) highlight, financial aid during the apartheid era also went to  the  so-called “Homelands” or “Banustans”, which were independent states within the 37

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characterized by isolation. With the end of the apartheid regime, South Africa opened up and established a multiracial democracy in the 1990s. The presidency of Thabo Mbeki was marked by the so-called African renaissance — an idea according to which African countries could achieve cultural, political, and economic renewal through mutual support and cooperation (Yanacopulos, 2013). This idea was also manifested in the New Partnership of African Development (NEPAD) in 2001 (Grimm, 2011b). In addition, Mbeki initiated the establishment of the African Renaissance Fund (ARF) in 2000, as a new institution for South Africa’s development cooperation and a replacement of the Economic Cooperation Promotion Loan Fund. In 2010, the Parliament decided that the fund needed restructuring due to several administrative failings (Besharati, 2013b). Around the same time the idea for a central implementing agency that would better coordinate and streamline South Africa’s aid activities was born (Besharati, 2013a). Since then the construction of the South Africa Development Partnership Agency (SADPA) has been ongoing.39 The current institutional setting of South Africa’s development aid is relatively complex. Based on interview evidence, Braude et al. (2008) estimate that “at least half of all national government departments are engaged” in development projects. Today, the ARF is the main implementing agency of South Africa’s aid activities. It is planned that SADPA will take over this role but the process has been extremely slow (Lucey, 2015). Besada and Tok (2015) claim that the ARF currently commands a budget of ZAR 600−800 million (US $70−94 million). This is expected to increase when SAPDA starts its operations.40 South Africa’s development aid concentrates on Sub-Saharan Africa. This is not surprising given that South Africa’s take on South−South Cooperation is informed by “its national interest as being intrinsically linked to Africa’s stability, unity, and prosperity” (DIRCO, 2011). According to an estimate of Besharati (2013a), more than 70% of South Africa’s development aid is channeled to member states of the Southern African Development Community (SADC). Historical exceptions to the focus on African countries have been places in humanitarian need such as South African territory designated for the black South African majority. The purpose of these flows was to strengthen the political regime by creating the image that “black South Africans had places where they could express themselves politically”. However, the independence of the “Banustans” was not recognised outside of South Africa. 39  See the Parliamentary Monitoring Group’s website at https://pmg.org.za/committeemeeting/22022/ (accessed 14 February 2017). 40  A more conservative estimate by Lucey and O’Riordan (2014) projects the prospective budget of SADPA at only ZAR 500 million (US $50 million).

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Palestine or Haiti after the 2010 earthquake (Grimm, 2011a; Tjønneland, 2013; Yanacopulos, 2013). The backbone of South Africa’s development model consists of institutionbuilding, peacekeeping, and post-conflict development (Grobbelaar, 2014). Examples include peacekeeping interventions in Burundi, Lesotho, and most prominently the Democratic Republic of Congo (Lucey, 2015; Hengari, 2016). Ultimately, South Africa has a self-interest in keeping the region peaceful and prosperous. South Africa draws on its own history of internal institution-building for these interventions — a fact which many scholars see as South Africa’s comparative advantage (Hendricks and Lucey, 2013; Vickers, 2013; Hengari, 2016). This sectoral focus stands in stark contrast to South Africa’s lip service to the principle of non-interference. This contradiction is also evident in aid projects that have been tied to political reforms. For instance, South Africa replied in 2011 to a request by Swaziland for a bailout with an aid offer tied to both reforms of the financial system and reforms related to democratic rights (Besharati, 2013a). The motives behind the regional and sectoral concentration of South Africa’s aid has been the subject of some debate. Besharati (2013a) names undesired migrant streams as one of the motives behind the allocation of funds. Grimm (2011a) further hypothesizes that some of the funds are meant as compensation for destabilization politics that South Africa practiced during the apartheid regime. One example is the case of Mozambique, where South Africa sponsored the militant organization during the Mozambican civil war. In addition, Yanacopulos (2013) claims that South Africa is trying to buy votes to enter the United Nations Security Council. Dreher et al. (2011) show some quantitative evidence of South Africa’s aid allocation pattern. They find that poorer, more fragile states have a significantly larger probability of receiving South African aid. They also find that countries that perform worse in controlling corruption receive more aid from South Africa. These results are generally in line with the notion that South African aid is directed towards conflict-prone countries with institutional struggles. Whether South Africa can indeed capitalize on its regional knowledge and own development history is still unclear. Evidence is limited to a few case studies on the effectiveness of South African aid (Hendricks and Lucey, 2013; Hengari, 2016). South Africa has actively participated in global meetings on aid effectiveness in Paris, Accra, and Busan (Besharati, 2013a; Grobbelaar, 2014). It also supports regional initiatives on aid effectiveness such as the African Platform for Aid Effectiveness of the African Union and the NEPAD. However, South Africa’s own aid activities do not meet these standards. Transparency and accountability are a continuing impediment to the analysis of South African aid. Due to the decentralized structure of its aid activities, comprehensive monitoring is difficult (Besharati, 2013a).

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The major implementing agency, the ARF, currently does not disclose any detailed spending accounts. Whether the SADPA will be more transparent in the use of its funds remains to be seen. The only available project-level data on South Africa’s aid activities can be found in a dataset provided by AidData, which covers projects from 2005−2009 (Tierney et al., 2011). In the NEPAD documents, South Africa recognizes country ownership as an important pillar of aid effectiveness (Besharati, 2013a). Although the ARF and SAPDA officially do not provide tied aid, South Africa’s development aid often comes de facto in a package with South African institutions, organizations and companies (Besharati, 2013a). Vickers (2013) claims that South Africa does not fit into the “traditional” aid donor category, primarily due to its lack of comparable financial resources. Its strength as an aid donor rather lies in its history of institution-building and knowledge of the cultural, political, and economic context of African countries. Whether this advantage in fact has a tangible impact still needs to be investigated. Future research could focus on the effects of South African aid on political stability and on the economic welfare of the recipients. More and better data is needed to make this assessment possible. In addition, future research could study the motives behind South Africa’s aid activities to better understand the underlying political agenda.

Conclusions The five BRICS countries have a long history in the field of development cooperation. Since the turn of the millennium, their commitments have become sizeable, and consequently, BRICS aid has moved to the center of the academic debate on foreign assistance. BRICS aid is generally associated with the principle of noninterference and an emphasis on mutual benefits. These principles run counter to the Western donors’ idea of aid untied to goods and services from the donor but tied to democracy and human rights in recipient countries. This concept questions the conventional DAC aid architecture, which in turn is often perceived as paternalistic. At the same time, it is suspected that BRICS aid is more strongly driven by their donor’s self-interests than aid provided by established donors. Compared to aid flows from OECD countries, aid from BRICS countries is still small. It is thus unlikely that it will grow into a standalone alternative to the DAC system. Still, the aid activities of the BRICS donors — with the exception of South Africa — have gained global reach. In terms of sectors, there is large variation between the individual BRICS nations. While China invests heavily in large-scale economic infrastructure projects and India is well-known for its work in the energy and IT sectors, Brazil focuses on agriculture, health, and education projects. Russia is also strongly engaged in education and health projects. Interestingly, South Africa

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engages very actively in peacekeeping activities. This focus stands in contrast to OECD aid, which typically avoids conflict-prone contexts. Overall, BRICS aid seems to be a complement to rather than a substitute for DAC aid. Ultimately, recipients should benefit from this growing diversity in international support. The manner in which the BRICS countries provide aid differs substantially from the DAC guidelines. The grant share is usually smaller and export support, particularly in the cases of China and India, is substantial. While the BRICS countries are often associated with the principle of non-interference, the reality of Russian and South African aid in particular is different. According to official documents, Russia asks its aid recipients to have national programs in place that tackle domestic poverty and economic development, and a true interest in developing bilateral relations with Russia (Ministry of Finance, 2007). South Africa even actively interferes with the governance of recipient countries, including conflicts and democratic crises. These interventions stand in stark contrast to its lip service to the non-interference principle. In general, BRICS donors seem to be motivated by their geopolitical and commercial self-interests. However, it is important to note that existing quantitative studies show no robust evidence that they follow self-interests to a larger extent than DAC donors. Little is known on the developmental effects of BRICS aid. The literature on this issue remains largely anecdotal, mainly due to the lack of comprehensive and wellstructured data. In contrast to the DAC donors, no comprehensive official database exists that tracks BRICS donors’ aid contributions at the project level. However, in the case of China and India, some research initiatives have been initiated to track and geo-reference individual aid projects. Making such data compatible with OECD standards will facilitate comparative studies on the allocation and effects of BRICS aid as well as on the coordination and competition of the BRICS countries with other bilateral and multilateral aid activities.

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Strandow, D., M. Findley, D. Nielson and J. Powell (2011). The UCDP-AidData Codebook on Geo-Referencing Foreign Aid. Version 1.1, Uppsala Conflict Data Program, Uppsala: Uppsala University. Strange, A. M., A. Dreher, A. Fuchs, B. Parks and M. J. Tierney (2017). “Tracking underreported financial flows: China’s development finance and the aid–conflict nexus revisited”, Journal of Conflict Resolution, 61(5): 935–963. Strange, A., B. C. Parks, M. J. Tierney, A. Fuchs, A. Dreher and V. Ramachandran (2013). “China’s Development Finance to Africa: A Media-Based Approach to Data Collection”, CGD Working Paper, 323, Washington, DC: Center for Global Development. Taylor, I. (2012). “India’s rise in Africa”, International Affairs, 88(4): 779–798. Tierney, M. J. (2014). “Rising powers and the regime for development finance”, International Studies Review, 16(3): 452–455. Tierney, M. J., D. L. Nielson, D. G. Hawkins, J. T. Roberts, M. G. Findley, R. M. Powers, B. Parks, S. E. Wilson and R. L. Hicks (2011). “More dollars than sense: Refining our knowledge of development finance using AidData”, World Development, 39(11): 1891–1906. Tjønneland, E. N. (2013). Providing Development Aid to Africa: Comparing South Africa with China, India and Brazil, SAFPI Policy Brief, 25, Cape Town: South African Foreign Policy Initiative. Tubilewicz, C. (2012). “The politics of compassion: Examining a divided China’s humanitarian assistance to Haiti”, International Relations of the Asia-Pacific, 12(3): 449–481. Vaz, A. C. and C. Y. A. Inoue (2007). Emerging Donors in International Development Assistance: The Brazil Case, Ottawa: International Development Research Centre. Vickers, B. (2013). “Towards a new aid paradigm: South Africa as African development partner”, Cambridge Review of International Affairs, 25(4), pp. 37–41. Walz, J. and V. Ramachandran (2011). “Brave new world: A literature review of emerging donors and the changing nature of foreign assistance”, CGD Working Paper, 273, Washington, DC: Center for Global Development. Wang, Y. (2016). Joining the Asian Infrastructure Investment Bank. Manuscript. http:// wp.peio.me/wp-content/uploads/2016/12/PEIO10_paper_101.pdf (accessed 4 February 2017). Will, R. (2012). “China’s stadium diplomacy”, World Policy Journal, 29(2): 36–43. Wolf, C., X. Wang and E. Warner (2013). China’s Foreign Aid and Government-Sponsored Investment Activities: Scale, Content, Destinations and Implications, Santa Monica: Rand Corporation. Woods, N. (2008). “Whose aid? whose influence? China, emerging donors and the silent revolution in development assistance”, International Affairs, 84(6): 1205–1221. World Bank (2017). Poverty & Equity. http://povertydata.worldbank.org/poverty/country/ IND (accessed 4 February 2017). Yanacopulos, H. (2013). “The janus faces of a middle power: South Africa’s emergence in international development”, Journal of Southern African Studies, 40(1): 203–216.

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Younis, M., E. Wilson and A. Shankland (2014). Brazil’s International Development Cooperation at a Crossroads, IDS Policy Brief, 56, Brighton: Institute of Development Studies. Zondi, S. (2013). Brazil and Africa: Cooperation for Endogenous Development? IGD Global Insight, 101, Pretoria: Institute for Global Dialogue.

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PART III

Investment and Finance

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CHAPTER 8

BRICS and the Global Investment Regime Yoram Z. Haftel Department of International Relations, The Hebrew University of Jerusalem, Israel

Introduction The regulation of international investment is currently in flux. Unlike international trade, a multilateral and centralized institution that regulates foreign direct investment (FDI) does not exist. Instead, cross-border capital flows are tackled by more than 3,000 international investment agreements (IIAs), many of which are bilateral investment treaties (BITs) that were signed in the 1990s.1 In addition, and largely based on these treaties, more than a thousand investment disputes were (or are) adjudicated by international arbitrators in a decentralized system known as investor-state dispute settlement (ISDS). Taken together, these two features form the so-called global investment regime. This regime is best understood in the context of the North−South divide. The stated objective of investment agreements and arbitration is to provide foreign investors with protection against political risk in the host countries. Thus, most treaties include provisions that guarantee standards of treatment (e.g. most favored nation (MFN), national treatment (NT), and fair and equitable treatment (FET)),2  Other IIAs are treaties with investment provisions (TIPs), most commonly free trade agreements (FTAs) with an investment chapter. 2  MFN and NT are relative standards that provide foreign investors with treatment no less favorable than investors from third countries and local investors, respectively. FET is an 1

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protection against and adequate compensation in case of expropriation, the freedom to transfer capital, and the like. In addition, many of them allow foreign investors to turn to international arbitration if they believe that the host government has violated the agreement. Given that much FDI flowed from economically developed countries (EDC) to developing countries, and given that the latter were associated with heightened political risk, developed countries utilized IIAs to shield their investors from such a risk. It is not surprising, then, that most IIAs are North−South.3 One might wonder why did so many developing countries sign so many IIAs that supposedly hurt them so quickly all the while they resisted investment protection at the multilateral level (Guzman, 1998). Allegedly, they did it in order to attract much needed flows of FDI into their economies and to demonstrate their commitment to liberal economic policies (Elkins et al., 2006; Haftel, 2010; Jandhyala et al., 2011; Salacuse and Sullivan, 2005). Many governments, it appears, have exaggerated the potential benefits and overlooked or minimized the costs associated with these treaties (Poulsen, 2015). The global investment regime has garnered only limited interest from relevant stakeholders and the public at large until the early 2000s. A growing number of ISDS cases during the first decade of the century, as well as their significant monetary and political implications, has brought this issue to the attention of policy-makers, experts, foreign investors, and transnational advocacy networks, who have begun reevaluating and debating the merits of the existing system. In particular, many critics wondered whether the alleged relinquishing national sovereignty and delegating power to international arbitrators is justified and called for a “rebalancing” of investors’ rights and host states’ flexibility. Indeed, as multinational corporations (MNCs) have begun to slap host governments with claims in international forums, some governments have responded with greater reluctance to sign new or ratify existing BITs (Haftel and Thompson, 2013; Jandhyala et al., 2011; Poulsen and Aisbett, 2013), to renegotiate or denounce existing treaties (Haftel and Thompson 2018; Thompson et al., forthcoming), or to seek annulment of costly awards handed down by arbitration panels (Simmons, 2014). While initial challenges to the regime emerged from the global South, dissatisfaction has spread to EDC as well. This trend is reflected, for example, by the fierce opposition to the investment chapters in the Trans-Pacific Partnership (TPP), Transatlantic Trade and Investment Partnership (TTIP), and the Canada-EU absolute standard that protects foreign investors from arbitrary measures and harassment by the host government (UNCTAD, 2012). 3  Former communist countries are subsumed under the South. There are also numerous South−South IIAs, but very few North−North IIAs. With respect to the latter, it is commonly argued that low political risk and independent court systems obviate the need for protection through an international agreement.

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Comprehensive Economic and Trade Agreement (CETA). In response, countries such as the United States and Canada have updated their Model BITs and have begun to sign agreements that provide governments with greater State Regulatory Space (SRS) and restrict the ability of investors to file claims in international tribunals (Alschner and Skougarevskiy, 2016; Broude et al., 2017).4 On the whole, it seems that most governments, in the North as well as the South, remain committed to the general principle that the protection of foreign investors is required, but strive to strike a better balance between this objective and the host state regulatory flexibility. Emerging market economies (EMEs) such as Brazil, Russia, India, China, and South Africa (henceforth: BRICS), are in a curious position vis-à-vis the global investment regime. On the one hand, all countries are part of the global South (with the exception of Russia, perhaps) and are historically recipients of FDI. From this perspective, one might expect them to oppose international agreements that impose investor protection at the expense of national sovereignty. Moreover, their sheer economic size might endow them with the political leverage to shape FDIrelated rules — especially if acting collectively. On the other hand, their dependence on the global economy for growth, as well as the increasing international exposure of their own MNCs, might motivate them to back the current regime, at least to an extent. This chapter takes a closer look at this tension by, first, examining the record of BRICS countries with respect to IIAs and ISDS. It shows that most of them have become increasingly skeptical about the benefits of investment agreements, especially after fighting arbitration claims. China and, to an extent, Russia appear to be an important exception to this generalization, however. The analysis also indicates that each country adopted a rather distinct strategy, without much coordination with other BRICS, thereby offering little prospect for collective action. The third section offers possible explanations for these divergent approaches, contemplating in particular the role of regime type and a country’s global economic profile. This section also charts research frontiers in this context and points to promising avenues of future research. The final section concludes with implications for the future of the global investment regime and the role of the BRICS in it.

BRICS and the Global Investment Regime: An Overview This section surveys BRICS policies and experience with respect to IIAs and BITs. Table 1 reports basic facts with respect to these two aspects of the regime: it first  SRS refers to the extent of the ability of governments to freely legislate and implement regulations in given public policy domains. For further elaboration, see Broude et al. (2018) and Thompson et al. (forthcoming). 4

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Brazil

Russia

India

China

IIAs Signed

49

23

81

85

130

IIAs in Force

15

1

64

57

111

IIAs Renegotiated

0

0

4

5

22

IIAs Terminated

10

0

1

60

3

ISDS Respondent

1

0

24

24

3

ISDS Claimant

3

0

22

6

5

reports the number of BITs signed and mutually-ratified for each country as well as the number of renegotiated treaties (as of the end of 2018). It then reports the engagement of these countries in ISDS both as a respondent and as a claimant.5 The remainder of this section takes a closer look at each country, starting with South Africa, Brazil, and Russia, and then India and China. South Africa The case of South Africa is perhaps emblematic of developing countries that initially embraced the global investment regime and then made a sharp turn to reject it (Poulsen, 2014, 2015).6 It signed close to 50 BITs, most of them in the second half of the 1990s. It pursued this policy in the post-Apartheid era in order to improve the country’s image and attract much needed FDI. Over the 2000s, however, South Africa had turned from an enthusiastic participant into an outspoken critic of the regime. The key episode to bring about this shift was a complaint filed by an Italian investor that challenged affirmative action measures enshrined in the South African constitution.7 This was followed by a governmental review of South Africa’s BIT policy that resulted in a report harshly criticizing existing practices and recommending that the country changes course (DTI, 2009; Poulsen, 2014). Since 2009, South Africa had virtually stopped signing new BITs and ratifying BITs not yet in force. Most controversially, it had embarked on a process of unilateral  Data on IIAs is based on UNCTAD, http://investmentpolicyhub.unctad.org/IIA, as well as author’s own calculations. Data on ISDS cases is based on UNCTAD, https://investment policy.unctad.org/investment-dispute-settlement (accessed 8 December 2017). 6  Other notable cases are Ecuador, Bolivia, and Venezuela. 7  Piero Foresti, Laura De Carli and others vs. Rep. of South Africa (ICSID Case No. ARB(AF)/07/1). 5

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BIT denunciation with nine important European partners as well as with Argentina.8 South Africa has terminated these BITs despite European pressure to keep them intact (Poulsen, 2015: 189). Interestingly, though, it did not terminate several other BITs, most of them with other developing countries (two of which with other BRICS, namely, China and Russia). This (incomplete) distancing seems to have achieved its stated goal: South Africa did not face an international investment claim since the Foresti case. On the other hand, South African investors have turned to ISDS three times since 2012, one claim two claims against Lesotho and one against Mozambique.9 In sum, South Africa appears to disavow the investment regime as a host country, but accept it as a home country. This approach does not offer a long-term solution to the tension between investor protection and national sovereignty, however. So long as South Africa’s remaining IIAs continue to be in force, it is exposed to arbitration claims in the future. Notably, most of South Africa’s IIAs were signed in the 1990s and do not include many of the recent innovations appearing in “modern” IIAs. It has not taken any proactive steps to renegotiate or update its IIAs and does not present an alternative governance structure to the current rules and institutions. Brazil As Table 1 shows, Brazil is one of few countries, and arguably the most important one, that remains largely on the sidelines of the global investment regime. Even though it signed 14 BITs in the 1990s, mostly with European partners, it ratified none. This failure to ratify seems to have emanated from a cumbersome legislative process combined with a determined and effective opposition (Lemos and Campello, 2015; Wei, 2012) as well as the belief that Brazil can be attractive enough to FDI even without BITs (Bento, 2013: 312; Collins, 2013: 38). As a direct consequence, Brazil was not involved in any ISDS either as a claimant or a defendant. Like in other emerging markets, however, the growing involvement of Brazilian MNCs in the global economy during the 2000s have resulted in a mounting pressure on the government to protect them through investment agreements (Bento, 2013: 275−276). Not least because Brazilian corporations found themselves entangled in investment disputes with host governments with no recourse to international arbitration (Bento, 2013: 317−318). Brazilian businesses were especially interested in agreements with developing countries where they had strong business ties, especially  These are Austria, Belgium/Luxemburg, Denmark, France, Germany, the Netherlands, Spain, Switzerland, and the United Kingdom. 9  The claims against Lesotho is based on the investment protocol of the South African Development Community (SADC) rather than a BIT. 8

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in Sub-Saharan Africa and Latin America (Collins, 2013: 38; Morosini and Badin, 2015). After long deliberations and consultations, in 2013 the government produced a new template of an investment agreement, labeled Cooperation and Investment Agreement (CIFA). This template agreement strives to strike a balance between investment protection and SRS. With respect to standards of protection, for example, it includes (qualified) MFN and NT but no FET clauses. Most importantly, CIFAs completely exclude binding ISDS provisions. Instead, they emphasize consultation and mediation through a Joint Committee and an Ombudsmen (Brauch, 2015; Morosini and Rotton, 2015). The first two CIFAs were signed in 2015 with Angola and Mozambique, two former Portuguese colonies, where Brazilian firms have strong economic interests. Since then, it signed several additional agreements, all with Latin American or African partners.10 Only the CIFA with Angola entered into force by the end of 2017, so their impact remains largely hypothetical. Given that they have no reference to ISDS, it is safe to assume that Brazil will not take part in the current system of international arbitration in the foreseeable future. It remains to be seen whether this model will satisfy Brazilian investors operating abroad and whether other governments will find it suitable for their needs. Russia Russia represents an interesting case of a large EME that has shifting and crosscutting interests with respect to foreign investment. As reported in Table 1, Russia has concluded a large number of BITs in the last 30 years or so, about three-quarters of them are in force. It was also involved in a large number of investment disputes, both as a defendant and as a claimant, most of them filed within the last decade or so. Indeed, Russia was entangled in the largest number of ISDS cases among the BRICS countries. At first blush, Russian lasting embrace of the global investment regime, despite the large number of investment arbitration instances, seems to defy theoretical expectations (Poulsen and Aisbett, 2014; Haftel and Thompson, 2018) and to diverge from the perspectives of South Africa and Brazil discussed above. A closer look at the records suggests that the reality is a bit more complex. Looking, first, at Russia’s BITs, Figure 1 shows the number of BITs signed each year since 1989 (during which it signed its first BITs, then as the Soviet Union),  The agreement with Peru is part of an FTA. According to the Brazilian Ministry of Foreign Affairs, negotiations are under way with South Africa, Algeria, Morocco, and Tunisia. See http://www.itamaraty.gov.br/en/press-releases/12538-brazil-mozambique-cooperationand-investment-facilitation-agreement-cifa (accessed 10 February 2017). 10

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Number of IIAS

7 6 5 4

LDC EDC

3 2 1 2015

2013

2011

2009

2007

2005

2003

2001

1999

1997

1995

1993

1991

1989

0 Year

Figure 1:   Annual number of Russian IIAs, 1989−2016. Source: UNCTAD’s International Investment Agreements Navigator. http://investmentpolicyhub.unctad. org/IIA (accessed 16 February 2017).

divided into two groups of countries: economically developed countries (EDCs) and less developed countries (LDCs). It is apparent that most of the BITs concluded right before and after the fall of the Berlin Wall were with developed, mostly Western European, countries, in an effort to attract FDI into the Russian economy.11 It also joined the Energy Charter Treaty (ECT), a regional BIT-like agreement in the energy sector, in 1994 (Rubins and Nazarov, 2008: 103).12 The last investment treaty signed with a developed country was the 1998 Russia−Japan BIT, however. The pattern for BITs concluded with developing countries is quite different. Only a handful of BITs with LDCs were signed in the early 1990s, but since the early 2000s all BITs are with countries from the global South (including all other BRICS except Brazil). Since 2005, Russia concluded more than 20 BITs, most recently with Cambodia, Iran, and Morocco. The causes for this shift echo the lines of thinking prevailing in other EMEs. The dissipating interest in BITs with EDCs was driven by a growing concern that they give foreign investors too much protection at the expense of national sovereignty. This issue gained salience after Russia faced an investment claim in the late 1990s  Russia signed a BIT with the US in 1992, but never ratified it.  The ECT involved mostly European countries and entered into force in 1998. Even though Russia never ratified the agreement, it was argued that it is still obliged by it. This issue turned out to have significant legal implications in an important arbitration case related to Yukos Oil (see below). 11 12

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(Collins, 2013: 57). This was coupled with high prices on exporting commodities, such as oil, which rendered the need for IIAs less pressing (Rubins and Nazarov, 2008: 103). Thus, the Putin government put the signing and ratification of BITs on hold in the early 2000s. At the same time, a growing global exposure of Russian MNCs resulted in pressure to protect them in host countries (Collins, 2013: 61). This might explain Russia’s continued eagerness to conclude treaties with developing countries. An examination of Russian BITs’ content is also quite revealing in this respect.13 The BITs signed under the Soviet Union followed a template espoused by communist governments in the 1980s. These agreements had rather limited investment protections and access to ISDS, which was available only for disputes over the amount of compensation in case of expropriation (Ripinsky, 2013: 598). Russia updated its Model BIT in 1992, adopting an investor-friendly template akin to Western European ones. Thus, the BITs signed in the 1990s contained standards of treatment, such as MFN, NT, and FET, as well as easy access to ISDS. Russia adopted a new model in the early 2000s. While some commentators suggest that this model was more sensitive to considerations of national sovereignty and flexibility (Rubins and Nazarov, 2008; Collins, 2013), it appears that current BITs do not significantly diverge from earlier ones. As Ripinsky (2013: 597) argues, “The current Model BIT — even though more developed than the first two (1987 and 1992) models — can still be described as minimalist: it includes only the basic bare-bones provisions which lack the details and sophistication of other States’ recent BITs.” Indeed, a glance over the texts of recent BITs, for example the 2010 Russia−Singapore BIT, suggests that it remains largely favorable to foreign investors.14 In late 2016, Russia adopted a new regulation that provides guidelines with respect to the content of future IIAs. Among other things, it includes a more demanding definition of foreign investors, no FET and Full Protection and Security provisions, and a more limited access to ISDS (Dahlquist, 2016). It remains to be seen whether these changes will be incorporated into future IIAs. Even if they are, the more cautious approach they embody remains largely in line with broader global trends and is much less radical than South Africa’s and Brazil’s. The Russian experience with ISDS largely dovetails its BIT program. As already mentioned, Russia faced a large number of claims, most of them rather recently. Many of these claims were filed by Western European investors. The most  For a detailed commentary on Russian Model BITs, see Collins (2013) and Ripinsky (2013). 14  It contains, for example, FET, NT (albeit with some exceptions), and MFN provisions as well as unrestricted ISDS rules. 13

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well-known case involves several claims by shareholders of the Russian oil company Yukos, which was nationalized in the early 2000s. In 2014, the claimants won a staggeringly high award of US $50 billion in the Permanent Court of Arbitration. This award was overturned in 2016 and is still litigated at the time of this writing.15 One line of defense pushed by the Russian government was that the claimants were not foreign investors, but local ones who established shell companies abroad and are therefore not entitled for protection under the agreement (Collins, 2013: 58). This is a likely impetus for Russia to define foreign investors as only those who have “substantial presence” in the home country. Seven recent claims represent a different dynamic: all were filed in the wake of the 2014 Russian invasion to and annexation of Crimea and are based on the 1998 Russia−Ukraine BIT. These claims are complicated by geopolitical disputes and raise difficult and intriguing political legal issues that are beyond the scope of this chapter (Tzeng, 2016). On the other side of the ledger, as of December 2018 Russian MNCs filed 22 claims against host governments. All of these claims involve other developing countries, most of which are in Russia’s “near abroad”. This shows, as argued by Collins (2013: 60), that “Russian firms are quite willing to pursue dispute settlement in international fora when it is in their interest”. In this context, it is unsurprising, perhaps, that an annex to the 2016 regulation states that Russian BITs should “focus primarily on outgoing investments, i.e. the interests of Russian investors abroad, and the scope to improve the investment climate faced by Russian investors (and indeed the possibility to receive incentives or preferential treatment)”.16 In short, Russia’s position has shifted from a largely FDI recipient country in the early 1990s to one that is both a recipient and a sender of foreign capital and thus have cross-cutting interests. Like South Africa and India, Russia appears to have had misgivings about its investment treaties that once faced international investment claims, which resulted in a more cautious approach to the global investment regime. Nevertheless, Russia’s response appears muted in a comparative perspective: it continues to sign and ratify IIAs, it did not denounce any of its existing treaties (with the exception of the 2009 withdrawal from the ECT) and has revised its model BIT incrementally and cautiously. While one might argue that signing agreements with countries that are more likely to be destinations to Russian investors rather than the other way around lessens the risk of exposure to future claims, the  “Russia wins legal victory over Yukos damages”, Financial Times, 20 April 2016. https:// www.ft.com/content/2a23a352-06ce-11e6-a70d-4e39ac32c284 (accessed 14 February 2017). The reason for the overturn emanates from the fact that Russia did not ratify the ECT, on which these claims are based. 16  Cited in Dahlquist (2016: 1). 15

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recent claims brought by Ukrainian investors suggest that such logic has its limits. Moreover, given that Russian BITs continue to include an MFN clause, investors from developed countries can use their provisions (substantive and procedural) to sue Russia (Rubins and Nazarov, 2008; Collins, 2013). Only time will tell if Russia will take a more assertive stance vis-à-vis the regime in light of the recent surge in ISDS cases it is embroiled in. India Much like other developing countries, India joined the BIT “train” in the early 1990s, as part of a broader economic liberalization program. This was a sharp turn from its previously staunch resistance to international regulation of FDI (Ranjan, 2014). Since its 1994 BIT with the United Kingdom (UK) in 1994, India concluded more than 80 IIAs, the large majority of which were in force until recently (revisit Table 1). These treaties brought about a large number of claims against India since the middle 2000s. In contrast to Russia, the balance is heavily tilted against India in this respect, with only six ISDS cases in which Indian investors are claimant. This has led to greater skepticism towards the global investment regime and a more assertive response. India’s initial BITs reflect the conventional position of host developing countries. As Figure 2 shows, many of its early agreements were with Western European countries with a clear aim to attract foreign investment (Ranjan, 2014).17 India also signed numerous treaties with other developing countries, but continued to sign IIAs with developed countries until at least 2011, when it concluded a Free Trade Agreement (FTA) with an investment chapter with Japan (contrast with Russia). It has stopped signing and ratifying investment agreements after 2011, which is a clear watershed in its investment policy (Ranjan, 2014, 2015). Most of the agreements signed by India are stand-alone BITs, but four are FTAs with an investment chapter: Singapore (2005), South Korea (2009), Malaysia (2011), and Japan (2011).18 A look at the content of Indian IIAs indicates that they are heavy on investor protection and light on SRS. Indeed, the template used by India is based on the UK−India BIT, which in turn is based on the UK Model BIT (Ranjan, 2014: 430). With few exceptions — that were most likely driven by more balanced templates  Ranjan (2014: 430) suggests that government officials were especially concerned about competition from China. 18  Notably, India also concluded older BITs with Malaysia (1995) and South Korea (1996). Both these BITs and FTAs appear to be in force. India also signed an FTA with ASEAN in 2014. It is not yet in force. 17

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7 6 5

LDC

4

EDC

3 2 1 0 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 Year

Figure 2:   Annual number of India’s IIAs, 1989−2016. Source: UNCTAD’s International Investment Agreements Navigator. http://investmentpolicyhub.unctad. org/IIA (accessed 16 February 2017).

of the partner country, such as the 2009 BIT with Colombia — offered foreign ­investors broad protections (Collins, 2013). Ranjan (2014) argues that this “rule taker” approach was driven by India’s wish to attract FDI rather than an effort to protect India’s investors abroad. A noteworthy exception is the handful of FTAs, which are much more sensitive to concerns of national sovereignty. For example, most of these FTAs qualify the FET provision and provide a detailed definition of indirect expropriation (Ranjan, 2015). The inconsistent approach reflected in the two types of agreements signed by India during the same time period is quite intriguing. Ranjan (2015) argues that this is partly due to their varying scope and partly due to the fact that they were negotiated by different ministries.19 As already mentioned, India stands out among the BRICS in the number of investment claims filed against it, especially relative to the number of claims filed by Indian investors. All of these disputes erupted since the middle 2000s and involve a variety of home countries (mostly Western European countries, but also Russia, Mauritius, and the United Arab Emirates) and sectors (e.g. telecommunications, energy, and real estate). In a significant early case, White Industries Australia Ltd.  BITs are within the authority of the Ministry of Finance while FTAs are within the Authority of the Ministry of Commerce. In a recent decision, the authority to negotiate FTAs was transferred to the Ministry of Finance, such that there is more policy consistency (Hanessian and Duggal, 2017: 217; Hepburn, 2017). 19

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vs. India, an UNCITRAL tribunal ruled in favor of the claimant after the Indian legal system failed to enforce an earlier award handed down by the International Chamber of Commerce. Two aspects of this ruling highlighted the potential risks existing in Indian BITs. First, it showed that the judiciary is part of the government and subject to the agreement’s rules. Second, the claimant used the MFN clause in the Australia−India BIT to access a provision contained in a different (India−Kuwait) BIT, drawing attention to the possibility of treaty shopping (Collins, 2013: 86−87; Malhotra, 2016; Ranjan, 2014). Subsequent claims, such as those that followed a controversial decision by the Indian Supreme Court to revoke licenses to several telecommunication companies, further underscored India’s vulnerability to international investment arbitration. Largely as a result of these disputes, which were accompanied by an outcry from academics, civil society, and legislators, India stopped signing and ratifying BITs and conducted a comprehensive review of its investment policy (Ranjan, 2014). Like South Africa, it came to the conclusion that its investment treaties went too far in protecting foreign investors at the expense of SRS. As stated by the Ministry of Finance:20 These reciprocal agreements had been negotiated on the basis of the Model Text adopted in 1993, […] which were susceptible to broad and ambiguous interpretations by arbitral tribunals regarding provisions of existing Indian BITs that do not adequately take into account the socio-economic conditions found in India and the broad objectives of government policy.

The review resulted in an overhaul of India’s investment policy. This is most clearly evident in the 2015 Model BIT, which tilts the balance back to host state flexibility. With respect to substantive provisions, it completely excludes MFN and FET as well as contains a large number of exceptions on investor protection and permits the government to take a variety of measures to promote social and economic objectives. Regarding procedural matters, the Model still includes ISDS but requires partial exhaustion of local remedies first (Hepburn, 2017). It includes additional hurdles that render the use of ISDS very difficult (Hanessian and Duggal, 2017; Ranjan, 2015, 2017). India has indicated its intention is to renegotiate all BITs that their initial term has expired according to this new template (Hanessian  Statement of Saurabh Garg, Joint Secretary, Department of Economic Affairs, India’s Ministry of Finance for the 2016 World Investment Forum. http://unctad-worldinvestmentforum.org/wp-content/uploads/2016/07/WIF-2016-Statement-India-.pdf (accessed 15 February 2017). 20

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and Duggal, 2017). For more recent treaties, India produced a “Joint Interpretative Statement”, which it hopes to sign with BIT partners. This statement includes more limited definitions of investors and investment, a qualification of FET, restrictions on treaty shopping through MFN, and more (Malhotra, 2016). This two-pronged approach ought to reclaim India’s regulatory space. On the face of it, India’s approach seems less radical than South Africa’s and Brazil’s, but more than Russia’s. While its new Model BIT offers much fewer protections to foreign investors, it keeps some key substantive provisions (such as NT and full protection and security) and leaves the door open to international arbitration. The implications of India’s actions are uncertain, however. So far it has signed only one agreement based on the 2015 Model. It has indicated, moreover, that it will terminate its BITs with partners who refuse to renegotiate. Given the lack of ­enthusiasm about India’s model elsewhere, this ultimatum has largely materialized.21 This puts India more squarely with the small but growing camp of countries that reject the current rules of the global investment regime. Surprisingly, perhaps, India’s changing orientation seems to pay little heed to its growing role as a sender of FDI. Its position as a home country is evident in the global profile of several Indian MNCs in the information technology (IT) and automotive sectors, for example (Collins, 2013: 79−82). It is also apparent in the handful of ISDS cases in which Indian investors were the claimants, such as against Poland (2014) and Indonesia (2015). While observers point out that India ought to take the protection of its own investors abroad into consideration (Collins, 2013: 100; Ranjan, 2014: 449; Ranjan, 2017), there is not much evidence that this factor has influenced current debates and policies. For example, India’s intention is to renegotiate or terminate all of its BITs, many of which are with other developing countries where India is more likely to be a sender of FDI rather than a recipient (Ranjan, 2017). From this perspective, it diverges from other BRICS in an important way.

 One European Ambassador to India said “[n]ot a single EU member country has any interest whatsoever to negotiate a new BIT with India and there will be numerous conditions attached to a hypothetical EU-India BIT.” See “India to Trade Partners: Sign New Bilateral Investment Treaties by 31 March” Live Mint, 11 January 2017. http://www.livemint.com/ Politics/8IRq2uiGhDAxjyiO2lEJ3K/India-asks-trade-partners-to-sign-new-BIT-pact.html (accessed 16 February 2017). Indeed, India’s agreements with 60 countries have been terminated by the end of 2018. The list of terminated BITs includes important economic partners, such as Germany, Australia, and Russia. The fate of other treaties remains unclear at the time of this writing (Hepburn, 2017).

21

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China China started signing BITs in the 1980s, mostly with developed European countries. It dramatically expanded its program in the subsequent two decades and has become a major player in the global investment regime. With more than 130 signed BITs and FTAs with investment chapters, over 110 of them in force, China ranks first among developing countries and second (to Germany) worldwide in the number of IIAs. Unlike other BRICS, China has continued to sign IIAs in recent years, for example a BIT with Turkey and an FTA with Australia (both in 2015). Moreover, despite the large number of treaties China concluded over the last three decades, its experience with ISDS is relatively limited. Various aspects of China’s IIA policy were examined quite extensively by other scholars (Berger, 2013, 2015; Gallagher and Shan, 2009; Hadley, 2013; Schill, 2007; Wei, 2012; Zeng and Lu, 2016), and is therefore discussed here more succinctly. China was highly suspicious of FDI and strongly resisted the global investment regime until its opening to the global economy in 1979 (Schill, 2007: 77). It started signing BITs shortly thereafter, though, with a 1982 agreement with Sweden (thus earlier than other BRICS). In the rest of the decade, it signed over 20 BITs, mostly with EDC (but not with the US). China concluded some 70 BITs in the 1990s, mostly with developing countries (because there were not many developed countries without which it had an agreement left). Beyond signing additional BITs in 2000s, China started renegotiating its older BITs, updating about 20 of them, and signed the first FTAs with a comprehensive investment chapter.22 Thus far, China concluded less than 10 such FTAs, but with important partners, such as ASEAN, Australia, Japan, New Zealand, and South Korea. It seems, then, that China continues to expand its IIA network with both developed and developing countries.23 A closer look at China’s IIAs points to at least two shifts in its approach to the balance between investor protection and SRS. The first wave of BITs, signed in the 1980s, left the parties with much room to maneuver. Like other communist countries, China was willing to grant access to ISDS only with respect to the amount of compensation in case of expropriation. In addition, Chinese BITs did not include a commitment to national treatment (Berger, 2015; Schill, 2007). China abandoned  The first renegotiated agreement is the 2001 Netherlands−China. The first FTA with an investment chapter was signed with Pakistan in 2006. 23  One notable country missing from this network is the United States, of course. The two powers have been negotiating a BIT over the last several years, but are yet to have a mutually-acceptable text. See Congyan (2009). 22

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this model in the late 1990s and started signing treaties that were consistent with Western European templates, thereby providing foreign investors with stronger substantive protections and easier access to international investment arbitration. Many of the renegotiated BITs of the early 2000s reflect this change as well, as they updated agreements from the 1980s and early 1990s (Berger, 2013; Wei, 2012). The more recent, “third generation”, of Chinese BITs and FTAs reclaims state sovereignty through a variety of carve outs, exceptions, and references to the state’s right to regulate (Berger, 2013, 2015; Collins, 2013; Congyan, 2009).24 For example, several recent Chinese IIAs define investors in a manner that excludes “letter box” companies and restrict access to MFN and FET standards. These innovations were borrowed from templates and treaties advanced by other countries, most notably the US. This has led observers to label this shift as the Americanization (Congyan, 2009) or “NAFTA-ization” (Berger, 2015) of Chinese IIAs. As Berger (2015) notes, however, China’s shifts from one generation to another were far from complete. He shows that the rules embodied in Chinese agreements vary quite widely across partners, even in the same time-period. For example, in the decade since 2006 China signed several traditional BITs that do not take into account recent attempts to provide host states with greater regulatory space. Berger (2015: 864) maintains that this trend is a result of a “flexible” Chinese approach, which tends to go along with the template of the partner country, regardless of economic size, level of development, and the like. Be that as it may, it appears that China is more comfortable with the principles and rules of the global investment regime, compared to other BRICS countries. This reality comports with the fact that over the 2000s China has transformed from a recipient to an important sender of FDI. In the first half of the 2010s, China (excluding Hong Kong) was consistently the third largest source of outgoing FDI, after only the United States and Japan (UNCTAD, 2016).25 Ostensibly, China views BITs not only as an instrument to attract FDI into its economy, but also a tool to protect its investors abroad (Berger, 2013; Collins, 2013: 129). China’s involvement in ISDS appears rather limited, especially considering its large number of IIAs in force. By the end of 2018, it was a respondent in only three  Here, too, several treaties are renegotiations of previous ones. It is interesting, though, that these newer agreements do not always terminate their older counterparts, which might result in legal ambiguities. In an extreme example, China currently has three IIAs in force with South Korea: the 2007 BIT (which replaces a 1992 BIT), the 2012 tripartite FTA with Japan, and a 2015 bilateral FTA. An examination of this perplexing overlap is beyond the scope of this chapter. 25  Adding Hong Kong, which is also a top-ten sender of FDI, to China bumps the duo to the second place. 24

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known cases, while Chinese investors filed five claims against host governments.26 These disputes had some effect on China’s perspective and policies. Interestingly, an (unsuccessful) attempt by a Chinese investor to use an MFN clause in the China− Peru BIT to “import” ISDS provisions from other Peruvian treaties caused concerns in China and prompted it to insert a provision that excludes ISDS from the MFN provision in subsequent treaties (Berger, 2015: 862). Nevertheless, this reaction is much more circumscribed than the ones advanced by South Africa and India, for example. Whether a larger number of disputes with higher stakes — a trend that experts expect, but is yet to materialize (Collins, 2013: 129) — will push China closer to these peers is too early to say.

BRICS and the Global Investment Regime: Convergence, Divergence and Research Frontiers The brief overview of BRICS policies in the area of investment treaties and arbitration allows one to make several broad generalizations regarding similarities among and differences between these EMEs. Zooming in on the latter, this section provides a preliminary account that underscores a combination of domestic economic interests and political institutions. Given the paucity of comparative and systematic research on EMEs and the global investment regime, this section also points to pressing and promising avenues for future research. As described above, all BRICS joined the BIT trend as they have integrated into the global economy in the 1980s and 1990s in order to attract much needed foreign capital into their economies. Thus, their programs initially emphasized agreements with EDC, mostly from Western Europe. Two later developments shaped their approach to the global investment regime. First, the emerging phenomenon of investment arbitration caught them by surprise, sowed doubts with respect to the benefits from the regime, and created a backlash against it. Second, the rapid shift from a traditional position of a recipient of FDI to a significant source of global capital compelled these countries to view the regime from a home country perspective. This transformation and the accompanying cross-cutting interests probably set emerging markets apart from other developing countries. These parallels nonetheless, the response of the five countries to the two developments just mentioned is clearly quite diverse.27 Generally speaking, Brazil, South  This count excludes the controversial claim Phillip Morris filed against Australia, which was based on the Australia−Hong Kong BIT. 27  Also see Alschner and Skougarevskiy (2016: 369−370). 26

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Africa, and India object to the current regime, which they perceive as tilted too heavily in favor of foreign investors at the expense of host states. China, on the other hand, appears at ease with the rules reflected in recent so-called “modern” IIAs as well as ISDS. Russia is somewhere in between these two poles. The remainder of this section ponders two preliminary explanations to this apparent divergence: (1) the volume of outwards FDI; and (2) the nature of the political system. Balancing Interests as FDI Recipients and Senders Governments of EMEs are possibly seeking to strike a balance between their interests as host and home economies. It may not be a coincidence that China and Russia — who appear more comfortable with the regime — are among the 10 largest senders of FDI worldwide, while the other three countries lag far behind them. As Figure 3 demonstrates, China’s FDI outflow was under $5 billion per annum until the early 2000s, but then started climbing briskly. It crossed the $100 billion per annum in 2013, which put China as the third largest sender of FDI in the world (not including Hong Kong and Macau). Russia shows a similar pattern: its FDI outflow have increased from about $3 billion in the early 2000s to more than $60 billion in 2013 and 2014. This puts Russia in a group of the 10 largest senders of foreign capital worldwide. The other three countries show a much more moderate growth of outwards FDI and rarely crack the top 20 senders of FDI in the world.

140,000

Millions of US$

120,000 100,000 80,000 60,000 40,000 20,000 0 –20,000 Year Brazil India South Africa

China Russia

Figure 3:   FDI outflows of BRICS countries, 1990−2015. Source: UNCTADSTAT. http://unctadstat.unctad.org/EN/ (accessed 18 February 2017). Data for China do not include Hong Kong and Macau.

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It seems, then, that the shift from an exclusively host country to a host and home country was felt more strongly in the former two countries, thereby exerting greater pressure to protect the assets of their MNCs abroad through IIAs and ISDS. Those governments that have remained mostly recipients of FDI, on the other hand, are more likely to use their growing economic clout to conserve or regain their national sovereignty. We know little about the process by which economic actors strive to affect their governments’ approach to the global investment regime and the extent to which they have an influence on actual policies. These poorly understood dynamics are ripe for further investigation. One intriguing possibility involves the nature of the firms investing abroad. In particular, state-owned enterprises (SOEs)28 are quite dominant in BRICS, compared to EDC. Moreover, available data show that some BRICS SOEs are active in international markets and are therefore, exposed to foreign investment risk (Kowalski et al., 2013). From a political perspective, one might conjecture that given the government’s direct stake in their performance, internationally-oriented SOEs are in a good position to obtain investment protection. The dominance of SOEs varies across the BRICS, of course. Kowalski et al. (2013: 22) assess this variation with the Country SOE Share (CSS), which is an equally weighted average of SOE shares of sales, assets, and market values among a country’s top ten companies. While all BRICS save South Africa are among the ten countries with the highest CSS, their individual raking is telling: China ranks first with a CSS of about 96% (!), Russia ranks third with 81%, India ranks seventh with 59%, and Brazil ranks eighth with 50%.29 These rankings echo the rankings of FDI outflows in general and appear consistent with the idea that SOEs are responsible, at least in part, to the greater willingness of China and Russia to stick with the current rules of the regime. Much more work is needed, however, to fully grasp the role of SOEs within the global investment regime and their varying impact on BRICS investment policies. Another aspect that requires further scrutiny is the economic sectors that engage in outwards FDI. Insofar as some sectors are more vulnerable to host state discrimination or unfair treatment and to the extent that the size of these sectors varies across the BRICS, one should expect divergent dispositions towards the global investment regime. It is commonly thought that sectors either with high sunk  Defined as a majority state-owned enterprise (Kowalski, 2013: 11).  The CSS does not distinguish between domestically and internationally-oriented companies. In addition, the calculations are based on data from 1 year only (2011). One should therefore treat these data with caution.

28 29

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costs (such as resource extraction, infrastructure, and utility provision) or that are ­politically sensitive (such as extractive industries, utilities, communications, and national defense) are the most susceptible to expropriation or maltreatment (Colen et al., 2016; Danzman, 2016). Sectoral FDI data for the BRICS is neither readily available nor easily comparable, but extant research indicates that Russian, and, to a lesser extent, Brazilian, outwards FDI concentrates in vulnerable sectors, such as resource extraction, energy, and infrastructure. India’s outwards FDI, on the other hand, is dominated by manufacturing and services. Chinese FDI is somewhere in between, with the lion’s share of outwards FDI in services sectors as well as resource extraction sectors (Andreff, 2015: 105−107). Interestingly, though, the latter is dominated by Chinese SOEs (Kowalski et al., 2013: 28). These initial observations hint that a fine-grained sectoral analysis might yield important insights into EMEs’ policies vis-à-vis the global investment regime. Domestic Political Institutions To the extent that IIAs and international investment arbitration are contested by civil society groups and viewed negatively by public opinion, their ability to affect policy could hinge on the nature of domestic political institutions. Specifically, we should expect that the backlash against the regime, to the extent that there is one, will exert greater pressure on governments in democratic countries, compared to other regime types. Indeed, Simmons (2014) shows that since 2008 democratic governments are more likely to seek annulments of ISDS awards. She argues, plausibly, that such governments face greater scrutiny and higher expectations of accountability to public interests. In his turn, Pelc (2017) argues that democracies are more vulnerable to frivolous investment claims, which strive to produce regulatory “chill” in the host country. Thus, as skepticism vis-à-vis the regime increases, democracies should be more assertive in their opposition to it. The BRICS appear to corroborate this conjecture. It would be uncontroversial to suggest that Brazil, South Africa, and India are more democratic and have more veto players compared to China and Russia. According to the Polity database, for example, the former three are mature democracies at least since 1995 (Marshall et al., 2016). China is consistently authoritarian, while Russia’s scores indicate that it is a “competitive authoritarian” country (Levitsky and Way, 2002).30 In line with the theoretical expectations, the more democratic countries hold a more negative view of the global investment regime, especially since the late 2000s. This conjecture  According to its Polity score, Russia was more competitive in the first half of the 2000s, but has become more authoritarian since then. 30

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receives further empirical support from the different cases. We have seen above that the opposition in the Brazilian Congress was effective in stalling the ratification of BITs signed by its executive. The pressure by the public and the media to retain national control over important policy areas was present in South Africa and, even more so, in India (Ranjan, 2014, 2015). There is no evidence of similar tendencies in the non-democratic BRICS. To be sure, the distinction between democracies and non-democracies is rather simple and somewhat rough. It does not account, for example, for variation within the three democracies in terms of their specific responses as well as their timing. As we have seen, Brazil rejected the regime early on, South Africa has changed course after hit by a single claim, while India faced multiple claims before rethinking its approach. A closer look at the different political rules that govern policy making, e.g. the number of veto players, the structure of the electoral system, and the constitution, might provide clues with respect to this question (Lemos and Campello, 2015). Relatedly, one might need to examine the domestic rules that govern foreign investment (as well as broader public policy, perhaps) and whether they complement, substitute, or contradict global ones. Taking up these issues is a fruitful avenue for future research. Bringing Interests and Institutions Together Undoubtedly, neither economic interests nor political institutions, in and of themselves, provide a complete account of the differences across the BRICS. Combining these two factors is more likely to offer a satisfactory explanatory framework. Table 2 does just that for the 2010s. As one can see, both the volume of outwards FDI and the level of democracy account for the variation in the acceptance of the global investment rules and principles. This result provides preliminary empirical support for the significance of interests and political institutions and suggests that further research is warranted.

Table 2:   Outwards FDI (OFDI), regime type, and acceptance of the global investment regime by the BRICS. Democracy Low OFDI High OFDI

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Brazil, India, South Africa (low acceptance) Russia (intermediate acceptance) China (high acceptance)

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Given that both explanations co-vary perfectly in these cases, however, it is difficult to assess their relative importance and whether the simultaneous presence of authoritarianism and high global exposure of local MNCs is required for EMEs to be comfortable with robust protection of foreign investors. From this perspective, greater variation on key variables might allow us to see the impact of different explanatory factors more clearly. One way forward would be to examine the evolution of BRICS policies over time. Another would be to expand the sample to other EMEs, such as Mexico, Indonesia, and Turkey. After all, the list of countries included in the BRICS club is rather arbitrary. The inclusion of cases that fit in the upper right or lower left cells in Table 2 might shed additional light on the role of interests and institutions. This is a promising avenue of future research.

Conclusion: Implications for the Future of the Global Investment Regime This chapter surveyed BRICS policies with respect to international investment agreements and disputes. It showed that the perspectives of these EMEs have shifted over time, reflecting global as well as domestic changes. While these countries share some similarities, there are notable differences between their approach and policies. I have suggested that these dissimilarities can be attributed to the degree to which their own corporations are exposed to investment risk abroad and their regime type. Given the growing economic and political clout of the BRICS, it may be ­reasonable to expect greater influence of these countries on global investment rules, especially if they can coordinate their policies. For example, Mehta and Ranjan (2015: 26) argue that the “changing treaty practice [of BRICS] could result in these countries emerging as rule-makers in investment treaties”. Moreover, as emerging economies are more likely to adopt a home country perspective, EDC increasingly view the regime from a host country lens. As these Western democracies were hit by investment claims, they have become more sensitive to considerations of regulatory space and sought to rebalance global investment rules (Broude et al., 2018). Following this logic, one could envision how a would-be US−China IIA could serve as a template for multilateral investment rules (Congyan, 2009). Such optimism about global convergence is likely unwarranted. To begin with, some of the BRICS policies in this area are internally inconsistent. We have seen, for example, that South Africa denounced some BITs but kept others intact, that India’s BITs and FTAs reflect a different set of rules, and that the content of China’s IIAs is quite diverse. Such incoherence would render it difficult for any given country, even China, to become a “rule maker” (Berger, 2015: 868). Furthermore, there seems to

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be little coordination between the BRICS on this issue. Ironically, perhaps, as Brazil started signing a new generation of investment treaties, India gradually terminates its own IIAs. In addition, this chapter shows that these countries have a very different approach to key issues, such as the rules governing ISDS. Hence, while the BRICS, as a group, largely oppose Western-led initiatives such as the TPP, they do not offer a coherent alternative (Alschner and Skougarevskiy, 2016). From this vantage point, it appears that EMEs will continue to be rule-takers rather than rule-makers.31

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Levitsky, S. and L. Way (2002). “The rise of competitive authoritarianism”, Journal of Democracy, 13(2): 51–65. Malhotra, S. (2016). “India’s joint interpretive statement for BITs: An attempt to slay the ghosts of the past”, Investment Treaty News, 7(4): 6–7. Marshall, M. G., K. Jaggers and T. R. Gurr (2016). Polity IV Project: Political Regime Characteristics and Transitions, 1800–2015. Dataset User’s Manual. College Park: University of Maryland. http://www.systemicpeace.org/inscr/p4manualv2015.pdf (accessed 26 December 2017). Mehta, P. S. and P. Ranjan (2015). Comparative Study of the Origin, Evolution and Current State of Play of Bilateral Investment Treaties (BITS) of BRICS Countries. https://ssrn. com/abstract=2765685 (accessed 26 December 2017). Morosini, F. and M. R. S. Badin (2015). “The Brazilian agreement on cooperation and facilitation of investments (ACFI): A new formula for international investment agreements”, Investment Treaty News, 6(3): 3–5. Pelc, K. J. (2017). “What explains the low success rate of investor-state disputes?”, International Organization, 71(3): 559–583. Poulsen, L. S. (2014). “Bounded rationality and the diffusion of modern investment treaties”, International Studies Quarterly, 58(1): 1–14. Poulsen, L. S. (2015). Bounded Rationality and Economic Diplomacy: The Politics of Investment Treaties in Developing Countries, Cambridge, UK: Cambridge University Press. Poulsen, L. S. and E. Aisbett (2013). “When the claim hits: Bilateral investment treaties and bounded rational learning”, World Politics, 65(2): 273–313. Ranjan, P. (2014). “India and bilateral investment treaties — A changing landscape”, ICSID Review, 29(2): 419–450. Ranjan, P. (2015). “Comparing investment provisions in India’s FTAs with India’s stand-alone BITs”, The Journal of World Investment & Trade, 16(5–6): 899–930. Ranjan, P. (2017). Investment Protection and Host State’s Right to Regulate in Indian Model Bilateral Investment Treaty 2015: Lessons for Asian Countries, in J., Chaisse, T. Ishikawa and S. Jusoh (eds.), Asia’s Changing International Investment Regime: Sustainability, Regionalization, and Arbitration, Singapore: Springer. Ripinsky, S. (2013). Russia, in Brown C. (ed.), Commentaries on Selected Model Investment Treaties, Oxford: Oxford University Press. Rubins, N. and A. Nazarov (2008). “Investment treaties and the Russian federation: Baiting the bear”, Business Law International, 9: 100–113. Salacuse, J. W. and N. P. Sullivan (2005). “Do BITs really work? An evaluation of bilateral investment treaties and their grand bargain”, Harvard International Law Journal, 46: 67–130. Schill, S. (2007). “Tearing down the great wall: The new generation investment treaties of the people’s republic of China”, Cardozo Journal of International & Comparative Law 15(1): 73–118. Simmons, B. A. (2014). “Bargaining over BITs, arbitrating awards: The regime for protection and promotion of international investment”, World Politics, 66(1): 12–46.

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Thompson Alexander, Tomer Broude, and Yoram Z. Haftel. Forthcoming. Once Bitten, Twice Shy? Investment Disputes, State Sovereignty and Change in Treaty Design. International Organization. Tzeng, P. (2016). “Sovereignty over crimea: A case for state-to-state investment arbitration”, Yale Journal of International Law, 41: 459–468. UNCTAD (2012). Fair and Equitable Treatment. UNCTAD Series on Issues in International Investment Agreements II, Geneva: UNCTAD. UNCTAD (2016). World Investment Report 2016: Global Value Chains: Investment and Trade for Development, Geneva: UNCTAD. Wei, D. (2012). “Bilateral investment treaties: An empirical analysis of the practices of Brazil and China”, European Journal of Law and Economics, 33: 663–690. Zeng, K. and Y. Lu (2016). “Variation in bilateral investment treaty provisions and foreign direct investment flows to China, 1997–2011”, International Interactions, 42(5): 820–848.

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CHAPTER 9

Exchange Rate Policies of the BRICS Andrew X. Li Department of International Relations, Central European University, Hungary and Austria

Introduction Exchange rate policy has been an important research agenda in the field of international political economy (IPE) since 1990s. This surging interest in exchange rate policy was driven intellectually as much as practically. It is worth mentioning that the diversification of exchange rate regimes temporally overlapped with the wave of globalization. The rapid expansion of international trade and global production networks created a powerful force of integration that brought national economies under one world economic system. Against this background, the significance of exchange rate policy cannot be overlooked. As Leblang (1999) points out, in this era of globalization, exchange rate policy serves as a buffer between international and domestic markets. Intellectually, it is widely recognized that such policies involve an inseparable mix of politics and economics (Frieden, 2000). This chapter has three goals. First, I review the global trends of exchange rate policies in the post-Bretton Wood era as well as the exchange rate policies of the five BRICS countries. My overall argument is that the exchange rate policies of the BRICS countries have converged to greater exchange rate flexibility and undervaluation of currencies, which are consistent with the global trend among developing countries. Second, I review the existing literature on the causes and consequences of exchange rate policies and pick out the explanations applicable to the BRICS countries. Third, I propose a few possible directions and questions for future research in response 207

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to the call to develop the “third generation” theories of the political economy of monetary institutions. In this connection, I also suggest research questions specific to the BRICS countries and discuss how the study of the BRICS may contribute to the “third-generation” agenda. Broadly speaking, exchange rate policy has two dimensions, the choice of exchange rate regime and the level of exchange rate vis-á-vis some equilibrium level. “Exchange rate regime/system” refers to the rules and policies that govern the appreciation and depreciation of currencies. Under a “fixed exchange rate regime”, governments establish a fixed price for their domestic currencies in terms of an external standard (gold, for example) or a foreign currency, whereas under a “flexible/floating exchange rate regime”, there is no fixed price for domestic ­currencies. Other exchange rate regimes lie in between these two ideal types. A “fixed-but-adjustable exchange rate regime” works like the fixed regime, but governments can adjust the fixed price at which the domestic currencies are pegged. “Managed float” works like the flexible regime, but exchange rates are allowed to float freely only within a band and are subject to government intervention if they appreciate or depreciate beyond the band. The second dimension is commonly known as the degree of overvaluation or undervaluation. According to Steinberg (2015), based on the purchasing power parity (PPP) criteria, “overvaluation” occurs when “(domestic) residents can buy more foreign goods than domestic goods” and a currency is “undervalued” when “domestic goods are cheaper than foreign goods” (22). This essay is organized as follows. The following section presents the global trends and stylized facts of developing countries’ exchange rate policies. Then I turn to the determinants and consequences of exchange rate regimes and currency valuation. Finally, I elaborate on the possible directions of intellectual advancement under the “Third-generation” agenda.

Global Trends and Stylized Facts The closing of the gold window on 15 August 1971 marked the collapse of the Bretton Woods system, an international financial system principally based on fixed exchange rates. To borrow the language of Ghosh et al. (2002), the end of the Bretton Woods also marked the beginning of a “brave new world” whereby countries were free to choose their exchange rate regimes. Indeed, the post-Bretton Woods period witnessed diverging paths of exchange rate regimes across the world. Since then, most developed countries, with the exception of those in Europe, have floated their currencies either against each other or independently. European countries, on the other hand, quickly agreed to maintain exchange rate stability through the coordination of exchange rate policies. This effort led to the creation of the European

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Monetary System (EMS) in 1979 and eventually the European Monetary Union (EMU) with a single currency in 2002. Bernhard et al. (2002) show that while the proportion of developed countries adopting fixed exchange rate regimes has remained fairly constant over time, an increasing number of developing countries has switched to flexible regimes. At the time, immediately after the collapse of Bretton Woods, almost all developing countries had some sort of fixed exchange rate regime. By the mid-1990s, however, more than half of the developing countries have floated their currencies. Using the binary coding of exchange rate regime developed by Shambaugh (2004b), I estimate that the percentage for developing countries with fixed exchange rates dropped further to just below 40% by 2000 and stayed around 40% after 2000. Overall, there is a clear trend toward more flexible exchange rate regimes among developing countries. A closer examination of the developing world reveals more nuances in exchange rate regimes beyond a binary classification. At the two ends of the spectrum are hard currency pegs (including dollarization) and free floating. The two extreme regimes represent two defensive strategies against speculative attacks. A hard peg serves as a signal of credible commitment while free floating removes the targets of such attacks. However, most developing countries have had exchange rate regimes between the two extremes. For example, Latin American countries such as Mexico, Chile, Argentina, Brazil, and Peru in general adopted a variant of fixed exchange rate regime known as the crawling peg, whereby the currencies are allowed to float within a narrow band. But even within this small sample of countries, Chile had a more flexible regime than the rest. According to De Gregorio (2001), in the early 1990s, Chile switched to a “wide band” regime in which the exchange rate is allowed to float in a wide range. In practice, this is very close to a free-floating exchange rate system. On the other dimension of exchange rate policy, it turns out that the exchange rates of most developing countries have been misaligned, meaning that they have been either overvalued or undervalued. Prior to year 2000, overvaluation was more common than undervaluation among developing countries. During the 1990s, for example, the overvalued Argentine Peso made imported luxurious goods very much affordable to average Argentine consumers. However, it also made the country’s export prohibitively expensive and harmed its economic growth. Worse still, the overvalued exchange rate was also partly responsible for a major economic crisis in Argentina towards the end of the 20th century, which led to a 22% fall in average incomes from 1998 to 2002 (Steinberg, 2015: 2). At that time, Argentina was joined by Brazil, Mexico and many countries in Africa, Eastern Europe and the Middle East in overvaluing their currencies. More recently, however, the trend has been reversed and undervaluation has become more popular among developing countries. Levy-Yeyati et al. (2013)

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find that in the 2000s, foreign exchange intervention has mostly been used to depreciate or limit the appreciation of the local currency. For example, Brazil has depreciated its currency from 1 Real per USD in 2000 to almost 4 Real per USD in 2015. China has long been accused of currency manipulation over the past 20 years by undervaluing the Chinese Yuan. Using the data for year 1990, Rogoff (1996) regresses the real exchange rate on the natural log of GDP per capita and reports that the Renminbi was undervalued by over 40%. The regression using 2000 data produces an even larger residual term for China, indicating that the Renminbi was undervalued by an even larger margin in 2000. The Big Mac Index by The Economist shows that in July 2011, four of the five BRICS countries had undervalued currencies against the USD. The Brazilian real was the only over­ valued currency at that time.

Exchange Rate Policies of the BRICS This section presents a brief history of the exchange rate policies of each of the BRICS countries. I place greater emphasis on the transitions of exchange rate regimes and changes in the currencies’ valuations. Brazil Brazil’s exchange rate regime in the last three decades of the 20th century was a typical crawling peg, or fixed-but-adjustable regime. During this period, the government frequently adjusted the exchange rate, resulting in alternating periods of appreciation and depreciation of the real exchange rate (RER) (Bonomo and Terra, 2001: 120). This adjustment of RER, according to Bonomo and Terra (2001), reflects the government’s choice between fighting inflation and improving the balance of payments. For example, in 1983 the Brazilian government announced a 30% maxi-devaluation, followed by continuous mini-devaluations as a response to the deterioration of balance of payment occurred in the previous year. Later as the government’s priority shifted from external adjustment to fighting inflation, a long period of RER appreciation was observed together with a few price stabilization attempts from 1985 to 1992. The Brazilian real was introduced in 1994 as a new currency at a one-to-one parity with the USD. The real was allowed to appreciate as capital flowed in. However, the appreciation of the real and reduction in tariff barriers promoted Brazilian import, leading to a growth of current account deficit from 1994 onward. With a current account deficit, the ability to maintain exchange rate pegs depends on inflow of foreign capital. Due to the Asian financial crisis in 1997 and the Russian crisis in

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1998, inflow of private foreign capital to Brazil quickly dried up. These conditions forced the Brazilian government to abandon its currency peg. The real became floated on 18 January 1999 and has been floating since then. Based on the 2011 Big Mac Index, Brazil is the only BRICS country with an overvalued currency. Given the free floating of the real since 1999, the overvaluation is hardly a policy outcome. In fact, since the floating of the real, Brazil’s central bank has been targeting inflation rather than the exchange rate (Fraga, 2000). The overvaluation of the real is possibly due to increased foreign demand for Brazilian assets and products, which bids up the price of the real in the foreign exchange market (Ross, 2016) (The Brazilian Real: A Case Study (PBR)). Furthermore, although the nominal value of the real has been falling, the real effective exchange rate (REER) between the Brazilian real and the USD has not changed much (Canuto, 2016) (Where has all the BRL depreciation gone?). Unlike the nominal exchange rate, REER corrects for domestic price level. As the Brazilian economy has undergone a structural transformation towards a service-based economy, the non-tradables and services become more expensive over time. As a result, the Brazilian real has not depreciated much in real terms. In 2011, the real was one of the most overvalued currencies in the world. However, according to the 2016 Big Mac Index, the real was slightly undervalued instead of overvalued. Russia The trajectory of Russia’s exchange rate policy is comparable to that of Brazil, but with one outstanding difference. The transition to a floating exchange rate regime was more gradual and carried out in phases in the case of Russia. The post-Soviet period (1992−1998) witnessed the dollarization of the Russian economy as a result of high inflation and loss of confidence in the domestic currency. During this period, monetary policy took the form of exchange rate policy as exchange rate was used as the policy anchor. As in the case of Brazil, the 1998 Russian crisis rendered currency pegs unsustainable and marked the beginning of the transition to greater exchange rate flexibility. After the crisis, the Bank of Russia shifted to a managed float regime. In the years following the crisis, the exchange rate was still tightly managed until 2005. In 2005, the Bank of Russia introduced a dual-currency basket system consisting of USD and Euro in unequal shares. The basket’s value was used to determine the ruble’s nominal exchange rate. The dual-currency band remained narrow and stable from 2005 to 2008. The global financial crisis (GFC) in 2009 eroded Russia’s current account balance and led to rapid capital outflows. The Bank of Russia had to allow the ruble to depreciate by widening the dual-currency band. It announced a wide fixed band and also introduced a floating operational band in January 2009. As a

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result, the volume of foreign exchange intervention was significantly less from 2009 onward. In November 2014, Russia switched to a fully floating exchange rate regime. Since then, the Bank of Russia has abandoned exchange rate based operational indicators and introduced inflation targeting, making price stability the main objective of the central bank. Overall, the Russian ruble has depreciated against the USD and other major currencies over the past two decades, as a consequence of three major depreciations during financial crises that occurred in 1998, 2008 and 2014 to 2015. As the economy recovered after the crises, there were periods of mild appreciation of the ruble, but the exchange rate never got back to the previous level. For example, although the ruble started to appreciate since the last quarter of 2015 after its collapse in the second half of 2014, the ruble’s value by the second quarter of 2016 was still more than 50% lower compared with the mid-2014 level. To some extent, the three financial crises have accelerated Russia’s transition to a flexible exchange rate regime, as each crisis and depreciation was associated with increased flexibility of the exchange rate system. Without the crises, Russia’s transition to a fully floating exchange rate regime and inflation targeting might have been slower and less decisive. India India’s transition to a managed float exchange rate regime in the early 1990s was driven by similar dynamics as in the case of Russia in 2009. India started with a par-value system in 1947 whereby the rupee’s value was fixed with gold. For a few years after the collapse of the Bretton Woods system, the rupee was fixed with pound sterling until September 1975 when the rupee began to be pegged with a basket of currencies. The Reserve Bank of India did not disclose the currencies in the basket and their weights as a measure to prevent currency speculation. In the late 1980s and early 1990s, with the widening of the current account deficit, the Indian economy began to face balance of payment difficulties that necessitated stabilization and structural reform. The most significant part of the reform with respect to the exchange rate was a two-step downward adjustment of the exchange rate by 9% and 11% in July 1991. Known as the “double devaluation”, this exchange rate adjustment also put an end to the pegged exchange rate regime. Following a short period of dual exchange rate system as a transitional arrangement between March 1992 and March 1993, a market determined exchange rate regime was introduced in March 1993. Since then, India’s exchange rate regime has been a managed float and foreign exchange intervention has been used merely as an instrument to prevent excessive exchange rate volatility of the rupee.

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Since the transition to a managed float regime in 1993, the rupee has generally depreciated against the dollar. From 1993 to 2002, the trend of depreciation of the rupee continued monotonically. Year 2003 witnessed the first reversal of this trend when the rupee appreciated against the dollar from 2003 to 2005. Another sharp appreciation occurred in 2007 followed by an even sharper depreciation in 2008 due to the global financial crisis (GFC). By June 2010, the rupee’s exchange rate had returned to its pre-crisis (2006) level. This trend also implies that India’s exchange rate regime has shifted from a one-way to a two-way managed float system and the Reserve Bank is willing to tolerate greater volatility in recent days. China China is the only BRICS country that still maintains some sort of fixed exchange rate regime today, despite greater flexibility in its exchange rate system after 2010. To some extent, China’s exchange rate regime since the early 1990s is comparable to that of Brazil in the last three decades of the 20th century, which was characterized by persistent government intervention in the foreign exchange market and periodic adjustment of the exchange rate. However, instead of having periodic cycles of overvaluation and undervaluation as in the Brazilian case, the Chinese yuan has generally been undervalued since 1993. According to Kaplan (2006), the degree of undervaluation of the Chinese yuan ranged between 15% and 50% based on the calculations of different researchers. Before 2005, the People’s Bank of China (PBoC) maintained a de facto peg with the USD. A major change came in July 2005 when the PBoC announced the end of the peg to the USD and the adoption of a managed float system based on a basket of currencies. The announcement was also accompanied by a revaluation of the RMB by 2.1%. However, as Steinberg (2015) points out, the actual degree of flexibility of China’s exchange rate regime hardly changed after the official announcement. In fact, exchange rate data shows that after an initial appreciation of the RMB against the dollar, the yuan was again pegged to the dollar from 2008 to 2010. Moreover, the 2.1% revaluation could by no means correct the big margin of undervaluation, which is estimated to be more than 40% around that time. The undervaluation of the RMB is observed only after China started its market oriented economic reform in 1978. Between 1949 and 1978, the exchange rate between RMB and the dollar was maintained around 2 yuan per dollar. By 1994, the RMB had depreciated by more than 80%. From 1994 to 2005, the exchange rate was kept around 8.3 yuan per dollar. During this period, there was a 15% appreciation of the RMB between 1996 and 1998 following the devaluation of various Asian

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currencies in 1997. Another appreciation occurred between 2007 and 2013 when the RMB appreciated against the dollar by 37%. At the end of 2013, the exchange rate between RMB and the dollar reached 6.04 yuan per dollar. Starting from 2014, the RMB once again depreciated against the dollar. The average exchange rate for the past 3 years is about 6.5 yuan per dollar. However, the past few years has witnessed greater exchange rate flexibility of the Chinese yuan. Since 2014, the exchange rate is allowed to fluctuate within a 2% band, making the exchange rate regime closer to managed float. South Africa South Africa is the earliest BRICS country to adopt a market-oriented exchange rate policy. For a brief period following the collapse of the Bretton Wood system, South Africa adopted a policy of independent managed float from 1974 to 1975. However, due to speculative attacks on the rand, the South African authority announced in mid-1975 that the rand would be pegged to the USD, and at the same time introduced very restrictive measures to control foreign exchange. These restrictive measures soon turned out to be inadequate and produced suboptimal economic results, as the currency peg did not permit the rand to respond to domestic economic conditions. As a result, starting from 1980, the South African government decided to switch to more market-oriented exchange rate policies. The goal was to have an independent and flexible rand subject to the management of the Reserve Bank. In 1986, the authority introduced soft and flexible monetary targets, whereby the Reserve Bank exercised discretionary judgement on the most appropriate combination of interest rates and exchange rates based on the economic condition. In the 1990s, the monetary policy framework started to place greater emphasis on the reduction of inflation. As South Africa normalized its relationship with the rest of the world, the goal was to bring domestic inflation in line with the country’s major trading partners. After a decade of informal inflation targeting, South Africa announced in 2000 that it would formally adopt the inflation targeting framework with a specified inflation target between 3% and 6%.

Convergence and Divergence in the Exchange Rate Policy of the BRICS The BRICS countries’ exchange rate policies are largely consistent with the global trends and patterns. Over time, their exchange rate regimes have also converged to a floating regime, with the exception of China. According to DeRosa (2009), in 1991, only South Africa had a “managed float” exchange rate regime. Brazil and India had

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“crawling peg” regimes while Russia and China maintained conventional currency pegs. In 2006, South Africa and Brazil were considered full-fledged floaters with independently floating currencies. India and Russia adopted the “managed float” system. China was the only country among the BRICS with a pegged currency at that time. However, things began to change with China’s exchange rate regime from year 2010. Since then, there has been a visibly greater degree of short-term fluctuations in the value of the Chinese yuan. In the meantime, the valuation of the currencies of the BRICS countries have also converged to undervaluation. As mentioned earlier, the 2011 Big Mac Index indicates that four of the five BRICS countries had undervalued currencies. The 2016 version of the index shows an even more dramatic situation. Not only that all five countries are having undervalued currencies, but the Indian rupee and South African rand have become the most undervalued currencies in the world, more undervalued than the Chinese yuan. One point of divergence among the BRICS countries’ exchange rate policies is the adoption of inflation targeting. Three of the five countries — namely, Brazil, Russia, and South Africa — have adopted inflation targeting while India and China have not. In the following section, I review the literature on exchange rate policies and pick out the explanations most applicable to the BRICS.

Explanation Choice of Exchange Rate Regime The choice of exchange rate regime has been the subject of a large literature in political science and economics. Existing studies on the choice of exchange rate regime is centered around the famous Impossible Trinity (Mundell, 1961), which states that it is not possible for a government to have a fixed exchange rate, autonomous monetary policy and free flow of capital at the same time. A government can at most have two of the three policy goals at any point in time. In an era of financial openness whereby capital mobility can be reasonably assumed to be given, governments often have to choose between a fixed exchange rate and discretion over monetary policy.1  In a very recent paper, Rey (2015) challenges the Impossible Trinity by pointing out that with capital mobility, cross-border flows and leverage of global financial institutions transmit monetary conditions globally, even under floating exchange rate regimes. Thus, we have a “dilemma” instead of “trilemma” in a sense that independent monetary policies are possible if and only if the capital account is managed in some way. Nevertheless, the Impossible Trinity has been the conventional wisdom at the heart of the existing literature of international finance. 1

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Conventional wisdom of international finance holds that fixed exchange rates and central bank independence are alternative mechanisms that solve the timeinconsistency problem by making a government credibly commit to low inflation. To summarize, the time-inconsistency problem refers to the fact that politicians have incentives to announce a policy of low inflation during elections and renege on it later. Since inflation can stimulate economic growth, politicians may find it politically beneficial to inflate the economy prior to elections. As politicians hold different preferences at different points in time, the announcement of low-inflation policy is incredible. Fixed exchange rates solve the problem by depriving the government of monetary policy autonomy. By adopting a fixed exchange rate regime, a government effectively “ties its own hands” from inflationary monetary policy. Alternatively, the government may grant the central bank independence so that the government has no say in the making of monetary policy. In light of this analysis, the question comes down to why a government chooses a particular commitment mechanism. This question has been tackled from either the complement or the substitute perspective. Broz (2002) sees the two forms of monetary commitments as substitutes as they differ in terms of transparency. According to the author, fixed exchange rate is a more transparent regime compared with central bank independence because the latter is much more difficult to monitor. When political decision-making is opaque as in countries governed by authoritarian regimes, a more transparent form of commitment is needed and authoritarian governments therefore are more likely to choose fixed exchange rate. In contrast, when the political process is more transparent as in the case of democracies, central bank independence is more credible and can be monitored more effectively. Thus, central bank independence is a more credible and effective mechanism to commit to low inflation in countries with higher levels of political transparency. However, the argument that democracies are more likely to commit to a flexible exchange rate regime does not go without challenges. Hall (2008) argues that we do not have a solid understanding of the causal mechanisms that link political democracy to exchange rate flexibility. The author points out three flaws in the argument by Broz (2002). First, it may not be plausible to assume that all governments seek to reduce inflation over the long run. Second, it is not clear that governments do treat fixed exchange rates and independent central banks as substitutes for committing to low inflation. Third, income policy represents an alternative strategy for fighting inflation in some developing countries. Though Hall (2008) does not offer additional theoretical explanations to the phenomenon, his evidence shows that the number of veto players or the regular use of competitive elections may be factors worth considering.

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The BRICS countries seem to fit well with the argument that political democracy is associated with exchange rate flexibility. According to the 2014 POLITY Score, Brazil, India and South Africa are classified as “Democracy”, Russia belongs to the category of “Open Anocracy” and China falls under “Autocracy”. Except China, all the other four countries have adopted flexible exchange rate regimes. At the same time, however, the BRICS countries also pose some challenges to Broz’s argument. Among the four exchange rate floaters, three have adopted inflation targeting. While it is true that inflation targeting requires some political transparency, it is not exactly the same as central bank independence. The case of India is even more puzzling. According to Dincer and Eichengreen (2014), the Reserve Bank of India is the least independent among the 89 central banks in their sample. As mentioned by Hall (2008), it may not be the case that governments treat fixed exchange rates and independent central banks as substitutes. Several existing studies are able to address the first and second criticisms of Hall (2008) as they provide clear causal mechanisms linking democracy to exchange rate flexibility without the assumption that governments treat fixed exchange rates as a form of commitment to low inflation. Leblang (1999) argues that economic integration and the rise of democratic institutions make it difficult for politicians to maintain fixed exchange rate as a credible commitment. This is because governments face “increased pressure for distributive and expansionary policy that occurs when more diverse groups are included in the policymaking and electoral process” (605). Bearce and Hallerberg (2011) refer to the Impossible Trinity and argue that the median voter in a democracy is likely to prefer autonomy in monetary policy. To win the median voter, politicians have to retain monetary sovereignty and forgo fixed exchange rates. The idea that the median voter is most likely to prefer autonomous monetary policy over fixed exchange rates is derived from the sectoral framework developed by Frieden (1991).2 It is argued that internationally oriented producers such as export sectors, international traders, and investors prefer exchange rate stability and would lobby for fixed exchange rates. On the contrary, domestically oriented sectors such as producers of non-tradable goods and services prefer monetary policy autonomy as the performance of these sectors depend to a large extent on the strength of the national economy. Based on this argument and their own calculation, Bearce and Hallerberg (2011) conclude that “the average national economy in the post-Bretton Woods era has about 65% of its GDP devoted to domestic production, making it very likely that the median voter works as a domestically oriented producer and  It should be highlighted that Frieden’s (1991) framework itself is not a median voter model. However, his sectoral analysis has implications on the sector in which the median voter might be located. 2

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thus favors exchange rate flexibility to achieve domestic monetary autonomy” (178). This argument sounds plausible for the BRICS countries as all of them have large domestic markets. It is therefore highly likely that the median voters in the BRICS countries are domestically oriented producers. Some authors have attempted to account for the variation in the choice of monetary institutions within democratic politics. Bernhard and Leblang (1999) consider the effect of electoral and legislative institutions and argue that in a system where the cost of electoral defeat is high and electoral timing is exogenous, such as in majoritarian systems, the incumbents are eager to retain monetary autonomy as a policy instrument to win the majority and therefore are more willing to forgo fixed exchange rates. On the contrary, in less decisive systems such as proportional representation, politicians are more likely to adopt fixed exchange rate regimes. Hallerberg (2002) considers the veto power of party players and subnational governments. In unitary systems where the government is formed by a single party, it is easy for voters to identify the party player’s policy that benefit them, such governments therefore prefer autonomous monetary policy and forgo fixed exchange rates. In unitary systems where the government is formed by multiple parties, such identification is difficult and the coalition government finds it more effective to target specific constituencies using fiscal policy.3 In this situation, the government prefers fixed exchange rates and independent central banks. In federal systems, the subnational governments are much stronger. The federal government in this case has less control over fiscal policies and the subnational governments do not like a dependent central bank that give more power to the federal government. The result is a combination of flexible exchange rates and central bank independence. Bernhard and Leblang’s (1999) argument could explain the cases of India and Russia, where elections to the House of the People and the State Duma follow the first-past-post rule. In these two cases, the theory successfully predicts the choice of flexible exchange rate regimes. However, the theory does not work too well for the cases of Brazil and South Africa, which have a party-list proportional representation electoral system but also flexible exchange rate regimes. Hallerberg’s (2002) argument does a slightly better job in explaining the monetary policies of the BRICS. Three of the four democratic BRICS countries, namely, Brazil, India, and Russia are federal systems. In these three cases, the theory successfully predicts exchange rate flexibility.  A distinction between monetary and fiscal policy is that the former is a macroeconomic policy affecting the entire economy. The latter, on the other hand, can be both macro and micro in nature, which makes it possible to be tailored to target specific groups. Thus, if the government intends to “sell” a policy only to selected groups, fiscal policy is a more viable option. 3

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Also, inflation targeting means that the central bank has partial independence. South Africa is a unitary state with the African National Congress as the dominant party, and the theory also achieves predictive accuracy in the South African case. In fact, an important reason why South Africa introduced a market-oriented exchange rate system in the 1980s was because a fixed exchange rate prevented interest rates from responding optimally to the economic conditions. Just like democracies, countries governed by non-democratic regimes also demonstrate variations in their choices of monetary regimes. Steinberg and Malhotra (2014) show that monarchies and military regimes are more likely to maintain fixed exchange rates than civilian dictatorships because the former regimes have smaller electorates. In these regimes, the diffuse groups that prefer a flexible exchange rate regime do not have political influence. The pressure to fix the exchange rate is especially strong when the small electorate predominantly consists of internationally oriented businesses. Civilian dictatorships, on the other hand, face large electorates just like democracies, so they have to care about the policy preference of the “median voter” who is most likely to oppose fixed exchange rates. China is the only BRICS country governed by a civilian authoritarian regime. Although this theory fails to explain China’s reluctance to allow the RMB to float before 2010, it is useful to understand the introduction of greater exchange rate flexibility by the Chinese authorities after 2010. Another group of literature focuses on countries’ structural position in the global economy in explaining the choice of monetary regime. Plümper and Neumayer (2011) see the structural position of a country in international trade as a determinant of its choice of monetary institutions. Import-dependent countries are more likely to peg their currencies for the fear of imported inflation. Moreover, the choice of anchor currency is determined by the degree of dependence of the pegging country on imports from the key currency country. Shambaugh (2004a) considers the effect of reliance on global capital and argues that reliance on different types of foreign capital generates distinct capital-specific policy preferences. Specifically, countries whose constituents rely heavily on commercial lending and/or portfolio investment are more likely to pursue fixed exchange rates because it reduces risks in the rate of return associated with exchange rate fluctuation. In contrast, foreign direct investors who usually produce tradables and target export sectors are more likely to lobby for flexible exchange rate systems in order to take advantage of exchange rate policy. These arguments shed an important light on the exchange rate regimes of the BRICS countries. First, this group of countries has big domestic markets and is not very dependent on imports. Therefore, they are less concerned about imported inflation and a fixed exchange rate does not look very attractive in this regard. Second, foreign direct investment has become a driver of economic development in

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the BRICS countries, particularly China and India. This also explains why a flexible exchange rate regime may be more attractive to this group of countries. Exchange Rate Valuation Now I turn to the explanations of the level of exchange rate. It should be emphasized at the beginning that quantifying currency overvaluation or undervaluation is itself a difficult task. The benchmark or equilibrium level of exchange rate is often determined by the Balassa−Samuelson regression. The Balassa−Samuelson effect, which is also known as the productivity biased PPP (Officer, 1976), has its intellectual root in two seminal pieces by Balassa (1964) and Samuelson (1964). It is a theoretical framework to account for the widely-observed phenomenon that consumer prices in more developed countries are systematically higher than those in less developed ones. The economic model consists of two goods (a tradable and a non-tradable), two countries (a rich one and a poor one) and one factor of production (labor). It is assumed that labor in both sectors of the same country is equally productive and international trade equalizes the price of the tradable products across the two countries. Then, if the richer country is more productive for various reasons, it follows that the price for the non-tradable good needs to be lower in the poor country to equalize wages across the two sectors. The implication of the analysis is that first, due to productivity and wage differentials, the Big Mac should not carry the same price in New York as in Beijing; second, as a country gets richer, there is real appreciation of its currency due to higher real prices. Thus, a typical Balassa−Samuelson regression would look something like this: log(RER) = α + βlog(real GDP per capita) + e, where RER stands for the real exchange rate. The Balassa−Samuelson Effect is an important theoretical contribution as it provides scholars with a foundation to pin down a country’s equilibrium exchange rate. The empirical testing of the model, however, is more nuanced and more controversial. This should not be surprising as the real world can seldom work as elegantly as theoretical models. Égert et al. (2006) in their study of transition economies find that the trend appreciation is usually affected by factors other than the Balassa−Samuelson effect. The authors identify three main sources of uncertainty, namely, differences in the theoretical underpinnings, differences in the estimation techniques and differences related to the time-series and cross-sectional dimensions of the data. Using more advanced techniques such as panel cointegration and bootstrapping, García-Solanes and Torrejón-Flores (2009) study a sample of 16 OECD countries and 16 Latin American countries and find evidence for not rejecting the

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Balassa−Samuelson hypothesis in the Latin American area. A more recent work by Frensch and Schmillen (2011) suspects that the empirical discrepancy may stem from measurement errors leading to downward-biased estimates. The authors adopt an innovative trade-based variety measure that differentiates between tradable and non-tradable sector productivities and find stable and robust Balassa−Samuelson effects across all specifications. Although all BRICS countries have undervalued currencies according to the 2016 Big Mac Index, all the countries except China have let their currencies float prior to 2016. Thus, it is a bit of a stretch and misleading to interpret the observed undervaluation as a policy choice of the floating countries. The rest of the section focuses on China, the only BRICS country that is still subscribing to some sort of fixed exchange rate regime, and a country that has long been an interest of scholars studying exchange rate policies. Steinberg (2008) argues that overvaluation is usually supported by broad coalitions and undervaluation is supported by specific sectors. Therefore, institutions with multiple veto points tend to produce overvalued exchange rates because such institutions induce governments to adopt policies that satisfy several industries. Undervaluation takes place when its advocates are politically influential and the institution provides few veto points. Steinberg (2015) constructs a “conditional preference theory” and argues that the preference of the manufacturing sector for undervalued exchange rates is contingent on whether the state controls labor and the financial market. Exchange rates are most likely to be undervalued in countries that combine a large manufacturing sector with a state controlled labor and financial system. Under such a system, undervalued exchange rates are more profitable to manufacturing firms as they are less likely to translate into higher borrowing costs and higher wages. Therefore, the manufacturing sector’s support for currency undervaluation strengthens with greater state control over labor and the financial system. Interestingly, according to Steinberg and Shih (2012), interest groups in fact have greater impacts on exchange rates in non-democracies because autocrats tend to choose exchange rate policies that serve the interests of the most powerful interest groups. In non-democracies, these groups often have access to political processes, which makes leaders sensitive to their preferences. China satisfies the conditions specified in the above arguments for currency undervaluation. As a non-democracy, China has fewer veto points in the policy making process compared with its democratic counterparts and that gives its policymakers greater autonomy. At the same time, as the world’s factory, China has a large and economically important export-oriented manufacturing industry. This has also increased the political influence of the country’s manufacturing sector. Last but not least, China has a state-controlled labor and financial system. According to the

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conditional preference theory, the manufacturing sector in China would prefer an undervalued exchange rate. Given the economic importance and political influence of the manufacturing sector and China’s institutional context, the manufacturing sector’s interests and preferences can be easily translated into policy outcomes. Another reason why undervaluation is preferred by the Chinese authority is that currency undervaluation produces future economic growth. Although undervaluation is generally unpopular in the short run, economists have found out that undervalued exchange rates promote economic growth in the long-run and there are few outliers to that hypothesis. Eichengreen (2007) simply argues that the RER should be made low in order to boost net export of the economy. Another seminal piece by Rodrik (2008) explores the relationship between currency undervaluation and economic growth. It is one of the few works that provide a solid theoretical explanation of why undervaluation favors growth. The author argues that an undervalued currency serves as a second-best mechanism that alleviates the adverse impacts of institutional weakness and market failure. Specifically, tradables are more susceptible to poor institutions compared with non-tradables. An undervalued currency boosts the production of tradables by raising their domestic prices relative to non-tradables. Similarly, tradables are particularly prone to market failure due to the presence of learning and coordination externalities. In this case, an undervalued currency again works as a second-best solution in lieu of Pigovian remedies. In other words, undervaluation is a substitute for industrial policy. The undervaluation-growth hypothesis put forward by Rodrik receives empirical support in a large number of studies.4 Some of the authors have attempted to find the channels through which currency undervaluation translates into growth. Mbaye (2013) finds that undervaluation promotes growth through its positive impact on total factor productivity. This is consistent with Rodrik’s argument that undervaluation alleviates the negative effects of poor institutions. Montiel and Servén (2008) rules out saving as a mechanism through which the RER affects growth. Lartey et al. (2012) see the exchange rate as an intermediate channel through which rising levels of remittances lead to the Dutch Disease. This is done through the spending effect whereby, remittances lead to real exchange appreciation and the resource movement effect that favors the non-tradable sector at the expense of the tradable sector. Regardless of the theoretical underpinning, the hypothesis that undervaluation promotes long run growth is one of the most robust relationship found in the growth literature. Steinberg and Malhotra (2014) note that “the aggregate (welfare)  See Cottani et al. (1990); Béreau et al. (2012); Williamson (2009); Mbaye (2013); Gala (2008), Berg and Miao (2010); Razmi et al. (2009); Vieira and MacDonald (2012); Gluzmann et al. (2012); and Levy-Yeyati et al. (2013). 4

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effects of over/undervalued exchange rates are often more noticeable than the distributional effect” (501). Authors who have challenged Rodrik’s hypothesis include Magud and Sosa (2010) and Woodford (2009). According to Magud and Sosa (2010), while overvaluation and high volatility harm growth, the effect of undervaluation is mixed and inconclusive. Woodford (2009) argues that first, the strong and robust correlation between currency undervaluation and growth may be exaggerated in Rodrik’s cross-country evidence and second, such a causal effect is hardly the only interpretation. In addition to offering several methodological reasons as to why the coefficient of undervaluation is overestimated in Rodrik’s regression, the author argues that even if we take the correlation between undervaluation and growth for granted, such a correlation does not necessarily mean causality. The first possibility is spuriousness in that policies leading to undervaluation are themselves favorable to growth. Second, there is also a possibility of reverse causation if the choice of exchange rate policy is not fully exogenous with respect to the state of the economy at that time. Despite the criticisms, it is hard to deny that China experienced the highest growth rates when its currency was the most undervalued. This also allowed China to enjoy a huge current account surplus and to build up its foreign reserves. As for other BRICS countries, given that India and South Africa now have more undervalued currencies than China, it would be interesting to watch the growth effect of undervaluation on the two economies in the years ahead. Moving Forward: Advancing the “Third Generation” Research Agenda Bernhard et al. (2002) categorize the political economy literature of monetary institutions into three generations. The “first generation” approach employs the policy demand−supply framework whereby interest groups, voters and economic sectors constitute the “policy demanders” and governments, politicians and political parties constitute the “policy suppliers”. The key contribution of the “second-generation” literature is the simultaneous consideration of exchange rate regime and central bank independence in solving the time-inconsistency problem. In this chapter, I have reviewed the works from the two generations of literature and used the theoretical arguments to explain the choices of monetary policies of the BRICS countries. In the concluding article of the 2002 special issue of International Organization, Freeman (2002) challenges the field of international political economy to develop “a new generation of theoretical models and empirical tests that encompass work on the micro-foundations of economic and political equilibria, a broader understanding of the welfare criteria used to evaluate institutional arrangements and a deeper

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analysis of the economic consequences of political information” (Bernhard et al., 2002: 719−720). This direction is what the authors label as the “third-generation” agenda. I conclude this chapter by offering three potential directions to advance the existing scholarship using the “third generation” approach for the study on exchange rate policies within and beyond the BRICS. Future research on exchange rate regime choice may develop an analytical framework that takes into consideration policy instruments available to the government of an open economy beyond monetary policy. The incorporation of other policy instruments allows for a richer action space whereby one understands a government’s rational choice with regard to the choice of exchange rate regime. For example, Freeman (2002) mentions that the effects of fiscal policy differ in open and closed economies. Future research may take that statement one step ahead and show that even among open economies, the effectiveness of fiscal policy and monetary policy differ depending on the choice of exchange rate regime. Such an approach offers a more complete picture of the welfare consequences associated with a particular choice of exchange rate system and provides scholars with a broader basis to understand how a government negotiates the monetary trilemma. This approach has an important implication for the study of the undervaluationgrowth hypothesis mentioned earlier. Overall, the existing literature finds a robust relationship between currency undervaluation and economic growth, but the causal mechanism is far from clear. If the choice of exchange rate regime conditions the effects of monetary, fiscal and even trade policies, then the growth effect of currency undervaluation may be contingent on the choice of exchange rate regime. In this connection, an interesting question for the study of the BRICS and developing countries is that if the other currency undervaluators like India and South Africa are able to “replicate” China’s growth experience under a different type of exchange rate regime. Second, future research on exchange rate valuation may capitalize on the temporal dimension. Steinberg (2015) notes that undervaluation has many longrun benefits, such as higher growth rates, lower unemployment, and lower risk of national financial crises. However, the author also notes that undervaluation is undesirable for many groups in the short-run. In other words, currency depreciation involves a trade-off between short-run political costs and long-run economic benefits. Such a trade-off could be central to a government’s decision-making calculus and can be theoretically explored from a dynamic optimization perspective. This approach represents a response to Freeman’s call for better interdisciplinary synthesis by incorporating economic ideas into political decision-making. While this may not apply to governments that really allow their currencies to float freely, it is an

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interesting question for those governments that still exercise some control over the value of their currencies, such as China. Finally, future research may aim to better understand the micro-foundations of the choice of exchange rate policies. A review of the history of the BRICS countries’ exchange rate policies seems to suggest that crises have been the driver behind the major changes in exchange rate regimes. In other words, the choice of exchange rate regime may not really be a choice, as some scholars tend to believe. In this connection, a bigger and certainly more difficult research frontier involves studies on how structure interacts with agency. For example, immediately after Brazil floated the real in January 1999, the real depreciated by more than 50%, which triggered panicky reactions and fueled inflation. The Central Bank of Brazil had to make a decision whether to go back to a fixed regime. As documented by Fraga (2000), the Central Bank felt it made sense to let the real continue to float and find a new nominal anchor. That was why a full-fledged inflation targeting framework was adopted in the end. The Brazilian experience shows that even under harsh structural constraints, there is still a room for policy decision that involves a lot of calculation on the part of the policymakers. It is therefore, interesting and important for scholars to better understand the micro-foundations behind the decision-making process. This is an area where qualitative research such as in-depth case studies and interviews can make an important contribution to the third-generation agenda.

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Canuto, O. (2016). Where has all the BRL depreciation gone? The Financial Times. http:// blogs.ft.com/beyond-brics/2016/12/22/where-has-all-the-brl-depreciation-gone/? mhq5j=e1 (accessed 20 December 2017). Cottani, J. A., D. F. Cavallo and M. S. Khan (1990). “Real exchange rate behavior and ­economic performance in LDCs”, Economic Development and Cultural Change, 39(1): 61–76. De Gregorio, J. (2001). “Something for everyone: Chilean exchange rate policy since 1960,” in J. A. Frieden and E. Stein (eds.), The Currency Game: Exchange Rate Politics in Latin America, pp. 157–197. DeRosa, D. F. (2009). Central Banking and Monetary Policy in Emerging Markets Nations. The Research Foundation of CFA Institute. Dincer, N. and B. Eichengreen (2014). “Central bank transparency and independence: Updates and new measures”, International Journal of Central Banking, 10(1): 189–259. Égert, B., L. Halpern and R. MacDonald (2006). “Equilibrium exchange rates in transition economies: Taking stock of the issues”, Journal of Economic Surveys, 20(2): 257–324. Eichengreen, B. (2007). “The real exchange rate and economic growth”, Social and Economic Studies, 56(4): 7–20. Fraga, A. (2000). “Monetary policy during the transition to a floating exchange rate: Brazil’s recent experience”, Finance and Development, 37(1): 16–18. Freeman, J. R. (2002). “Competing commitments: Technocracy and democracy in the design of monetary institutions”, International Organization, 56(4): 889–910. Frensch, R. and A. Schmillen (2011). “Can we identify Balassa–Samuelson effects with measures of product variety?”, Economic Systems, 35(1): 98–108. Frieden, J. A. (1991). “Invested interests: The politics of national economic policies in a world of global finance”, International Organization, 45(4): 425–451. Frieden, J. A. (2000). “Exchange rate politics”, in J. A. Frieden and D. A. Lake (eds.), International Political Economy: Perspectives on Global Power and Wealth, London: Routledge, pp. 257–269. Gala, P. (2008). “Real exchange rate levels and economic development: Theoretical analysis and econometric evidence”, Cambridge Journal of Economics, 32(2): 273–288. García-Solanes, J. and F. Torrejón-Flores (2009). “The Balassa-Samuelson hypothesis in developed countries and emerging market economies: Different outcomes explained”, Economics: The Open-Access, Open-Assessment E-Journal, 3(2): 1–24. Ghosh, A. R., A. M. Gulde-Wolf and H. C. Wolf (2002). Exchange Rate Regimes: Choices and Consequences, Cambridge, MA: MIT Press. Glüzmann, P. A., E. Levy-Yeyati and F. Sturzenegger (2012). “Exchange rate undervaluation and economic growth: Díaz Alejandro (1965) revisited”, Economics Letters, 117(3): 666–672. Hall, M. (2008). “Democracy and floating exchange rates”, International Political Science Review, 29(1): 73–98. Hallerberg, M. (2002). “Veto players and the choice of monetary institutions”, International Organization, 56(4): 775–802.

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Kaplan, S. B. (2006). “The political obstacles to greater exchange rate flexibility in China”, World Development, 34(7): 1182–1200. Lartey, E. K., F. S. Mandelman and P. A. Acosta (2012). “Remittances, exchange rate regimes and the Dutch disease: A panel data analysis”, Review of International Economics, 20(2): 377–395. Leblang, D. A. (1999). “Domestic political institutions and exchange rate commitments in the developing world”, International Studies Quarterly, 43(4): 599–620. Levy-Yeyati, E., F. Sturzenegger and P. A. Gluzmann (2013). “Fear of appreciation”, Journal of Development Economics, 101: 233–247. Magud, N. E. and S. Sosa (2010). When and why worry about real exchange rate appreciation? The missing link between Dutch disease and growth, Washington, DC: International Monetary Fund. Mbaye, S. (2013). “Currency undervaluation and growth: Is there a productivity channel?”, International Economics, 133: 8–28. Montiel, P. J. and L. Servén (2008). “Real Exchange Rates, Saving and Growth: Is There a Link?”, World Bank Policy Research Working Paper Series. Mundell, R. A. (1961). “A theory of optimum currency areas”, The American Economic Review, 51(4): 657–665. Officer, L. H. (1976). “The productivity bias in purchasing power parity: An econometric investigation”, Staff Papers, 23(3): 545–579. Plümper, T. and E. Neumayer (2011). “Fear of floating and de facto exchange rate pegs with multiple key currencies”, International Studies Quarterly, 55(4): 1121–1142. Razmi, A., M. Rapetti and P. Skott (2009). “The real exchange rate as an instrument of development policy”, Working Paper No. 2009–07, University of Massachusetts, Department of Economics. Rey, H. (2015). Dilemma not trilemma: The global financial cycle and monetary policy independence, National Bureau of Economic Research, No. w21162. Rodrik, D. (2008). “The real exchange rate and economic growth”, Brookings Papers on Economic Activity, 2008, Fall: 365–412. Rogoff, K. (1996). “The purchasing power parity puzzle”, Journal of Economic Literature, 34(2): 647–668. Ross, S. (2016). The Brazilian Real: A Case Study (PBR). http://www.investopedia.com/ articles/forex/040516/brazilian-real-case-study-pbr.asp (accessed 20 December 2017). Samuelson, P. A. (1964). “Theoretical notes on trade problems”, The Review of Economics and Statistics, 46(2): 145–154. Shambaugh, G. E. (2004a). “The power of money: Global capital and policy choices in developing countries”, American Journal of Political Science, 48(2): 281–295. Shambaugh, J. C. (2004b). “The effect of fixed exchange rates on monetary policy”, The Quarterly Journal of Economics, 119(1): 301–352. Steinberg, D. (2008). Capture or Compromise? Logrolling and the Political Economy of Exchange Rate Overvaluation in Developing Countries. APSA 2008 Annual Meeting Paper.

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Steinberg, D. A. and K. Malhotra (2014). “The effect of authoritarian regime type on exchange rate policy”, World Politics, 66(3): 491–529. Steinberg, D. A. and V. C. Shih (2012). “Interest group influence in authoritarian states: The political determinants of Chinese exchange rate policy”, Comparative Political Studies, 45(11): 1405–1434. Steinberg, D. (2015). Demanding Devaluation: Exchange Rate Politics in the Developing World, Ithaca: Cornell University Press. Vieira, F. V. and R. MacDonald (2012). “A panel data investigation of real exchange rate misalignment and growth”, Estudos Econômicos, 42(3): 433–456. Williamson, J. (2009). “Exchange rate economics”, Open Economies Review, 20(1): 123–146. Woodford, M. (2009). Is an undervalued currency the key to economic growth? Columbia University Department of Economics Discussion Paper (0809-13).

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CHAPTER 10

He Who Pays the Piper Calls the Tune: And the “Relocation of the World’s Credit Rating Center” Goes To? Giulia Mennillo* Department of Political Science, National University of Singapore, Singapore

Introduction At the eighth BRICS Summit 2016 in Goa, India, the BRICS countries agreed to explore “the possibility of setting up an independent BRICS Rating Agency based on market-oriented principles” (Goa Declaration, 2016: 9, par. 44). The initiative which was born during the seventh BRICS Summit 2015 in Ufa, Russia, is emblematic of the BRICS’s institution-building efforts to transform the “global governance architecture” and to become a major player in it. Even though no timetable has been announced for the actual setup of the BRICS rating agency, the undertaking as a whole reflects the group’s desire to “bridge the gap”, as Indian Prime Minister Narendra Modi put it, between its economic weight gained over the last decade and the corresponding lack of authority in financial governance (The Times of India, 2016).

* Some fragments of this chapter are extracted from the author’s dissertation. The author thanks Kimberly Tan Hui-An for providing helpful research assistance. 229

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The intention to set up an own credit rating agency (CRA) is the first attempt of the BRICS countries as a group to rival the Western dominated rating oligopoly.1 Even though in the past individual countries or groups of institutions tried similar initiatives on their own, these efforts did not succeed in breaking up the dominance of the American headquartered “Big Three”, namely, Standard & Poor’s Ratings Services, Moody’s Investors Service, and Fitch Ratings. For example, in 2013, a consortium of five rating agencies from India, South Africa, Brazil, Malaysia, and Portugal launched the credit agency “ARC Ratings” which is headquartered in Lisbon, Portugal, and is recognized by the “European Securities Market Authority” (ESMA) as a registered CRA to operate in the EU.2 Since the individual agencies were not able to expand beyond their national markets on their own over the last decades, they decided to join their forces.3 The exception that proves the rule in terms of the prospects of seriously ­challenging the “Big Three” might be China. Major players of its increasingly relevant rating industry are starting to expand abroad. Against this backdrop, it is remarkable that China had already expressed concerns about the credibility of the new BRICS initiative to establish an own CRA (Mutize and Gossel, 2017). Such a stance raises the question whether China will be a leading, passive, or even paralyzing force in the BRICS’s institution building efforts. This chapter does not give an answer to this question, and, at this stage, any answer is probably premature. Instead, familiarizing the reader with the politics of CRAs, this chapter aims to convey an understanding why China and the BRICS view the establishment of an “own” CRA as instrumental in achieving their vision to challenge Western hegemony. Therefore, this chapter will equip the reader to approach the question raised above from a different and more informed perspective. The world’s leading CRAs have been dubbed as “pivotal gatekeepers” (Partnoy, 2006) and “global monitors” (Sinclair, 2003) of global financial markets. Sovereign  In order to avoid misunderstandings, in this chapter the acronym “CRA” does not refer to the BRICS “Contingent Reserve Arrangement” which was established in 2015 as an instrument to provide liquidity in case of short-term balance of payments pressures. For further details about the BRICS Contingent Reserve Arrangement, see Kaya, Chapter 14. 2  See the list of “registered or certified” CRAs published by the European Securities Market Authority (ESMA): https://www.esma.europa.eu/supervision/credit-rating-agencies/risk (accessed 20 July 2017). 3  Participating companies are “Credit Analysis and Research Ltd.” (CARE Ratings) founded in India 1993, “Global Credit Rating Co. Ltd.” (GCR) established in South Africa in 1996, “SR Rating, LTDA” founded in Brazil in 1993, the “Malaysian Rating Corporation Berhad” (MARC) founded in Malaysia in 1995, and the former “Companhia Portuguesa de Rating, S.A.” established in Portugal in 1988: http://www.arcratings.com/uk/our arc/37 (accessed 18 July 2017). 1

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ratings can have a decisive impact on the fiscal autonomy and economic condition of a country. They directly affect the interest rates sovereign borrowers have to pay to refinance themselves on international bond markets. They indirectly affect the refinancing conditions of corporations including financial institutions given that sovereign ratings are used as “sovereign ceiling” for determining corporate bond ratings. Not for nothing, K.V. Kamath, current President of the BRICS’s “New Development Bank” (NDB), noted that “ratings of multilateral banks like the BRICS-promoted NDB were affected by the parent countries’ ratings, despite having deep capital buffers” (The Hindu, 2016). The US-headquartered rating agencies would “constrain growth in emerging nations”. This chapter is structured as follows: To begin with, I provide a snapshot of the status quo of the global rating market; firstly, how the criticism of the American rating oligopoly has been driving calls for having “own” CRAs in different parts of the world and, secondly, why the persistence of the CRA oligopoly is a puzzling issue until today. Then, I illustrate the case of the Chinese CRA industry giving a short account of its history and major players. Finally, I discuss whether it is really the “American-ness” per se or other aspects that constitute the main problem of rating and, correspondingly, to what extent a Chinese or BRICS rating agency can be a remedy for these. The chapter ends with concluding remarks.

The Status Quo Criticism of “Big Three” Driving Calls for “Own” CRA With the onset of the global financial crisis (GFC) in 2007, CRAs have come under the public spotlight in the “developed” world in a way never experienced since their existence. Standard & Poor’s, Moody’s, and Fitch faced harsh criticism because of their questionable assessments of structured financial products leading up to the crisis. The subsequent CRAs’ excessive downgrading of European sovereign debt incited calls for the establishment of a “European” CRA.4 It would be erroneous to assume that the criticism of CRAs only existed since the GFC. Emerging economies have been feeling disadvantaged by the Western CRAs already for a long time (Barta, 2012). Frequent downgrades sparked criticism that the “Big Three” would not treat developing countries fairly, and primarily “serve Western political interests” (Mutize and Gossel, 2017). Consequently, calls for having an “own” authoritative CRA grew louder. An oft-repeated reproach is that CRAs would be overly conservative giving developing countries worse ratings than economic fundamentals would justify (Persaud, 2009). CRAs would reproduce a well-known phenomenon of investors’  For a concise account of why simultaneous efforts to build a European CRA failed in the decades preceding the financial crisis, see Engelen (2004: 6). 4

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behavior by imposing an insinuated “original sin” on emerging economies which would “suffer from an inherited burden, almost irrespective of the policies of their governments” (Nelson, 2016). In Asia, the politics of sovereign ratings raised scholarly and public attention already during the East Asian crisis in 1997−1998. Ferri et al. (1999: 394) show that “rating agencies attached higher weights to their qualitative judgment than they gave to the economic fundamentals”. At the time, Asian governments complained about the frequency and timing of CRAs’ sovereign downgrades, which were regarded as driven by US standards. The American CRAs were criticized for their apparent “lack of cultural awareness” (Bruner and Abdelal, 2005: 203−204) and inability to “really ‘understand’ Asian business practices” (Sinclair, 2001: 443). Curtailing governments’ room for maneuver in the midst of the crisis, the rating events were interpreted as an illegitimate foreign intrusion into domestic affairs (Sinclair, 2003: 151−155). More than 10 years after the East Asian crisis, also the West had to face the ­f inancial market’s questioning of the once taken-for-granted sovereign ­creditworthiness of many European sovereigns. Also in this case, the CRAs’ role in setting the terms of orthodox economic and fiscal policy-making has caused controversy (Gärtner et al., 2011; Paudyn, 2013; Gärtner et al., 2013; Hiss and Nagel, 2014; Fuchs and Gehring, 2015). The excessive and hasty downgrades sparked criticism of the CRAs’ “procyclical” role in terms of the market’s sovereign risk perception similarly to the Asian financial crisis. Instead of mitigating the market’s excessiveness both in terms of risk appetite and aversion, ratings would fuel a certainty bubble in good times, and favor herd behavior almost “off the cliff edge” in bad times.5 In the course of the European sovereign debt crisis, also the CRAs’ putative US bias has been a hotly debated issue of controversy. Especially when the CRAs started downgrading European sovereigns to a massive degree and at a high frequency, the criticism that CRAs would have a politically biased perception grew even louder. Reminiscent of the Asian policymakers’ reactions to the sovereign downgrades a decade earlier, European politicians who problematized the American origin of the CRAs were also those that called for establishing a European CRA (Die Welt, 2011).6 Rating actions are susceptible to such politicking because of the simple fact that a rating is not a technical product independent of context, but a judgment and, thus,  One explanation for the conservative ratings in the wake of both sovereign debt crises is that CRAs wanted to compensate for past mistakes. Demonstrating their learning capacity, CRAs aimed at restoring reputation and credibility — critical assets to survive in the rating industry (Bruner and Abdelal, 2005; Ferri et al., 1999). 6  For example, in 2011, German politician of the Christian-democratic-liberal governing coalition Rainer Brüderle criticized sovereign ratings for their political bias (Süddeutsche Zeitung, 2011). 5

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product of deliberation. By necessity, a judgment cannot be exempt from ideological predilections and normative considerations. For this reason, the location of the major CRAs’ headquarters has always been an easy target for criticizing the agencies’ work and questioning the ratings’ credibility. Nevertheless, the oligopoly of the US headquartered CRAs has shown to be remarkably resilient despite crisis-induced waves of criticism. The Persistence of the CRA Oligopoly Despite the dominance of the US headquartered “Big Three”, the rating market is becoming more globalized and competitive. The recent rise of CRAs in other parts of the world such as China suggests that the oligopoly will likely be challenged economically and ideationally speaking. If the rating market experiences a geographical shift in terms of market power and epistemic authority, this will have profound implications for sovereigns that borrow on international bond markets as these will have to adapt to different conceptions of sovereign creditworthiness and other norms of economic and fiscal policy.7 So-called “market orthodoxy” as we know it today and experienced in the past through the politics of sovereign ratings in the European sovereign debt crisis and the East Asian financial crisis, will be redefined. However, the long-standing persistence of the CRA oligopoly and the failure to break it up, necessitate a closer look at the dynamics which perpetuate the status quo, otherwise, future attempts to challenge the oligopoly may come to nothing. The US headquartered CRAs have a world market share of 96% (Gaillard and Harrington, 2016: 39).8 Depending on the counting method, there are between 80 and 150 CRAs operating on the global rating market. Despite the apparent high number of players, the credit rating market is still highly concentrated, both overall and at the individual product category level, i.e. comprising ratings of corporate and sovereign bonds, as well as structured financial instruments (EC, 2016).9  Paudyn (2013: 804) refers to this imperative as the “prescriptive normativity” of ratings. This dynamic is facilitated by the fact that sovereign ratings are unsolicited, i.e. CRA issue them without the order of a bond issuer. The conflict of interests associated with the issuer-pays business model of rating does not exist in this case; the CRA has no incentive to please the issuer. 8  In the EU, the “Big Three” have a total market share of 92.85%: Standard & Poor’s has 45%, Moody’s 31.29% and Fitch 16.56% of market shares based on 2015 turnover from credit rating activities and ancillary services (ESMA, 2016: 6). 9  The authors of EC (2016: 52) note that “[m]easures of market share and HHI [HerfindahlHerfindahl Index] based on total revenues (from rating activity and ancillary services) imply slightly lower levels of concentration compared to measures based on revenue from credit rating activity alone. However, this is likely to be driven, at least in part, by different definitions and treatment of ‘ancillary services’ across CRAs in their Transparency Reports […] this could also indicate that smaller CRAs rely less on rating revenues than the larger CRAs.” 7

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There seems to be a stable equilibrium between smaller market players and the “Big Three”. Smaller credit rating agencies operate either on a local−national basis or are specialized in niche markets and specific sectors. By building strategic alliances with the market oligopoly, small agencies benefit in terms of reputation, publicity and credibility, whereas, the “Big Three” can secure their dominant global market position. This quasi win−win situation tends to underpin the oligopolistic market structure of the global rating industry. Even though such an explanation may be an accurate account of the status quo, it would be naive to assume that no disruptive structural shift will be able to change the market share distribution of the global rating market in the future. One example of such a disruptive change may be the extraordinary growth of the Chinese bond market (which has become as large as the rest of the emerging countries’ bond markets combined), the concomitant rise of a domestic credit rating industry, and the incremental opening up of its capital account.10

The Case of the Chinese CRA Industry Overview: From Ornament to Systemic Relevance? China’s endeavor to create “a more market-oriented financial system” over the last 30 years predetermined, at least in the long run, that banks would not play their traditional role in financial intermediation any more (Kennedy, 2008)11 and that a financial infrastructure in which CRAs fulfil a key role as informational ­intermediators would be needed. As the Chinese bond market has grown to the third largest in the world after the US and Japan,12 it was only a matter of time that the divergence between theory  The Asian Development Bank’s (ADB) “Asia Bond Monitor” conveys an impression of the growth dynamic of the Asian bond market: In China, it increased from 13% to 19% in terms of GDP between 2005 and 2014. In Korea, from 55% to 72%, and in the Philippines from 0.3% to 6.0% (Nakagawa, 2015: 5). Despite these developments, there is a general lack of scholarly interest in the nexus between bond market development and emerging markets. This is not to say that bond market development in the BRICS and particularly in China has not been object of inquiry, for example, see Rethel and Sinclair (2014); Elliott and Yan (2013); Zhen (2013); Gras (2005); Harwood (2000). 11  This process is referred to as “financial disintermediation” which will be discussed more in detail below (subsection “Not American-ness but regulatory and institutional reliance on CRA ratings”). 12  The volume of China’s bond market has reached the volume of Rmb 48 trillion (US $7.4 trillion) beginning of 2016, the US market is at US $35 trillion and Japan at US $11 trillion (Financial Times, 2016). 10

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and practice as regards the importance of the Chinese CRA industry decreased significantly, if not, disappeared completely over the last decade. A closed capital account with an almost zero share of international investors further facilitated the rise of a “home-grown” credit rating industry. In 1987, China made the first step to establish a credit rating industry by introducing new regulations on corporate bonds (Cousin, 2007: 35). As a consequence, in the beginning of the 1990s the rating of corporate bonds became the core business of the rating industry (Gras, 2005: 32). Since the former planning Commission (NRDC), however, retained the exclusive authority as the market’s gatekeeper, Chinese CRAs had the symbolic function of a “decorative fig leaf ” and ornament, apparently only established for creating the impression of a developed capital ­market.13 Therefore, the factual influence of CRAs on bond issuers and investors was characterized as “weak” at the time (Kennedy, 2008). This tide has been reversed only in the early 2000s, when the industry started to take shape (Chen and Everling, 2002). In 2002, the China Securities Regulatory Commission (CSRC) came up with “comprehensive regulations” for the CRA industry including accreditation requirements (Kennedy, 2008: 75). It was the same CSRC, preceded by the “People’s Bank of China” (PBoC), which since the late 1990 was the spiritus rector for creating a fully-fledged and functional credit rating industry oriented towards the American model. Indeed, China started to adopt international regulatory practices and standards by introducing rating-based financial regulation. As in the United States, Chinese CRAs have been granted “regulatory licenses;” ­ratings are used as regulatory requirements for bond issuance and investments (Gras, 2005: 52−53). As Kennedy (2008) puts it, the government mandate CRAs received by using ratings as tools in financial regulation “may be the best barometer to measure the Chinese government’s general stance towards private authority”. With exception of the Asian financial crisis 1998−99, there is a general neglect of the constitutive and “catalyst” role of CRAs for bond market development (Gras, 2005). In the case of China, the effort to build up a fully-fledged credit rating system, as a function of developing a domestic bond market, has been widely unnoticed in the literature with a few exceptions (Kennedy, 2008; Gras, 2005; Kennedy, 2003). Quite the contrary the practitioner’s self-perception; the Chinese CRA, Dagong, publicly propagates its mission to actively participate in

 This “re-regulation” of the bond market happened in two steps, 1993 and 1999. For more details, see Gras (2005: 53). 13

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the construction of the Asian Bond Market, as “recommended by the Ministry of Finance”.14 A further indicator that the Chinese rating industry’s irrelevance belongs to the past is the concern by Chinese authorities that credit risks are, at the time of writing, underestimated in the market. Also in China, the dominant business model in the rating industry is “issuer-pays”, meaning that the issuer of a bond or security, instead of the investor, orders the rating from the CRA.15 Being bond issuer and CRA customer at the same time creates the infamous conflicts of interest of the rating industry that are regarded as triggers of the GFC that started in 2007. In order to maintain old customers and acquire new ones, under the issuer-pays business model, rating analysts have an incentive to be less severe in their assessments than required, which goes at the cost of the quality of ratings. Higher competition among CRAs multiplies this effect as the customers’ bargaining power increases. In the worst case, this can result in “rating shopping” and seriously inflated ratings. In the Chinese case, conflicts of interest are even more exacerbated. Since 2009, local governments were incentivized to issue bonds to stimulate the economy, which increased the number of small CRAs (Bloomberg News, 2015). The promotion of small domestic CRAs has led to an intensified competition on the rating market, while “issuer-pays” has remained the dominant business model. State-owned enterprises (SOEs) and private firms with close ties to the government are also customers of CRAs. All these factors taken together have the potential to seriously harm rating quality and distort the representation of credit risks. Consequently, the National Development and Reform Commission (NDRC) “issued tough guidelines in late December 2012 that barred CRAs from soliciting customers by promising artificially inflated credit ratings, in a bid to remedy the negative impacts of the “issuer pays” model in the credit rating business” (China Daily, 2013). If Chinese authorities succeed in prioritizing the “investor-pays” business model over the predominant “issuer-pays” business model in its rating industry reforms, this would amount to a game-changer in the industry.16 Considering that authorities neither in the United States nor in Europe were able to change the industry’s business remuneration models in the post-GFC regulatory reforms, China would start to mutate into a “maker” of financial governance. It would put  Source: http://en.dagongcredit.com/content/details20_8205.html (accessed 30 December 2016). 15  According to Bloomberg (2017a), approximately 41% of China’s domestic corporate bonds are rated triple “A” by the major domestic CRAs. 16  The alternative business model of “investor-pays” contains other conflicts of interests, for example, free-rider problems. 14

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an end to being “governance taker”, given that its rating industry adopted many of the flaws of the Western counterparts not only regarding business models, but also with respect to rating analytics or the hard-wiring of ratings in financial regulation, as mentioned above. Major Players In 2001, when the “Association of Credit Rating Agencies in Asia” (ACRAA) was founded by a consortium of Asian credit rating agencies with the assistance of the Asian Development Bank (ADB), there was yet no Chinese CRA among its members.17 More than 15 years later, the major Chinese CRAs are members of ACRAA.18 Nowadays, the Chinese credit rating industry is dominated by five accredited CRAs; Dagong Global Credit Rating Co., Ltd., Shanghai Far East Credit Rating Co., Ltd. (SFECR), China Lianhe Credit Rating Co., Ltd., Shanghai Brilliance Credit Rating & Investors Service Co., Ltd., and China Chengxin International Credit Rating Co., Ltd. (CCXI). But these companies are not the only players on the Chinese rating market. There are also about 68 smaller domestic CRAs that operate in niche markets, in specific sectors or industries, or only locally. In most cases, local authorities or research institutions are founders of these companies (Cousin, 2007: 35). Chinese policymakers inverted to their own advantage the logic of the abovementioned win-win situation between the global players and emerging CRAs. Usually, the strategic alliances between domestic CRAs and the “Big Three” have served to perpetuate the status quo of the global rating market, but restrictive market access policies prevented that the typical structure of the global rating market would be reproduced in China. While the closed capital account kept international  ACRAA regards its mission to undertake “activities aimed at promoting the development of Asia’s bond markets and cross-border investment throughout the region”. Founding members were 15 Asian CRAs from 10 countries. As of September 2016, ACRAA doubled its members to 30 CRAs from 14 countries: Bahrain, Bangladesh, India, Indonesia, Japan, Kazakhstan, Korea, Malaysia, Pakistan, China, Philippines, Taiwan, Thailand, and Turkey. Source: http://www.acraa.com/final.asp (accessed 30 December 2016). 18  The ACRAA members of the People’s Republic of China are: China Lianhe Credit Rating Co., Ltd.; Dagong Global Credit Rating Co., Ltd.; Shanghai Brilliance Credit Rating & Investors Service Co., Ltd., Shanghai Far East Credit Rating Co., Ltd. (SFECR) and Golden Credit Rating International Co. Ltd. Source: ACRAA website, http://acraa.com/acraamembers.asp, last accessed 12 July 2017. China Chengxin International Credit Rating Co., Ltd. (CCXI) does not appear on this list. However, the following link features CCXI as an ACRAA member and subsidiary of Moody’s: http://acraa.com/china_c.asp (accessed 19 December 2017). 17

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investors outside, foreign CRAs were granted access to the Chinese market only by forming joint ventures with domestic agencies.19 Indeed, CCXI has been in a joint venture with Moody’s, China Lianhe with Fitch Ratings, and Shanghai Brilliance has a partnership with S&P. But this did not imply the end of Dagong and Shanghai Far East, quite the contrary. Turning the equilibrium dynamics upside down, China created a breeding ground for the emergence of a home-grown rating industry. “Dagong”, the current market leader, has no contractual relationship with the American CRAs, neither the pioneer “Shanghai Far East”. The Pioneer The “Shanghai Far East Credit Rating Agency Co., Ltd.” (SFECR) is a Chinese credit rating agency, headquartered in Shanghai. The company was founded in 1988 by the Shanghai Academy of Social Sciences “with the mission to develop internationally accepted standards of capital market in China” (PR Newswire, 2004). The ownership structure is private, with Xinhua Financial Network, Ltd. as the largest shareholder. After recognition by the Shanghai branch of the PBoC, Shanghai Far East had maintained over 50% market share in the loan certificate-rating sector in Shanghai from 1999 to 2002 (PR Newswire, 2004). While being operational only domestically, it was the leading agency at the time. In 2002, SFECR and Hong Kong-based Xinhua Finance formed a “Strategic Alliance” (PR Newswire, 2002), a joint venture named “Xinhua Far East China Credit Ratings” providing equity ratings and issues stock market indices (Kennedy, 2008: 72). Shanghai Far East was the first mainland Chinese CRA that joined ACRAA in December 2003 (PR Newswire, 2004). The company has 72 employees, more than half of it are analysts. The Chairman of the Board of Directors is Xing Jun, its Vice Chairman is Dr. Chung-Hsing Chen.20 Its product portfolio consists of ratings of securities, corporate bonds, bank loan certificates, financial institutions, structured finance products, and of public finance, i.e. ratings of domestic institutions that issue public debt, such as local governments.21 Over the last decade, Shanghai’s Far East market share in China decreased to less than 5% (Zhen, 2013: 71). As of writing, SFECR has not expanded outside Asia.

 Since July 2017, international rating agencies are allowed to set up wholly owned units in China (Bloomberg, 2017a). 20  See http://www.bloomberg.com/research/stocks/private/snapshot.asp?privcapId=8032413. Previously, this Bloomberg note erroneously indicated that Shanghai Far East would be out of business. Following our inquiry, the information was corrected. 21  For more information, see the website of Shanghai Far East, http://www.sfecr.com/. 19

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The Example of a Joint Venture CCXI is an example of a Chinese rating company that is in joint venture with one of the “Big Three”, namely, Moody’s. Next to Dagong, as of writing, CCXI is the only Chinese CRA that issues sovereign ratings. As a subsidiary of China Chengxin Credit Rating Group, which was founded in 1992, CCXI was established in 1999. Before Moody’s stepped in in 2006, CCXI was a joint venture credit rating company among China Chengxin Securities Rating Co., Ltd., Fitch Ratings and International Finance Corporation, the private sector arm of the World Bank Group. In 2005, further reforms of the Chinese capital markets took place that fostered the development of the Chinese bond market. In the wake of these changes, in September 2006 Moody’s took over the regulatory cap of 49% share of CCXI. It contributed managerial expertise and technical know-how to the company including the training of staff. In March 2017, a share-holding re-organization took place, which reduced Moody’s share. As a result, Moody’s holds 30% of CCXI, and China Chengxin Credit Management Co. Ltd. holds 70%.22 CCXI has its headquarter in Beijing and a staff of over 220 professionals. Its product portfolio covers ratings on “bonds publicly traded in or privately placed through China’s interbank market” of medium-term notes (MTN), commercial papers (CP), bank financing bonds, structured finance products, and other fixed income instruments.23 CCXI has also expanded outside mainland China. It opened its first overseas subsidiary in Hong Kong in July 2012, named “China Chengxin (Asia Pacific).” In order to operate there as a CRA, it was granted a “Type 10 license” by the Hong Kong Securities and Futures Commission (SFC) in June 2012 (China Daily, 2013). Indirectly, this also supports CCXI’s expansion beyond Asia. Regardless of the fact that “China Chengxin (Asia Pacific)” is not listed as a certified CRA in Europe unlike its competitor “Dagong Europe”, the “endorsement regime” under the European CRA Regulation can benefit companies in the situation of CCXI. Given that ESMA considers the regulatory frameworks for CRAs of Hong Kong (among others) “to be in line with European rules” (ESMA, 2012), this means that EU CRAs can “endorse” credit ratings issued in non-EU countries, under the condition that “the ratings must be issued by CRAs that are registered or licensed and are subject to supervision in those countries” (ibid.).24 Simultaneously with its expansion efforts, CCXI also  Source: http://www.ccxap.com/About.aspx (accessed 17 July 2017).  Source: https://www.moodys.com/Pages/atc002001002.aspx (accessed 4 January 2017). 24  This is facilitated by the fact that the EU CRA Regulation provides two alternatives for a  non-EU CRA that “wants its ratings to be used for regulatory purposes in the EU”; ­certification (equivalence) or endorsement. Source: ESMA website on “Non-EU Credit 22 23

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started to issue sovereign credit rating reports, starting with 30 countries in 2012 (China Daily, 2012). The “Big Fish” “Dagong Global Credit Rating Co., Ltd.” is a stand-alone Chinese CRA and market leader in China, at the time of writing. It is the largest domestic credit rating agency in China with a 30% market share. The company explicitly positions itself as the counter-hegemonic challenger of the “Big Three”. According to Dagong’s Chairman and founder Guan Jianzhong, it is the company’s “historic call” to relocate “the world’s center of credit rating […] from the Occident to the Orient […], to create a professional, impartial, authoritative and influential CRA, [and] to make long-term contributions for the continual improvement of the financial market”.25 Dagong was founded in 1994 upon the joint approval of the PBoC and the former “State Economic and Trade Commission”.26 Its headquarters are in Beijing. Major shareholders are the private companies Beijing Shi Xing Hong Liang Investment Management Consultant Co., Ltd. and Beijing Da Gong Xin Yuan Credit Rating Consultant Co., Ltd. (Cousin, 2007: 36). Dagong employs approximately 600 analysts and staff, and operates with 34 branches domestically. It has launched two subsidiaries outside mainland China; in Europe and Hong Kong. This expansion has been interpreted as the “first Asian credit rating company to challenge US domination in the European credit rating business” (China Daily, 2013). But this was not the only attempt by Dagong to expand beyond China. Already in September 2010, the Securities and Exchange Commission (SEC) in the US rejected Dagong’s application to be granted the status of “Nationally Recognized Statistical Rating Organization” (NRSRO), a regulatory requirement for CRAs to access and operate on the US market (Financial Times, 2010). The subsidiary “Dagong Europe Credit Rating srl” was established in March 2012 and is headquartered in Milan, Italy. Since July 2016, Dagong has also a branch office in Frankfurt, Germany. In its beginnings, Dagong Europe was a joint venture between Dagong Global (60% ownership) and Mandarin Capital Rating Agencies” (https://www.esma.europa.eu/supervision/non-eu-credit-ratingagencies, last accessed 20 July 2017). Given the “extensive use of the endorsement regime in practice” ESMA Chairman Steven Maijoor announced changes to the endorsement guidelines for third country credit ratings (Reuters, 2017). 25  Source: http://www.dagonghk.com/AboutUs.php?act=list&parent_id=19&menu_id=28 (accessed 13 July 2017). 26  Source: Dagong website, http://en.dagongcredit.com/ (accessed 12 July 2017).

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Partners, “a Private Equity fund linking Mid-Market European businesses with Chinese partners” (40% ownership). Since January 2015, Dagong Global Credit Rating is the sole shareholder of Dagong Europe. Since 13 June 2013, ESMA, the supervisor of CRAs within the EU, lists “Dagong Europe” as a registered CRA, which allows the company to pursue its business activities in the EU.27 As of writing, Dagong Europes is the only Chinese CRAs that holds the status as certified CRA in Europe.28 In 2013, Dagong Europe was also recognized by the Joint Committee of the three European Supervisory Authorities (ESAs) as External Credit Assessment Institutions (ECAI) operating in the European Union.29 According to the 2016 annual market share calculation undertaken by ESMA, Dagong Europe has a 0.04% market share based on its revenues from credit ratings and ancillary services reported to ESMA on the basis of their 2015 accounts (ESMA, 2016). In September 2014, the subsidiary “Dagong Global Credit Rating (Hong Kong) Co., Ltd.” was officially launched.30 Two months before, the Securities and Futures Commission of Hong Kong (SFC) granted a Type 10 License to Dagong HK, which entitles the company to provide credit rating services in Hong Kong. The establishment of the Hong Kong office is seen as the “spearhead [of] Dagong’s regional and global expansion, as it becomes a leader in the pan-Asian credit rating space”.31 The product portfolio of Dagong is split between domestic and international ratings. The former includes ratings of, e.g. short-term financing bonds, mediumterm notes, enterprise bonds, financial bonds, asset-backed securities, convertible bonds, and corporate bonds. The product segment of international ratings consists of both enterprise and sovereign ratings. Sovereign Ratings — Dagong Only Reinventing the Wheel? Dagong issued its first sovereign credit rating report in July 2010 in the wake of the GFC. Since then, it has issued sovereign ratings of more than 90 countries and regions. Dagong describes itself as “a globally-oriented” and “first non-western” CRA  Registered status “is guarded diligently” and only granted if applicants “demonstrate their ability to meet all the regulatory requirements”. Source: https://www.esma.europa.eu/ supervision/credit-rating-agencies/supervision (accessed 27 December 2016). 28  See the list of “registered or certified” CRAs published by ESMA: https://www.esma. europa.eu/supervision/credit-rating-agencies/risk (accessed 20 July 2017). 29  Source: http://www.dagongeurope.com/about_us.php (accessed 27 December 2016). 30  Source: http://en.dagongcredit.com/content/details20_8156.html (accessed 27 December 2016). 31  Source: http://www.dagonghk.com/AboutUs.php?parent id=19 (accessed 11 July 2017). 27

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that “[a]s the founder of sovereign credit rating criteria […] provide[s] the world with sovereign credit risk information” (Dagong Europe, 2016). There is an emphasis by Dagong of having developed an own and original rating methodology (Dagong Hong Kong, 2015). Dagong is trying to distinguish itself from its competitors, and especially from the “Big Three”. To what extent references to the “Dagong credit theory” or to “the establishment of the Chinese rating theory” is only rhetoric or points to a truly “new way” of rating, opens up a wide research agenda. Indeed, the English version of Dagong’s published sovereign rating methodology is reminiscent of those published by the American counterparts. For example, what Dagong refers to as “national management ability” features more or less as “political score” in S&P’s methodology (S&P’s, 2012). Dagong’s “economic strength” is equivalent to S&P’s “economic score;” “fiscal strength” corresponds to “fiscal score;” and Dagong’s “foreign exchange strength” corresponds largely to S&P’s “external score”. “Financial strength” corresponds roughly to S&P’s “monetary score”, even though Dagong splits up “financial strength” in two categories, namely, “development level of financial system” and “stability of financial system”. The former category includes the analysis of monetary policy. The latter category seems to have no equivalent in S&P’s sovereign rating methodology. All these similarities among Dagong and the “Big Three” in terms of sovereign rating methodologies should not be overemphasized. Compared to the English 3-pager of Dagong’s rating methodology, a glance on Dagong’s Mandarin version with its 52 pages reveals that Dagong uses a different taxonomy. According to this elaborated document, the sovereign analysis consists of the following four factors; “debt servicing environment”, “wealth creation ability”, “source(s) of debt service”, and “solvency analysis”. In part, they overlap with the categories listed in the English ­version, but there are aspects which are unique to Dagong’s approach. This shows that further research is required to systematically compare the rating methodologies of Dagong and the American oligopoly in order to determine to what extent Dagong is really adopting a unique method of rating, or whether it is only reinventing the wheel. On the occasion of the sovereign debt crisis in Europe, Guan commented on the supposedly “ideologically driven standards” of the CRAs’ sovereign rating methodologies (Lietsch, 2011, own translation). It would not be “sensible” to stylize an ideology as a benchmark for the determination of a sovereign’s creditworthiness. The American CRAs would equate sovereign creditworthiness with the Western standards of liberal democracies. Deviation from this ideal type would inform the ordinal rating scale. For example, central bank independence, currency convertibility, the openness of the economy and of the financial sector, would not be relevant factors that determine a country’s creditworthiness. The “Big Three” would put too

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much emphasis on the willingness of a sovereign to repay its debt (which escapes from measurement), at the cost of neglecting the sovereign’s actual practical capability to repay its debt (which is usually measured by economic fundamentals). Even though the published “Dagong Sovereign Credit Rating Methodology” also includes the sovereign’s “willingness” to repay debt in its definition of sovereign ratings (Dagong Hong Kong, 2015), rhetorically, Dagong distances itself from this tricky task. The company would mainly focus on a country’s de facto “capability” to repay debt. Put differently, whatever is conducive to this capability, scores positively in the rating, for example, the policy effectiveness of the “system” on its economic management, or, the extent to which the financial sector serves the “needs” of the real economy (Lietsch, 2011, own translation). However, it is questionable whether these aspects really correspond to an output-oriented capability approach. They rather reveal that it is in the eye of the beholder what aspects are deemed conducive to the practical capability of a sovereign to repay its debt. In short, the idea that rating can be exempt from ideological and normative considerations and follow a purely output-oriented approach is illusory. This point can be well-illustrated with Dagong’s downgrade of the US from “A” to “A-” with a negative outlook in October 2013 (Langner, 2013). According to Dagong, the US would be in “a situation that cannot be substantially alleviated in the foreseeable future”. Debt growth in the US would still outpace fiscal income and GDP. Despite a “last minute agreement in Congress” the US would be “still approaching the verge of default crisis”. At the time, the CRAs stuck to a relatively high US sovereign rating regardless of the turmoil in Congress accompanying the shutdown and debt ceiling debates.32 Guan Jianzhong seized this opportunity to blame the CRAs for “having lost their professional ethics” (Süddeutsche Zeitung, 2013, own translation). The CRAs would function as an extended arm of the US government by indirectly approving the expansive monetary policy of the Federal Reserve with the favorable ratings. Dagong’s opinion about the Federal Reserve’s quantitative easing as a monetary policy response to the GFC shows that what constitutes a “good” or a “bad” monetary policy in a specific historical circumstance is a highly controversial issue. But raters, in the end, have to come up with a judgment on whether a sovereign government will be able and willing to repay its debt, despite existing ambiguities. In other words, owing to the contingency of social reality, the politics of creditworthiness is inescapable.  When Dagong downgraded the United States in October 2013, Moody’s rated the US “Aaa” with a stable outlook, Fitch “AAA” with a negative outlook, and S&P’s “AA-” with a stable outlook (Lopez, 2013; Böcking, 2013). S&P’s downgrade to “AA-” had occurred 2 years before in the course of the previous debt ceiling debates (Reuters, 2011). 32

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As a pragmatic answer to the intricacies of the rating business, Dagong proposes a “Reform of the International Credit Rating System”. As “a representative of Chinese CRAs, Dagong pushes forward” this reform (Dagong Europe, 2014) and has mapped out “guiding principles” (Dagong, n.d.-a). Dagong identifies the current international credit rating system as “the source of the global credit crisis” (Dagong, n.d.-b: 6). Therefore, it promotes the establishment of an “international credit rating agency” that would be able to provide a platform in which the rating agencies of all countries could work together in order to guarantee the safety of the “global credit systems” (Lietsch, 2011, own translation). It remains an object of further inquiry whether the planned BRICS rating agency will function as the mini-pilot project in this respect, or whether Dagong has something different in mind.

“American-ness” of CRAs Our Problem — Chinese and/or BRICS Rating Agency the Solution? The Presumptive US Home Bias of the “Big Three” To regard a Chinese or BRICS rating agency as the “solution” presupposes to regard the “American-ness” of the CRAs as “key problematique” of rating (Abdelal and Blyth, 2015: 58). The following section gives an overview of the debate on the presumptive US home bias reproach held against the “Big Three”. The world’s two largest CRAs, S&P’s and Moody’s, are exclusively headquartered in the United States. The “epistemic predilections” of the US are inferred from this geographical position and attributed to the CRAs (Sinclair, 1999: 160). From this perspective, ratings can be characterized as “a US phenomenon” (Sinclair, 2005: 120). By “subjecting all [differently institutionalized forms of capitalism] to the expectations inherent in the American model”, ratings can have “profound effects over time” (Sinclair, 1999: 162). Countries deviating from the CRAs’ expectations ex ante may go through disruptive adjustment processes, which can result in harsh criticism towards the CRAs. Not only in terms of sovereign ratings, but also in the case of corporate ratings, CRAs have been facing a wave of criticism due to their supposedly American world view. In continental Europe, characteristics of the bank-based financial system in terms of accounting methods and financial ratios (Bruner and Abdelal, 2005: 204) led to “[b]ad experiences with the Anglo-Saxon–oriented raters” which in turn “built up resentments among companies and financial institutions” (Engelen, 2004: 69). Since CRAs are part of the US-centered financial system and its institutional infrastructure, some argue that the CRAs’ self-preservation instinct makes them

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“advocates of American interests” (Hörbst, 2010). The CRAs’ presumptive “clearly visible political agenda” would consist in maintaining the status quo and preserving the US dollar’s role as main global reserve currency. CRAs would have an interest in weakening the relative position of competing currencies for international reserve currency status, and would downgrade other countries accordingly. In turn, granting the top rating to their domicile country and preserving its c­ reditworthiness, regardless of its high public indebtedness, is thus conducive to this aim. Such a mercantilist reading of the CRAs’ role implies that the establishment of an “own” (non-US) CRA is inevitable for successfully challenging US hegemony. In the wake of the GFC, a range of empirical studies analyzed whether sovereign ratings suffered from a so-called “home bias”. For example, Vernazza et al. (2014) identify the “Eurozone periphery” as the US CRAs’ “biggest casualty”. Measured against economic fundamentals, affected countries were “on average rated almost five notches” too strictly between 2009 and 2011. Further empirical work that gained prominence in the CRA “home bias” discourse is Fuchs and Gehring (2015, 2013). Especially in the aftermath of the financial crisis, the “Big Three” would have given European states excessively severe sovereign ratings compared to the US sovereign rating (Buhse, 2014). Fuchs and Gehring (2017, 2015, 2013) find empirical evidence that sovereign ratings are biased “in favor of the respective home country, culturally more similar countries, and countries in which home country banks have a larger risk exposure”. Remarkably, these results do not only apply to the “Big Three”, but also to, for example, the smaller German agency “Feri EuroRating Services” and “Dagong”.33 For this reason, the authors do not only recommend a higher degree of competition in the rating industry, but also a greater variety in the domiciles of CRAs. Different national and regional backgrounds of the CRAs could balance the home bias, resulting in more “objective” and high-quality ratings. In view of the presumed home bias of the CRA oligopoly, practitioners’ and academics’ calls for a more competitive and heterogeneous rating market are plausible. Questions of effectiveness and desirability aside, and regardless of the harsh criticism CRAs faced during the last years, the establishment of a CRA which is able to effectively challenge the “Big Three” and based outside the US, seems still mission impossible. However, the rise of a significant Chinese credit rating industry

 At the time of writing, Feri is out of business. On 1 August 2016, “Feri EuroRating Services” was acquired by “Scope KGaA”, which is the parent company of “Scope Ratings”. ESMA withdrew the credit rating registration of Feri on 29 March 2017 (ESMA, 2017). “Scope Ratings” is a German-based CRA registered under ESMA. 33

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including larger players with ambitions of expansion, and the intention to set up a BRICS rating agency may have already started the ball rolling. “American-ness” of CRAs Our Problem, Really? This section gives an overview of the arguments that question the problematization of the “American-ness” of CRAs. For if the American-ness does not constitute the “key problematique” of rating but something else, then, ceteris paribus, a counterhegemonic BRICS or Chinese rating agency may risk perpetuating the weaknesses of the current rating system. Not American-ness, but Outraged Policymakers With regard to policymakers’ criticism of sovereign ratings, and this applies both to the East Asian crisis and the sovereign debt crisis in Europe, “a curious dialectic in rating agency–state relations” manifests itself. Sinclair (1999: 160) notes that “when states are downgraded by the major global agencies they are often vocal in their denunciation of the judgments”, and interpret them as an affront. In the extreme case, policymakers regard CRAs as part of a conspiracy of American imperialism, which only further aggravates the hostility towards the US-based firms (Hackhausen, 2012, own translation). In 2011, in the midst of the sovereign debt crisis, former European Internal Market Commissioner Michel Barnier criticized the CRAs for not taking many EU governments’ unprecedented reform measures sufficiently into account. He proposed a temporary ban on sovereign ratings of countries during bailout talks (Norman and Neumann, 2011). The unwillingness to accept “bad grades” would cause discomfort and induce policymakers to accuse the CRAs of partiality and complicity.34 Although the American CRAs are private firms that have no official link to the US government, such a suspicion is hard to falsify, and therefore persistent. Policymakers, however, lose credibility if they boast about their top ratings in good times, and complain about ratings in bad times. When states tacitly enjoy the benefits of their triple “A” status, they implicitly acknowledge the validity of ratings. When the tide turns, the entity being judged is not best positioned to question the validity of the judgment by accusing CRAs of a “home bias”. A sovereign debt crisis is therefore not the best time for policymakers to problematize the politics of sovereign

 Brummer and Loko (2014) and Dittmer (2011) argue that since US authorities would not see CRAs as advocates of foreign interests, policymakers in the EU would have imposed harsher regulations on CRAs in the aftermath of the GFC. 34

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ratings. Their accusations of CRAs will likely by dismissed as “policymakers wanting to take revenge on their judges”. A counter-hegemonic BRICS or Chinese rating agency will not be able to alleviate this dynamic of outraged policymakers. When states will experience a downgrade, they will likely accuse the alternative CRA of partiality and complicity with the foreign government as well. Not American-ness, but Unintended Consequences Another argument that questions the problematization of the CRAs’ “Americanness” as the main problem of rating is related to the fallacy of over-emphasizing vested interests. As an unintended consequence of rating actions, sovereign rating downgrades may weaken other currencies against the USD. This, however, does neither imply that CRAs change sovereign ratings intentionally nor that the US government stands behind this. Once a counter-hegemonic BRICS or Chinese rating agency will have acquired the market power and epistemic authority as its American counterparts, its sovereign rating actions may likely trigger similar unintended consequences on exchange rates, interest rates and other factors that affect the economic situation of a borrowing nation. Not American-ness, but Special Role of USD Some regard S&P’s downgrade of the US on 5 August 2011 as further evidence to falsify the US home bias reproach (Hackhausen, 2012, citing German politician, and former ECB board member, Jörg Asmussen).35 The market reactions to the downgrade were remarkable: Treasury bills (T-Bills) rose in value, and yields went down (Reuters, 2011; CNN money, 2011). Market reactions to downgrades of other sovereigns usually move vice versa. The American downgrade suggests the firmness of the market’s conviction that there is no serious reason to question US ­creditworthiness. What observers from outside the US perceive as a home bias in sovereign ratings, may just be the CRAs’ “reproduction” of this market belief. There are, indeed, material reasons that cast a different light upon the home bias reproach. To this day, the USD has a unique status as the dominant global reserve currency (Norrlof, 2014). If the US enjoys certain privileges due to the special role of the dollar, this compounds the comparability with other debt-issuing nations.  The weakness of this argument lies in the fact that, at the time, the CRAs had been already criticised for being less strict with the US government. It remains an open question to what extent the US downgrade can be interpreted as a reaction by S&P’s to weaken the accusation of home bias. 35

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If the “American-ness” per se does not constitute the problem of rating which is perceived as the home bias, but instead, it is the special role of the dollar as the leading reserve currency, this means that a counter-hegemonic BRICS or Chinese rating agency will not be able to alleviate this problem unless there is no leading reserve currency in the future. Sovereign ratings are, by definition, relative expressions. From this follows that the “Big Three” would do themselves a favor in terms of credibility if they withdrew their US sovereign rating, at least for the present, to silence the home bias reproach. For the future, this also means that CRAs that are headquartered in the country that issues the leading reserve currency would do themselves a favor if they do not issue the sovereign rating of their respective home country in order to avert the home bias reproach.36 Not American-ness, but Susceptibility of Sovereign Ratings to be Interpreted as Political Instruments As mentioned above, US headquartered CRAs are often regarded as a prolonged arm of US government, and Dagong, although privately owned, faces criticism for not being independent from its own government.37 The insinuated lack of independence from the government goes at the cost of rating credibility. There seems to be a general susceptibility of sovereign ratings to be interpreted as political instruments, whoever is issuing them. The greater the consequences of rating actions, the more this susceptibility tends to increase. On 24 May 2017, Moody’s downgraded China “for the first time since 1989” (Bloomberg, 2017b). The company justified its decision based on the prospect that “economy wide-leverage” will outpace economic growth “over the coming years” and “erode China’s Credit Metrics” (Moody’s, 2017). The Chinese Ministry of Finance reacted that the rating decision would be “absolutely groundless” arguing that Moody’s would underestimate “the capability of the government to deepen reform and boost demand” (Bloomberg, 2017b). Particularly the timing of the downgrade raised controversies, given that China has recently been on the path of opening up its bond market to foreign investors, and a lower rating makes it more costly for a sovereign to issue bonds because of the higher risk premium it has to pay to investors. At the same time, Dagong assigns China a top rating, whereas, it rates the US as “A-”, “below Russia and France”.  Unless there will be a “multi-polar” reserve currency basket in the future, in practice, it is highly unlikely that CRAs would stop issuing the rating of the country with the leading reserve currency given investors’ demand for it. 37  Chairman Guang never tires of repeating that there are no ties between Chinese ­authorities and Dagong (Süddeutsche Zeitung, 2013; Grzanna, 2013a,b; Lietsch, 2011). 36

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As is the case with the American counterparts, only when Dagong will downgrade its own domestic government, this may be interpreted as the litmus test of its independence.38 The same logic will probably apply to a new BRICS rating agency issuing sovereign ratings. Otherwise, an insinuated lack of independence will likely dampen its prospects of success given the importance of reputation for the rating business.39 Not American-ness, but Other Biases In case of the “Big Three”, the specific propensity of sovereign ratings to be subject to the home bias is commonly referred to as the “American-ness” of the CRAs. However, if there is a general propensity of sovereign ratings to be subject to other types of biases altogether, objections can be raised as to whether it is the CRAs’ “American-ness” that constitutes the main problem of rating. For example, Bartels and Weder di Mauro (2013) show that sovereign ratings of the small German CRA “Feri” are susceptible to a negative “neighborhood bias” that even tends to outperform the CRAs’ presumptive home bias. During the sovereign debt crisis in Europe, “Feri was even more aggressive both in terms of a lower level and a higher propensity to quickly downgrade Eurozone problem countries than the Big Three.” Although it may be questionable whether Feri really reflects “an unbiased European view”, the authors conclude “that European countries would have received an even tougher treatment from a European rating agency than from the US-based ones”. If there is a general propensity of sovereign ratings to be subject to biases other than home bias, then a counter-hegemonic BRICS or Chinese rating agency will likewise perpetuate this problem. Not American-ness, but Transnational Character Unsurprisingly, CRAs dismiss criticisms of being advocates of partisan interests as conspiracy theories. Rejecting accusations of partiality, Moritz Krämer, Head of EMEA Sovereign Ratings at S&P’s asserts: “We do our job” (Hackhausen, 2012, own translation). In line with the “synchronic-rationalist” mental framework of rating orthodoxy (Sinclair, 2005: 70), CRAs in their self-understanding adopt a crosscultural perspective which — by definition — cannot have a US bias. According to Sinclair (2005: 120), the global expansion of CRAs with subsidiaries and allies all over the world contributes to an increasingly “transnational”  As seen in the American case, such actions are not able to entirely silence accusations.  If the European Union as a public institution were to promote a European CRA, its independence, especially in terms of sovereign ratings, would likewise be questioned (Bartels and Weder di Mauro, 2013; Paudyn, 2011).

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character of rating. Regarding the CRAs’ “transnational view” as an affirmation of “the agencies’ US origins, norms and practices”, Sinclair infers that “the mental framework of rating remains largely American”. I argue that such a line of reasoning hinges critically on the understanding of “American” and “transnational”. As sovereigns converge because of financial globalization,40 it will become increasingly difficult to identify the kind of bias the sovereign rating actually suffers from. If “transnational” stands per se and does neither mean “American-ness” nor “Chineseness”, then transnational actors such as the rating agencies will be constitutive of this category. Abdelal (2007: 3) maintains that there is an “important misconception of the conventional account” of the role of the United States concerning the origins and politics of financial globalization. What if the criticism of the CRAs’ US bias is based on this misconception, and the CRAs should instead be regarded as crucial players in the general development of global financial capitalism? For example, Ouroussoff (2010) conceives of the CRAs as a counterpart to the executives in charge of the world’s largest corporations. The relevant dichotomy would lie between the CRAs as representatives of a new model of capitalism, “whose task it is to enforce the criteria on investors’ behalf ” and “the old model of the risk-taking entrepreneur”. On Wall Street, the “silent war” between these two counteracting forces would shape the global economy. It is likely that a BRICS rating agency will continue to reproduce the dichotomy between investors and entrepreneurs in global capitalism, representing the interests of the former. Also in the case of Dagong a straightforward investor orientation seems to confirm Ouroussoff (2010), as literally the company’s slogan “Sincere service for investors” suggests (Dagong Hong Kong, 2015). However, particularly as regards the transnational character of the investor orientation, there is a clear-cut difference between a future BRICS rating agency and Dagong. Dagong perceives itself as an immediate advocate of “Chinese” investors. As the Chairman’s message states: China is both an international creditor and an exporter of capital […] it should be for the creditor to evaluate the credit risks of the debtor, and we should not rely on the debtor’s ratings to protect the creditor’s interests.41

 Indirectly, these dynamics of convergence can also be related to sovereign ratings, which induce sovereigns to align to common criteria of assessment. 41  Source: http://www.dagonghk.com/AboutUs.php?act=list&parent_id=19&menu_id=28 (accessed 13 July 2017). 40

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As being an “international creditor” is equated with being “Chinese”, the i­nvestor orientation of Dagong thus serves as a constitutive element of its identity as a Chinese CRAs. Constructing the “Western rating agencies” as advocates of debt issuers — which is a point one can hardly deny, let alone due to the issuer-pays business model — Dagong legitimizes its mission to relocate the “world’s credit rating center” to China, remarkably, out of a seemingly technical necessity derived from the “creditor−debtor relationship”. From such a perspective, Dagong’s expansion strategy can be rationalized as a legitimate reaction to the failure of the American agencies to “provide proper services to investors” during the GFC. Insinuations of hegemonic aspirations including accusations of a “Chinese home bias” can be silenced straight away. Protecting the interest of the theoretically transnational investor suffices as raison d’être for a Chinese CRA. Not American-ness, but Regulatory and Institutional Reliance on CRA Ratings When claiming that it is “not the American-ness of the [CRAs] that creates the key problematique” of rating, Abdelal and Blyth (2015: 58) argue that the challenges are of “more fundamental” nature and related “to the practices of regulatory delegation and producing market conventions”. Disintermediated financial markets necessitate an epistemic authority for passing judgments on creditworthiness, as banks do not fulfil their traditional role as financial intermediators between lenders and borrowers any more. This outsourcing of judgment to a third-party for investment decisions has become such an entrenched practice that even institutional investors and regulatory authorities cannot escape the temptation to delegate due diligence. The consequence of the delegation of credit risk assessment to a centralized third-party is the harmonization of the market’s risk perception that leads to herd behavior and amplifies systemically destabilizing “cliff effects”. Practices that accompany structural changes of financial disintermediation and their consequences do not disappear only because the headquarters of the market leading CRA will shift to the East or to one of the BRICS countries. Under these circumstances, the epistemic authority of CRAs will continue to exist, no matter where the headquarters of the rating agencies are. Institutional and regulatory reliance on CRA ratings may continue, as well as procyclical market behavior. Not American-ness, but “Market Forces” vs. “the State” An alternative problematization of rating that goes beyond its “American-ness” relates to the aspect of ceding “further sovereign authority to market forces” (Paudyn, 2011: 259). An example which suggests that the “Big Three” are not necessarily advocates of “American” but “market” interests, is the CRAs’ discursive intrusion into US domestic policy issues. As the US debates about raising the debt ceiling in

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2011 and about the government shutdown in 2013 have shown, when the situation evokes the CRAs’ disapproval, CRAs issue direct warnings with negative rating or outlook implications (S&P’s, 2013; Puzzanghera, 2013).42 This means that the politics of sovereign ratings manifests itself less in a s­ truggle between states, but rather between “market forces” and “the state”. This implies that the country which hosts a CRA is also subject to the rating judgment. If this is the case, a counter-hegemonic BRICS or Chinese rating agency will not make a difference in this respect. Furthermore, if the investor-pays remuneration model will become the dominant business model of rating in the future, as the name already suggests, investors’ ideas, norms and world views are likely to play a more important role than is already the case for the understandings of creditworthiness underlying the rating process. This has a straightforward implication for the “prescriptive normativity” (Paudyn, 2013: 804) of ratings, as rated entities will have to orient themselves towards investors’ understandings of creditworthiness even more in order to preserve their access to credit. As long as sovereign states refinance themselves on international bond markets, the normative implications of sovereign ratings with respect to fiscal and economic policy deserve close scholarly attention, independently where the market and opinion leading CRA has its headquarter. This opens up a wide spectrum of research questions that can be addressed by scholarship in the future: How do understandings of creditworthiness and their inherent world view converge and diverge across the global rating industry? Which understandings of sovereign creditworthiness may come to dominate the global financial markets in the future, and shape ideas about economic and fiscal policy accordingly? Not American-ness, but Flawed Methodology Another problem that goes beyond the aspect of the CRAs’ American-ness concerns the rating methodologies. CRAs have been criticized for their “fallacious analytics” (Paudyn, 2011: 259) and for “not understand[ing] or adequately model[ling] the economic fundamentals” (Bartels and Weder di Mauro, 2013; Afonso et al., 2012). If, ceteris paribus, the rating methodologies remain the same, and only the headquarters of the agencies change, then a counter-hegemonic BRICS or Chinese rating agency will not be able to alleviate the CRA problem of flawed methodologies.

 Pressure can also be exerted implicitly articulating a positive prospect: “In Fitch’s opinion, agreement will ultimately be reached on raising the debt ceiling and the US government will make full and timely payments on its debt” (Fitch Ratings, 2011). 42

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Conclusion When China opened up its interbank bond market to foreign capital beginning of 2016, the Financial Times warned that “[l]ike China itself, its bond market is too big to ignore”. This chapter suggests that the same logic will apply to the Chinese credit rating industry as well. With the ongoing opening up of China’s capital account, the authority Chinese CRAs started accumulating domestically over the last years may very likely transcend their own boundaries. The influence of Chinese CRAs over international investors and issuers may still be regarded as weak and insignificant. However, as China is becoming a global investor of systemically relevant size, ratings from Chinese CRAs may increasingly matter for global investment decisions. Nevertheless, a wide spectrum of challenges of rating will not disappear once the market and opinion leading CRAs will be headquartered outside the United States. Whether it is the special role of a leading reserve currency in a global financial system; the general tendency of sovereign ratings to be interpreted as political instruments; other biases sovereign ratings can be subject to different from home bias; the transnational character of rating; the regulatory and institutional reliance on CRA ratings; the power struggle between “the market” and “the state” in financial capitalism; or a flawed rating methodology — a counter-hegemonic BRICS or Chinese rating agency per se are not the solution to these challenges. Finally, even if we concede that the US home bias of the American CRAs exists, it is highly unlikely that a BRICS or Chinese CRA will not suffer from a similar home bias as well. What seems to be more relevant at this point is not whether a home bias in rating really exists, but that it is perceived to exist by policymakers, as the promotion of an own CRA by Chinese authorities and the more recent BRICS’s initiative to establish an own CRA testify. Independently whether one conceptualizes the “key problematique” of rating in its American-ness or in something else, these controversies caution us against treating ratings as unambiguous metrics. That non-Western policy-makers have gotten a feel for the structural power CRAs wield in global financial markets — and that they are determined to host firms they can identify themselves with as these reproduce and shape opinions of creditworthiness according to own ideas, norms, and world views — reveals the social dimension of rating.

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CHAPTER 11

Treaty Shopping and Unintended Consequences: BRICS in the International System Julia Gray Political Science Department, University of Pennsylvania, USA

Introduction Since the end of the Cold War, the BRICS countries, along with emerging markets across the world, have been quick to sign on to a variety of economic agreements — including preferential trade agreements (PTAs) and bilateral investment treaties (BITs) — in the international system. Many of these agreements served to signal those governments’ friendliness to investors and to the globalized world more generally (Gray, 2009). But Investor-State Dispute Settlement (ISDS) mechanisms — which allow private actors to launch litigation against other countries, effectively giving firms the same rights as countries (Simmons, 2014) — are some of the most contentious features of the international cooperative landscape. Although these provisions have existed for some time in some form (Miles, 2013; Hale, 2015), recent cases have put ISDS provisions under increased scrutiny. Emerging markets such as Brazil, Indonesia, and India have recently terminated many of their bilateral investment treaties (BITs) precisely because those provisions leave them open to litigation (Poulsen, 2014). But in an interesting twist, the complainant may not even be from the state with whom the agreement is signed.

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The practice of so-called “treaty shopping”, where actors can avail themselves of the web of international adjudication to pick the regime that best suits them, puts into focus the contentious and complicated nature of these dynamics. Treaty shopping — long present across treaties governing taxation and now spreading to international arbitration (Streng, 1992; Reinhold, 2000; Barthel et al., 2010) — has become widespread in recent years.1 The BRICS countries fall along the entire spectrum of implications of this phenomenon, including as complainant, r­ espondent, and vehicle. For example, in one famous case, the US-based tobacco firm Philip Morris brought a lawsuit in 2011 against Australia concerning the regulation of cigarettes (specifically, the requirement that cigarettes be sold in plain packaging). However, it used its subsidiary in Hong Kong — Philip Morris Asia — to launch the suit, so that it could take advantage of a relatively lenient bilateral investment treaty (BIT) signed between Hong Kong and Australia in 1993. The tribunal ultimately ruled that the tobacco firm did not have jurisdiction for the suit, but it led Australia to request an opt-out of the ISDS provisions in the negotiations for the Trans-Pacific Partnership (although it subsequently softened its position).2 This example demonstrates how the rule overlap in international agreements can have unintended consequences for BRICS, emerging markets and developed economies alike. The original goal of the particular bilateral investment treaty that Philip Morris deployed was to promote investment by limiting the degree to which the governments of Hong Kong and Australia could discriminate against foreign direct investment. Even though that treaty had not been much in use between its original signatories, it created a window for international litigators as well as for a multinational firm to attempt to use the agreement to their own advantage. This action created consequence for the countries in question, as well as for subsequent international agreements. Thus, even when governments have not signed formal agreements with countries of interest, multinationals whose subsidiaries extend across multiple jurisdictions can, with the help of international law firms, take action against states from third jurisdictions (in this case, Hong Kong). The lack of  Treaty shopping in arbitration and taxation should not be confused with forum shopping. In the latter, states pick the international forum of which they are already members that stands the best chance of giving them a favorable outcome in a given issue area. Treaty shopping means that non-state actors such as firms structure their ownership to take advantage of other countries’ arrangements. 2  In another case of overlap, Australia’s plain packaging requirement is also currently being contested at the WTO, with actions brought against Australia by five different countries — Ukraine, Honduras, the Dominican Republic, Indonesia, and Cuba. 1

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a centralized ISDS system means that firms can use ISDS provisions across a wide variety of international agreements to attempt to gain leverage over states.3 This can have many potential consequences for emerging markets and for the BRICS countries, although those states have varied in both their susceptibility and response to treaty shopping. As the example above shows, convergence and divergence exists among those countries. At times, the BRICS countries can be used as vehicles in treaty shopping, as the Hong Kong example above shows; other times, companies in those countries can be the perpetrators of treaty shopping, as is frequently the case in Russia. Governments including Brazil and India have also chosen to withdraw from such treaties altogether. Nonetheless, the web of international treaties on offer just after the end of the Cold War have entangled many of these countries in protracted and costly legal battles and lost revenue via taxation. Many of the BRICS have taken measures to avoid leaving them vulnerable to treaty shopping for arbitration (South Africa, India, and Brazil) as well as taxation (China). Rather than thinking of international agreements as contracts solely among signatory states, and as the BRICS countries as signing individual treaties to secure particular outcomes, these agreements are best viewed as part of a complex dynamic in the international system. This approach makes two important moves. The first is to view agreements not as bilateral or multilateral, but rather as systemic. The second is to shift the emphasis from the formation and joining of international institutions, to an examination of the ways in which institutions evolve over time, giving power to substate as well as non-state actors. This allows for a more holistic view of the international system, and of the ways that the system affects different actors in the BRICS countries. International legal instruments, including treaties with ISDS provisions, can empower some firms with respect to governments as well as to other firms, both within and outside the BRICS (Buthe and Milner, 2009). Viewing the rule overlap in international agreements as opportunity structures, rather than strictly as the products of bargaining over states for a certain cooperative outcome, allows for a more nuanced understanding of the reciprocal interactions among states, markets, non-state actors, and the international system in an era of globalization. This approach is echoed in the literature concerning regime complexes  One legal briefing identifies investor protection in five areas — BITs, PTAs, the Energy Charter Treaty, ASEAN’s Comprehensive Investment Agreement, and human rights ­treaties — and went on to say that “it is increasingly important that international investors understand these protections, both when structuring their foreign investments and when they face interference by a host state” (Client Alert Commentary; Latham and Watkins; International Arbitration Practice Number 1563, 29 July 2013). 3

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(Colgan et al., 2012) and forum shopping (Busch, 2007; Drezner, 2008; Davis, 2009), integrating with recent work on transnational non-state actors as well as bureaucracies (Johnson, 2013). This chapter gives an overview of the various roles that different actors — firms and governments alike — in the BRICS countries have played in the treaty shopping landscape. Assessing whether the BRICS have been helped or hurt by treaty shopping requires looking both at state and non-state actors. While some governments and firms have been beneficiaries of treaty shopping, others have faced losses — at times even within the same country, as the Russia example below will illustrate. Furthermore, the benefits and costs can vary widely depending on the judgment of the tribunal. That is to say, as the international system of treaties and agreements grows increasingly tangled, it becomes difficult to offer a clear assessment as to whether countries are better off integrating fully into it or opting out of part or all of it, as some of the BRICS have done. This is a very different policy prescription than what was on offer in the 1990s, when the BRICS countries first rose to prominence.

The BRICS and Treaty Shopping in an Interdependent World After the fall of the Berlin Wall, developing countries the world over — including the BRICS — rushed to sign international agreements of all varieties. These agreements were meant to signal that the countries belonged in the global regime for cooperation, as well as to attract investment and trade. However, these agreements carried with them many unintended consequences (Poulsen, 2015), including opening themselves up to litigation. But the web of treaties also opens up the possibility for actors to jump jurisdictions. This exposes countries to new layers of international interactions. Lawyers have been writing about treaty shopping for decades, particularly as it emerged in taxation,4 but this phenomenon has only recently attracted the attention of political scientists (Buthe and Milner, 2009; Gertz, 2015; Tucker, 2015; ArelBundock, 2016). Treaty shopping in the area of international investment arbitration stems from the ability of private investors to sue states, an important feature of the postwar regime for international investment (Simmons, 2014). Indeed, the world’s first investment treaty — drafted in 1959 between Germany and Pakistan — did not include arbitration provisions in its investment treaties until 1981. These provisions grew in popularity in the 1980s and are now a standard feature of many international agreements (Lupu and Poast, 2015).  See, for example, Streng (1992), Haug (1996), Reinhold (2000), Rodriguez (2008), Skinner et al. (2010), and de Swart (2015). 4

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At first glance, it might seem that these disputes are the purview of developed countries, leaving the BRICS out of the game. Of those ISDS claims that have been filed, around 70% are from investors in the US or the EU. And yet, closer examination reveals that it is not always firms that originate in the country that initiated the dispute. Companies in the Netherlands are among the most frequent initiators of disputes, second only to firms in the United States and the United Kingdom. But this is partially because the Netherlands has an extremely liberal investment regime, with their boilerplate investment treaty having quite broad and general legal language that is favorable to investor interpretation of concepts, such as expropriation and violation of rights (Skinner et al., 2010). The Netherlands in total hosts around 20,000 “shell companies” or “mailbox companies” (1,600 of which are subsidiaries of US companies) to benefit from investment protection (Van Os and Knottnerus, 2011), as well as from around 95 BITs and ISDS provisions around the world.5 The Dutch BITs in general contain widely similar provisions, largely due to the fact that, despite the theoretical predictions of the rational design literature, agreement design tends not to vary much within a country (Allee and Elsig, 2014). Once a country has forged its first agreement in a given issue area, subsequent agreements tend to look quite similar to the initial one (Poulsen, 2014). This means that the many BITs and ISDS provisions held by the Netherlands tend to offer domestically registered firms very similar types of protection, regardless of the part of the world or the host country. This helps account for the high number of ISDS cases initiating from firms ostensibly based in the Netherlands. In terms of treaty shopping, developing countries have been respondents in 53 out of 66 cases, which accounts for 80.3% of the potential treaty shopping cases. In certain treaties, MNCs wishing to launch dispute procedures against a given country can do so through setting up or utilizing an existing office in a third country with whom the primary country does have an agreement. This practice of “treaty shopping” circumvents the channel of direct interstate bargaining over investment agreements and leaves governments potentially vulnerable to litigation from unexpected sources (Harten, 2005; Kirtley, 2009; Skinner et al., 2010).

 According to Van Os and Knottnerus (2011), Dutch cases “account for a full 10% of the roughly 400 known investment cases world-wide. The majority (29) of the investors that have sought arbitration under a Dutch investment treaty are foreign (i.e. the ultimate or controlling parent is not based in the Netherlands), while 25 of these claimants are indeed shell companies that appear to have set up shop in the jurisdiction of the Netherlands with the sole objective of availing themselves of the generous Dutch tax breaks and investment protections.” 5

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In treaty shopping for investment litigation, the presence of multiple dispute settlement mechanisms at the international level can allow firms and states to select the forum that is most likely to give them a favorable outcome (Romano, 1998; Stahl, 2005). Firms can choose to adhere to the investment provisions in a BIT or a PTA, thereby obviating the other agreements that a country may have signed (Baccini and Dur, 2015). But the globalized structure of production as well as of jurisdiction mean that the state and territory are not always equivalent (Agnew, 1994). The web of overlapping treaties mean that legal jurisdiction can transcend particular territories. This holds true as well for treaty shopping regarding taxation, where firms can set up shell companies to take advantage of bilateral tax treaties that offer more favorable terms than those between their home and host countries. Just as globalization creates an overlapping tangle of transnational adjudication (through BITs as well as through the investment portion of PTAs,6 as well as other international agreements that contain ISDS provisions) — it also gives rise to opportunities for firms to decouple themselves from national commitments (through FDI, production networks, affiliates abroad). This gives firms an opportunity to use the international legal commitments made by their host state to gain advantage over third states. This creates a complex politics in which firms can use these features of globalization strategically to both equalize their position with respect to other firms and to the state. However, these strategies may not prove successful in arbitration. As St John (2016) describes, when the World Bank initially promoted ISDS provisions to countries’ agreements, they were intended to solve the political problem of nationalizations of investment in a peaceful manner. Indeed, Poulsen (2015) provides compelling evidence that most developing countries that signed on to BITs in the 1990s did so without conducting any kind of systematic cost-benefit analysis, and many representatives did not even realize that the ISDS provisions would be legally binding. Thus, at best, states (both individually and collectively) were unable to anticipate the way in which these multiple treaties could be deployed by law firms and MNCs with multiple jurisdictions. At worst, ISDS emerged as a standard provision in many agreements as a result of World Bank bureaucrats’ influence,7 and many countries did not even know what they were signing.

 It should be noted that the ISDS provisions in PTAs only apply to the investment portions of those agreements, not to all products covered. 7  This is consistent with the dynamics described by Johnson (2013), in which IO bureaucrats can play an influential role in treaty design. 6

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The result is that the BRICS, as well as many emerging markets have signed onto a set of institutions that are not under their direct control. At present, states, IOs, or other actors that are beholden to states do not govern the international regime of investment arbitration. Rather, the system is both delegated to private arbitration within the very general framework to which states have agreed, and is also open to other private actors, MNCs and other firms and the lawyers working for them.8 Thus, in the period where states signed onto international agreements that included ISDS provisions, they unwittingly built in opportunity structures that firms and lawyers could attempt to exploit. Although many states are currently endeavoring either to limit their involvement or exit altogether from treaties containing these provisions, opportunities for arbitrage on the part of non-state actors still exist. This is a consequence of the rule overlap that exists in the international system, as well as non-state actors’ ability to construe jurisdiction in creative and unexpected ways. Among the BRICS countries, an assessment of the benefits and losses very much depend on the level of analysis. Individual firms within those countries can benefit from treaty shopping, but states themselves can bear costs if they end up in arbitration proceedings. Even domestic firms can reincorporate abroad to gain leverage on their home governments. In a similar example to the Yukos case in Russia, described below, an Argentine firm that claimed mistreatment at the hands of the Kirchner regime set up a shell company in the Netherlands to sue the Argentine government for breach under international, not domestic, rules (Wellhausen, 2014), in the case of TSA Spectrum de Argentina SA v. Argentina, 2005. The case was ultimately dismissed due to suspicions of treaty shopping.9 Further, one of the first acknowledged cases of treaty-shopping occurred when a Lithuanian company, Tokios Tokeles, brought a case via a Ukraine−Lithuania BIT against the Ukrainian government in 2004 for unfair investor treatment. But jurisdictional questions arose once it was discovered that 99% of Tokyo’s capital and around two-thirds of its management originated from  For a journalistic account of how this system emerged, see Haley Sweetland Edwards’s “Shadow Courts: The Tribunals That Rule Global Trade”, Columbia Global Reports, September 2016. 9  The tribunal ruled that “the ultimate owner of TSA on and around the date of consent was the Argentinian citizen Mr. Jorge Justo Neuss. It therefore follows that, whatever interpretation is given to the BIT between Argentina and the Netherlands, including the Protocol to the BIT, TSA cannot be treated, for the purposes of Article 25(2) (b) of the ICSID Convention, as a national of the Netherlands because of absence of ‘foreign control’ and that the Arbitral Tribunal therefore lacks jurisdiction to examine TSA’s claims.” 8

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Ukraine itself (Skinner et al., 2010).10 This has repercussions for BRICS including China and Russia, where investors may suspect unfair treatment at the hands of domestic courts and establish shell companies abroad to gain preferential treatment. The Role of Firms: MNCs and Law Firms Some BITs contain denial-of-benefits clauses that include specific definitions of what constitutes as an investor. These are meant explicitly to discourage firms from establishing ownership structures solely to obtain treaty benefits. These also can be found in taxation treaties; for example, US income tax treaties have a “limitation on benefits” that serves the same purpose as restricting the definition of investors (Fleming, 2012; Buthe and Milner, 2009).11 For this reason, back-end treaty shopping is considered to be a relatively riskier prospect for firms, because tribunals may decide that the firm is not a legitimate party to the ISDS provision in the new country (Skinner et al., 2010). The fact that firms can incorporate post-hoc — often under different names than the parent company — makes the phenomenon of treaty shopping very difficult to quantify. Treaty shopping can manifest at many points along an investor’s decisionmaking timeline, making it difficult to say the precise moment and motivation for offshore structuring. Furthermore, firms are not transparent about when and why they choose to incorporate abroad, making the systematic study of their intentions challenging.12 ISDS cases also tend to be confidential, meaning that tribunals do  Cases addressing arguments that the claimant did not in fact have the nationality of the other Contracting Party include Aguas del Tunari vs. Bolivia, ICSID, Decision on Jurisdiction (2005); ADC vs. Hungary, ICSID, Final award (2006); Saluka B.V. vs. Czech Republic, UNCITRAL, Partial award (2006). See also Antoine Martin, International Investment Disputes, Nationality and Corporate Veil: Some Insights from Tokios Tokeles and TSA Spectrum de Argentina, Transnational Dispute Management, Volume 8, Issue 1 (February 2011). 11  In most German treaties, for example, a firm must have a seat in Germany in order to be treated as an investor in these treaties. 12  Constructing a large-N empirical test of these propositions is challenging, for several reasons. First, the disputes themselves can be difficult to identify. Because of the thousands of possible venues for litigation, there is as of yet no off-the-shelf measure of disputes across all possible tribunals. Second, the data on shell companies are even more difficult to track down. Often these companies have different names than their original owners, so i­ dentifying a shell company that formed to take advantage of a given ISDS provision involves backtracking from the dispute itself. Furthermore, globalized MNCs often use intermediaries to transfer the assets, which makes identifying the legal owners almost impossible. 10

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not publish systematic accounts of their proceedings. Nonetheless, non-systematic evidence suggests that treaty shopping abounds.13 The critical role of law firms — many of which operate in the BRICS — in this process is also difficult to measure directly. Many firms actively advertise their services, offering expertise in treaty shopping both in international taxation as well as, increasingly, investment arbitration (Poulsen, 2015; St John, 2016). Indeed, some argue that it is primarily law firms — who stand to gain from the legal fees — that are driving the agenda of treaty shopping.14 But their influence is difficult to observe directly and systematically. Many of these proceedings are secret; many are conducted in hotel rooms and not in formal courts; and although the number of international arbitrators has been growing in the past 5 years, it is challenging to obtain formal figures of their presence.15 If even domestic firms are able to use these treaties against their own governments, this clearly prompts a rethinking of the conventional rendering of dynamics between domestic governments and foreign companies. Thus, many of the traditional arguments about information asymmetries and obsolescing bargains may be called into question. Domestic firms that can use international arbitration tools would not be subject to these types of dynamics, and further investigation would

 Wellhausen (2014) has collected data on 586 investor-state disputes. In her data, 11 ­ isputes — around 2% — involve three or more “home” countries, and an additional 59 — d 10% — involve two home countries. Some of these cases are almost certainly instances of shell companies. 14  “Legal vultures: Law firms driving demand for investment arbitration”, Corporate Europe Observatory, 27 November 2012. https://corporateeurope.org/trade/2012/11/chapter-3-­ legal-vultures-law-firms-driving-demand-investment-arbitration. Accessed 26 December 2017 15  As one arbitrator noted, “There has come into existence an elite group of international arbitration practitioners … If you ask an international arbitration practitioner where they are based, they will answer Geneva, London, New York, Paris; increasingly also Dubai, Hong Kong or Singapore. If you ask them who their clients are, they will tell you sovereign states, energy companies, telecoms companies and so forth. But if you ask them where their clients are from, you may well find that you have to reach for your Smartphones to locate the answer. Where exactly are Luanda, Bishkek, Bamako, Riga? No territory is too remote. The arbitration practitioner cuts a bold and fearless figure, travelling across the world to anywhere an arbitration agreement may exist, armed only with an iPhone with access to Google Translate. It is no wonder that many young lawyers want to join this elite corps of practitioners.” Ndanga Kamau, arbitrator with King and Spalding in Houston, at the International Council for Commercial Arbitration 50th Anniversary Speech, 19 May 2011. 13

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be needed to theorize about the balance of power between such firms and their own governments and legal systems. Nonetheless, treaty shopping demonstrates the many layers of political and economic interaction among states, firms, territories, and international legal commitments. The following section describes some of the practical and normative consequences of this type of politics for emerging markets and BRICS.

Convergence and Divergence among EMEs and BRICS Responses to treaty shopping have varied among the BRICS. India, Brazil, and to some extent South Africa have sought to insulate themselves from treaty shopping by withdrawing from many of their treaty obligations. By contrast, Russia has emerged as both the target of and the vehicle for treaty shopping, often as nationals seek to find recourse from expropriation outside of the country’s own courts. Chinese companies via Hong Kong have themselves participated in acting as vehicles for treaty shopping, and China as an outward investor has both the need for such treaties to protect its companies. This section gives an overview of the BRICS and their response to treaty shopping. Russia Russia is a good example of the complexities of the international treaty system for the BRICS. It is a country where even Russian nationals face potentially unfair treatment from the government and have then resorted to incorporation abroad and the use of international treaties as a means of gaining compensation from government expropriation. For example, consider the case involving Yukos Oil Company shareholders, in which Russia specifically invoked the transnational nature of firms as a defense against charges of expropriations. In three linked arbitrations — involving two firms in Cyprus and one in Isle of Man, which combined held 70.5% of shares of Yukos — shareholders sued Russia for compensation for the indirect expropriation of Yukos. They argued that the launching of tax evasion proceedings against Yukos in 2004 — which ended up bankrupting the company — were not done in good faith. Russia’s defense was two-fold. First, Russia argued that the claimants could not be judged to be foreign investors, since the firms were shell companies that were operated by Russian nationals. To that end, the state has the right to deny investor protections to an entity that does not do business where it is organized. Russia argued that its 1994 agreement on partnership and cooperation with the European Union laid out conditions through which companies may only be considered as such if

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they operate substantial and continuous links with Russia’s economy. Thus, Russian nationals used foreign shell companies to attempt to sue their own government — but that same government used a third-party international agreement in its defense. The case — which involved five separate jurisdictional issues — has had a mixed history. In 2014, an UNCITRAL arbitral tribunal found that Russia had not exercised the right of denial because the Energy Charter Treaty (ECT) Article 17(1), which reserves this right, was not referred to in the 1994 agreement. The tribunal ordered the payment of over $50 billion in compensation to the firms — at the time the biggest damages award in investment treaty arbitration. However, in 2016 the district court of The Hague overturned the award, on the grounds that Russia had never ratified the ECT, despite signing it. This demonstrates the complicated nature of the international landscape for firms, agreements, and legal systems. In the Yukos case, private actors set up shell companies in other territories in order to sidestep their own domestic legal system. This means that for the government, the international treaty system proved subversive, but for the investor it proved advantageous. Similarly, in the extensive cases of Sedelmeyer v. Russian Federation (brought through 80 distinct legal proceedings around the world), Franz Sedelmeyer, a German national who had set up companies in the then-USSR starting in 1989, sought compensation for expropriated assets through using the USSR−Germany BIT. Russia attempted to use the same defense — disqualifying Sedelmeyer as an investor — without success.16 China: Treaty Shopping in Arbitration and Taxation Similarly, as in Russia, many Chinese firms have taken advantage of the web of international treaties just as the Chinese government has sought to insulate itself from their ramifications. For China, firms tend to engage in treaty shopping with respect to taxation rather than arbitration (Arel-Bundock, 2016). It is common practice for multinational companies based outside of China to investing in that country through a shell or holding company based in a country with a more favorable tax arrangement, such as Barbados or Singapore — or even Hong Kong, which has special status within China. The Chinese government has pushed back on these arrangements, with a series of decisions and policies. For example, in 2008, the State Administration of Taxation in China pushed back on a claim of exemption from capital-gains tax from a company in Barbados. The company — established by US citizens — purchased  “Major Pitfalls for Foreign Investors in Russia: What Are Russian BITs Worth?” Kluwer Arbitration Blog, Elvira R. Gadelshina (Khrenov & Partners), 1 December 2011.

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a third of the equity of a Chinese company in 2006, selling it back to the original shareholder at a profit of nearly $12 million the following year. A China−Barbados tax treaty should have meant that the firm did not need to pay capital gains tax in China, but the Chinese authorities questioned the provenance and legitimacy of the Barbados-based company and ultimately determined that the company did not qualify as a tax resident of Barbados, making them liable to capital gains tax. Starting in 2008, China has made a number of efforts to clarify in legal terms its definition of investors, specifically to prevent treaty shopping. For example, in 2009 the country issued a circular specifically aimed at defining a beneficial owner, in an attempt to prevent foreign companies from treaty shopping regarding taxation through intermediary holding enterprises. In recent years, it has signed treaties that pay particular attention to these definitions, such as with the Netherlands, which as mentioned is a locus of treaty shopping.17 To that end it converges somewhat with the other BRICS, which have endeavored to insulate themselves from the possibility of treaty shopping. Yet, China’s role as a significant outside investor — as well as the special status of Hong Kong, which leaves it open to participating in treaty shopping as described in the Australia case — make its relationship to these treaties somewhat tenuous. India: Limiting Taxation “Round Tripping” Like China, India has been subject to treaty shopping regarding both investment arbitration as well as taxation. On the former, it has played several roles. India has been defined as acting as the host country for eight cases of treaty shopping in arbitration (the second-most frequent host after Venezuela). In terms of taxation, India only recently took direct steps to curb treaty shopping (known as well in that country as “round tripping”), after having been long subject to lost tax revenue. Cyprus, Mauritius, and Singapore are candidates for tax treaty shopping, wherein Indian nationals as well as investors from other countries would set up shell companies in those jurisdictions, with which India had signed bilateral tax avoidance treaties. Those companies could then invest back into India while avoiding taxation. As a result, Mauritius became the largest source of FDI for India, with 34% of total FDI revenues between 2000 and 2015.18

 “New Tax Treaty signed between The Netherlands and Mainland China”, DLA Piper, 18 June 2013. 18  “India, Mauritius to amend tax treaty: All you need to know”, Hindustan Times, 11 May 2016. 17

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Treaty shopping with respect to taxation was viewed as enough of a problem that the government took measures to curb it. The Indian government in 2013 labeled Cyprus as a “noncooperating jurisdiction”, hoping to send a signal to investors and making them liable for a 30% withholding tax on investments in India. The measure proved inadequate, and a more drastic step was required. In 2016, India announced changes to its tax treaty with Mauritius as well as Cyprus, ending the exemptions after a 2-year grace period.19 Indeed, India has concurrently become something of a leader in terms of combating tax evasion, working in the context of the G20 to establish common reporting standards for taxation. Some have raised normative questions about the utility of treaty-shopping possibilities as a way of attracting investment. It is possible that the overall economic benefits of a particular investment could outweigh the losses, particularly if it increases overall economic activity. Indeed, in one domestic legal case (Union of India v. Azadi Bachao Andolan) the Indian Supreme Court’s judgment stressed that treaty shopping for taxation could help attract capital and technology to India. “Developing countries need foreign investments, and the treaty shopping opportunities can be an additional factor to attract them. […] The developing countries allow treaty shopping to encourage capital and technology inflows, which developed countries are keen to provide to them. The loss of tax revenues could be insignificant compared to the other non-tax benefits to their economy” the court opined (Avi-Yonah and Panayi, 2010). Pushback from the BRICS and Around the World: India, South Africa, and Brazil Given such concerns, one might think that the states would be able to insulate themselves to opt out of potential investor litigation by simply refusing to sign such treaties, or exiting them. Several countries have, in fact, done so: in recent years Argentina, Bolivia, Brazil, Ecuador, Indonesia, South Africa, and Venezuela have all pulled out of agreements that contain ISDS provisions.20 Other countries that fear that governments are disadvantaged in these disputes have moved to set up an alternate arbitration regime that would be less friendly to investors.21 As the chapter in this volume on investment notes (see Chapter 8), treaty shopping has also prompted states to revoke or refuse to sign agreements with ISDS  “Tax pacts and India: Bye bye, treaty shopping,” Financial Express, 22 November 2016.  “The arbitration game,” The Economist, 11 October 2014. 21  “ALBA Members Take the Lead in Crafting Alternatives in Arbitrating Investor-State Disputes,” CEPR, 13 May 2013. 19 20

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provisions, as a means of protecting themselves from treaty shopping (Peinhardt and Wellhausen, 2015; Poulsen, 2014; Poulsen and Aisbett, 2013). In emerging ­markets, the general concerns about developing countries being beholden to powerful MNCs — and that ISDS provisions tend to be biased in favor of investors — have led to rhetoric about the need to establish alternate forms of international dispute settlement (Fiezzoni, 2011). Brazil and South Africa have sought to pull back from treaties that open them up to international arbitration. India has also given notice that it will terminate the nearly 60 investment treaties that it has already signed.22 The cries have been taken up by developed and developing countries alike; Australia, as mentioned, has expressed caution about entering agreements with ISDS provisions following its litigation via Hong Kong, and France and Germany have made similar protests concerning ISDS procedures in a proposed EU-Canada trade agreement.23 These concerns have filtered up to the level of the EU commission as well.24 Recently the French trade minister, spoke against investor-state settlement provisions, saying “[w]e must preserve states’ rights” to “set and apply their own standards”, he told the French Senate.25 In terms of developing countries more generally, in early 2017 Romania and Poland took initial steps to terminate their BITs with countries already in the EU, reducing some of the overlap.26 Similarly, after a series of cases, the Venezuelan government terminated BIT with the Netherlands in 2008 as well as from the World Bank’s ISDS.27 Indonesia has done the same, revoking nearly all its BITs, and Bolivia also has withdrawn from the ICSID.28 Similarly, Brazil signed 14 BITs in the 1990s, but none was ever ratified in domestic legislature.29 The absence of these agreements, however, does not mean that deals are not struck — indeed, Campello and Lemos (2015) argues that Brazil, which remains a record attractor of FDI,  “India’s bilateral investment treaties: Once BITten, 57 times more shy,” Hindustani Times, 25 November 2016. 23  “Paris and Berlin want changes to EU-Canada trade deal,” EurActiv, 27 January 2015. 24  “Commission floats ISDS reform ahead of EU ministerial trade talks,” Euractiv, 6 May 2015. 25  “When Corporations Sue Governments,” New York Times, 3 December 2014. 26  “Green Light for Romania to Terminate its Intra-EU Bilateral Investment Treaties,” Kluwer arbitration blog, 14 March 2017. 27  “Venezuela’s Withdrawal From ICSID: What it Does and Does Not Achieve,” Investment Treaty News, IISD, 13 April 2012. 28  “Indonesia to terminate more than 60 bilateral investment treaties,” Financial Times, 24 March 2014. 29  “The arbitration game,” The Economist, 11 October 2014. 22

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simply addressed most of the demands placed on it by investor through alternative channels that were less transparent and more tightly controlled by the executive. The Bolivarian Alternative for the Americas (ALBA), founded by Venezuela’s Chavez to counter market-based international economic organizations, has discussed creating an alternate center for dispute settlement provisions that would allegedly not be biased in favor of investors’ interests. The agreement includes Ecuador, Bolivia, Cuba, Nicaragua, Dominican Republic, St Vincent, and the Grenadines, as well as Venezuela. At the discussions to form the tribunal, Argentina, Guatemala, El Salvador, Honduras and Mexico were also present.30 This is perhaps not surprising, since Argentina, Ecuador, Venezuela, and Mexico each had around disputes lodged against them in recent decades. More to the point, however, the exit from ISDS provisions mean that less transparent deals between states and investors might be struck. The irony of the treaty-shopping that has emerged as a result of rule overlap is that it takes place in the absence of a truly comprehensive multilateral investment regime. The OECD’s attempts to forge a multilateral Investment Agreement ran aground in 1995; the Uruguay Round attempts to forge cooperation on investment were controversial. By withdrawing from ISDS provisions, states are not eschewing foreign investment; such investment will still likely not be deterred, but the transactions between governments and firms will be obfuscated, and citizens and non-governmental organizations will not have a chance to participate in the discussions. However, these calls have intensified; one legal expert was recently quoted as saying, “[w]hat I would say to Australians is that while the system is in the state it’s in right now, signing any new treaty is a very serious mistake. You have to weigh the benefits against the burdens. Somebody at some point might be able to explain to me where all the benefits are, but I certainly haven’t seen any.” 31 Examples from Other Emerging Markets The impact of treaty shopping can be either positive or negative, or both simultaneously. For example, the Nomura case in the Czech Republic had profound consequences, both materially and legally. The country faced a number of suits with total claims of over $1 billion. The IPB incident also sparked a change in Czech banking laws; one such law now prohibits banks from owning non-financial companies.  “ALBA Members Take the Lead in Crafting Alternatives in Arbitrating Investor-State Disputes,” CEPR report, 3 May 2013. 31  “TPP’s clauses that let Australia be sued are weapons of legal destruction, says lawyer” Jess Hill, The Guardian, 9 November 2015. 30

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Another requires investors to take a minimum 51% stake in a bank. Although the losses through the legal fees made the case the most expensive in Czech history, some argue that the cases did improve the regulatory environment surrounding banks.32 That said, of its ISDS cases — which have in total sought around $3.5 billion in damages from the country — the Czech government has lost three, paying around $500 million in those settlements. Similarly, contradictory outcomes emerged in the Rompetrol case, which turned out to be one of the most protracted ones in Romanian legal history, and with different outcomes on the domestic and international levels. On the domestic front, in 2012, the Romanian court acquitted Patriciu of the charges of money laundering, but not before the defendants a number of times attempted to have the case thrown out of court, alleging that it was unconstitutional and that the charges were politically motivated.33 However, in 201434 many of the other managers — including a senator and a former minister — received jail sentences for stock-market manipulation with respect to Rompetrol shares. On the international front, however, the outcome was different. In 2009, the tribunal for the Netherlands−Romania BIT did find that the fair and equal treatment principle was violated. However, it refused to award any monetary amount to Rompetrol, which had claimed that it had incurred moral damages as well as economic losses. Treaty-shopping was an explicit part of the respondents’ defense, arguing that “the dispute amounts in its essence to a complaint by a Romanian national against Romanian authorities and in relation to activities in Romania” (Kirtley, 2009). But the tribunal affirmed that the jurisdiction was relevant both under Chapter 2 of the ICSID convention as well as Article 8 of the Netherlands− Romania BIT. The international ruling in favor of Rompetrol but without any damages awarded ultimately, was a short-term victory for the firm and seemed to have no impact on the lawsuits within Romania itself. After the domestic cases dragged on, Rompetrol filed for bankruptcy in Romania in 2015, with a debt of $58.5 million

 “Pád IPB zlepšil český bankovn systm, řika analytik,” Cesky rozhlas, 16 July 2010.  “Romanian court acquits prominent businessman accused of money laundering,” BBC Worldwide Monitoring, 29 August 2012. 34  Patriciu also died in that same year, but not before (in a further layer of international adjudication) filing a complaint with the European Court of Human Rights about inhumane treatment during his detention. In 2012, the tribunal rejected the claim as inadmissible. Domestically, in 2007 Patriciu sued the Romanian Intelligence Service for illegally tapping his phone; domestic courts awarded him around $13,000 in compensation. 32 33

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along with three times that amount as legal interest to the country.35 Therefore, at the end of the day it is unclear that the international ISDS case had a lasting impact on the Romanian government’s path to resolve the dispute, apart from occupying its resources as it responded to international adjudication. Of course, deep investigation would be necessary in order to make evaluations of each case and the real impact it had on both the firms and the states in question. But this is a fruitful area of research for future study that looks at the outcomes and impacts of investment arbitration, particularly when treaty shopping is involved. Thus, the complexity of the international system of arbitration can lead to differing and contradictory outcomes for emerging markets. The consequences of arbitration on state sovereignty are even more problematic in a world of rule overlap and opportunity structures, as states may find their resistance strategies to be limited in the face of treaty shopping. At the same time, many have expressed concern about the ad hoc nature in which these legal decisions have been made. In Argentina, several companies brought ICSID cases against the government over its decision in 2002 to abandon its currency board, which pegged the peso to the USD. The Argentine government claimed that doing so was a matter of national security and therefore trumped its treaty obligations. This led to a flurry of cases from several different jurisdictions, which have all been arbitrated with different rulings and procedures. One legal scholar described the phenomenon as “extremely poor legal analysis with substantive outcomes that do not reflect either the text of Argentina’s BITs nor the intent of the state parties to those BITs” (Burke-White, 2008). Tribunals are increasingly alert to the issue of shell companies using jurisdictional overlap to their advantage. For example, when a Czech citizen named Vladimir Beno, who owned multiple Czech companies, was brought to prosecution for evading taxes and customs duties, in 2004 he sold two of his metal companies — Benet Praha and Benet Group — to an Israel-based company called Phoenix Action, which was run by his own family members. That company quickly brought a case against the Czech Republic under the jurisdiction of a Czech−Israel BIT, saying that the cases involving Benet Praha and Benet Group effectively appropriated Phoenix’s assets, therefore violating the Full Protection and Security provisions in the BIT. However, the tribunal called out the treaty shopping provisions, saying that Phoenix itself was “nothing more than an ex post facto creation of a sham Israeli entity created by a Czech fugitive from justice, Vladimir Beno, to create diversity of nationality”. The tribunal further found that the company had not been undertaking any significant investment in the Czech Republic, but simply acted as “a rearrangement of assets  “A tangled business: Romanian oil company Rompetrol SA files for insolvency,” Romania Insider, 5 June 2015.

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within a family, to gain access to ICSID jurisdiction to which the initial investor was not entitled”.36 The ruling involving a recent Venezuela gas dispute was similarly ambiguous on the effects of treaty shopping and its broader consequences for international law. When Venezuelan President Hugo Chavez nationalized oil and gas projects in the country, Exxon Mobil gas — which is headquartered in Irving, Texas — had no immediate legal resource because of the lack of any kind of investment agreement between the US and Venezuela. However, Mobil was able to restructure its investment to a Dutch subsidiary of Mobil Gas that centered on the nationalization of oil and gas projects by Venezuela. The tribunal noted that Mobil restructured its investments through the Netherlands with the sole purpose of gaining access to ICSID arbitration to contest Venezuela’s new energy policy through the Netherlands−Venezuela BIT. The tribunal concluded that this was “a perfectly legitimate goal as far as it concerned future disputes”. However, the tribunal took exception to this approach with regard to pre-existing disputes, stating that “to restructure investments only in order to gain jurisdiction under a BIT for such disputes would constitute […] an abusive manipulation of the system of international investment protection under the ICSID Convention and the BITs”.37 That judgement, however, did not prevent Exxon Mobil from being found in favor and awarded $1.6 billion — although that amount was a tenth of their claimed damages.38 Both Rompetrol and Nomura relied on backend incorporation to treaty shop, incorporating in the Netherlands subsequent to a dispute. In both cases the tribunal acknowledged the claim but took no issue of the validity of the identity of the claimant.39 But those other cases have been mixed.

 Quoted in Skinner, Miles and Luttrell (2010). That being said, future tribunals have not been constrained by that precedent. One ISDS tribunals — in the case of Metal-Tech v. Uzbekistan — disagreed with the Phoenix case’s definition in terms of what counted as an investment. By contrast, in the case of Tidewater v. Venezuela, the tribunal invoked the Phoenix case as an example of a firm abusing the international system through restructuring its investment to gain access to different international treaties. “Recent Developments in Investor-State Dispute Settlement,” UNCTAD Report, April 2014. 37  Quoted in Van Os and Knottnerus (2011). 38  “Exxon Mobil awarded $1.6 billion for assets seized by Venezuela,” Los Angeles Times, 4 October 2014. 39  Interestingly, this differs from the case lodged against the Czech Republic through Phoenix Action, where the attempt to sue the country through the Israeli BIT was thrown out on precisely those grounds. That may have been a function of weaker language in the IsraeliCzech BIT, since that case was not launched appreciably later than the other ones (it was initiated in 2004). 36

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The presence of rule overlap means that as states integrate with the ­international system, it is more likely that one set of agreements will contradict another automatically. For example, Eastern European countries have also been particularly subject to treaty shopping. They tended to be caught among several cross-cutting pressures, including the enthusiasm for signing many different types of international agreements in order to convince investors of their creditworthiness after the fall of the Berlin Wall (Gray, 2009); the adoption of relatively lax standards to attract investors and increase competitiveness; and the subsequent attempts to harmonize their own policies with EU standards in the run-up to EU accession. The subsequent cracking down of regulatory standards combined with the earlier ISDS provisions left those countries exposed to litigation. Some 65% of all disputes against Central and Eastern Europe stem from other EU countries that had previously signed BITs prior to accession. One case — again featuring the Netherlands — involved the Dutch investor Eastern Sugar claiming that the Czech Republic had violated its BIT principles of fair and equitable treatment through imposing regulations on sugar imports. The Czech Republic countered that the Netherlands BIT should have been obviated by the country’s 2004 accession to the EU — of which both countries were members. Indeed, the Czech Republic further argued that they had enacted the disputed regulations in order to comply with the EU’s acquis communautaire requirements for EU membership. The tribunal, however, found in favor of the Netherlands and seemed to favor the BIT law over EU law, writing that “an international arbitral tribunal, independent from the host state is the best guarantee” of investor protection.40 All these examples illustrate the tension between domestic law and international law, as well as with the overlapping jurisdictions when countries are accountable to multiple legal frames, is problematic for transparency but also for the legitimacy of the domestic legal structure.41

 “A test for European solidarity: The case of intra-EU Bilateral Investment Treaties,” Transnational Institute report, January 2013. 41  Cases addressing arguments that the claimant did not in fact have the nationality of the other Contracting Party include Aguas del Tunari vs. Bolivia, ICSID, Decision on Jurisdiction (2005); ADC vs. Hungary, ICSID, Final award (2006); Saluka B. V. vs. Czech Republic, UNCITRAL, Partial award (2006). See also Antoine Martin, International Investment Disputes, Nationality and Corporate Veil: Some Insights from Tokios Tokeles and TSA Spectrum de Argentina, Transnational Dispute Management, Volume 8, Issue 1 (February 2011). 40

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Research Frontiers For the BRICS countries, this points to a more thorough understanding of the political salience of arbitration. States increasingly encounter unanticipated and complex relationships that emerge as a result of globalization. Although legalization was initially meant to be an impartial solution to the problem of ensuring international cooperation (Goldstein et al., 2003), the system of international arbitration is politically charged. Scholars have noted that power matters in legalization, observing asymmetries among states in the use of WTO dispute mechanisms (Kim, 2011) as well as in other types of litigation (Yackee, 2014). Acknowledging that politics and power matter even in the allegedly neutral system of arbitration is an important first step in exploring, then, the outcomes that legalization produces for states. After the fall of the Berlin Wall, states formed, signed, and joined international agreements at an unprecedented rate. These efforts included the signing of economic agreements — including BITs and PTAs — many of which included dispute settlement mechanisms. Developing countries in particular tended to sign these agreements because they viewed it as a necessary part of joining the global order, not because their governments had done any type of economic analysis of the costs and benefits of those agreements (Poulsen, 2014). At the same time, most of those countries did not anticipate that the dispute-settlement provisions that the agreements contained would be legally binding. Thus, the investor disputes came as an unwelcome surprise to many (Poulsen and Aisbett, 2013). The contradictions and complications of the international network of treaties, agreements, and legal frameworks hold many consequences for emerging markets in general and the BRICS countries in particular. In previous understandings of the international system, power was the ultimate driver of influence and reward in this system. This put developing countries as well as the BRICS at a potential disadvantage. Long perceived as the weaker players, many of these emerging markets had to navigate the international system on the back foot, relying on institutional rules to ensure fair treatment. In today’s interconnected world, however, countries and firms of all v­ arieties — not just powerful ones — can attempt to benefit from the legal tangle of international regimes. Firms can not only take advantage of the ambiguity created by rule overlap and attempt to use it to their own ends. They can also use their own abilities to incorporate abroad to take advantage of jurisdictions where their original governments might not have agreements, through so-called treaty shopping. In fact, some law firms explicitly advise clients to consider structuring their investments so that they

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can take advantage of treaty shopping.42 However, states still have recourse against firms, and the litigation does not always go the firms’ way; treaty shopping does not guarantee a favorable outcome for the investor. Although the legal implications of treaty shopping are not uniform, and although many cases have specifically focused on the identity of the investor in their consideration of the legal merit of the case, it cannot be denied that treaty shopping — or the fear of it — has structured not only international agreements but also state behavior with regard to membership and ratification of international treaties. Russia’s failure to ratify the ECT has temporarily saved it from a massive payout regarding unfair treatment of Yukos, and Brazil’s and India’s reluctance to sign onto these treaties aims to limit vulnerability to litigation in the international system. Future research could explore the dynamics created by these types of interactions among the state, firm, and non-state actor as they are shaped by the international system. Furthermore, the relationship between the BRICS and the international system of agreements is somewhat called into question by these developments. Less powerful, non-Western countries previously relied on the international system as a means of reining in more powerful states and providing fair treatment and access to less powerful ones. These treaties also sent signals to markets and other actors about the credibility of developing countries, demonstrating that they were interested in signing on to a rules-based system (Simmons, 2000). However, now that signing on to these treaties is making countries vulnerable to litigation, the BRICS countries’ relationship to the international system may have shifted. Larger countries such as China are themselves outward investors, meaning that they might themselves be subject to unfair treatment in other countries and might be interested in using the international regime of arbitration to their advantage. At the same time, firms in parts of China may be used as vehicles for this arbitration, as the Philip Morris-Hong Kong case illustrates. We can thus imagine contradictory pressures within the BRICS countries in terms of their government’s level of engagement with the international system of treaties. On the one hand, governments might want to insulate themselves from global litigation and might be tempted to withdraw from or refuse to ratify these treaties. On the other hand, firms in those countries that are engaged in outward investment might push their home governments to sign up to those treaties to afford them protection outside of their home territories.  N. Blackaby and S. Noury, International Arbitration in Latin America, Latin Lawyer Review (2006) (section on “Structuring the investment to attract the protection of i­ nvestment treaties”). 42

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Future research could also explore the various ways in which private actors in the BRICS countries — including firms, individual investors, and NGOs — contribute to and utilize regime complexes across a variety of issue areas. For example, similar layers of international rules and regimes exist in the environment, in energy,43 and in human rights. Those areas as well, are populated by firms and non-governmental organizations along with governments. Similar patterns of overlap most likely occur in these substantive areas, and closer examination could reveal the ways in which those various actors interact in those situations. Much of the popular commentary on ISDS provisions frame them as opportunities for powerful firms to litigate unsuspecting — and implicitly less powerful — countries, and this would be an area of investigation.44 Treaty shopping is an example of the transnationalization of the authority of private actors. The rule overlap in the international system means that firms can leverage institutional transitivity to obtain their objective. However, the issue for the BRICS countries has to do with the degree to which their firms are powerful and have influence with their own country. Relative access to institutions — domestic or international — compared to other sub-state or market actors is potentially a source of asymmetric power with regard to agenda setting. These opportunity structures are not equally distributed among actors. In principle, many kinds of firms — both small and large — can take advantage of treaty shopping. Indeed, many less powerful firms are able to establish shell companies — which in many countries can be  In fact, the majority of ISDS cases filed against the Czech Republic and Spain — the EU’s most frequently sued countries — involve government measures concerning renewable energy. 44  Several factors complicate the analysis of this claim. First, the economic logic of FDI s­ uggests that firms in more capital-intensive countries would tend to invest in labor-­ intensive countries. Thus, there is already something of a power asymmetry inherent in the theoretical structure of FDI (that said, the empirical pattern shows that most FDI actually occurs between developed countries, with the US and the EU accounting for the bulk of FDI inflows). Second, in the instances when expropriations or violations of investment do occur, they tend to happen in less democratic countries (Jensen, 2008; Wellhausen, 2014), which also tend to be poorer countries; the US and Western Europe have seen relatively fewer cases. So although it is the case that less developed countries tend to be the targets of litigation from firms based in richer countries, we would need to analyze this claim given the likelihood of both the initial FDI investment, as well as the likelihood of an alleged ­violation of investor rights. Even then, the secrecy of many ISDS claims would make this difficult to analyze; one might expect that particularly the more powerful firms would be better able to obfuscate their suits, meaning that the data may be censored to ­disproportionately ­represent legal action from smaller firms. 43

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done quickly and inexpensively — making treaty shopping accessible to a wide range of actors in principle. However, it tends to be the case that more powerful multinational companies are better positioned to treaty-shop for their own benefits, as they have both the resources and the information to use these treaties to their advantage. Furthermore, more powerful multinationals are more likely to have already structured their ownership to take advantage of favorable taxation, after which “back end” ISDS treaty shopping becomes easier. They can also better afford the often protracted legal costs of an international dispute.

Conclusion Most international relations theory takes the emergence of international agreements as a product of bargaining among states (Koremenos et al., 2001). In the formulation of the rational design of institutions, firms that had concerns about expropriation could lobby their governments to strike an agreement with the state in question. Firms would lobby for provisions, but voters and non-governmental organizations would have the chance to weigh in on those provisions. Treaty-shopping makes the international treaty bargaining process — long held by many as the primary form of interstate efforts toward cooperation — somewhat obviated. If firms are able to bypass the process through which states agree to reciprocal treatment of investment, this lessens the value of international bargaining and leaves states vulnerable. Dispute-settlement provisions are usually intended to be leveling features of the international system, giving all parties in the international system equal voice in the arbitration process. Prior to the introduction of ISDS provisions, it was only the powerful states who could protect their firms’ investments abroad, by intervening either at the diplomatic level, or even militarily. In the absence of a unified regime on investment protection, the uncertainty created by jurisdictional overlap leave the system open to abuse by firms from powerful countries. This is an example of the asymmetric power relations that the new interdependence theory would predict. This chapter has drawn from two phenomena that effect emerging markets around the world. The first is the rule overlap between BITs and PTAs in terms of ­substantive issue areas (shared investment chapters, overlapping rules of origin, etc.). The second is overlapping jurisdictions created by multiple international tribunals, including those found in BITs and PTAs, as well as regional agreements and international tribunals. These empirical realities have created the ability for firms to treaty shop among tribunals that may not span their original jurisdictions, incorporating abroad to take advantage of differing dispute-settlement provisions. Although this does not guarantee an outcome in favor of the firm, it does create further oppor­tunities for litigation, which can be costly and time-consuming for

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states. This reality might benefit powerful firms more than less powerful ones in terms of the overall settlement. Thus, for the BRICS countries, the theoretical and empirical phenomenon of treaty shopping creates a mixed bag in terms of outcomes. These countries have been on both the receiving end and the “shopping” end of treaty shopping. In terms of legal consequences, tribunals seem appreciative of the phenomenon of incorporating abroad, although wide variation persists in terms of whether they use the incorporation of a firm as grounds for dismissing a case. In terms of state power, countries also retain the option to exit or to renegotiate treaties that contain ISDS provisions, and many — such as Brazil and India — are choosing to do so. This ability of firms — both within and outside the BRICS countries — to jump jurisdictions as a way of taking advantage of international tribunals has implications both for IR theory and for public policy. On the theoretical front, this phenomenon cuts against the prominent theories of international integration, which put the state as primary in international cooperation and conflict. Under this view, MNCs are limited to lobbying their home country for treaty provisions that are favorable to them. However, the globalized nature of productions allows firms to sidestep the bargaining process in their country of origin. Thus, it is not only large and powerful firms that can take advantage of treaty shopping, as theories of power politics might predict. Rather, a firm needs only to have access to the global economy to avail themselves of treaty shopping. This can potentially put developing countries as well as the BRICS in a position of power in the global treaty network. On the policy front, the ability of non-state actors to supersede the interstate negotiation process might raise concerns about the consequences of globalization. If firms have the ability to act through jurisdictions to which they are not primarily accountable, this undercuts the role of the state — and the channels through which voters have to express their preferences on matters that concern them. As many debate ISDS provisions in current international economic agreements, and as governments such as Brazil and India threaten to pull out of agreements that contain such provisions, the fact that firms can dodge the interstate negotiating process might be cause for concern among those who raise questions about the democratic accountability of such agreements.

References Agnew, J. (1994). “The territorial trap: The geographical assumptions of international relations theory”, Review of International Political Economy, 1(1): 53–80. Allee, T. and M. Elsig (2014). “How Much of International Agreements is Boilerplate?”, Working paper. Arel-Bundock, V. (2016). “Treaty shopping and international tax policy”, Working paper.

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Avi-Yonah, R. S. and C. Panayi (2010). Rethinking treaty shopping: Lessons for the European Union, in M. Lang and P. Pistone (eds.), Tax Treaties: Building Bridges Between Law and Economics, Amsterdam: IBFD, pp. 21–50. Baccini, L. and A. Dür (2015). “Investment discrimination and the proliferation of preferential trade agreements”, Journal of Conflict Resolution, 59(4): 617–644. Barthel, F., M. Busse and E. Neumayer (2010). “The impact of double taxation treaties on foreign direct investment: Evidence from large dyadic panel data”,  Contemporary Economic Policy, 28(3): 366–377. Burke-White, W. W. (2008). “The Argentine financial crisis: state liability under bits and the legitimacy of the ICSID system”, Asian Journal of WTO and International Health Law and Policy, 3(1): 199–234. Busch, M. L. (2007). “Overlapping institutions, forum shopping, and dispute settlement in international trade”, International Organization, 61(4): 735–761. Büthe, T. and H. V. Milner (2009). Bilateral investment treaties and foreign direct investment: A political analysis, in K. P. Sauvant, and L. E. Sachs (eds.), The Effect of Treaties on Foreign Direct Investment: Bilateral Investment Treaties, Double Taxation Treaties, and Investment Flows, New York: Oxford University Press, pp. 171–225. Campello, D. and L. Lemos (2015). “The non-ratification of bilateral investment treaties in Brazil: A story of conflict in a land of cooperation”, Review of International Political Economy, 22(5): 1055–1086. Colgan, J. D., R. O. Keohane, and T. Van de Graaf (2012). “Punctuated equilibrium in the energy regime complex”, The Review of International Organizations, 7(2): 117–143. Davis, C. L. (2009). “Overlapping institutions in trade policy”, Perspectives on Politics, 7(1): 25–31. De Swart, F. (2015). “The use of mailbox companies in international investment protection”, European Company Law, 12(1): 19–25. Drezner, D. W. (2008). All Politics is Global: Explaining International Regulatory Regimes, New York: Princeton University Press. Fiezzoni, S. K. (2011). “The challenge of UNASUR Member Countries to replace ICSID Arbitration”, Beijing Law Review, 2: 134–144. Fleming, J. C. (2012). “Searching for the uncertain rationale underlying the U.S. Treasury’s anti-treaty shopping policy”, Intertax, 40(4). Gertz, G. (2015). “Commercial Diplomacy and the informal settlement of investment disputes”, Working paper, University of Oxford. Goldstein, J. O., A. M. Slaughter, R. Keohane, and D. Snidal (2003). Legalization and World Politics, Cambridge, UK: Cambridge University Press. Gray, J. (2009). “International organization as a seal of approval: European Union accession and investor risk”, American Journal of Political Science, 53(4): 931–949. Hale, T. (2015). Between Interests and Law: The Politics of Transnational Commercial Disputes, Cambridge, UK: Cambridge University Press. Harten, G. V. (2005). “Private authority and transnational governance: The contours of the international system of investor protection”,  Review of International Political Economy, 12(4): 600–623.

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Haug, S. M. (1996). “The United States policy of stringent anti-treaty-shopping provisions: A comparative analysis”, Vanderbilt Journal of Transnational Law, 29(2): 191–239. Jensen, N. (2008). “Political risk, democratic institutions, and foreign direct investment”, The Journal of Politics, 70(4): 1040–1052. Johnson, T. (2013). “Institutional design and bureaucrats’ impact on political control”, The Journal of Politics, 75(1): 183–197. Kim, M. (2011). “Asymmetry in relative liberalization commitments: Adjustment costs and commitments on the rate and the depth of liberalization in PTAs”, Working Paper, University of Colorado at Boulder. Kirtley, W. L. (2009). “The transfer of treaty claims and treaty-shopping in investor-state disputes”, The Journal of World Investment & Trade, 10(1): 450–458. Koremenos, B., C. Lipson and D. Snidal (2001). “The rational design of international institutions”, International Organization, 55(4): 761–799. Lupu, Y. and P. Poast (2015). “Are Bilateral Investment Treaties Really Bilateral?”, Working Paper. Miles, K. (2013). The Origins of International Investment Law, New York: Cambridge University Press. Peinhardt, C. and R. Wellhausen (2015). “Treaty withdrawal: The case of international investment institutions”, Working Paper. Poulsen, L. (2014). “Bounded rationality and the diffusion of modern investment treaties”, International Studies Quarterly, 58(1): 1–14. Poulsen, L. (2015). Bounded Rationality and International Economic Diplomacy, New York: Cambridge University Press. Poulsen, L. and E. Aisbett (2013). “When the claim hits: Bilateral investment treaties and bounded rational learning”, World Politics, 65(2): 273–313. Reinhold, R. L. (2000). “What is tax treaty abuse? (Is treaty shopping an outdated concept?)”, The Tax Lawyer, 53(3): 663–702. Rodriguez, A. F. (2008). “The most-favored-nation clause in international investment ­agreements: A tool for treaty shopping?”, Journal of International Arbitration, 25(1): 89–102. Romano, C. (1998). “Proliferation of international judicial bodies: The pieces of the puzzle”, NYU Journal of International Law and Politics, 31: 709–730. Simmons, B. (2000). “International law and state behavior: Commitment and compliance in international monetary affairs”, American Political Science Review, 94(4): 819–835. Simmons, B. (2014). “Bargaining over BITs, arbitrating awards: The regime for protection and promotion of international investment”, World Politics, 66(1): 12–46. Skinner, M., C. A. Miles and S. Luttrell (2010). “Access and advantage in investor-state arbitration: The law and practice of treaty shopping”, Journal of World Energy Law & Business, 3(3): 260–285. St John, T. (2016). Above Politics? ICSID and the Rise of Investor-State Arbitration. Manuscript, Oxford: Oxford University Press.

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Stahl, M. (2005). “Overlapping membership in COMESA, EAC, SACU and SADC: Trade policy options to overcome the problem of multiple memberships”, Working Paper. Streng, W. P. (1992). “Treaty shopping: Tax treaty limitation of benefits issues”, Houston Journal of International Law, 1(15): 1–66. Tucker, T. (2015). “Judicialization without tenure: Principal and regime complexes in investment arbitration”, Working Paper. http://papers.ssrn.com/sol3/papers.cfm? abstractid=2663778. Van Os, R. and R. Knottnerus (2011). “Dutch bilateral investment treaties: A gateway to ‘treaty shopping’ for investment protection by multinational companies”, SOMO Working Paper. Wellhausen, R. L. (2014). The Shield of Nationality: When Governments Break Contracts with Foreign Firms, New York: Cambridge University Press. Yackee, J. W. (2014). “Do states bargain over investor-state dispute settlement-or, toward greater collaboration in the study of bilateral investment treaties”, Santa Clara Journal of International Law, 12(11): 277–301.

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PART IV

Climate Negotiations and Energy Governance

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CHAPTER 12

BRICS in the International Climate Negotiations Axel Michaelowa and Katharina Michaelowa Department of Political Science, University of Zurich, Switzerland

Introduction This chapter examines the role that the BRICS, i.e. Brazil, Russia, India, China, and South Africa, have played in the international climate negotiations. These negotiations have been undertaken continuously since the late 1980s, with the following key milestones: The United Nations Framework Convention on Climate Change (UNFCCC) being agreed in 1992, the Kyoto Protocol to the UNFCCC negotiated in 1997, which covered the period 2008−2012, and finally, the Paris Agreement for the period after 2020, agreed in 2015. Due to a traumatic negotiation failure in Copenhagen 2009, the regime has shifted from a “top-down” structure with centralized rules and mitigation commitments exemplified by the Kyoto Protocol to a “bottom-up” approach embodied in the Paris Agreement. Here, all countries define their mitigation “contribution” and report about their implementation progress according to rules defined on the international level. In international climate negotiations, countries have traditionally formed groups who try to push joint negotiation positions. Initially, there was just one major divide, namely, between countries listed in Annex I of the UNFCCC (“industrialized countries” or “Annex I countries”) and those not listed (“developing countries” or Non-Annex I countries’). Over time, more specific negotiation groups have been 289

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Late 1990s (a)

Mid-2010s (b)

Figure 1:   Negotiation groups in the early and the current phase of international climate negotiations. Note: Groups are overlapping due to multiple membership.

formed, the landscape has become more fragmented, and groups on specific issues, such as forest protection, have emerged (see Figure 1). These negotiation groups are not linked to the emissions growth of countries — there is no group of countries with high emissions growth, nor one of those with low emissions growth. All five BRICS countries are often thought of as emerging powers, i.e. countries that have become powerful, individually or as a group, and thereby challenge the established power structure within international regimes or regime complexes. Statements of BRICS foreign ministers regularly mention the need to address the c­ limate change problem (Brütsch and Papa, 2013: 322; Ruppel and RuppelSchlichting, 2013: 562−563), but BRICS countries do not negotiate jointly within the UNFCCC (Gladun and Ahsan, 2016: 40; Davenport, 2012: 38). Even at the most

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basic level of differentiation, Russia is part of Annex I while the other BRICS are not. Given this situation, how relevant are the BRICS, individually and as a group, in the context of the international climate negotiations, over time and especially in the most recent period after the Paris Agreement in 2015? Does it make sense to look at them as a group at all? Can these countries all be considered as emerging powers in this context, and if so, in which way do they challenge any established international players? At the same time, how stable has their own position become by now, and what are the main challenges they face themselves? In the following, these questions will be discussed with a specific focus on relevant dynamics over time.

Emerging Powers within the UNFCCC: BRICS, BASIC or just China? When comparing different fields of international policy making and/or ­different regime complexes, it becomes obvious that the BRICS do not always assume relevance in the same way. In some areas, e.g. development aid, the truly emerging donor at any relevant scale, effectively challenging the established donor community, is China (see Chapter 7). In other fields, such as energy security, and security policy more broadly, Russia seems to play a predominant role (see Chapters 2 and 13). Within BRICS, Brazil and South Africa seem to have been chosen as representatives of the Latin American and African continent, while not necessarily playing in the same economic and political league as China, India, and Russia (see Ruppel and Ruppel-Schlichting, 2013: 558−559 for a discussion on why South Africa was invited into the BRICS). With regard to our field of interest, Davenport (2012: 38) clearly states that they have never formed a homogeneous group: The BRICs have certainly never acted as a concerted force in international climate change negotiations; instead, their behaviour reveals marked and intriguing differences between four countries [sic] with a broadly similar status in the global economy.1

This view is echoed by Brütsch and Papa (2013: 319) and Leal and Nabuco (2016: 6). In yet other areas such as science (Finardi and Buratti, 2016), all five countries collaborate, which gave rise to the joint group term “BRICS” in the first place. In the climate negotiations, the term “BRICS” has never been used.

 Note that Davenport counts only four countries because South Africa was included only in 2011 into the BRICS. Even though it joined the group in December 2010, South Africa’s BRICS membership was formally confirmed only at the third BRICS Summit in April 2011. 1

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The Emergence of BASIC In 2009, just before the major Conference of the Parties (COP) 15 in Copenhagen, the four countries Brazil, China, India, and South Africa formed a negotiation group known as “BASIC”. The initial push came from China and India in October 2009, with the alliance formally unveiled in November 2009, one week before the start of the Copenhagen negotiations (Qi, 2011: 307).2 This group dominated the negotiations and the “Copenhagen Accord” was the result of a deal between the US and BASIC, while the previously leading EU was sidelined. Since then BASIC countries have met at a ministerial level every quarter, and also engaged domestic researchers in joint analyses of key problems of international climate policy (see e.g. BASIC experts, 2011). This provides us with a first idea about who the emerging powers may be in the context of this policy field, and that Russia may have a somewhat less relevant position here. Russia: The Outlier Within BRICS Russia was always member of a different negotiation group than the BASIC countries, and had markedly different interests, especially in the context of the Copenhagen conference (see Brütsch and Papa, 2013: 321, Leal and Nabuco, 2016: 7). Here, Russia promulgated a “Climate Doctrine” that stressed the benefits of climate change for the country (Gladun and Ahsan, 2016: 28). Russia essentially wants to avoid any negative effects of international climate policy on its fossil fuel export revenues, and has always resisted ambitious emission targets. Ever since the Kyoto Protocol it has tried to generate revenues from sale of surplus emission allowances, the so-called “hot air”. At the Durban conference of 2011 Russia teamed up with Canada and Japan in order to block the extension of the Kyoto Protocol beyond 2012 unless other major economies, i.e. BASIC countries, accepted binding emission commitments (Brütsch and Papa, 2013: 323). In Doha 2012, Russia almost scuppered the final plenary due to its anger about the elimination of “hot air” from the second commitment period of the Kyoto Protocol. Gladun and Ahsan (2016: 9) see Russia’s “distancing itself from its partners” in the context of global climate change as a deficiency that weakens the  Qi (2011: 301−302) stresses the role of an EU funded project which brought together researchers and stakeholders from the later BASIC members between 2005 and 2007, and which did actually create the acronym “BASIC”. This project led to a “Sao Paulo Proposal” that contained many elements of the 2015 Paris Agreement, notably voluntary contributions of developing countries and the 2°C target. However, it was still anchored in the Kyoto Protocol architecture. 2

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role of BRICS in global governance overall. It should also be stressed that Russia has been seen as highly unpredictable player in the climate negotiations. Assessing the Strength of BRICS Member Countries in the UNFCCC Negotiations We will examine the role of the different BRICS countries more systematically in the following using two specific indicators of power within the UNFCCC. The first relates to the countries’ contribution to global greenhouse gas emissions and their development over time. In the specific context of the international climate negotiations, this indicator is highly relevant for a country’s role in the negotiations because any agreement that does not include a substantial share of world emissions will not yield any substantial benefits in the future. As a consequence, the entry into force of all major agreements in the context of the UNFCCC required a minimum share of world emissions to be covered by member countries. For instance, the entry into force of the Kyoto Protocol in 2005 depended on 55% of Annex I emissions (i.e. of all emissions from countries that would have binding commitments under the Kyoto Protocol) to be covered. Similarly, the entry into force of the Paris Agreement in 2016 required a minimum of 55 countries jointly covering at least 55% of world emissions to ratify.

14000 12000 10000 8000 6000 4000 2000

Russia

Brazil

South Africa

India

2013

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2007

2005

2003

2001

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1995

1993

1991

1989

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1983

1981

1979

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0

China

Figure 2:   Cumulative CO 2 emissions from fossil fuel use of BRICS countries 1971−2014 (million t).

Note: The share of Russia in total emissions of the Soviet Union in 1990 has been applied to the Soviet Union emissions from 1971−1989 to extend the Russian data series. Source: IEA (2016).

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BASIC share

BRICS share

2013

2011

2009

2007

2005

2003

2001

1999

1997

1995

1993

1991

1989

1987

1985

1983

1981

1979

1977

1975

1973

0

1971

10

OECD share

Figure 3:   The share of BASIC, BRICS and the OECD in global CO2 emissions (%).

In terms of overall emissions, China clearly stands out, with India becoming relevant since the 2000s. Brazilian and South African emissions are dwarfed by those of the other BRICS (see Figure 2). However, it should be noted that Brazilian emissions from deforestation, which are not covered in the Figure,3 oscillated between 500 and 1500 million t CO2 annually, making the country a relevant emitter on the global scale. Note that Russia significantly lost importance in relative terms: The country had a much higher share in world emissions when the Kyoto Protocol was negotiated in 1997 than when the Paris Agreement was concluded in 2016. This is due to both the rapidly increasing emissions of the other BRICS, notably of China, and the decline of the Russian economy. Figure 3 shows how the share of BASIC countries in global emissions has more than quadrupled since 1970, while the share of the BRICs only doubled. This discrepancy is again explained by the initially high, but subsequently declining Russian emissions. By 2013, BASIC had overtaken the OECD in terms of overall emissions. The second indicator for relevance within the UNFCCC directly reflects the role of the respective country or country group in the negotiations. These negotiations take up at least four weeks every year, with two weeks used for the formal decisionmaking by the Conference of the Parties (COP) and two weeks for the meeting of the subsidiary bodies to the UNFCCC. Formal decision-making requires consensus. Consensus however, has been interpreted differently over time. Opposition of one  Reliable long-term statistics on CO2 emissions from deforestation are unfortunately not available. 3

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400 350

Brazil

300

China

250

India

200

South Africa

150

BASIC

100

Russia

50 13

12

20

11

20

10

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09

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08

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07

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96

0 95

Number of comments received by other parties

or two smaller countries has repeatedly been overridden by the COP president, but even Russia’s opposition in 2012 was not seen as lack of consensus by the Qatari COP president. We use an indicator based on a count of statements commenting upon the statements of other parties at these negotiation sessions, i.e. whether countries support, agree with, oppose, or criticize other countries’ statements or positions. On the one hand, this indicator shows the active participation of any given country, and on the other hand, it shows how often the country’s interventions have been used as a reference for others. This dataset is based on Castro’s (2017) hand-coding of summaries of the international climate negotiations published in the Earth Negotiation Bulletins (ENBs) between February 1995 (11th Session of the INC in New York) and December 2013 (COP19 in Warsaw).4 The ENBs have been chosen as the data source since they are seen as a detailed and objective source of information by many negotiators and observers in the climate talks, and because there are no publicly available official transcripts of the negotiations. Figure 4 uses these data to show how often statements by individual BRICS countries as well as by BASIC as a whole have been used as a reference by other parties in the negotiations, which we use as a proxy for their relevance in the negotiations. The graph shows that China has consistently been the BRICS country most frequently referred to by other countries, followed by India. Brazil was seen as important at some COPs, for example in the context of the “Brazilian Proposal”

Figure 4:   Comments received by other parties at UNFCCC COPs.

Note: The peaks in 1995, 2000, 2009 and 2012 are due to the increased significance of the COPs in these years and the broad range of topics covered there. Source: Castro (2017).

 The original ENBs can be downloaded from http://www.iisd.ca/vol12/. For a detailed description of the new dataset by Castro (2017), see Bagchi et al. (2017, Annex 1). 4

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­ uring the late 1990s but not at others. Russia was seen as important in the beginning d of the period, but not at its end. Castro’s (2017) data also allow us to classify the BRICS within all other p ­ arties and negotiation groups based on the above indicator. The resulting ranking shows that in 2013, the last year of the coding period, China was the country most ­frequently referred to among all parties (ahead of the EU), and both India and Brazil also ranked among the top 10 countries, on ranks four and ten respectively. In contrast, Russia and South Africa only reached ranks 28 and 39. India: Principled Approach to UNFCCC Negotiations In terms of active participation in the negotiations, India stands out. It has been renowned for a highly principled stance on the principle of equity, and on the interpretation of “common but differentiated responsibilities”, but at times, it has also been successful in brokering consensus. Already in Berlin 1995, India built a key bridge between industrialized and developing countries through formation of a “Green Group” within the G77 (Happaerts, 2015: 249). In Kyoto 1997, it opposed emissions trading unless initial allocation of emissions budgets was done equitably (Davenport, 2012: 43). India was crucial in brokering agreement on “Nationally Appropriate Mitigation Actions” at the Bali conference in 2007 (Qi, 2011: 303). India played a key role in the endgame in Copenhagen as well as in Cancun 2010, especially due to its environment minister Jairam Ramesh taking relatively progressive positions with regard to mitigation commitments that were subsequently criticized at home (Michaelowa and Michaelowa, 2012: 578−579). While the Indian position hardened again after Ramesh took over a different ministry within the Indian government, India played a crucial role in the final plenaries between Durban 2011 and Warsaw 2013, where it was a relevant participant of “huddles” to resolve remaining conflicts. In Cancún, India’s intervention allowed to overcome the stalemate between industrialized and developing countries with regard to external monitoring of mitigation in the latter (Qi, 2011: 312−313). As compared to other BRICS except for South Africa, India has the advantage of a well-trained elite fluent in English, which represents a major advantage within the negotiations (Michaelowa and Michaelowa, 2012: 586). China — Rising Negotiation Star China engaged strongly in the UNFCCC negotiations in the latter half of the 2000s, sending huge delegations, and since Copenhagen the country has always played a critical role in the final outcome of the COPs. While pushing strongly for energy efficiency policies on the domestic level for many years (see e.g. Leal-Arcas, 2013:

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25), until 2014, China unambiguously argued against any kind of obligations at the international level, which was a crucial determinant of the “bottom up” nature of the Copenhagen Accord (Michaelowa and Michaelowa, 2015: 509). The standoff between Annex I countries and China at the Copenhagen conference in 2009 on this issue became legendary. Representatives of the former had proposed a global emission reduction target of 50% between 1990 and 2050 in order to reach the 2°C target, while industrialized countries would reduce their emissions by 80% during that period. China opposed this proposal which led to the exasperation of German Chancellor Merkel who asked “why are we not allowed to set targets for ourselves?” However, as the Chinese correctly recognized, the joint definition of the overall target and the part taken over by commitment of Annex I countries would have led to implicit emission reduction requirements for Non-Annex I countries that would have been even more stringent than those for Annex I countries. This is due to the fact that if one sets a global emissions target and a target for industrialized countries, this automatically defines an emission target for developing countries. Figure 5 shows how the target for developing countries would have looked like. It depicts business as usual emissions growth for Annex I and Non-Annex I countries until 2020, and the necessary emission reductions from 2020 onwards to reach the 2050 target. The Chinese role after Copenhagen was further strengthened by the intense diplomatic outreach of the Obama Administration to the Chinese government, which led to a “tandem” role of these two countries both in the run-up to the Paris COP and its aftermath. A special US−China deal in November 2014 on long term

Figure 5:   Emissions development for Annex I and Non-Annex I countries under business-asusual, and the proposed Copenhagen global emission target for the year 2050. Data Sources: Global level and industrialized countries 2020: UNEP (2012, Appendix 1: 7), Industrialized countries (Annex I) 1990 and 2010: UNFCCC inventories, Developing countries (Non-Annex I): calculatory difference.

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mitigation by both countries indicated China’s readiness to take up an international commitment, and paved the way for the Paris Agreement. Brazil and South Africa — Playing Bridging Roles Brazil and South Africa were less visible than India and China, but in contrast to the latter, both countries have indicated an openness to take up mitigation ­commitments since the late 2000s. Happaerts (2015: 248) stresses that Brazil had “the most a­ mbitious climate policies, arguably even among all non-Annex I c­ ountries” and thus found itself at odds with China’s and India’s positions. Since 2007, South Africa developed detailed scenarios for long-term mitigation, determined in terms of absolute emissions and including the idea of a peak year (Michaelowa and Michaelowa, 2015: 507). Qi (2011: 309) underlines that South Africa faced criticism by other African countries about its alignment with China and India at the Copenhagen conference. In Durban 2011, South Africa pushed for emissions mitigation by developing countries. Russia was a key player at the Kyoto conference in 1997, refusing to take up an emission reduction target, and called the “greatest winner” by Davenport (2012: 42). In contrast, Gladun and Ahsan (2016: 21) state that Russia “remained largely irrelevant in international negotiations on climate change”. This shift from key player to outsider can be linked to the changed political context due to different US Administrations. When it became clear in 2000 that the United States would not ratify the Kyoto Protocol, Russia’s ratification became crucial for the Protocol’s entry into force. This allowed the country to play an important role for a while and to push through a number of special clauses to its own advantage, notably the possibility to receive credits for carbon sequestration of forests which would happen anyway (Davenport, 2012: 45). Only when the EU stated clearly that it would block Russia’s accession to the WTO if Russia did not ratify the Protocol, the Russian government did so in 2004 (Makarov, 2016). In contrast to the situation under the Kyoto Protocol, the Obama Administration ratified the Paris Agreement without delay, and once the world’s two largest emitters China and the United States had ratified in September 2016, there was no more risk that the emissions threshold for the entry into force of the agreement might not be met. As a consequence, Russia did not have special bargaining power anymore. Overall, clearly the relevant emerging powers in the international climate negotiations are China with its now extremely high share of world emissions, but also India, Brazil, and South Africa due to their strong emissions growth. This is also evidenced by the countries’ active role in the negotiations, especially by India, but also by BASIC as a group. BASIC took up the position that industrialized

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countries should continue to carry the main burden of climate change mitigation as long as per capita emissions of emerging economies remained significantly below those of industrialized countries. Over the years and following the initial surprise regarding BASIC’s negotiation power at Copenhagen, other parties started developing ­expectations for BASIC and its individual members to actually take over leadership roles for the whole UNFCCC process. At the Paris conference, BASIC countries worked carefully towards an agreement, bolstered by the strong diplomatic interaction between the US and the BASIC countries prior to the conference. At the start of the Trump Administration, which renounced any leadership from the side of the United States on climate change, Chinese Prime Minister Xi Jinping expressed willingness to take over a leadership role (World Economic Forum, 2017). In contrast, Russia cannot be counted into the group of emerging powers here. Rather than as “emerging”, it appears to be a declining power (see also Hou, 2014: 27): While being part of Annex I, i.e. a country that should have committed to active emission reduction policies, such policies were never actually introduced in the country, given the continued replacement of outdated socialist heavy industry technology by more modern equipment, which led to co-benefits in terms of a lower emissions intensity. Given the country’s long-term blocking attitude as well as unpredictability (Andonova and Alexieva, 2012: 614), it is not confronted with any international expectations. While Russia was important for the ratification of the Kyoto Protocol due to its high share of world emissions, it has become a more or less irrelevant player now, whose only interest is widely perceived as protecting its economic growth and selling “hot air”.

Where BASIC Is Challenging the Established Players As described above, especially during the Copenhagen negotiations, BASIC ­managed to reach a key position within the negotiations. The countries’ strategy was successful, not only with respect to international recognition as major players (both for BASIC as a whole, and individually for China and India), but also with respect to the solution adopted in the Paris Agreement, namely, with no top-down obligations, but a pure bottom-up system. In addition, following the Chinese criticism at Copenhagen, the Paris Agreement does not link the individual countries’ “nationally determined contributions” to the overall goal to avoid global warming beyond 1.5−2°C. This yields a large emissions gap between the global target and national pledges — a problem that was discarded in Paris in the hopes to achieve a strong ratcheting-up process. In contrast, the EU did not find sufficient support for its positions, and generally seems to be losing more and more of its leadership role.

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As opposed to other areas, where the large emerging economies have tried to challenge industrialized countries outside established fora, notably by building new and competing institutions, BASIC has always referred to the UNFCCC as the key ground for climate change negotiations. Arguably, this is due to the consensus principle — even in its somewhat hollowed-out form that has developed in the UNFCCC context — and the absence of weighted voting rights in contrast to the decision-making rules in other international organizations, such as the World Bank and the IMF. It is not yet clear to what extent the greater power of BASIC members, notably of China and India, will be a challenge or rather an advantage for the future dynamics of the climate negotiations. With increasing power, they appear to also (slowly) adjust their positions to take up greater responsibilities. Given their growing importance they also face increasing demands to contribute to the solution of the problem of global warming. BASIC members “have been pushed by mounting international pressure to play a greater role in international affairs in line with their growing global impacts” (Hallding et al., 2013: 620). This pressure increasingly came from developing countries, too (e.g. Michaelowa and Michaelowa, 2012: 578). Initially, BASIC countries insisted that their status as developing countries meant that they were not obligated to take up emissions reductions commitments. When pressured to do so in Copenhagen, they simply referred to the principle of “common, but differentiated responsibilities” and did not accept any differentiation within the group of developing countries for that purpose. Accordingly, Tabau and Lemoine (2012: 197) see BASIC countries as wanting more power but fearing responsibilities. 2 years later Hochstetler and Milkoreit (2014: 224) stressed that BASIC is destabilizing the climate negotiations by introducing a third category beyond Annex I and Non-Annex I. Finally, del Pilar Bueno and Pascual (2016: 127) see BASIC as a key reason for the success of the Paris conference. They argue that Paris negotiations were based on an agreement between the US, BASIC and the EU. This increasing willingness to take up responsibility was already predicted by Michaelowa and Michaelowa (2015).

Own Challenges and Inconsistencies Within the BASIC Group Some of the changes within BASIC may be related to challenges that have emerged within the BASIC group soon after its creation. In particular, there has been a somewhat contradictory self-representation strategy of BASIC and its individual members: On the one hand, they state that they are poor developing countries that

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cannot be burdened with significant mitigation contributions. On the other hand, they argue that they are strong economic and political powers able to play a key role in defining the climate policy architecture of the future. This is particularly visible in the case of India. At the UNFCCC COPs in 2015 to 2017, India presented itself as a high-tech nation with a flashy pavilion that would have raised attention at a World Exposition. At the same time, it was arguing for “climate justice” ­(implying that one should not point at poor countries like India to engage in potentially growth-impeding climate change mitigation solutions) and stated how age-old traditions contribute to low-emission lifestyles. For BASIC as a whole, the same dilemma was obvious: On the one hand, its main objective initially was to clarify that its members firmly belonged to non-Annex I (and should thus remain without any binding ­commitments). On the other hand, as rightly stated by Hochstetler and Milkoreit (2014: 224) the creation of BASIC itself signaled the existence of a new set of emerging powers, and hence a third category of countries between Annex I and Non-Annex I. An additional challenge is that BASIC members are less homogeneous as it may appear at first glance. As shown in Table 1, they strongly differ with respect to their income status, with India having a GNI per capita of less than half of any of the other BASIC countries and emissions that are much smaller than those of the

Table 1:   Key characteristics of BASIC member states. Country

GNI pc 2015 t CO2 USD (PPP) pc 2014

Economy and Climate Change

Climate Policy Preferences

Brazil

15,020

2.3

Deforestation based. Large biofuel production sector.

Pro REDD+ and CDM

China

14,160

6.6

Large coal producer, but strongly upcoming on renewables, huge energy needs.

Energy efficiency (gave up on CDM)

India

6,020

1.5

High vulnerability to climate change, rural energy poverty (traditional biomass).

Moral claims, pro CDM and climate finance (≠ aid)

South Africa

12,830

7.9

Large coal producer, mining.

Most accommodating — accepted absolute targets, COP17 in Durban 2011

Notes: Per capita emissions refer to fossil fuel combustion (IEA, 2016). GNI per capita in many Eastern European countries is comparable to BASIC members, e.g. $16,000 in Bulgaria and $7,800 in Ukraine.

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other countries in per capita terms. Despite its recent growth spur, it hence largely remains a developing country for the moment. The relevant economic sectors and hence both vulnerability to climate change and the cost or benefits arising from mitigation policies also differ significantly across the four countries. This in turn generates different priorities in the context of international climate policy. Brazil, for instance, has a strong interest in obtaining finance for the protection of its remaining rainforest, i.e. policies negotiated under the label REDD+ (Reducing emissions from deforestation and forest degradation), and funding for emission reductions in the framework of market mechanisms such as the Clean Development Mechanism (CDM) introduced in the framework of the Kyoto Protocol. China and India have also greatly benefitted from the CDM in the past, developing thousands of projects and receiving billions in revenues of sales of emissions credits to industrialized countries. Given its own financial capabilities, China seems to have given up the hope that other countries would thereby fund its mitigation projects in the future. In contrast, India still expects external f­unding — not just through the CDM, but also through other support for its mitigation activities (climate finance) — but tries to ensure that this funding should be distinct from development aid in order to obtain full freedom over the use of funds and — presumably — to avoid the stigma of an aid recipient that does not fit well with the economically and politically powerful image the country otherwise wishes to project. South Africa, finally, takes up a rather open and more accommodating position in the negotiations, which is quite surprising given that its economy is widely based on coal and mining with less opportunities to explore in the renewables sector than in the other BASIC countries. Hence within BASIC, preferences and policy priorities are clearly diverging. Ever since the success in Copenhagen, it has become difficult to keep the unity among BASIC members given these significant differences. South Africa for instance, chose the role of a “bridge builder” between North and South when it hosted the Durban Conference in 2011. In this context, it published a national emissions limitation strategy at a time when the other BASIC members were adamantly refusing defining national emission commitments (Michaelowa and Michaelowa, 2015). Hochstetler and Milkoreit (2014: 230) stress that BASIC was in disarray during the Durban conference, even denying that it was a real negotiation group. South Africa as host country pressed for concessions of Non-Annex I to Annex I countries. Similarly, Brazil was relatively open to national mitigation action as its deforestation emissions were coming down steeply in the late 2000s (Hochstetler, 2012). China tried to keep the original Copenhagen position and — finding BASIC too soft — was instrumental in the creation of a new negotiation group. This “Like-minded developing country group” (LMDC) set up in 2012 became the hardline voice of those countries that

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did not want to engage in any significant mitigation, unless receiving substantial financial and technical assistance (Blaxekjaer and Nielsen, 2015: 759). China so could use either BASIC or the LMDC to spread different messages depending on its negotiation strategy. India has followed China in this use of two negotiation groups depending on the degree of stringency of its position.

Whither BRICS in the International Climate Negotiations? Convergence, Divergence, and Research Frontiers Can BRICS countries play a positive role in international climate policy by ­brokering “upward compromises” (Davenport, 2012: 52) or do they lead to further fragmentation of the international climate policy regime? Will they be able to go beyond “taking up actions only in areas in which their economic trajectories would not be hampered” (Leal and Nabuco, 2016: 7)? Prior to the Paris Agreement, BRICS could not act as one group in the UN due to the Annex I-Non-Annex I divide that separated Russia from the rest of the group. After the Paris Agreement, which formally did away with the divide, BRICS countries theoretically would have the chance to form a strong negotiation bloc. The BRICS environment ministers established a working group on the environment in 2015 which could, in principle, fulfil a coordination role for climate negotiation positions (Gladun and Ahsan, 2016: 40−41). Principally, BRICS could become a powerful negotiation group. But this has never happened. Instead, parts of BRICS with converging interests were able to form a negotiation group, BASIC, which played a critical role in redefining the international climate policy regime between the Copenhagen Conference and the Paris Agreement. But once its aim of preventing legally binding commitments for emerging economies was reached, BASIC lost relevance in the negotiations, as differences in interest became visible. The substantial divergence of interests among BRICS members due to different economic structures, levels of income and emissions intensities has led to different positions in the UNFCCC negotiations, especially in the last years. These significant differences in interest make it very unlikely that BRICS will speak with one voice, unless the countries converge with respect to their economic performance and emissions intensity. Russia does not make any efforts to wean itself off fossil fuel export revenues, and thus will not support any significant mitigation targets. China is now increasingly seeing itself as world leader in climate policy, especially after the US can no longer fulfil this role under President Trump. In this role, it does not want to be bound by specific negotiation group interests, but remain flexible as shown by its use of various negotiation groups in the past. India with its still low, but rapidly

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rising per capita emissions and high poverty-related challenges will continue to argue for significant headroom to grow its emissions, and equity-based approaches to mitigation. Brazil’s domestic political and economic woes will relegate climate policy issues to lower political relevance than in the past decade. The same is likely in South Africa, which, in 2017, again deferred the introduction of a carbon tax. Future research may try to assess what conditions could lead to a closer collaboration of BRICS, and what conditions would further a continued increase of divergence. In hindsight, the huge success of BASIC in Copenhagen (see the detailed description of BASIC’s activities there by Nhamo (2010: 365−366)) may be seen as a historical “lucky punch” instead of the start of a negotiation alliance successful in the long run. Therefore, climate leadership is unlikely to emanate from the BASIC or BRICS as a group.

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Hochstetler, K. (2012). “The G-77, BASIC, and global climate governance: A new era in multilateral environmental negotiations”, Revista Brasileira de Política Internacional, 55: 53–69. Hochstetler, K. and M. Milkoreit (2014). “Emerging powers in the climate negotiations: Shifting identity conceptions”, Political Research Quarterly, 67(1): 224–235. Hou, Z., J. Keane, and D. te Velde (2014). Will the BRICS Provide the Global Public Goods the World Needs? ODI: London. IEA (2016). CO2 Emissions from Fossil Fuel Combustion, Paris. Leal, A. and P. Nabuco (2016). “The BRICS on climate change global governance”, Meridiano, 47, 17: e17020. Leal-Arcas, R. (2013). “The BRICS and climate change”, International Affairs Forum, 4(1): 22–26. Makarov, I. (2016). “Russia’s participation in international environmental cooperation”, Strategic Analysis, 40(6): 536–546. Michaelowa, A. and K. Michaelowa (2015). “Do rapidly developing countries take up new responsibilities for climate change mitigation?”, Climatic Change, 133(3): 499–510. Michaelowa, K. and A. Michaelowa (2012). “India as an emerging power in international climate negotiations”, Climate Policy, 12(5): 575–590. Nhamo, G. (2010). “Dawn of a new climate order: Analysis of USA + BASIC collaborative frameworks”, Politikon, 37: 353–376. Del Pilar Bueno, M. and G. Pascual (2016). “International climate framework in the ­making: The role of the BASIC countries in the negotiations towards the Paris Agreement”, JANUS.NET e-Journal of International Relations, 7(2): 121–140. Qi, X. (2011). “The rise of BASIC in UN climate change negotiations”, South African Journal of International Affairs, 18(3): 295–318. Ruppel, O. and K. Ruppel-Schlichting (2013). “The BRICS partnership: Development and climate change policy from an African Perspective”, in O. Ruppel, C. Roschmann and K. Ruppel-Schlichting (eds.), Climate Change: International Law and Global Governance (Volume II: Policy, diplomacy and governance in a changing environment), BadenBaden: Nomos, pp. 549–569. Tabau, A.-S. and M. Lemoine (2012). “Willing power, fearing responsibilities: BASIC in the climate negotiations”, Carbon and Climate Change Law Review, 3: 197–208. World Economic Forum (2017). President Xi’s speech to Davos in full. https://www.weforum. org/agenda/2017/01/full-text-of-xi-jinping-keynote-at-the-world-economic-forum (accessed 26 February 2017).

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CHAPTER 13

The BRICS, Energy Security, and Global Energy Governance Matteo Fumagalli School of International Relations, University of St Andrews, UK

Introduction On 1 June 2017, US President Donald J. Trump announced that the United States would withdraw from the Paris Agreement on Climate Change (hereafter, PACC), which the United States had previously signed in April 2016 (Rucker and Johnson, 2017). Although the earliest this can formally happen is 2020, the announcement nonetheless deals a significant blow to global energy governance due to the defection of one of the world’s largest emitters of greenhouse gases. With even Syria signing the PACC in November 2017, that left the US as the only country that will not be part of the agreement. Whether this will in the end be tantamount to a “gift” to China’s president in the form of an opportunity for global leadership, as the New York Times wrote at the time (Sanger and Perlez, 2017; Urpelainen, 2017), remains to be seen. Regardless of that, the US’s withdrawal raises questions about the future of the Western-led international order and global governance arrangements (Bomberg, 2017). Recent developments and shifts in global energy markets have brought adjustments to how consuming countries pursue energy security, here understood in terms of the accessibility, affordability, efficiency, and environmental sustainability of energy (Sovacool, 2010a). Changes to domestic energy strategies and international energy diplomacy are having implications for global energy governance (here 307

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defined as “international collaborative efforts undertaken to manage and distribute energy resources and provide energy services”) (Florini and Sovacool, 2009: 5239). Thus, developments in the field of energy offer a useful vantage point to reflect on developments in global governance arrangements and the emergence of a new post-Western architecture, and the role of rising powers in bringing that into reality. Energy security is one of the greatest challenges of the 21st century (Dannreuther, 2017; Goldthau and Sitter, 2015). The global economy is changing rapidly, with population and economic growth shifting towards emerging markets. Nowhere is this more evident than in the case of the BRICS countries (Brazil, Russia, India, China, and South Africa). Virtually all the growth in world energy demand comes from these fast-growing emerging economies, especially China and India. These five countries alone will make up over 50% in world energy demand by 2035 (BP, 2017a). China is expected to be the largest growth market for energy for most of the next two decades, but it is expected to be overtaken by India by 2035 (BP, 2017a). By contrast, energy demands among OECD economies is forecast to barely increase. This chapter focuses on how the BRICS are responding to the intertwined politics of energy and climate change, domestically and internationally. The origins of the BRICS acronym date back to 2001, when “Jim O’Neill, then head of global economic research at Goldman Sachs, predicted the rise in economic power of Brazil, Russia, India, and China (then only BRIC, as South Africa joined in December 2010) in the following decade” (D’Ambrogio, 2014: 1).1 The five countries surely can be regarded as “heavyweights” in terms of size, demography and economy (D’Ambrogio, 2014: 1). “Taken together they encompass 26% of the world’s land and 42% of the world’s population” (D’Ambrogio 2014: 1). In 2015 their GDP reached $33.1 trillion, and their per capita GDP was $10,709 (BRICS Energy Indicators, 2015: 1). In the energy sector, the BRICS accounted for 37% of the world’s energy demand (up from 30% in 2008) and for 41.4% of CO2 emissions due to energy usage (up from 33% in 2008), in large part owing to the significant presence of coal in their energy mix (MME, 2015: 1; MME, 2008: 1). They represent 20% of world trade. These are impressive figures. Yet, “the BRICS remain a heterogeneous group of countries. They do not share a geographical context, they are not a trading bloc, nor are they united by cultural affinities or historical ties” (D’Ambrogio, 2014: 1−2). In fact, they do not have many ties apart from the fact that they are rising economic powers, or that they are perceived to be.2 The asymmetry between the various BRICS countries is also evident: China’s economy is larger than those of the other four combined. Beijing’s GDP represents  South Africa’s BRICS membership was formally confirmed only at the third BRICS Summit in April 2011. 2  Russia went through severe economic slumps first during the 2008−2009 global financial crisis (GFC) and later as a result of the Western sanctions imposed after Moscow’s 1

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58% of the group’s GDP. “Two thirds of BRICS’ trade is generated by China, placing it in a dominant position” (D’Ambrogio, 2014: 1). China ranks among the top three destinations for the exports of the other members of the BRICS group; furthermore, 85% of intra-BRICS trade involves China (D’Ambrogio, 2014: 1). The two countries’ economies differ starkly from one another: China and India are pursuing industrial development. Brazil and Russia tend to rely more extensively on the gains of commodities exports (D’Ambrogio, 2014: 2). The group includes “three multi-ethnic and multi-cultural democracies (Brazil, India, and South Africa) and two authoritarian states (Russia and China)” (D’Ambrogio, 2014: 2). All this taken together raises considerable questions about the cohesiveness and coherence of the group. At the same time, the group has gone a long way in institutionalizing; regular summits, an expanding agenda, a BRICS bank. While the role of BRICS in global economic governance has been subject to some degree of scrutiny (Hopewell, 2017 on trade; Huotari and Hanemann, 2014, Slaughter, 2017, Cooper, 2017 and Schollman, 2014 on finance; Nicolas, 2016 on economic governance), less has been said about their role in energy and environmental governance. When it has, this has typically come in the form of country case studies3, with few limited BRICS-wide exceptions4. The subject has also been neglected in earlier reviews of the field such as the Routledge Handbook of Energy Security (Sovacool, 2010b), the Routledge Handbook of Global Environmental Politics (Harris, 2016), and the relevant entries of International Studies Association (ISA)’s Compendium (Ozdamar, 2017; Duffield, 2010), Global Energy (Ekins et al., 2015), the Handbook of Global Environmental Politics (Dauvergne, 2012), or Bernauer (2013) and Hughes and Lipscy (2013)’s reviews of the field. The 2012 study by the Norwegian Institute of International Affairs (NUPI) (Eriksen et al., 2012) and Anceschi and Symons (2012) are rare exceptions, but are in need of updating. Thus, this chapter contributes to the field by taking stock of recent trends in the form of shifts in the energy markets and the way they have affected and in turn been reshaped by the BRICS and also, theoretically, by reviewing the terms of the scholarly debate and conversations on the relationship between the BRICS and energy security. Scholarship on energy and energy governance has grown tremendously in recent annexation of Crimea in 2014. South Africa and Brazil experienced recessions in recent years, too, and China went through a slowdown in 2014−2015. 3  On Russia see Shadrina and Bradshaw (2013), Henderson and Mitrova (2015), Heinrich (2003); on China (Kong, 2011; Christoffersen, 2016; Wu and Nakano, 2016; Wang, 2014), on India see Bisht (2012), and Bajpai et al. (2015), and on Brazil see Setzer (2014). 4  Eriksen et al. (2012), Dubash and Florini (2011), Downie (2015), Van de Graaf and Colgan (2016), Camilleri (2012), Sun (2014), Van de Graaf and Westphal (2011), Van De Graaf and Colgan (2016), Underal (2017), Martin-Moreno (2014), Symons (2012), and Falkner (2014).

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years and has produced valuable insights on issues of definitions and measurement (Sovacool, 2010a; Cherp et al., 2011; Cherp and Jewell, 2014; Spreng, 2014; Stirling, 2013; Falkner, 2014), as well as discussion of the promise and limits of emerging governance arrangements (Bernauer, 2013; Florini, 2011; Escribano, 2015; Dubash and Florini, 2011; Florini, 2012; Florini and Dubash, 2011; Harris, 2010; Ladislaw, 2011; Krickvic, 2015; Downie, 2015; Hochstetler and Milkoreit, 2015). By so doing, the chapter seeks to engage the following questions: how do changes in the global economy and energy markets affect the BRICS and how are they responding to them? What role do they play in global energy governance arrangements? Are the BRICS revisionist or supporters of the institutional status quo? When and why does competition prevail over cooperation, and competition with whom, exactly? How do the BRICS relate to advanced industrialized countries and countries in the Global South, or with each other, for that matter? The main story this contribution tells is that of a rather heterogeneous group which struggles to position itself as a coherent entity, as far as energy security and governance are concerned. This is not to say that no progress has been made (the 2016 New Delhi Summit forcefully added energy as a new area in which cooperation should be pursued by the members of the group, a point later restated in the 2017 Xiamen summit5), but the diversity in economic structures and resource endowments of the BRICS leads to them pursuing different agendas and priorities. The BRICS are responding differently to the challenge of climate change and are responding differently and unevenly to energy transitions, although here the outlier is clearly Russia, whereas the other four seem to be eager to play an active role in nascent global energy governance arrangements. Overall, although the BRICS seek greater representation and voice in the current institutions, they do not share a vision of what a new post-Western order will look like. The chapter is structured as follows. The second section provides a short overview of the key shifts in the global energy markets, paying attention to changes in the patterns of both supply and demand. Third section discusses the BRICS’ contribution to global governance by reviewing areas of agreement and contention among the five countries and vis-à-vis countries in the global South and advanced industrialized countries. And the fourth section turns to the international political economy of energy and identifies key debates in this exciting and expanding inter-disciplinary scholarly field. It highlights the main research frontiers and also identifies some of the most promising questions raised by recent developments, before concluding.

 Ministry of External Affairs. Government of India (2016), Ministry of Foreign Affairs of the People’s Republic of China (2017). 5

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Trends and Shifts in Energy Markets: Supply, Demand and Energy Transitions The center of gravity of the global economy has shifted towards non-OECD markets and players. The world economy is expected to double over the next 20 years (BP 2017a), with growth averaging 3−4% per year (BP, 2017a). China and India will account for half of the increase in the growth of the global economy. The BRICS “club” includes energy importing (China, India, South Africa) as well as energy producing (Russia, Brazil) countries. With the world’s eighth largest oil reserves and the largest natural gas reserves (17% and 26% respectively (Henderson and Mitrova, 2015; Russell, 2015)) Russia is a producer of global importance, though much of its oil goes to domestic needs, unlike Brazil, which produces mostly for export. Brazil’s off-shore discoveries have made the country a relevant producer of hydrocarbons over the past decade, which it sells primarily to China. The situation in India, China, and South Africa is remarkably different. There economic development takes priority, and these countries are net importers. China’s continued rise depends on continued reliable access to natural resources. India and South Africa suffer from domestic constraints, poverty and insufficient economic development (Rich and Wilson Rowe, 2012: 6−8). In the pages below, I examine each country in turn, paying attention both to the current situation in terms of reserves, production and consumption, and trends over the 2006−2016 period. While production of oil in Russia has increased tremendously over the past 10 years, production of natural gas has remained stagnant, primarily as a result of the lack of investment and discoveries (Table 1). Consumption of coal has increased. As Russell notes, “Russia’s energy mix is essentially made up of fossils fuels (90%) with some nuclear power and, in light of the country’s energy strategies, this situation is unlikely to change in the near future” (Russell, 2016: 1). Natural gas covers about 90% of Russia’s domestic energy needs and the largest domestic source of energy (54% of consumption), followed by oil (22%) and coal (12%) (Russell, 2016). Nuclear constitutes the largest non-fossil source of energy and the country is largely self-sufficient in that regard, as it is home to the world’s third largest uranium deposits and has highly developed technology (Russell, 2016: 2). The hydro-electric sector is in dire need of investment; Russia uses a mere 20% of hydroelectricity potential, and thus there is an enormous scope for expansion. As for renewables Russia boasts massive potential which, however, appears likely to remain untapped due to domestic political considerations. Renewables account for a small share of the energy mix, less than 1% (Russell, 2016: 2). After averaging 9.8% per year between 1978−2013, China’s real GDP growth has slowed since 2014, with a target now set at 6.5% for 2016−2020 under the g­ overnment’s 13th 5-year program. The Chinese economy has entered an era of low

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312  M. Fumagalli Table 1:   Energy reserves, production, and consumption in Russia (1996−2016). 1996 Oil

Natural gas

Reserves

2016

Share (2016, %)

104

109.5

26.6

Production

98.19

11,227

12.2

Consumption

2,762

3,203

3.3

Reserves Production

113.6

2006

30.9

31.2

32.3

17.3

595.2

579.4

16.3 11

Consumption

415

390.9

Coal

Consumption

141

192.8

5.3

Nuclear

Consumption

97

97.3

2.3

Hydro-electric

Consumption

39.6

42.2

4.6

Renewables

Consumption

0.1

0.2

—

Electricity

Consumption

992.1

1,087.1

4.4

Source: BP Statistical Review of World Energy (2017b). Oil is measured in million tonnes, and all other sources of energy in MTE (million tonnes equivalent).

growth (since 2014). The structure of the Chinese economy is changing and energy demand growth is likely to slow down as well. As China’s economy goes through significant changes, so do its patterns of energy production and consumption. Table 2 shows, reserves and production of oil and gas have increased in the period between 1996 and 2016, although they have not been able to keep up with the country’s demand for energy. Oil consumption has nearly doubled from 2006 (increasing to 12.8% in 2016), with natural gas consumption going through a stunning four-fold increase over the same period, although in terms of its share of global gas consumption it remains below 6%. Coal consumption remains at very high levels (at over 21% of the world’s coal consumption), which inevitably has led to high levels of global greenhouse gas emissions. The rise in China’s GHG emissions in 2016 has pushed up global CO2 emissions after a 3-year lull. Consumption of nuclear, hydro-electric, and electric energy has also grown tremendously over the past decade, and so has renewable energy, particularly in the form of solar and wind. India’s economy has grown considerably in recent decades, although at a slower pace than China’s. Its energy reserves are negligible and so is production, especially insofar as hydrocarbons are concerned. India is, however, a key consumer of coal (8.3% of global coal consumption), oil (4.6%) and electricity (5.6%) (Table 3). Renewable energy is, at current levels, also negligible.

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The BRICS, Energy Security, and Global Energy Governance 313 Table 2:   Energy reserves, production, and consumption in China (1996−2016). 1996 Oil

Reserves

Natural gas

2016

Share (2016, %)

20.2

25.7

1.5

Production

3,711

3,999

4.3

Consumption

7,432

12,381

12.8

1.7

5.4

2.9

60.6

138.4

3.9

Reserves

16.4

2006

1.2

Production Consumption

59.3

210.3

5.9

Coal

Consumption

23,004

244,010

21.4

Nuclear

Consumption

12.4

48.2

8.1

Hydro-electric

Consumption

98.6

263.1

28.9

Renewables

Consumption

2.5

86.1

20.5

Electricity

Consumption

2,865.7

6,142.5

24.8

Source: BP Statistical Review of World Energy (2017b).

Table 3:   Energy reserves, production and consumption in India (1996−2016).

Oil

Reserves

1996

2006

2016

Share (2016, %)

5.5

5.7

4.7

0.3

760

856

4.3

2,737

4,489

4.6

Production Consumption Natural gas

Reserves

1.1

1.2

0.7

Production

0.6

29.3

27.6

0.8

Consumption

37.1

50.1

1.4

Coal

Consumption

897,782

8.3

Nuclear

Consumption

4.0

8.6

1.4

Hydro-electric

Consumption

25.5

29.1

3.2

Renewables

Consumption

3.3

2.6

0.6

Electricity

Consumption

744.1

1,400.8

5.6

Source: BP Statistical Review of World Energy (2017b).

Although its overall reserves of hydrocarbons are small by world standards (Table 4), Brazil has emerged as an important producer and exporter of oil due to recent discoveries (Lazarou, 2015). After a period of sustained growth in the late 2000s, Brazil’s economy slowed down in the early 2010s, before entering recession

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314  M. Fumagalli Table 4:   Energy reserves, production and consumption in Brazil (1996−2016). 1996 Oil

Reserves

6.7

Production Consumption Natural gas

Coal

Reserves

0.2

2006

2016

Share (2016, %)

12.2

12.6

0.7

1,806

2,605

2.8

100

138.8

3.1

0.3

0.3

0.2

Production

11.2

23.5

0.7

Consumption

20.6

Reserves

36.6

1

6,596

0.2

Production

2.6

3.5

0.1

Consumption

12.8

16.5

0.4

Nuclear

Consumption

3.1

3.6

0.6

Hydro-electric

Consumption

78.9

86.9

9.6

Renewables

Consumption

419.4

581.7

2.3

Electricity

Consumption

419.4

581.7

2.3

Source: BP Statistical Review of World Energy (2017b).

in 2015 (Lazarou 2015: 1). Brazil is an emerging economic power in crisis. Brazil’s growth in the 2000s was essentially the result of two factors: macroeconomic reforms and fiscal adjustment begun in the 1990s, and the demand for Brazilian exports of primary products from international markets, especially from China. The global economic turndown, however, reached Brazil too, with stagnation in 2011−2014 and finally a recession in 2015. South Africa is home to the African continent’s most developed economy and, until it was overtaken by Nigeria in 2014, the largest economy (Latek, 2015: 1). It is Africa’s only member of the G20 and has been a member of the BRICS since 2010. However, despite some important growth in the 2000s, South Africa resembles an “economic powerhouse in decline” (Latek, 2015: 1). The South African economy has been crippled by the 2009 crisis, has only made a very slow recovery since then, and has been further slowed by the 2015 turbulence on the global commodity markets (Latek, 2015: 1). South Africa’s high reliance on exports of natural resources makes the country sensitive to external shocks. Furthermore, there are evident internal constraints, such as frequent electricity outages and years of under-investment in power generation and distribution (Latek, 2015: 1). Oil and gas reserves, and production are negligible in South Africa. Renewable energy also remains an untapped potential, and coal consumption

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remains comparatively high (Table 5). Mining of natural resources remains a pillar of South Africa’s economy (2). Energy Transitions Among the BRICS The BRICS are serious CO2 emitters (BP, 2017b). As Figure 1 indicates, greenhouse gas emissions have increased considerably over the space of 10 years. At present, China and the United States remain the world’s leading emitters, with India and Russia catching up. Brazil and South Africa have also increased their CO 2 emissions between 2006 and 2016. They do respond to the challenge of climate change remarkably differently. At one extreme of this ideal spectrum lies Russia. Due to Table 5:   Energy resources, production and consumption in South Africa (1996−2016). 1996

2016

Share (2016, %)

9,893

0.9

2006

Coal

Consumption

Nuclear

Consumption

401.3

425.7

1.3

Hydro-electric

Consumption

2.7

3.6

0.6

Renewables

Consumption

0.1

1.8

0.4

Electricity

Consumption

253.8

251.9

1.0

Source: BP Statistical Review of World Energy (2017b).

3500 3000 2500 2000 1500 1000 500 0

Russia

China

South Africa

Brazil

Oil

Gas

Coal

Nuclear

Hydro

Renewables

India

Figure 1:   BRICS CO2 emissions (2006−2016). Source: BP (2017b).

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abundance of cheap fossil fuels, widespread climate change skepticism, and lack of international pressure, Russia’s leadership has not felt compelled to make anything other than a loose commitment to curbing CO2 emissions. This, in fact, means it can increase emissions by 50% while still meeting its target (Russell, 2015: 2). What has aided Russia in the past is that due to the protracted economic decline of the 1990s — which led to the closure of some of the worst polluters — Russia’s emissions have remained relatively low, only 5% of global GHG emissions are Russia’s (China 22%, US 12%, EU 9%, India 6% and Brazil 4%). Domestic policy inaction has gone hand in hand with a lack of enthusiasm for climate commitments (Russell, 2015: 2). Being a large producer and consumer of fossil fuels explain this. Russia did not ratify the Kyoto Protocol until 2004, 7 years after its adoption, despite the fact that due to the reasons outlined above Russia was never in danger of missing the target (Russell, 2015). Moscow declared that it would not accept any binding reduction for the post-2012 period. Russia has barely participated in the pre-Paris climate conference negotiations and “boasts” a fairly un- ambitious submission (Russell, 2016). At the opposite end, both in terms of a remarkable improvement in its data and its disposition towards climate change negotiations and the moves needed to curb emissions, is Brazil. Not long ago a serious CO2 emitter, Brazil has made considerable progress on the renewables and the hydro-electricity front. Brazil plays an active role in international climate change negotiations. Its success record on reducing deforestation has made it a leader in the reduction of carbon emissions. Between 2005 and 2012 it reduced its CO2 emissions by over 40% through a focus on deforestation (illegal deforestation was reduced by 78%) and boosting the share of renewables in its energy mix. Brazil nonetheless remains the world’s seventh biggest emitter of GHG, responsible for 1.45% of global emissions. It is party to UNFCCC and to the Kyoto protocol, but it does not have a compulsory goal for carbon emissions reduction stemming from the Kyoto Protocol, as it is not classified as a developed country. Data in Table 6 and Figure 2 highlight the fuel mix of the economies of the BRICS as of 2016. Oil remains the most important type of fuel for all BRICS except for Russia, for whom the main source of domestic energy is natural gas. Coal is hugely important for China and India, although its share in the fuel mix is expected to decrease in the coming decades (BP, 2017b). Although the share of renewables in China, Brazil and India’s energy mix is increasing, fossil fuels continue to make up the lion’s share of it in all five countries, ranging from 63% in Brazil to 86% in China, 87% in Russia, 92% in India and 95% in South Africa. In sum, this section has shown that the BRICS are a heterogeneous group, made of producers and consumers of energy, of countries that have embraced energy transitions and where renewables are steadily growing as part of their energy mix, with others resisting such trends. The data above illustrate the intertwined nature of

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The BRICS, Energy Security, and Global Energy Governance 317 Table 6:   Energy mix and the BRICS. Russia

China

South Africa

Brazil

India

Oil

148

578.7

26.9

138.8

212.7

Gas

351.8

189.3

4.6

32.9

45.1

Coal

87.3

1,887.6

85

16.5

411.9

Nuclear

44.5

48.2

3.6

3.6

8.6

Hydro

42.2

263.1

0.2

86.9

29.1

Renewables

0.2

86.1

1.8

19

16.5

TOTAL

674

3,053

122.1

297.7

723.9

Source: BP (2017). 3500 3000 2500 2000 1500 1000 500 0

Russia

China

South Afirca

Brazil

Oil

Gas

Coal

Nuclear

Hydro

Renewables

India

Figure 2:   Primary energy and the BRICS: Consumption by fuel (2016). Source: BP (2017).

the politics of energy and climate (Rich and Wilson Rowe, 2012: 6). The economic rise of the BRICS is closely tied to the global politics of energy and their consumption of global energy/and climate change. Each member of the BRICS “club” faces multifaceted domestic energy issues and politics that shape its energy strategy and, consequently, its participation (or lack thereof) in climate change negotiations. To what extent does this internal diversity of the BRICS group affect its behavior and stance on the international stage? This is what the following section examines.

The BRICS and Energy Governance This section reviews both key developments and progress in terms of the BRICS’s role in global energy governance and some of the major contentious issues, amongst

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them and between them and countries of the global South, as well as advanced industrialized countries. The most visible progress of the BRICS as a group has been its relatively rapid process of institutionalization, from a mere acronym in 2001 (BRIC, then BRICS from 2010 when South Africa joined) to a more institutionalized organization. The group has held annual meetings since the one in New York at the side of the UN General Assembly meeting in 2006, followed by regular summits in Ekaterinburg (Russia) in 2009 and then hosted in each country on a rotating basis. At the 2013 summit in Durban (South Africa), the members established a BRICS Think Tank Council and the BRICS Business Council. Gradually, BRICS cooperation has extended to financial governance, with the establishment of the BRICS bank and a reserve arrangement (D’Ambrogio, 2014). At the sixth summit held in Fortaleza (Brazil) in July 2014 the BRICS decided to create the New Development Bank (NDB), with the purpose of mobilizing resources for infrastructure and sustainable development projects in BRICS and other emerging and developing economies. At the seventh BRICS summit in Delhi (India) in 2016, the BRICS explicitly referred to energy as an area in which cooperation among the members should expand and deepen, a point later stated in the 2017 Xiamen (China) summit. This is not to say that there are no differences among the member countries or contentious issues. Although the BRICS’ rise has been peaceful, this has not been free of contention. Some of these issues pertain to them only (such as the China−India geopolitical rivalry), whereas others blur the lines between the BRICS, advanced industrialized countries and countries in the Global South, such as the difficulty of setting up inclusive and sustainable global governance arrangements and the risk of creating a new oligarchy, a “concert” of a select group of powers, with the exclusion of the majority. Contentious Issues Among the BRICS Two main fissure lines exist within the BRICS. The first concerns bilateral issues, of which the rivalry between China and India, the two largest and most populous countries, is the most vivid example of how competition, rather than cooperation, has come to define energy security in Asia (Jain, 2014). The China−India relationship is plagued with several unresolved issues, from territorial disputes (Tibet), Beijing’s relationship with Pakistan and, not least, competitive energy relations. Energy is reshaping the international relations of Asia, where it is a subject of geostrategic contest rather than cooperation and interdependence. A site of production, as much as of huge consumption of energy, primarily fossil fuels. As Jain notes “Asia is now the center stage of the world’s energy concerns” (Jain, 2014: 547). This is not to say that energy cooperation between New Delhi and Beijing is impossible, as joint activities in Sudan and Syria have shown (Reischer, 2012;

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Bajpai et al., 2015), but these are marginal issues, and thus energy cooperation remains the exception rather than the rule. Despite all the rhetoric of a strategic partnership, Russia−China relations are not less fraught with challenges. Although Russia has seemingly acquiesced to the shift in power to China which saw it becoming the junior partner in the relationship (Kaczmarski, 2015), some of the irritants remain and have deeper historical roots, such as Moscow’s fear about an encroaching Chinese presence — through migration — in the sparsely inhabited regions in the Russian Far East, where six million Russian citizens face over 100 million Chinese on the other side of the border. Other irritants are of a more recent nature, such as Moscow’s occasional departure from its advocated principle of non-interference in the domestic affairs of another country and the staunch defense of sovereignty. Its recognition of Abkhazia and south Ossetia in 2008 and its more recent annexation of Crimea in 2014 were not well-received in Beijing. Apart from immediately bilateral issues, Russia and China also share a neighborhood: Central Asia. Although both powers have peacefully co-existed so far (Cooley, 2012), in practice Central Asia is where competition already takes place between the region’s main security provider (Russia) and the main commercial partner and investor (China). Bilateral issues aside, the BRICS also differ in terms of their stance on climate change and ways to tackle it. They may well-agree about their dissatisfaction with a global institutional order they did not create and whose rules they did not write, but they agree on little else in terms of what an alternative should look like, something which hasn’t changed since the NUPI study in 2012 (Eriksen et al., 2012). Russia is very much the spoiler in the group. Russia remains an important international player, more relevant in some regions (the post-Soviet neighborhood and Syria, among others) than in others. Moscow is playing a decreasing role in G8, G20, and OECD, which turned their back on Russia post-sanctions and Crimea. Moscow remains a member of the G20 not least due to the support of fellow BRICS. Accession to OECD was suspended. In short, Russia’s prestige has taken a hit, although the negative impact on the relationship with its fellow BRICS has been negligible. Moscow tends to favor working within the framework of the United Nations, which, the Russian government emphasizes, remains “at the center for regulation of international relations and coordination in world politics” (Russell, 2015: 1). Domestically, Brazil has developed a National Plan on Climate Change set out in 2007−2008, consisting of a comprehensive framework to combat climate change which proposes a set of mitigation actions. The plan focuses on deforestation and increasing energy efficiency and renewable energy. Beyond its borders, having hosted the 1992 Earth Summit and the 2012 Rio+20 UN Conference on Sustainable Development, Brazil has positioned itself as a significant actor in the international climate arena (Lazarou, 2015: 2). The EU and Brazil have been the two first actors to adopt the UNFCCC and the Kyoto

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Protocol, in a move that signaled the importance of cooperation on environmental issues. On the whole, although some writers have perhaps too alarmistically pointed to coming resource wars in Asia (Chellaney, 2013a, 2013b) or the coming of an “energy great game” (Jain, 2014), it is a fair point to note that China as the leading Asian consumer sees little point in cooperating (Jain, 2014: 547), and that more generally completion prevails over cooperation. This is not because there is anything intrinsic to natural resources that makes rivalry or even conflict inevitable, but rather because of an institutional void. The BRICS and Advanced Industrial Countries Energy governance is an area in which progress has been slow and, again, uneven. There are, of course, several reasons for this. One is a lack of institutional architecture (Downie, 2015): At present there is a plethora of multilateral organizations for dealing with energy in which emerging markets are unevenly involved, such as the G20, IEA, International Energy Forum (IEF), OPEC, International Renewable Energy Agency (IRENA), and IAEA. Acronyms aside, what is evident is that membership in the relevant clubs (sellers and buyers) does not accurately reflect the contribution to the global economy any longer. Among the sellers, some emerging economies are members of OPEC (Qatar), and most of the members are from the Middle East, with no Central Asian state (or Russia, for that matter) being a member. Neither of the BRICS is part of OPEC. As to the buyers, the IEA included Japan and Korea only recently and is de facto a club for OECD economies. Again, the organization does not include a single BRICS country. In this regard, therefore, the Paris Agreement represents a small but important step towards building an institutional architecture. The most significant development because of its relevance to global energy governance is the 2016 Paris Agreement on Climate Change (PACC) (IEA, 2016). Reflecting a long and arduous path of negotiations, failures and agreements from Durban to Kyoto to Brisbane, PACC, which entered into force in November 2016, it is “fundamentally, at its heart, about energy” (IEA, 2016). Covering over 190 countries, with China, India and Brazil as parties to the agreement (not Russia, which was a signatory), the agreement focuses on emissions reductions in the power sector (electricity), seeking to tackle global warming through a reduction in GHG emissions. This brings about transformative change in the energy sector. Changes are in fact already under way, as countries are on target to achieve, even exceed, the targets, sufficient to slow the projected rise in CO2 emissions but not enough to limit warming to less than 2°C. Growth in energy-related CO2 emissions stalled in 2015, as a result of a 1.8% improvement in the energy intensity of the global economy, a trend bolstered by gains in energy efficiency and the use of

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cleaner energy sources worldwide (mostly renewables), before increasing again in 2017 (Hausfather, 2017). The group has not threatened the current multilateral and financial international structure. It has called for reforms and for them to acquire decision-making power consistent with their economic weight. Politically, in this newly emerging world order they are also challenging the old powers in the field of security. However, there has been no open contestation of the current order and, if anything, the Paris agreement constitutes a way in which AICs and BRICS can work together. The importance of reducing the carbon intensity of their economies is evident to all BRICS. China leads the way. Russia is recalcitrant. At the same time, it should be clear that the pursuit of energy efficiency and diversification among emerging economies, and the big ones among the BRICS such as China and India, is driven less by concerns about climate and more by concerns about energy security. This, however, is not tantamount to an alternative to the status quo; at the moment there is no shared vision among the BRICS as to what a post-Western global (energy) governance arrangement may or should look like. Despite the rise of new players and the emergence of new voices (and new interests and agendas), membership to both clubs (IEA and OPEC) remains restricted, despite the “association dialogues” of the IEA with key non-members. It goes without saying that without membership the emergence of new players and voices goes unrepresented. Relations Between the BRICS and Other Developing Countries In climate change negotiations, the BRICS have been quite content with being ­“bundled” with other developing countries, a position which indicates how the BRICS still perceive themselves (as being outside “the establishment” and the defenders of the status quo). Ties between individual BRICS and the Global South have received some attention, typically in the form of China’s energy diplomacy in Africa (Taylor, 2009), Central Asia (Cooley, 2012), or in South-East Asia (Hong, 2015). Interest in China’s $1 trillion flagship One Belt, One Road (OBOR) initiative is also growing, although so far it is more the drivers of Beijing’s initiative have been subject to scrutiny and less has been said about the countries, economies and societies on the receiving end of the OBOR. As economic growth, and consequently demand for energy, is shifting eastwards, it is not surprising that attention has especially focused on developments in Asia. In this respect, energy dynamics in Asia well-illustrate the challenges of institutionalized energy cooperation between the BRICS and developing countries in specific regions of the world. Neither ASEAN (Association of Southeast Asian Nations) nor the Shanghai Cooperation Organization (SCO) deals with energy explicitly, let alone effectively. In Southeast Asia, international

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cooperation is driven primarily through ASEAN-centered institutions and yet, energy is not seen as an issue warranting its own separate organization in the region. ASEAN+3 deals with economic matters, but not energy specifically, and ARF (the ASEAN Regional Forum) focuses primarily on security. The 2007 Cebu Declaration has seemingly remained a “toothless arrangement” (Jain, 2014). Similarly, attempts to move beyond a focus on security within the framework of the SCO has not yielded any tangible result. While ASEAN’s consensus based modus operandi seems to prevent a focus on an admittedly fractious issue such as energy security and cooperation, in the case of SCO it seems that the organization’s main added value lies in its being a forum that allows Central Asia’s smaller players to simultaneously manage relations with two great powers such as China and Russia, and for the two to manage ties with each other. On a separate issue, the different structural economic conditions and economic capacity of some of the poorer less developed countries (LDCs), such as Myanmar, Laos, or Cambodia, places them in a radically different situation when it comes to considering embracing energy transitions and radically altering their fuel mix in favor of renewables. While these are choices that countries like Brazil and China have been able to “afford” to make, coal remains a cheaper and thus more realistic option for many poorer economies. In sum, as Jain puts it, “to speak of Asia as top player is not to suggest that it is a cluster of actors or act as one in its quest for energy” (Jain, 2014: 549). Energy competition, interwoven with matters of geopolitical rivalry, status, prestige and history, is the compelling story of Asian politics and security in this early part of the 21st century. If, as Jain claims, “the nature of energy fuel as an essential commodity traded in a highly competitive world market makes energy security a competitive strategic pursuit for Asian states” (Jain, 2014: 554), it is also fair to note that an institutional void has not helped with moving away from the current zero-sum game that prevails in Asia’s energy markets. The big risk here is that the eagerness of the BRICS to get recognition and a “seat at the table” is that new divides will emerge and that a “new oligarchy” will emerge (Melchior, 2012: 3). To summarize, two issues stand out in relation to the relationship between the BRICS and the current global governance arrangements. First is the emerging economies’ — and the BRICs most notably among them — dissatisfaction with the current architecture of the global economy (Downie, 2015). Second is the lack of an alternative vision by the very same actors. This is clearly the result of their different priorities and interests, which hinder their operation as a coherent coalition of international actors (Downie, 2015). The BRICS are important and mighty but their interests are sometimes diverging, and their international role is still in the making (Melchior, 2012: 4). Despite the evident progress in institutionalizing the BRICS as an organization, is this a group of like-minded countries or a heterogeneous bundle of states, some of which are rising powers (China), some “declining-rising” powers

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(Russia), and the rest a mixture? Will they act together or individually? What does China want to make out of the BRICS and how does this relate to Beijing’s OBOR initiative?

The BRICS and the International Political Economy of Energy: Convergence, Divergence, and Research Frontiers The study of energy has long suffered from under-theorization, with policy-oriented research receiving the bulk of attention. There are signs that this might be changing, driven by theoretically-innovative contributions in international relations (Dannreuther, 2017), public policy (Florini, 2011; Florini and Dubash, 2011; Dubash and Florini, 2011) and international political economy (Goldthau and Sitter, 2015). As the single greatest area of convergence among the BRICS — and among scholars researching global governance and the BRICS — is the demand for greater representation and voice in international institutions, it is not surprising that a key debate has revolved around questions of change versus continuity in the international system and, by extension, about the durability of current Western-designed and -led governance arrangements. The extent of the individual BRICS’ — and especially China’s6 — dissatisfaction with the status quo in the form of a Westernmade and Western-led international order is debated (Breslin, 2013; Hochstetler and Milkoreit, 2015; Cunliffe and Kenkel, 2016), with some scholars emphasizing the status quo orientation of the BRICS (Downie, 2015), or at least some of them, and others highlighting some (potentially) revisionist initiatives. While there may be a desire for a new global order, at present there has been no detectable move towards revisionism or a direct challenge to the existing arrangements, as intraBRICS energy cooperation efforts are still in their infancy. This has to do with the fact that the BRICS do not see “eye to eye” as to what the new order may look like. There is, in other words, no unified vision of an alternative order (Downie, 2015). In practice, this leaves the BRICS as norm-takers, rather than norm-makers (Dubash, 2011; Downie, 2015), although the Paris Agreement on Climate Change has the potential to transform global energy governance. The lack of BRICS institutional space is clearly visible in energy-related organizations. A second “big debate” in the study of the BRICS is between those that emphasize the competitive nature of energy and those instead who privilege cooperative relations. This, by and large, depends on the analytical tools used to make sense of such phenomena. On a larger level  On China-specific debates, also beyond the confines of energy, see Allison (2017), French (2017), Lim (2015), and Beeson (2009). 6

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there appears to be a divide between those that see relations as more competitive or cooperative. At the risk of some simplification, such a divide can be captured by the conversation between those that focus more on the geopolitics of energy (Jain, 2014; Pascual, 2015; Hashim, 2010; Heinrich, 2003; Henderson and Mitrova, 2015) and those, informed by public policy and IPE perspectives and tools, that have a greater interest in governance, with recent innovative endeavors to bridge the two (Goldthau and Sitter, 2015). Cooperative dynamics stand out clearly in publications on Brazil and South Africa. Literature on Russia, by contrast, has concentrated on Moscow’s use of energy as a foreign policy tool, particularly in its immediate neighborhood (Hashim, 2010; Heinrich, 2003). An approach focused on Russia’s “weaponization of energy” has not been free of critique, and Orttung and Overland had subjected the claim to close empirical scrutiny (Orttung and Overland, 2015). Empirically, the literature has paid greater attention to Russia’s European neighborhood and the implications for EU-Russia relations, with far less being written about Russia’s Asian relations. As noted elsewhere in this chapter, competition prevails over cooperation when it comes to energy security in Asia (Jain, 2014; Chellaney, 2013a, 2013b), although that is compounded by other pre-existing issues (historical legacies and geopolitical rivalries), raising questions as to whether competition needs to be the “default” condition when it comes to Asia’s energy relations. Beyond this, energy offers a new and refreshing starting point for reflecting on the transformation of the BRICS and more generally or rising powers beyond the BRICS. Drawing on neo-Gramscian sensibilities in international relations, Hameiri and Jones have challenged one of the key assumptions of international relations — the state as a unitary actor — and have examined how processes of de-centralization, fragmentation and internationalization are taking place in countries often associated with the image of Westphalian statehood (China and Russia being among them) and how such domestic processes are having external implications, often diverging from that country’s foreign policy (Hameiri and Jones, 2016). In practice, one dimension that is especially relevant to the BRICS is the internationalization of sub-national actors and the emergence of the “energy giants”, the state-owned enterprises (SOEs). The emergence of the SOEs is clearly visible in the renationalization of energy giants like Yukos in Russia in 2004 and, most notably the rise of state-owned enterprises in China (Andrews-Speed and Shi, 2016) and Russia (Hashim, 2010; Henderson and Mitrova, 2015; Heinrich, 2003). More than the domestic role of these state-owned enterprises, what has attracted interest is their assertive role abroad as part of their respective countries’ energy diplomacy (on China: Cutler, 2014; Hubbard and Williams, 2014; Wang, 2017; Dannreuther, 2011; on Russia: Poussenkova, 2010). Sub-national actors are playing a growing role in international affairs by carrying out initiatives which are at times aligned with and at times diverging from the

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foreign policy of their respective countries. The para-diplomacy of sub-national actors has been subject to investigation in India (Plageman and Destradi, 2015; Dossani and Vijaykumar, 2006; Jenkins, 2003a, 2003b; Sridharan, 2003), South Africa (Cornelissen, 2006; Geldenhuys, 1998; Nganje, 2014a, 2014b) and Russia (Sharafutdinova, 2003; Joenniemi and Sergunin, 2014). This is starting to be visible in the areas of energy and environmental governance, as evidenced by Setzer’s work on Sao Paulo in Brazil in environmental governance (Setzer, 2014) and Fraundorfer’s research on China’s cities and climate governance (Fraundorfer, 2017). Hameiri and Jones (2016) and Tubilewicz (2017) have also shed light on the internationalization of China’s provinces. Yunnan Province and the Greater Mekong Sub-Region. An important insight that is relevant to debates on energy and energy governance is that domestic processes of decentralization and fragmentation have both domestic and international ramifications, in the form of the rise of multiple and competing centers of power and the challenges this poses to coherent policy-making, especially in under-institutionalized countries (on India: Dubash, 2011; on China: Cabestan, 2017; Freizer, 2010). Last, but not least, are efforts to bring insights from more critical strands of international relations into the study of energy. In a recent important study of energy security, Dannreuther, in particular, argues that energy security should be understood as a value in competition, even conflict, with other values such as economic prosperity and environmental sustainability (Dannreuther, 2017). Dannreuther’s dual focus on power and justice is also highly innovative as, typically, energy has been framed in the language of the form, but not the latter (Dannreuther, 2017). What is especially interesting about China, but similar points can be made about Brazil and India, is the attempt to frame the country’s attempts to tackle climate change and thus steer the energy transitions processes in the language of a “green growth” or “transition to a green economy”, thereby combining the emphasis on sustained economic growth — oftentimes the pillar of performance legitimacy — with exploring new opportunities by reducing fossils in the fuel mix in favor of renewable energy. So far, however, with the exception of Hameiri and Jones (2016) and Dannreuther (2017), critical approaches to international relations have struggled to make inroads in energy debates. Following from this, questions arise about the impact of energy transitions, especially in terms of the impact that energy transitions might have on domestic power configurations, especially of the more authoritarian members of the BRICS. While much scholarly attention has focused on the policies and strategies of the BRICS themselves, remarkably little has been said about how countries on the receiving end of the BRICS’ attention are responding to it. How are local states, economies and societies being reshaped by the actions of China and its state-owned

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enterprises? What are the negative externalities of natural resource diplomacy? Although something has been written about the effects of China’s Africa diplomacy, more should be done about the periodic rise in resource nationalism, understood as a state’s effort at restoring ownership over key strategic assets in the natural resource sector, a phenomenon of growing salience in countries on China’s doorstep such as Myanmar, Mongolia, and Kyrgyzstan (Fumagalli, 2015). Attention to this issue has been limited and sporadic, with oil receiving the bulk of attention (for an exception on South Africa’s mining sector see Andreasson (2015). The case of the OBOR initiative is also relevant here; at least in terms of the initiative’s official objectives and how it is framed publicly, energy cooperation is ascribed great importance, and energy, infrastructure and logistics linkages are expected to create goodwill for enhanced political partnerships between China and the partner countries.

Conclusion Are the BRICS a new player in their own right, or an assemblage of different actors each with its own specificities and divergent interests? They are certainly a heterogeneous collection of actors rising in their own different ways, asking for greater voice on the international stage in light of their economic weight. Yet, this combined growth has thus far not translated into a coherent voice, let alone a shared vision for what a post-Western international order might look like. At the same time, there are visible signs of institutionalization of the bloc. The chapter has advanced the following propositions. First, it has shown that the label BRICS conceals as much as it reveals when it comes to either identifying shifting patterns of demand and consumption or gauging, whether the BRICS countries behave as one coherent group. In all this, the BRICS have become not only an important part of the story, but central players. At the same time, they have not yet articulated a shared vision, let alone one which may be an alternative to the current Western-designed and Western-led institutional architecture. The BRICS relate differently, unevenly, to one of the biggest challenges of the early part of the 21st century: climate change and energy transitions. The chapter has highlighted that how the individual BRICS countries respond to energy transitions is a result of both domestic issues (such as the fragmentation of energy governance and the low level of institutionalization more generally) and global processes, and the interaction of the two. Furthermore, while many among the BRICS eagerly present themselves as models of Westphalian states, jealous of their own sovereignty and resistant to foreign interference, in practice state transformation has already affected them deeply in recent decades. This has led to the

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rise of new important international actors even in the energy sector, such as stateowned enterprises (Gazprom, Sinopec, PetroChina, PetroBras) and sub-national actors, such as cities (Sao Paulo) or provinces and regions (India’s states or China’s provinces such as the Yunnan). Inevitably, several questions remain, the answers to which will only become apparent in the coming years. How will China’s flagship initiative, the OBOR, impact on the countries and economies on the receiving end of China’s attention? How will further advances in technological innovation affect the BRICS’ energy security strategies? Lastly, how far will the populist Zeitgeist push the backlash against globalization and what impact is this going to have on global governance, its fragile architecture and the role of the BRICS? Developments in the late 2010s serve as stark reminders that global governance is still a work in progress even in the field of energy, the role of the BRICS is still in flux and, thus, significant challenges to redefining a new world order lie ahead.

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Ladislaw, S. O. (2011). Energy and Development Trends. The Role of Rapidly Emerging Countries, Washington: CSIS, December. Lazarou, E. (2015). “Brazil: Economic situation”, EPRS at a Glance, Brussels, PE 571.310. Latek, M. (2015). “South Africa: An economic powerhouse in decline”, EPRS at a glance, Brussels, PE 571.349. Lim, Y. H. (2015). “How (dis)satisfied is China? A power transition theory perspective”, Journal of Contemporary China, 24(92): 280–297. Martin-Moreno, J. M. (2014). “The rise of emerging markets and its impact on global energy security”, Modern Economy, 5: 967–979. Melchior, A. (2012). “Western economic decline”, the New World Order, and the BRICS, in Eriksen, S. S., Lodgaard, S., Melchior, A., Rich, K., Rowe, E. W., and Sending, O. J. (eds.), BRICS, Energy and the New World Order, pp. 14–19, Oslo: NUPI. Ministério de Minas e Energia (MME) (2015). BRICS Energy Indicators 2015. http://www. mme.gov.br/documents/10584/3580500/06+-+BRIC+Energy+Indicators+%28year+-+ 2015%29+%28PDF%29/470882ae-364b-4d37-8463-8f1220016315?version=1.2 (accessed 24 November 2017). Ministério de Minas e Energia (MME) (2008). BRICS Energy Indicators 2008. http://www. mme.gov.br/documents/10584/3590324/5+-+BRIC+Energy+Indicators+(PDF)/0b9b0 91c-cef8-405d-b2ae-b4ee73a340c2;jsessionid=24705A9333A13CE6F948800664F1CF03. srv154?version=1.1 (accessed 24 November 2017). Ministry of External Affairs. Government of India (2016). Goa Declaration at 8th BRICS Summit, 16 October. http://mea.gov.in/bilateral-documents.htm?dtl/27491/ Goa_Declaration_at_8th_BRICS_Summit (accessed 20 November 2017). Ministry of Foreign Affairs of the People’s Republic of China (2017). BRICS Leaders Xiamen Declaration. 8 September. https://www.brics2017.org/English/Documents/ Summit/201709/t20170908_2021.html (accessed 20 November 2017). Nganje, F. (2014a). “The developmental paradiplomacy of South African provinces: Context, scope and the challenge of coordination”, Hague Journal of Diplomacy, 9(2): 119–149. Nganje, F. (2014b). “Paradiplomacy and the democratisation of foreign policy in South Africa”, South African Journal of International Affairs, 21(1): 89–107. Nicolas, F. (2016). “China and the global economic order”, China Perspectives, 2: 7–14. Orttung, R.W. and I. Overland (2011). “A limited toolbox: Explaining the constraints on Russia’s foreign energy policy”, Journal of Eurasian Studies, 2(1): 74–85. Ozdamar, O. (2017). “Energy, security and foreign policy”, in R. A. Denemark and R.-M. E. Bennett (eds.), The Encyclopaedia of International Studies, London: Wiley. http:// www.oxfordreference.com/view/10.1093/acref/9780191842665.001.0001/acref9780191842665 (accessed 20 November 2017). Pascual, C. (2015). The New Geopolitics of Energy, New York: Columbia, SIPA, September. Plagemann, J. and S. Destradi (2015). “Soft sovereignty, rising powers, and sub-national foreign policy-making: The Case of India”, Globalizations, 12(5): 728–743.

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PART V

Representation, Fragmentation, and Legitimacy

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CHAPTER 14

BRICS and the International Financial Institutions: Voice and Exit Ayse Kaya Department of Political Science, Swarthmore College, USA

Introduction This chapter analyzes the BRICS’ relations with the two international financial ­institutions (IFIs) with near-universal membership, the International Monetary Fund (IMF) and the World Bank. The chapter, following not just the literature on this topic but also the way actual events unfolded, examines BRICS’ “voice”, i.e. expressions of discontent with and efforts to reform the IFIs, and the creation of pathways to “exit”, i.e. the beginnings of BRICS-led financial institutions, specifically the Asian Infrastructure Investment Bank (AIIB), the New Development Bank (NDB), and the Contingent Reserve Arrangement. It argues that explanations drawing in a detailed ­manner from specific institutional features and policies do a better job of accounting for partial successes with voice. It also charts possibilities for refining future research on this topic.

BRICS and the IFIs: Voice and Exit The relative economic rise of large emerging economies (BRICS) in the last several decades has been one of the most monumental changes in the global economic

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landscape. For instance, in 1997, the year of the Asian Financial Crisis, the G20 emerging economies’ share of world economic output was about 27%; whereas, the same number for the G20 advanced economies was approximately 45%. By 2015, however, these emerging economies had increased their share of world GDP to 40%, as the G20 advanced economies’ share declined to about a third. In other words, the importance of the two groups of countries for the world economy had almost reversed in 1997−2015.1 China, in particular, has seen unprecedented growth levels, making its individual share of world GDP in 2015 over 17%. Meanwhile, in 1997−2015, the USA’s share of world GDP declined by 5 percentage points, making the 2015 US GDP slightly smaller than China’s. And, once the second largest world economy, Japan’s GDP in 2015 was only about 4.5% of the world’s total economic output.2 The 2008 financial crisis, which threw the USA into the Great Recession and continues to affect parts of Europe in the form of a debt crisis, has further solidified this seemingly tectonic shift. The shift has also raised numerous questions regarding the governance of the global economy, particularly as it pertains to its key IFIs with universal membership, the International Monetary Fund (IMF) and the World Bank (WB). Not only have these institutions come to be seen as representing the economic asymmetries of decades gone by, but the BRICS’ enhanced capacity to contribute to the institutions has rendered them more important for institutional functions, such as lending, and thus for governance (Kaya, 2015). This paper assesses the rise of BRICS in the context of IFIs. The recent story of BRICS in the IMF and the World Bank has been one of both “voice”— ­articulations of dissatisfaction with the IFIs’ existing structures and pressing

 There are valid disagreements regarding the coherence of BRICS as a category (see Kirton (2015) for a review of different perspectives). Nonetheless, BRICS’ activities within and related to the IFIs show a relatively high degree of cohesion (e.g. Cooper and Farooq, 2013). Exploring the origins of this cohesion constitutes a different analysis altogether, but it ­plausibly emerged as a byproduct of institutional factors in addition to BRICS’ coordination. In the IFIs, discussions on formal representation (voting rights and seats on the Executive Board) center around country classifications, pitting institutionally dominant advanced economies against emerging and developing economies. Hence BRICS face a strong incentive to coalesce around as unified of a position as possible (surely, this does not mean their preferences are perfectly aligned). As discussed here, BRICS have endorsed clear goals: reducing the dominance of advanced economies in a way that carves out more autonomy for their policies and representation (Kaya, 2015). 2  These numbers were calculated based on GDP, PPP (constant 2011 international USD) from the World Development Indicators. For a skeptical perspective on the rise of BRICS, see Sharma (2012). 1

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for reform — and creating potential pathways of “exit” from the institutions (Hirschman, 1970).3 While notions of voice and exit mesh with actual events as well as the way in which observers have studied those events, it is important to note at the onset that at this point exit neither means abandonment of existing institutions, nor creating true substitutes for them. Rather, questions about exit center around institutional arrangements led by BRICS, which boost the credibility of the threat of exit and could plausibly constitute pathways to exit at a future point. BRICS have exercised their voice, namely, discontent, with two related but distinct aspects of these institutions: (1) the distribution of voting power, thus formal power, within the institutions; (2) policies of key concern to them — specifically controls on the capital account and the expansion of the basket of currencies that make up the Special Drawing Right (SDR), which is a reserve asset and the IMF’s unit of account. In both these realms, the BRICS’ attempts to alter the institutions more in line with their own preferences has met with some success. At the same time, the credibility of the BRICS’ so-called exit from the two IFIs has particularly been enhanced since the creation of the New Development Bank (NDB) and the Contingent Reserve Arrangements (CRA) in 2014 and the launch of the AIIB in 2015. The relevant literature, in turn, has advanced a number of variables in explaining the BRICS’ success with voice, including: the pressures created on the IFIs by the BRICS’ credible threat of exit; the BRICS’ effective negotiation strategies, and the particular features of institutions, such as the nature of their funding. Explanations for BRICS’ enhancing of “exit” options seem similarly varied: each of the BRICS have domestic rationale for pursuing the NDB and the AIIB; the BRICS, particularly China, could have “counter-hegemonic” desires; and only partial success with voice in exiting institutions propels exit from those very institutions. There, thus, seems to be a complex dynamic between “voice” and “exit”. Some see inadequate progress with voice compelling exit from the IMF/WB, while others identify  In Hirschman’s (1970) original conceptualization of “exit” and “voice”, customers’ abandonment of the firm’s products denotes the exit option, whereas in using their voice, the customers appeal to the firm’s management to fix their discontent related to the deterioration of the product. Not only did Hirschman explore his framework in the context of organizations and politics, his set-up has been influential within political science (e.g. Drezner, 2007). As will be shown, it is particularly suited to understanding the theory and empirics of BRICS and the IFIs. Differently from exiting the products of a firm, however, exit from a multilateral institution more likely involves a state’s disengagement from the institution, and only rarely formally abandoning membership in the institution.

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exit as enhancing influence within the institutions. For example, the presence of the AIIB is interpreted as due to the dissatisfaction of the BRICS with the IFIs, as well as a reason for BRICS’ success with reforms in the IFIs. Although the literature has adequately spelt out “voice” and “exit” rationales, there is room for teasing out the dynamics between these two. Particularly, even though the threat of exit did not seem more severe in the case of the IMF, the BRICS have nonetheless received more concessions in that institution relative to the World Bank in 2008−2010 (Kaya, 2015). In other words, the threat of exit does not seem to adequately explain the degree of success through voice. Rather, it seems to be the case that a degree of exit — in this case the creation of the AIIB and the NDB with functions similar to those of the World Bank’s — follows lack of adequate success with voice. Further, to more fully explain how BRICS have exercised voice successfully, consulting the IFIs’ particular institutional characteristics (such as, existing rules or autonomy of the staff) as well as the preferences of the dominant powers seems crucial (ibid.; Gallagher, 2014). The presence of voice and the credible threat of exit also raise questions about the durability of the post-war order led by the USA and its allies, including the European Union and Japan. Obviously, since existing institutions reflect the preferences of their creators disproportionately (Ikenberry, 2000), any success BRICS have with reform is, by definition, going to change the institutions away from the dominant states (regardless of whether the dominant powers approved of such change). But, such change could ultimately boost the legitimacy of these institutions, thereby prolonging the post-war order. Indeed, voice aims to reduce the prevalent discontent with the institution, and it is a sign of “loyalty”, that is the participant’s continued interest in the institution (Hirschman, 1970). At the same time, some of the successes that BRICS appear to have scored simultaneously bind them to the existing institutions. For instance, the Chinese currency (renminbi)’s inclusion in the IMF’s SDR basket is a source of prestige for China, but it was contingent upon China promising further capital account liberalization in accordance with IMF norms. Yet, if exit begins to dominate voice, then the post-war order, which has already weakened due to factors not related to the BRICS’ rise, could further disintegrate. The verdict, however, is out on whether the creation of new institutions truly means exit from existing ones (doubtful) and whether exit will dominate voice (also doubtful). The rest of this chapter, first, discusses BRICS’ partial success with voice, i.e. their efforts to alter existing institutional rules and norms and the extent to which these efforts came to fruition. It then discusses the BRICS’ threat of exit with an emphasis on the AIIB, the NDB and the CRA. Each of these sections contains a critical and synthetic assessment of existing explanations. The final section turns to the question of the impact of these developments on the US-led post-war order.

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Voice The proceeding discussions examines the BRICS’ calls for reform (i.e. expressions of discontent) within the IMF and the World Bank along two dimensions: (1) changes to (formal) governance rules and procedures, and (2) policy changes. Surely, governance and policy changes are inextricably related — the former likely spurs the latter, but these categorical distinctions serve analytical clarity, and they also follow the way actual negotiations took place. Discontent with Governance Structures In 2008−2010, member states in both the World Bank and the IMF reformed the distribution of voting power (across the membership), the method of calculating each state’s voting power, and the structure of the Executive Board (Kaya, 2015, Chapters 5 and 6).4 Importantly, as a result of these reforms, the rate of change in the G20 emerging economies’ total voting power within the IMF and the World Bank were 27.74% and 18.62%, respectively (ibid.: 173, Table 6.4). Such a change has meant that the G20 emerging economies as a group ended up with more voting power than G20 European economies (ibid.). Within the IMF, China increased its voting power from under 3% to over 6%, making it the third largest shareholder. India, Russia, and Brazil also got promoted to being among the top 10 shareholders in the IMF. Further, the IMF moved to an all-elected Board, removing the privilege of some states to appoint their Directors. While the effects of this reform are yet unclear, it was a move toward flattening institutional hierarchies. Not just the significance of these reforms, but also the length of time it took US Congress to ratify them — Congress passed the bill endorsing the change, which naturally required an increase in American financial contributions (known as the quota) to the IMF, at the end of 2015 — attracted a great deal of attention. The US Congress’ recalcitrance was seen as giving impetus to the formation of alternative institutions, particularly the AIIB. Against this backdrop, the rest of this sub-section focuses on BRICS’ efforts to alter the way in which the IMF calculates members’ voting power (based on quotas). It also contrasts this success with BRICS’ less successful efforts at the WB. This selected focus illuminates the key factors at work and the main issues of debate. Importantly, the benchmark against which to judge BRICS’ efforts here are not subjective assessments of how much the BRICS’ power should have been boosted, but what the BRICS’ pre-reform demands were. In this way, instead of a subjective  Other works that discuss select dimensions of these reforms are: Woods (2010), Wade (2011), and Lesage et al. (2013). 4

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yardstick that shifts across actors and authors, the analysis can focus on a benchmark that is relatively more objective and consonant with institutional debates. Reforming the Quota Formula in 2008 Quotas in the IMF serve critical functions, as they determine the member states’ financial contributions to the institution, thereby their relative voting power. A member’s quota can also affect the size of the loans the member receives from the institution. Even though the ultimate distribution of the quotas does not depend solely on quota formulae, by virtue of forming the technical reference point for the quota distribution, quota formulae carry great importance. In 2008, the IMF moved from an opaque system of multiple quota formulae to a single one with some variables of preference to the rising states, though the new quota formula did not reflect all of the rising states’ demands.5 The BRICS began pushing for a reform of the quota formulae soon after the 1997 Asian Financial Crisis, during which the IMF conditionality imposed on borrowing members, particularly Thailand, S. Korea, and Indonesia, was seen as too austere (e.g. Stiglitz, 2002). In turn, the IMF’s seemingly unfair treatment was seen as intrinsically related to the Western powers’ disproportionate influence over the institution (e.g. Birdsall, 2006). In a 1997 Executive Board meeting, the Chinese Executive Director emphasized that “in order to solve the protracted anomalies in quota calculations and distributions, I would like to stress my support for a Board discussion on quota formulas to take place …” (IMF, 1997: 13). Several years later, the Brazilian Director again expressed a sentiment shared among the large emerging economies (IMF, 2001: 6): Preserving the legitimacy of the [IMF] depends on the ability to adapt the quota structure to reflect changes in the world economy… consensus on a new quota formula that can better support these objectives is an essential aspect of the new architecture of the international monetary system, and should be treated by the Board with the corresponding importance and priority.

A putative turning point came with the 2006 “Singapore Resolution”, which committed the IMF to boosting the voting power of countries that had experienced sustained levels of high economic growth and to focus on the voice of low-income countries. Taking an ad hoc step toward this end, in 2006, China, Mexico, South Korea and Turkey got quota, thus voting power, boosts.  For a history of quotas and the various formulae used until 2015, see Kaya (2015, Chapter 3). For most of the institution’s history five formulae and two datasets were used. 5

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The structural change, however, came 2 years later with the introduction of the 2008 quota formula, which Table 1 summarizes. Along the BRICS’ preferences, the weight of the GDP in this new formula was significantly larger than in p ­ revious ­formulae, permitting the fastly growing economies to translate some of that ­economic capacity to representation within the IMF. The inclusion of GDP calculated at purchasing power parity (PPP) exchange rates, further boosted the large emerging economies’ economic size and therefore relative voting power. This shift was a first for the institution, since up to that point, only GDP calculated at market exchange rates had been a part of the formula. And, it met BRICS’ long-standing demands. For instance, in the 2002 discussions on the issue, the Indian representative put it unequivocally: “Quotas and hence contribution to Fund resources should be on the GNP/GDP computed on a PPP basis” because, as opposed to GDP converted at market exchange rates, GDP PPP “better reflect the real value of total output produced by a country” (IMF, 2002, 3, 6). In the discussions leading up to the formula, the Chinese central bank’s Deputy Governor echoed these views, “we believe a quota formula including PPP GDP, which is simpler and more transparent, is the most effective way to raise the overall share of developing members” (Xiaoling, 2007). Further, given the build-up of their reserves, the retention of reserves in the 2008 formula revision was a boon to boosting the BRICS’ quota and thus, relative voting power. Reserves had all along been a factor in the IMF’s quota calculations, but its retention in the formula was nonetheless subjected to intensive debate pre-reform. If quotas are seen as a benchmark for accessing loans from the IMF, then the higher reserves of a country, the lower its need for such funds. A number of advanced economies initially took this view, but the final outcome was in accordance with BRICS’ desire to retain reserves. Table 1:   IMF’s quota formula. CQS = (0.5Y + 0.3O + 0.15V + 0.05R)k. CQS = calculated quota share. Y = a blend of GDP converted at market rates (60%) and PPP exchange rates (40%) averaged over a 3-year period. O = the annual average of the sum of current payments and current receipts (goods, services, income, and transfers) for a 5-year period. V = variability of current receipts and net capital flows (measured as a standard deviation from the centred 3-year trend over a 3-year period). R = 12-month average over a year of official reserves (foreign exchange, SDR holdings, reserve position in the Fund, and monetary gold). k = a compression factor of 0.95. The compression factor is applied to the uncompressed calculated quota shares, which are then rescaled to sum to 100. Source: IMF documents.

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However, the inclusion of the “openness” variable (O in Table 1) and the small weight given to reserves were against BRICS’ preferences. BRICS were particularly concerned about the impact of openness because it primarily benefitted the Europeans, given intra-EU trade is counted as inter-country trade. Within-­ currency union trade, BRICS’ Directors emphasized, was less likely to cause the kind of ­balance of payments crises facing countries trading outside of their own currency. For example, the Russian Director noted that, like their Indian counterpart, they could live with the openness variable only if “all intra-union trade was excluded during quota calculations” (IMF, 2002: 41). This wish, however, was not met. Further, the BRICS’ Directors would have preferred the weight on reserves as well as GDP PPP to be higher (e.g. IMF, 2007). Despite these unfulfilled preferences, the 2008−2010 reforms nonetheless boosted the BRICS’ voting power in unprecedented ways. The same cannot be said of the 2008−2010 reforms at the World Bank. For example, as a consequence of these reforms, the rate of change in G20 emerging economies’ voting power was 19% in the Bank, compared to 28% in the IMF (Kaya, 2015: 172−173). China’s gains were twice as large in the IMF compared to the World Bank’s International Bank for Reconstruction and Development (IBRD). The 2010 change to World Bank’s shareholding formula, which officially de-linked World Bank shareholding calculations from the IMF’s quota calculations for the first time, also fell short of BRICS’ expectations. This formula consisted of three components: economic size, following the IMF blend of GDP (75%), “development contributions” (5%), and cumulative contributions to the International Development Association (IDA) (20%). Both the low weight of development contributions — a catch-all phrase of countries’ input to the Bank’s mission of economic development — and the high weight of the IDA contributions ran counter to the BRICS’ interests. Not only have BRICS been relatively significant borrowers from the IBRD (as a proportion of the IBRD’s total lending), they also contribute miniscule amounts to the IDA, whose primary donors remain the G7 countries (see Kaya, Chapter 6 for more detail). Nor did the BRICS end up seeing the reform they wished to see in IDA’s donor-controlled governance. Another issue is the Bank is controlled relatively more from the top by a President, who has always been an American. In contrast, more of the IMF’s senior management is now from BRICS, including a Deputy Director from China. Voicing Discontent with Key Policies The picture has been similarly one of partial success when it comes to policy changes. Given space constraints, the pursuant discussions on this topic focus on the two issues most critical to the BRICS’ preferences and the governance of the

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global economy: (a) BRICS’, particularly China’s, calls for change to the basket of ­currencies that make up the IMF’s Special Drawing Right (SDR), and (b) BRICS’ calls for ­leniency on the use of capital controls within the IMF. Case of the Special Drawing Right (SDR) In November 2015, the IMF welcomed the Chinese renminbi to the basket of currencies that constitute the SDR, the IMF’s reserve asset, with this decision to be implemented in October 2016. The SDR’s original purpose was to provide relief from dollar-dependence in the Bretton Woods era of fixed exchange rates, when in the 1960s the supply of dollars (USD), which was tied to gold, was becoming tighter in the face of growing demand (e.g. Clark and Polak, 2002). A basket of currencies (until October 2016 — the USD, the euro, the Japanese yen, and the pound sterling) determine the value of the SDR.6 Two main criteria have governed the inclusion of a currency in the SDR basket. First, countries/regions whose currencies qualify for the basket hold the highest ranks in terms of the value of their exports of goods and services. A 2000 decision limits the exports criterion to the currencies of the top four exporters (IMF, 2010a). Second, in 2000, with encouragement from the staff, the IMF Executive Board decided to introduce a second requirement for qualification to the SDR basket — that a currency be “freely usable” (FRU).7 Until the November decision, the latter of these criteria was seen as the impediment for the Chinese currency to enter the SDR basket. BRICS, over the years, have requested re-evaluation of the SDR basket, with the eventual goal of revamping SDR’s role in the international monetary system (IMS). Famously, in 2009 the Governor of the Bank of China, Zhou Xiaochuan, called for the creation of a “super sovereign” reserve asset to reduce IMS’ reliance on the USD as the primary reserve currency, specifically pointing to the SDR to fulfil this key yet, unclaimed role (Xiaochuan, 2009). In 2011, at various platforms, the G20 emerging economies called for the IMF to reform the SDR to enhance its importance. They also argued that the inclusion of an emerging economy currency in the SDR basket could increase the attractiveness of the asset (IMFC, 2011; IMF, 2011a). In a representative statement, the Brazilian Finance Minister emphasized, “[t]he SDR could play a larger role in the international monetary system, especially if its basket is enlarged with the inclusion of emerging market currencies” (Mantega, 2011).

 The rationale of a basket methodology, which commenced in 1974, is to reduce volatility in the value of the SDR (Polak, 1979). 7  Freely usable means the currency is widely traded and used in international transactions. 6

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At the same time, BRICS’ summits have also emphasized the role of the SDR and its valuation.8 Initially, however, these calls were met with resistance from the dominant shareholders of the institution. For example, the 2010 IMF evaluation of the SDR basket commended China’s efforts to liberalize the international usage of the RMB, but found the currency to fall significantly behind the currencies in the SDR basket in terms of international financial transactions. In other words, the Chinese currency did not meet the FRU criterion, though by 2010 China had become the third largest exporter (IMF, 2010b). Further, in 2011, Timothy Geithner, the US Secretary of the Treasury, downplayed the importance of the SDR: “[It] can’t provide the role that many people would aspire to it, and there is no risk of ” it replacing the USD (Geithner quoted in Somerville and Wroughton 2011). The European representatives were, similarly, resistant to change with an emphasis on the FRU criterion (e.g. Rostowski, 2011). Eventually, however, BRICS’ “voice” on the issue compelled several in-depth staff reports (e.g. IMF, 2011a, 2011b). The last one of these reports (IMF, 2015) reversed course on earlier ones, noting that the renminbi’s (RMB) international usage, in trade and trading, had increased significantly, and the Chinese authorities were willing to improve impediments, such as access to financial markets on mainland China. The report essentially justified the extension of the SDR basket to the RMB, while at the same time committing China to further capital account liberalization. Changing Views on Capital Controls Until after the 2008 crisis, the IMF’s general policy toward controls on inflows of capital was one of “stigmatization”, seeing them as “harmful for economic performance, generating severe distortions, delaying policy adjustment and sending negative signals to market actors” (Chwieroth 2015: 52). Indeed, in 1995 the IMF’s Executive Board debated at length a staff proposal to endorse capital account convertibility as one of the IMF’s mandates.9 While different works disagree on the sources of this emphasis on capital account liberalization (e.g. Abdelal, 2007; Chwieroth, 2010; Stiglitz, 2002), they converge on identifying it as a key area of the IMF’s advocacy of liberalization. Yet, after 2010, the IMF’s position on capital controls seems to have evolved (Gallagher, 2014). For example, in a key 2011 policy paper, the IMF staff noted that “Emerging markets…are experiencing a surge in capital inflows…While inflows are typically beneficial for receiving countries, inflow surges can carry macroeconomic  See, for instance, Third and Fifth BRICS Summit Declarations (http://www.brics5.co.za).  These discussions died out, as there was inadequate shareholder support to extend the IMF’s jurisdiction, especially after the Asian crisis. 8 9

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and financial stability risks” (IMF, 2011b: 3, emphasis added). This shifting position culminated from a series of articles by IMF economists questioning the previouslyheld conventional wisdom in addition to years of pressure by emerging economies, particularly Brazil, but also China and India. In fact, BRICS pressed on this matter not just within the IMF, but also through other platforms. Importantly, in 2011 the G20 released “Coherent Conclusions” on capital account management, supporting the right to control inflows (ibid.: 11). Although this shift in institutional stance was significant, it nonetheless did not go as far as completely meeting BRICS’ preferences. For one, although BRICS preferred to not bring the management of capital flows under IMF surveillance, a 2012 shift within the IMF endowed the institution with powers to undertake surveillance on capital account movements (Gallagher, 2014, Chapter 6). In other words, national autonomy was restricted in favor of multilateral guidance. At the same time, the Brazilian view of mutual-adjustment, where both capital sending and receiving countries had to take measures to decelerate the flow of cross-border capital, was overlooked (ibid.).

Explanations What explains these (partial) successes BRICS have had? Credible Threat of Exit One plausible answer appears to be their credible threat of exit. Randall Stone (2011), for instance, argues that the options a state has outside of the institution increases with greater economic power. And the more options a state has outside of the institution, the greater the willingness of the other members of the institution to allow the state to have exceptional sway over the institution. From this perspective, as the BRICS’ economic importance has increased, so have their exit options. This point holds true even in the absence of the creation of new institutions. For instance, increasing economic fortunes have allowed BRICS to build up foreign exchange reserves, which in turn provide these states with self-reliance mechanisms during crises. In the presence of the increasing credibility of the threat of exit, if the current institutions are to retain their participation, then they need to heed BRICS’ expressions of discontent. In Stone’s words, the membership needs to “restore incentives” for the exiting state to “invest [back] in the institution” (40). Kastner et al. (2016: 171) also emphasize the importance of exit options: “China’s favorable outside options, combined with perceptions of its indispensability on issues of global financial governance, provided China with the wherewithal to pursue a

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hold up strategy — a strategy by which China could make its cooperation conditional on concessions from other actors.” Here, the aforementioned reforms are seen as the conditional “concessions”. While the authors’ exit argument is compelling and “hold up” is a pithy concept, it is debatable whether there was actual hold-up. Long before Congress had ratified the IMF reforms, China, and the other BRICS, had already provided credit lines to the IMF (Kaya, 2012), had consistently participated in reform discussions, and had conceded to reforms that did not meet their full demands. China had even agreed to voting increases below what the calculations had shown. Even more, whether the reforms were concessions per se remains debatable. The upshot is that from one perspective, the threat of exit compels increases to the BRICS’ ability to rectify their discontent with the institutions. And, the institution’s (partial) meeting of these demands, in turn, incentivizes them to cooperate in the institution. Institutional Factors Analyzing different issue areas, other authors have pointed to the importance of various institutional factors, as well as the role of advanced economies, which act as institutional gatekeepers (e.g. Gallagher, 2014; Kaya, 2015). For instance, the way in which the IMF is funded, with quotas and lending lines, demands more upfront contributions from shareholders than the way in which the World Bank is funded, since the IBRD can raise its own funds and the bulk of its capital is callable (drawn only when needed), which has never happened. Even more, since the IDA is donor-dependent with the advanced economies as its major donors and because these states are loath to forgo influence over it, there was little impact the threat of exit could make (Kaya, 2015). In another example, the staff ’s changing views on capital controls, backed by new economic theories and research, has made them more amenable to the emerging economies’ views on capital controls (Gallagher, 2014). From this perspective, the institutional effects of underlying economic power will be contingent upon particular institutional characteristics (Kaya, 2015). Negotiation Strategies Another set of factors that could be considered is strategies for change (e.g. Kahler, 2013; Gallagher, 2014; Chwieroth, 2015). Gallagher, for instance, notes that on the issue of capital controls, BRICS skillfully connected their demands for change in IMF policy to the academic shifts underway in the institution. And, the relatively unified voice of BRICS on critical financial governance issues eased their success with reforms. There are, however, remaining questions here. For instance, would even the

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best of strategies work in the absence of other factors, such as lack of willingness for change on the part of dominant states? Plausibly, lack of intra-group cohesion, poor timing, or institutionally irrelevant framings of voice can act as stumbling blocks even when the pathway to reform is relatively clear. 2008 Financial Crisis One final factor is the 2008 global financial crisis (GFC), which has stressed advanced economies, thereby reminding the world of underlying shifts in economic power, and increased the demand for borrowing from the IMF and the World Bank. Rather than a cause for the particular changes, however, the 2008 crisis seems to, at best, explain their timing. Specifically, 2008 reforms at the IMF were foreseen in 2006, and the 2010 reforms were foreseen in 2008, but perhaps they could not be delayed beyond 2010 because of the IMF’s need to replenish its coffers during the global crisis. A similar argument could be made in the case of the Bank. In sum, the threat of exit needs to be coupled with institutional explanations in order for it to better explain success with voice.

Pathways to Exit? Since the credibility of exit increases with alternative institutional options and because the extent to which these institutions are truly alternatives could signal pathways to exit (if not partial exit), it is important to analyze the institutions created by BRICS. This section’s discussions on the AIIB, the NDB, and the CRA suggest that while these institutions are not truly substitutes of existing institutions, which would strongly point to exit (Hirschman, 1970), they nonetheless should be taken seriously as future pathways to exit, if BRICS’ “voice” in current IFIs is stymied. Asian Infrastructure Investment Bank (AIIB) The BRICS’ most significant institutional achievement stands as the AIIB, which in early 2017 had 57 members, 37 of which were from Asia. A widely-noted fact about the institution has been that a number of key American allies — including the UK, Germany, Australia, and South Korea — joined despite US officials’ discouragement (Perlez, 2015).10 The AIIB’s main mission is to “promote investment” for “development of infrastructure”, and it currently holds a capital stock of $100 billion (Articles  G20 is not included as a BRICS accomplishment, since the transition from G7 to G20 was led by advanced economies. 10

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2 and 4 of the AIIB’s Articles of Agreement (AA)). “Sustainable development” is the other primary goal of the institution. The institution is endowed with functions that are similar to the WB Group: it can directly loan or co-finance, make equity investments in an institution, guarantee loans, and provide technical assistance. Like the IBRD, it can buy and sell securities to raise funds (Chapter IV of the AA). The institution’s structure also bears significant similarity to existing IFIs, with a Board of Governors composed of all members and a smaller Board of Directors (12 members, with nine from regional members) as well as a professional staff. As in the IMF and the WB, as the numbers would suggest, while some members have their own Directors, other members share a Director under a constituency system. Also, as in the IFIs, voting power is weighted based on the member’s capital subscriptions. China is the highest contributor (about 33% of the total capital) with the greatest formal voice (about 28% of the voting power).11 Paralleling the IFIs, there are also “basic votes”, which are distributed to members equally. Currently, the basic votes constitute 12% of the member’s total voting power. Interestingly, this number is about the original share of basic votes in the World Bank (11%), and was the number aimed by a range of developing countries in the 2010 reforms (Kaya, 2015, Chapter 5). In a further similarity with the WB, the AIIB has both paid-in capital (20% of the total capital) and callable capital (80% of the total capital, to be called upon in time of need) (Chapter II of the AA). Another important similarity with the IMF/WB lies in the way in which the dominant member of the institution — in this case, China as opposed to the USA — exercises institutional power. As the institution’s main architect, on decisions that require a “Super Majority” (two-thirds of the vote representing at least three-fourths of the total voting power), China so far has de facto veto power. Recent statements by the AIIB President, Jin Liqun, however, have emphasized that China does not intend to use its veto and expects to lose it, as new members join the institution (Kynge and Pilling, 2017). Given that US veto power in the WB (as well as the IMF) was retained throughout, this would be a novel development at the intersection of power and institutions. Further, the AIIB is headquartered in Beijing — the placement of the IMF/WB in DC has long been seen not just as a symbol of American dominance in the institutions, but also as a conduit for American informal influence over them. The AIIB, however, also has some unique features. Noted as an “innovation” by some scholars (e.g. Chin, 2016), the organization does not have a resident Board of Directors. The reasoning for this institutional feature was to speed up lending, in direct criticism of the cumbersome procedures of accessing the IMF and the WB. Existing research (Stone, 2011) shows that when there are greater levels of  As of September 22, 2016, as reported by the institution.

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delegation (from the Directors to the management/staff), this actually provides more opportunities for the dominant shareholders of the institution to influence key policy outcomes, such as lending. Higher levels of delegation permit obfuscation of discussions pertaining to policy, providing an opportunity for the major shareholders to insert their (likely disagreeable) preferences without the prying eyes of the rest of the membership. Hence, existing research would suggest that the lack of a resident Board, all else equal, should make it easier for China to pursue its policy preferences relatively more effectively. Without adequate data on lending, however, this point remains theoretical, especially because principal (shareholder)-agent (staff) problems that plague other international institutions will also be relevant here (e.g. Hawkins et al., 2006). Indeed, more certainly, the lack of a non-resident Board suggests the staff ’s influence over the policy decisions. This is compounded by the fact the AIIB President, like his/her counter-part at the World Bank, holds a significant deal of sway over the institution. For now, the AIIB seems committed to hiring based on professional criteria — “an open, transparent, merit-based process”, which means the training of the staff and the tendencies they bring with that training will be crucial variables to study in the coming years (AIIB AA, Article 30). It also appears that the selection of the President will be more open than the process at the World Bank. Until the election of Jim Yong Kim in 2012, the WB’s process did not include transparent interviews; whereas, the AIIB’s Articles of Agreement foresees voting by the Board of Governors, though with a special majority (ibid., Article 29). The New Development Bank (NDB) While the AIIB stands as the BRICS’ most impressive institutional achievement, the NBD, which was India-initiated, shortly preceded it, having been launched at the 2014 Fortaleza Summit of the BRICS (Cooper and Farooq, 2015). The NBD endorses the same mission as the AIIB: investment in infrastructure and sustainable development. Yet, its membership is restricted to the BRICS. While originally China pushed for unequal contributions to the NDB, based on capacity to contribute, the other countries rejected this design with the fear that it would give China too dominant of a role (Kirton, 2015). A compromise on China’s part led to the institution being founded with $20 billion paid-in capital shared equally among its five members (ADB, 2014). Like, the AIIB, NDB can provide financing in local currencies. Contingent Reserve Arrangement (CRA) During the Fortaleza summit, the BRICS also agreed on a currency swap arrangement worth $100 billion to be activated in case of balance payments crises, which

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could take the form of either a precautionary credit line or an actual provision of liquidity. Brazil, Russia, and India pledged equal amounts of $18 billion toward this arrangement, whereas China and South Africa promised, respectively, $41 billion and $5 billion. With its focus on crises and currency swaps, some could question whether this arrangement could replace the IMF. Key institutional features of the agreement suggest that rivaling the IMF is likely not the CRA’s purpose, nor is it in its capacity. First, the arrangement promises credit lines (see Article 1b of the CRA). Since states do not have to make assessed, mandatory contributions as in the case of the IFIs, their commitments are relatively lower. Second, only the BRICS are eligible to access these credit lines, which means that the institution will not be as multilateral as the universal IMF. Hence its capacity to provide financial stability as a global public good is restricted. Third, the IMF’s technical capacity as well as its ability to dole out loans with conditionality remain attractive to countries, as the case of Germany’s insistence on IMF’s recent (2010, 2012) involvement with Greece shows. Fourth, CRA actually foresees IMF involvement. If countries want to access more than 30% of their maximum allowance from the reserve arrangement (which is a country-specific multiplier of each country’s contribution), then they need to have an ongoing borrowing arrangement with the IMF (Article 5 of the CRA). Put differently, 70% of a country’s access to the CRA is contingent upon an IMF arrangement, with which the country should be in compliance. In this respect, while the CRA may further reduce the already diminished chances of the BRICS’ reliance on the IMF, it cannot be assessed as a truly alternative institution at this stage. Similarly, bilateral and regional currency swap agreements, such as Chiang Mai, are ruled out as alternatives to the IMF, even if their role in buttressing balance of payments crises for a short period is acknowledged (Kawai, 2015; Li, 2015).

Explanations What explains the BRICS’ moves to create these new institutions, which can be seen as creating pathways for partial exit or as boosting the credibility of exit? Institutional Gap One explanation is the need to focus on infrastructure investment, which is ­inadequately met through current development institutions. Here, a number of BRICS, prominently China and India, have voiced the gap in infrastructure financing with particular references to the $8 trillion gap claimed in an ADB study (Wan, 2016: 48; see also Chin, 2014). From this perspective, then, inadequate

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provision of a quasi-public good has compelled a new leadership to emerge in the global scene. While such arguments about an “institutional vacuum” are important to recognize, BRICs’ leading of the creation of new institutions cannot be explained by mere reference to it, since an explanation for why the vacuum was filled is pertinent. Slow Reform at the IMF/WB Perhaps the most widespread explanation for the BRICS’ creation of new institutions has been the slow nature of progress on reform at the WB/IMF. Particularly, the significant lag between when the 2010 reforms were approved within the IMF and when they were ratified by the US Congress met with widespread public criticism (see above). Ben Bernanke, the former Chairman of the US Federal Reserve, for instance, remarked that “The US Congress is largely at fault for all that’s happening [i.e. ‘exit’]”, “The US Congress has not approved it. They should, they haven’t…So I understand why other countries say, ‘well let’s take our marbles and go home’” (Bernanke quoted in Pilling and Noble 2015). David Dollar, a well-known expert on China and former World Bank official as well as an advisor to the AIIB, expressed similar sentiments, pointing to the inefficiencies in the Board-led loan diffusion by the WB as well as unfulfilled demands by BRICS for more infrastructure lending by the Bank (Dollar, 2015). While the World Bank’s cumbersome lending procedures could reasonably explain the emergence of the AIIB and its dedication to faster loans, the connection between the IMF and the AIIB seems a bit looser — a point which is further discussed below. Generally, however, failed reform lowers the cost of exit, since there is less to lose in (wholly or partially) abandoning existing institutional frameworks (Reisen, 2015). Chinese Ambitions China’s recently more assertive attitude could explain the creation of the AIIB and the NDB (Wan, 2016). As Wan (ibid.: 44) notes, it is important to see these institutions as belonging to a “series of major policy initiatives adopted by the Chinese government to expand its influence overseas, including a ‘Silk Road economic belt’ and a ‘21st century maritime Silk Road’”. Eswar Prasad of the Brookings Institution echoes this view, calling the AIIB “an instrument for China to lend legitimacy to its international forays and to extend its sphere of economic and political influence even while changing the rules of the game” (Quoted in Perlez, 2015). It has long been noted that there is also prestige in pursuing a leading position in the international order (e.g. Gilpin, 1981).

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Since state-specific goals (such as needing to attract infrastructure investment or the need to invest foreign exchange reserves) could be pursued bilaterally or in an ad hoc multilateral manner, China’s efforts toward multilateral institution-building raises questions about the extent to which these institutions are challenging the existing, US-led multilateral order.

Challenges to the US-Led Order To the extent that BRICS have success with their voice in the existing institutions, they inevitably alter it away from the dominant members’ preferences. This occurs by definition, since the existing institutions reflect the preferences of their creators relatively more.12 For instance, while the AIIB promises to uphold labor, environmental, and anti-corruption standards, the traditional donors are reportedly concerned about these standards being eroded (Perlez, 2015). The bigger issue, however, seems to be the one Gilpin (1981) raised decades ago: as new states gain economic power and as their capacity and ambition to alter the existing institutional equilibrium increases, a period of disequilibrium arises, followed by a new equilibrium under the newly dominant (i.e. formerly rising) states. The first part of Gilpin’s theory seems to be materializing — the increasing economic prowess of BRICS is translating into bolder policy positions. But, disequilibrium is in the eye of the beholder. From the perspective of US officials and those wanting to see a continuation of US global institutional hegemony, it may seem like a disequilibrium, while it might be a much welcome and long-awaited shift in institutional rules and norms from the perspective of others that have lamented a US-dominated order. Likely, the more immediate disequilibrium will be felt in Asia, particularly by Japan. Research has shown the negative effects of China’s rise on Japanese influence at the Asian Development Bank (ADB) (Lim and Vreeland, 2013). And, the AIIB’s emphasis on regional cooperation and focus on infrastructure is more likely to immediately affect the ADB’s actions and policies. Perhaps the Memorandum of Understanding signed between the institutions in May 2016, could be taken as a recognition of this potentially uneasy co-existence.13 Along these lines, some authors have argued that the creation of the AIIB indicates clearly that “China wants to assume regional leadership” (Hamanaka, 2016: 5).  Notably, a diverse set of approaches in international relations — realism, liberal institutionalism, historical institutionalism — support this point. 13  ADB, AIIB Sign MOU to Strengthen Cooperation for Sustainable Growth,” May 2, 2016, www.adb.org. 12

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Regardless, the success of BRICS-led institutions is yet unknown. In both the AIIB and the NDB, an important factor to watch is the institutions’ borrowing and therefore lending costs, as BRICS face less developed financial markets, not fully convertible currencies with relatively shallow trading markets, and domestic institutional weaknesses (Reisen, 2015: 8). Additionally, even though IFI reform and the global development/financial landscapes have been areas where BRICS have shown relatively high levels of coherence, there exist many plausible sources of potential conflicts between these countries, including: intra-group competition, China’s perceived dominance of institutions and conflicting interests given the large economic disparities within the group. Further, the trade-off between looking inward to development needs and outward to international influence could intensify during economic downturns for BRICS. Crucially, the IMF and the World Bank are still standing, and indeed the recent changes that BRICS sought and gained within them likely prolong their survival. Hirschman’s original treatise on voice and exit emphasizes this point: consumers who exercise voice are those that have decided — for now — to stick with the product. As Hirschman notes (1970: 83), the “threat of exit will typically be made by the loyalist — that is, by the member who cares — who leaves no stone unturned before he resigns himself to the painful decision to withdraw or switch”. By the same token, however, to the extent that repeated efforts with voice go unsatisfied, not just pathways to exit, but actual exit can begin to emerge. In any case, at the time of writing, arguably the largest challenge to the US-led post-war order seems to come from within the USA itself. A domestic backlash against globalization has been building for years, including Congressional intransigence and more recently with the new Trump administration’s nationalist economic policies. While such a state of affairs might be transitional, the long-term effects of it may not be. For instance, on January 24, 2017, reports of 25 new countries, including Canada, Ireland, and a couple of African countries, joining the AIIB surfaced (Kynge and Pilling, 2017). If US abandons the leadership of existing institutions, where it is formally and informally the dominant member, or if calls for reforms fall on deaf US ears, then pathways for exit will strengthen and truly alternative institutions may emerge. The AIIB is providing a glimpse into that possible future.

New Research Frontiers on BRICS and IFIs How can future academic studies expand upon existing analyses? One, it seems that the frontiers of research on BRICS and IFIs focuses on specific features of institutions and how BRICS’ efforts for reform fare across different issue areas. For instance, research clearly identifies the issue of capital account liberalization as an area where

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BRICS have had some success in achieving their goals for more autonomy on capital controls. It seems important to probe what made this area particularly suitable for success. As noted previously, existing studies provide a number of compelling explanatory factors, ranging from the shift in academic research within the IMF, to the smart negotiating strategies of BRICS, but more room remains for systematically exploring the interaction of these different factors. And, studies should analyze why and how BRICS failed to achieve similar levels of success in other issue areas.14 Second, and continuing with the theme of variation across institutional settings, it would be helpful to differentiate across the World Bank and the IMF more, instead of bundling them together. As noted here, BRICS have achieved more of their goals for reform in the case of the 2008−2010 reforms to the IMF than to the World Bank. While some studies (Kaya, 2015) argue this had to do with the constellation of a couple of key factors — the particular funding structure of the IMF being more state-dependent compared to the World Bank and the institutionally dominant states’ greater interest in BRICS’ involvement in the IMF — there is room for more differentiation across the IMF and the World Bank. In particular, the World Bank faces an increasingly populated arena of development banks, with the recent addition of the AIIB and the NDB to a relatively long list of regional multilateral banks. It would be good to probe whether “regime shifting” is a greater possibility for the Word Bank than the IMF. Similarly, when discussing the effects of the rise of BRICS on the US-led order, it would be more fruitful to discuss uneven effects across different institutions within the order; rather than a single, uniform impact on the system. Third, while “voice” and “exit” provide a compelling framework that mirrors actual developments pertaining to IFIs and BRICS (that is, the dominant story has been BRICS seeking reforms to ameliorate their discontent with institutions, as well as bolstering their credibility of exit through new institutions), the interaction between these two phenomena needs fine tuning in the literature. For instance, existing arguments that explain the formation of the AIIB and the NDB with reference to slow reform at the IMF are confusing institutional platforms, since AIIB and NDB have functions similar to those of the World Bank, not the IMF. More likely, the lack of adequate progress with “voice” during the 2008−2010 reforms at the Bank, in addition to grievances with Bank’s lending procedures, spurred the creation of the AIIB and the NDB. Furthermore, even if the IMF could be taken to respond to any sort of exit (disengagement from the institution), it was not responding to the creation of the relatively small CRA, which came a few years after IMF reforms were undertaken. Exit and voice are likely to co-exist and the translation of voice into  For the sake of disclosure, the author of this piece is currently working on such a book project. 14

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desired outcomes is a lengthy process in multilateral institutions. Therefore, instead of trying to link the fulfilment of BRICS’ demands for change to clear instances of (threat of) exit, it is more fruitful to raise questions about when voice, hence loyalty to the institution, will be abandoned. Finally, “exit for whom?” is a critical question that needs to be answered. There is a distinction between exit for one’s self and exit for others. The only new institution studied here that may eventually offer an exit, an alternative, for others is the AIIB, given it is the only one with membership that extends beyond BRICS. In this respect, just as it is too late to declare the US-ledorder-as-we-know-it is still intact, it is too premature to announce the dawn of a completely alternative multilateral order.

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Lim, D. Y. M. and J. R. Vreeland (2013). “Regional organizations and international politics: Japanese influence over the Asian Development Bank and the UN Security Council”, World Politics, 65(1): 34–72. Li, C. (2015). Banking on China through Currency Swap Agreements, Federal Reserve Bank of San Francisco, published 23 October 2015. Mantega, G. (2011). Statement to the IMFC Twenty-Fourth Meeting, 24 September, Washington, D.C. Perlez, J. (2015). “China Creates a World Bank of Its Own, and the U.S. Balks”, The New York Times, published 4 December 2015. Pilling, D. and J. Noble (2015). US Congress pushed China into launching AIIB, says Bernanke, Financial Times, published 2 June 2015. https://www.ft.com/content/ cb28200c-0904-11e5-b643-00144feabdc0 (accessed on 26 December 2017). Polak, J. (1979). The SDR as a Basket of Currencies, IMF DM/79/86. Reisen, H. (2015). “BRICS contribution to global governance: Policy areas”, International Organisations Research Journal, 10(2): 81–89. Rostowski, J. V. (2011). Statement to the IMFC Twenty-Fourth Meeting, September 24. Sharma, R. (2012). Broken BRICs, Foreign Affairs, Comment, published 23 October 2012. Somerville, G. and L. Wroughton (2011). U.S. dollar’s role not at risk from SDRs: Geithner, Reuters, published 9 March 2011. https://uk.reuters.com/article/businesspro-us-usatreasury-dollar-idUKTRE7287P820110309 (accessed on 26 December 2017). Stiglitz, J. E. (2002). Globalization and its Discontents, 1st Edition, New York: W.W. Norton. Stone, R.W. (2011). Controlling Institutions: International Organizations and the Global Economy, Cambridge, UK: Cambridge University Press. Xiaoling, W. (2007). Statement to the IMFC Sixteenth Meeting, 20 October. Xiaochuan, Z. (2009). Reform the International Monetary System. http://www.bis.org/review/ r090402c.pdf (accessed on 26 December 2017). Wade, R. H. (2011). “Emerging World Order? From Multipolarity to Multilateralism in the G20, the World Bank, and the IMF”, Politics & Society, 39(3): 347–378. Wan, M. (2016). The Asian Infrastructure Investment Bank: The Construction of Power and the Struggle for the East Asian International Order, London: Palgrave Macmillan. Woods, N. (2010). “Global governance after the financial crisis: A new multilateralism or the last gasp of the great powers?”, Global Policy, 1(1): 51–63.

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CHAPTER 15

The Representation of BRICS in Global Economic Governance: Reform and Fragmentation of Multilateral Institutions Michal Parízek* and Matthew D. Stephen† *Institute of Political Studies, Charles University, Czech Republic † Faculty of Economics and Social Sciences, Helmut-Schmidt-University Hamburg, Germany; GIGA Institute of Asian Studies, Germany

Introduction Already in 2001, when Jim O’Neill wrote his famous Goldman Sachs paper “Building Better Global Economic BRICs” (O’Neill, 2001), he proposed quite directly that the growth rates of these continent-sized economies raised questions about representation in global economic governance (GEG). Specifically, the banker concluded that the rise of the BRICs would require a new G7 in which major emerging economies would also be represented (2001: 11). Arguably, O’Neill would get his wish in 2008, when a financial panic and the threat of economic crisis prompted the George W. Bush administration to “upgrade” the G20 Finance Ministers’ forum to include a Heads of Government summit. The rise and fall of the great powers in history has always generated tensions over international hierarchies, whether it be in terms of the distribution of territory, status, or the ability to write the rules of world affairs (Kennedy, 1988; Cox, 1983; Schweller, 1999; Clark, 2011; Bukovansky et al., 2012; Larson et al., 2014). But compared to historical power shifts, today, the BRICS have emerged in a heavily institutionalized 361

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international system (Zürn and Stephen, 2010; Ikenberry, 2011; Stephen, 2012; Gray and Murphy, 2013; Kahler, 2013; Lesage and Graaf, 2015). Examples of international institutions in GEG include the World Trade Organization (WTO), the International Monetary Fund (IMF) and the World Bank. At the same time, these institutions embody representational inequalities (Zürn, 2007; Parízek, 2017), meaning that they allocate the ability to participate in the policy making process unequally. Examples include the informal hierarchies of participation that characterize trade negotiations at the WTO, the selective membership of elite forums like the G7 and G20, and the weighted voting procedures at the IMF and World Bank. In each of these cases, great economic powers receive more representation than other states. Almost all of the existing institutions of GEG were created at a time when the world economy was dominated by advanced, Western, developed economies. As such, they often embody procedures and practices that favor the established ­powers. Today, by contrast, the global economy is experiencing a transformation as the global economy rebalances, with the BRICS countries, and China and India in particular, ascending to the position of principal economic powers. Consequently, representation conflicts have emerged whereby the BRICS have demanded increased influence over the procedures and practices of international institutions. While the BRICS want a say in international economic institutions commensurate with their new status, international institutions are sticky, and established powers are reluctant to let go of their privileges. As such, conflicts emerge over representation within GEG, and institutions adapt only imperfectly (Zangl et al., 2016). In this contribution, we examine how these conflicts over representation have played out in several institutions of GEG. The rise of the BRICS has led to a general contest over representational inequality in international institutions. However, these inequalities vary considerably across institutions, depending on the institutions’ specific features. Consequently, there is significant variation in the content and outcomes of representation conflicts in different institutions. We therefore examine the nature of representation conflicts as they differ across institutions. In a second step, we examine the institutional outcomes of representation conflicts. First, to what extent have institutions responded to the rise of the BRICS, by allocating them increased representation? Have the prior institutional inequalities persisted, or have they been reduced? Second, how did the representation conflict affect the institutions’ policy output? Third, was the representation conflict resolved through reform, or did it cause countries to explore outside options such as transferring policy functions to an alternative existing institution (regime shifting) or creating a new institution (institutional creation) (Helfer, 2004; Morse and Keohane, 2014; Urpelainen and Van de Graaf, 2014), thus fragmenting the regime (Zürn and Faude, 2013; Acharya, 2016)?

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The contribution is structured as follows. First, we survey existing theoretical approaches to understanding the link between the rise of new powers and representation conflicts in GEG. Following this, we examine the conflicts over representation that have emerged as a result of the rise of the BRICS in several economic fields, such as informal economic policy coordination (the G7/G20), trade (the WTO), crisis lending and surveillance (the IMF), and development finance (the World Bank). In the conclusion, we summarize our findings and offer some inductivelyderived observations about the factors that lead representation conflicts to generate different outcomes across different institutions. We find that fragmentation is a common outcome of insufficient institutional reform. In the context of an external power shift, institutions appear to need to pass a double test to avoid fragmentation: they need both to accord new powers increased representation, and maintain their policy-making capacity. We close with suggestions for future research.

Representation Conflicts in Global Economic Governance International power shifts have historically led to conflicts over representation in global governance. After the Napoleonic wars, the Congress System introduced a hierarchical system in which a club of mutually recognized “great powers” ordered international affairs among themselves (Simpson, 2004: 91−131; Clark, 2011: 73−97). Representation was largely limited to the members of this self-appointed club. After the First World War, the League of Nations took a step towards formalizing this inequality in a League Council in which four members were represented permanently (Henig, 2010). Similarly, as the Second World War drew to a close, “sovereign inequalities” (Donnelly, 2006) were once again enshrined, even more explicitly, in the UN Security Council (Hurd, 2007). At each step, status-based political inequalities were renegotiated according to evolving criteria that determined which powers received special representation in the high organs of global governance. For realists, international institutions need to privilege powerful states if they are to remain stable. Indeed, because powerful states create and control international institutions to further their interests, this is their main purpose (Krasner, 1985; Mearsheimer, 1994). International institutions need to represent powerful states because without them the institutions will become irrelevant. Constructivists and sociological institutionalists, by contrast, emphasize the need for institutions to maintain legitimacy (Meyer and Rowan, 1991; Hurd, 2008; Zaum, 2013). Especially since the Second World War, the norm (if not the practice) of sovereign equality has become increasingly significant. In the same way that democracy became a way to realize the political equality of individuals through equal representation, the sovereignty of states came to be associated more strongly with equal representation

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in international institutions (Meyer et al., 1997; Donnelly, 2013). The prominence of “democratic” criteria for legitimacy of international institutions is also said to have grown (Grigorescu, 2015). The extent to which international economic institutions can claim to be representative has therefore become, in a sociological sense, a critical resource of their own legitimation (Meyer and Rowan, 1991; Rapkin et al., 2016). Finally, rational institutionalists have traditionally emphasized the functional gains from cooperating through formal international organizations (IOs), in which case both power and legitimacy play only a subordinate role (Keohane, 1984; Martin, 1992; Abbott and Snidal, 1998). The path is then open to considering representation as a dimension of purely “rational” design (Koremenos et al., 2001). This is indeed what Jim O’Neill had in mind when he argued that the rise of the BRIC economies required creating a new G7 that would be more effective as a forum for macroeconomic policy coordination (2001: 11). There are, then, power-based, cultural, and rationalist reasons to suppose that international power shifts, embodied in the rise of the BRICS, will prompt calls for changes in representation within institutions of GEG. The demand that GEG be “representative” in some sense therefore finds ­practically universal acceptance. But what does representation mean in the context of contemporary GEG? For Rapkin, Strand and Trevathan, representation is relevant to IOs in two ways (2016: 78−80). The first pertains to situations where authority is delegated to some agent on behalf of a group of principals, and refers to making sure such an agent “represents” the preferences of those they represent. This principal-agent (P-A) type of representation is particularly relevant where IOs have apex bodies, such as Boards of Directors. The second meaning of representation is “descriptive representation” (or mirror representation), which refers to the extent to which a legislative body reflects certain relevant characteristics of its political constituency. Examples of such criteria from contemporary international organizations include regional representation, share of quota held, or capacity to contribute to international peace and security (Rapkin et al., 2016: 81). These notions of representation underpin, inter alia, the kinds of voting procedures that IOs adopt, such as consensus or majority voting (Blake and Payton, 2015). In this contribution, we define representation in international institutions broadly as the ability to participate in the policy making process. It refers to the capacity to make oneself heard and have influence over the input side of an institution’s activities. This definition includes representation in apex bodies (P-A representation) and descriptive representation (such as voting rules), but also includes membership in exclusive clubs or the capacity to participate in decision-making practices. Representation in this sense can be allocated equally between states, reflecting sovereign equality, but can also be allocated unequally through measures,

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such as weighted voting or exclusive membership. Representation conflicts refer to political disputes over how to distribute representation within an institution. Ultimately, how institutions accord representation to various groups is a matter of political bargaining. Where institutions are unable to adequately accord representation to the newly powerful BRICS states, dissatisfied states may turn to extrainstitutional strategies such as regime shifting or institutional creation (Pratt, 2017). In the cases that follow, we apply the concept of representation to specific institutions of GEG, and reveal in which of them representation is allocated unequally and, if so, to what extent it favors the established powers over BRICS. Our focus is mainly on state representation in IOs, as this is still by far the most dominant mode of representation in IOs (Zürn and Walter-Drop, 2011), and the major focus of the BRICS governments. In a second step, we examine the institutional consequences of these representation conflicts. We discuss whether and how representation has been adjusted, the impact on the institutions’ policy output, and whether institutional fragmentation emerged.

Informal Economic Policy Coordination: The G7/G20 In 1975, as an economic crisis loomed and the old policy tools no longer appeared to work, the first “international economic summit” of what would emerge as the G7 group of major industrialized countries was convened (Hajnal, 2016). Between 1976, when the addition of Canada completed the G7, until 2008, the G7 would remain the major great power summit for economic matters at the head of government level. The G7 can be considered either an “informal” intergovernmental organization (Vabulas and Snidal, 2013) or a rather formal “club” (Payne, 2008) of major economic powers. While originating as a forum for discussion and coordination in matters of economic policy, the agenda of the G7 expanded over time to include adjacent issues such as aid, climate change and terrorism. Outcomes are typically non-binding, often vague summit declarations. Its value is seen to lie in its flexibility and the speed with which it can react to events (Vabulas and Snidal, 2013: 194). Nonetheless, the role of the G7 in acting as an agenda setter for other institutions of global governance, and the exclusiveness of the countries represented there, quickly made it a contentious institution with contested legitimacy. While the G7 always espoused “shared beliefs and shared responsibilities” rooted in liberal democracy and the market economy (Group of Seven, 1975), there have never been formal criteria for membership. Rather, the core G7 members have increasingly entertained a series of sporadically invited guests (Kirton, 2015: 119−124). Like great power clubs before it, this tended to reproduce a ­hierarchical structure of representation in which some states are in, some states are out, and

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other states may do with sporadic invitations to attend. As a purely informal forum, representational inequality at the G7 has taken the form of the exclusivity of membership. Representation Conflict The process by which the BRICS achieved representation at the high table of GEG was initiated by the G7 themselves. Beginning in 2007, the then-G8 began formally to court five major emerging economies as the “Outreach 5” (the “BICSAM” countries — BRICS minus Russia, but including Mexico) (Cooper and Antkiewicz, 2008). This had been foreshadowed already in 2005 when the BICSAM countries were invited by the United Kingdom to attend the G8 summit in Gleneagles, as it became increasingly evident that economic issues — such as negotiations in trade and climate change — could not be adequately addressed without emerging economies’ participation (Cooper, 2008; Kirton, 2015). Initially launched for a period of 2 years, the process was extended into a so-called “Heiligendamm Process” in 2009, referring to the institutionalization of dialogue between the G8 and the Outreach 5. The achievement of greater representation for the BRICS in relation to the G7 has two peculiarities. First, Russia had already been courted as a core dialogue partner in the early 1990s, and had become a member of the expanded G8 in 1997 (Panova, 2008). This put it in a fundamentally different relation to the institution compared to other BRICS countries. Second, while critical of the G8’s selectivity and its self-arrogated political role, the BICS states (excluding Russia) were hardly desperate to join as new members of the pre-existing club. Rather, the BICS were critics of its exclusivity while calling for alternative platforms of coordination of economic policy. According to Gregory Chin, China approached the G7 cautiously because it perceived it as a club for rich countries. Closer association could have challenged its credentials as a member of the developing world (Chin, 2008: 20). China was first invited to attend the G7/8 in 1999 and again in 2000, but rebuffed both invitations (Chin, 2008: 85). Rather than seek formal representation in the G7, as Jim O’Neill had envisioned, China emphasized the role of the United Nations and preferred to relocate the economic policy functions of the G7 to the more inclusive G20, initiated at the Finance Ministers’ level in 1999. India’s identification as a longstanding pillar of the global South also affected its approach to the G7, with Abdul Nafey describing it as one of “studied indifference” (Nafey, 2008: 123). The “Outreach Five” format of inviting the BICS and Mexico as guests was perceived as incommensurate with India’s rightful status (Nafey, 2008: 126−127). Brazil under the Lula administration was similarly concerned to build up alternative avenues

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for international cooperation, such as the IBSA Dialogue Forum involving India and South Africa, rather than reinforcing established Western institutions such as the G8 (Gregory and Almeida, 2008: 152). South Africa was similarly critical of the exclusionary character of the G7, but was “among the keener participants” of the Outreach Five, according to Brendan Vickers (Vickers, 2008: 181). But the Heiligendamm Process would peter out, especially after the initiation of regular BRICS collaboration from 2006 (at Foreign Ministers’ level). The approach of the G7 countries — to integrate the BICS as second-class “invitees” or “guests”— was therefore insufficient to resolve the disagreement over representation in the major global forum for informal economic policy coordination. Institutional Outcomes Ultimately, representation conflicts between established powers and the BRICS would be resolved not by the expansion of the G7, but by the addition of a G20 Heads of State and Government forum. This effectively relocated the economic policy functions of the G7 to the G20. This was also a matter of necessity rather than choice. If the rise of China and the other major emerging economies had increasingly called into question the legitimacy and effectiveness of the Western-centric G7/8 format, the global financial crisis (GFC) undermined them completely. As Vestergaard and Wade put it, continuing to meet as the G7 without consulting with major developing countries would have been “like the captain of a ship who stands at the wheel turning it this way and that — knowing that the wheel is not connected to the rudder” (2012: 258). In other words, there was a strong functional logic in according new powers representation at the economic high table. The major and proximate cause, however, was the emergence of new economic shocks that precipitated the upgrading of the G20. The G20, much like the G7 before it, was initially convened at the level of finance ministers and central bankers. It was convened formally for the first time in Berlin in 1999 in the aftermath of the Asian financial crisis, in recognition of the need to involve newly “systemically significant” economies in a flexible and timely forum (Alexandroff and Kirton, 2010; Cooper, 2015; Kirton, 2015). At the same time, its membership was determined at least partly by political considerations (Payne, 2008; Vestergaard and Wade, 2012). While the G7 has been retained as an informal forum for like-minded states, the emergence of another major economic crisis in 2007−2008 prompted a shift to the G20 at the Washington Summit in November 2008 (Alexandroff and Kirton, 2010). The G7 continues to meet, but the shift in the major apex body of informal economic governance was made official after the G20 summit in Pittsburgh in 2009, when it was designated the “premier forum” for international economic cooperation (G20,

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2009: 19). Today, the G20 plays a similar role to that of the previous G7: providing an informal and flexible forum for powerful countries to seek agreements, which can then be presented as a fait accompli to outsiders without their participation. Decisions taken at the G20 can then be externalized to formal IOs such as the IMF (Vabulas and Snidal, 2013: 194). The BRICS states have received the G20 format far more positively than the attempts at incorporation by the G7. The risk of being incorporated as junior partners into a pre-existing G7 club seems to have underpinned the reluctance of BRICS leaders to endorse the outreach process, who called instead for formal changes to institutions such as the IMF and World Bank, and expressed a preference for the format of the G20 (Baker and Donadio, 2009). Additionally, the policy performance of the G20 as an informal crisis committee for inter-country macroeconomic policy during the GFC of 2007−2008 has widely been seen as successful, at least by comparison to the international response to the stock market crash of 1929. This centrally involved coordinating economic stimulus programs and providing mutual reassurances to avoid the competitive erection of trade barriers or currency devaluations (Cooper, 2010; Woods, 2010; Drezner, 2014: 24−56).1 Later, in November 2010 in Seoul, all the G20 governments endorsed the Third Basel Accord on banking regulation. The increased representation of the BRICS in the inner circle does not appear to have decreased its policy output capacity (although see Chodor, 2017). Through the relocation of policy functions from the G7 to the G20 summits, the BRICS won representation in the focal institution of GEG. Moreover, in the context of global economic crisis, the G20 largely delivered on its policy functions. This largely successful case of reform by increasing BRICS’ representation marks a contrast to other cases, however.

International Trade: The WTO All of the BRICS, and most notably China, have rapidly expanded their trade relations and become global trading nations. Indeed, China, with its more than $2 trillion worth of exports every year, sometimes referred to as the workshop of the world, is the second largest world exporter after the European Union. International trade represents one of the cornerstones of the BRICS’ economic growth. In line with that, since 2012 (when Russia joined), all of the BRICS have been members of  There is the objection that the G20 countries would have pursued these policies anyway. Yet, the G20 is not designed to enforce binding decisions, so it arguably was successful on its own terms.

1

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the central GEG institution tasked with the maintenance and further liberalization of world trade, the WTO. Representation Conflict In the global trade regime, by comparison to other cases discussed further in the text, the position and representation of the rising powers may seem at first relatively equitable. The WTO, as the cornerstone of the regime, applies predominantly the sovereignty-protecting consensus principle as its decision-making rule (Haftel and Thompson, 2006). Combined with the one-country/one-vote rule, this procedure is supposed to ensure that dissenting voices are heard and that no-one can be outvoted when important decisions are made. Jackson (2001) even includes this notion as the first of the seven “Mantras” of the WTO. Furthermore, the WTO does not have a powerful secretariat or apex body to which substantial competences could be delegated, and which could operate in a biased fashion, for example by favoring the established over the rising powers or over the weaker members (Elsig, 2010). In other major GEG bodies, formal or informal, this is not necessarily the case (Woods and Narlikar, 2001). Finally, India, Brazil, and South Africa have all been among the founding members of both GATT and the WTO, suggesting that they had some say in the design of the body’s structure and purpose. All these factors point to a possibly very limited role for representation conflict within the WTO. Nevertheless, the reality of the BRICS’ positions in the global trade regime is historically more problematic. First, two of them, China and Russia, only acceded to the WTO relatively recently, China in 2001 and Russia as late as 2012. While in the case of Russia, the slow progress may have been at least partly explained by the wavering interest of Russia itself in WTO membership (Zimmermann, 2007), in the case of China, its belated accession is primarily attributable to a remarkably tough accession bargaining process, whereby China has been forced to offer major concessions to the WTO membership (Kim, 2010; Pelc, 2011; Adhikari and Yang, 2002). This is perhaps most symbolically epitomized by the postponement of the market economy status for China for 15 years after the accession, until late 2016. Second, with regard to the representation of BRICS within WTO decisionmaking procedures, the notion of consensus decision-making can function in a variety of ways, from a deeply deliberative process of reaching a common position (Consultative Board of the WTO, 2004), to an almost rule-free power game, where the opacity of the procedures enables power bargaining to flourish. In the WTO, the latter seems to have been notoriously much closer to the reality (Steinberg, 2002). Thus, the capacity for states to exercise their rights to representation within the WTO has been circumscribed by inegalitarian practices within the institution.

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A number of works discusses at length the concrete mechanisms through which such a rule-free game may play out in the WTO context (Jawara and Kwa, 2004; Wallach and Woodall, 2004). One key mechanism has been the selectivity of participation in inner circles of multilateral trade negotiations, which have effectively operated as informal apex bodies (Kapoor, 2004) — in other words, unequal representation. Additionally, the age and path dependence of WTO rules also plays a role. These mostly date back to the Uruguay Round negotiations, which were still largely dominated by the established power “Quad” countries (United States, European Communities, Japan, and Canada). These were able to impose much of their preferences on others in the final stages of the Uruguay Round, as the rest of the membership, including the today’s rising powers, faced a serious threat of being excluded from the newly created WTO (Finger and Nogués, 2002). So the BRICS’ historical lack of representation continues to shape their levels of satisfaction with the institutional status quo. In sum, while the consensus and one-country, one-vote principle of decisionmaking in the WTO imply a relatively open space for the representation of the BRICS in the global trade regime, most BRICS members perceive a palpable bias in the substantive content of the existing rules in favor of the established powers as a result of their historical lack of representation. As a result, the turn of the millennium witnessed an increased demand by BRICS states for a real say in the formulation of the rules and policies governing global trade, and an increase in their readiness to engage in a direct representation conflict with the established powers. This took the form primarily of seeking better representation within the informally constituted “inner circles” of multilateral trade negotiations (Efstathopoulos, 2012; Stephen, 2012: 299−303; Hopewell, 2017). This new assertiveness became most visible at the notorious Ministerial Conference in Seattle in 1999, but continued through to the walk-out of the Cancún ministerial in 2003 (Blackhurst, 2001; Narlikar and Wilkinson, 2004), and beyond (Hopewell, 2017). Institutional Outcomes In response to these pressures, the WTO has been relatively successful in i­ ncreasing the representation of the major emerging economies, with the participation of countries like India, Brazil and China in the inner negotiating circles of the Doha negotiations (Narlikar, 2010) and their increased use of the dispute settlement mechanism (see Chapter 1; Davis and Bermeo, 2009). There is little question today that these countries are seen as critical actors in the WTO. But, while increased representation of BRICS countries may have improved the WTO’s perceived legitimacy, it has come at a cost in terms of its policy output,

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at least in the eyes of members seeking greater multilateral trade liberalization. A key consequence has been the effective blockage of the WTO’s rule-making pillar (Stephen and Parízek, 2019). When the current Doha Round of negotiations was launched in 2001, it was envisioned to last 4 years, with a mid-term review in 2003 at the Cancún Ministerial Conference. Yet, the Cancún Ministerial turned out to be the place where the developing world and the rising powers proved able to effectively oppose the proposals tabled by the established powers (and the Trade Negotiations Committee chair) and block further negotiations progress along the lines set up by them (Narlikar and Tussie, 2004; Narlikar and Wilkinson, 2004; Vickers, 2012). In spite of some further efforts, notably in 2007, further collapse occurred in 2008 and the negotiations have never fully recovered from this shock. The first substantive results of the Doha Round came only in 2013 at the Bali Ministerial Conference, where a Bali “mini-package” was approved (Wilkinson et al., 2014). In late 2015 a further “Nairobi” package was approved, again covering a relatively small portion of the original Doha agenda (European Centre for International Political Economy, 2015). After that, for the first time, some of the WTO member states, notably the United States, refused to join a common declaration reaffirming the states’ commitment to the Doha Round, suggesting that in their eyes, the round is “dead”, something they have effectively argued for a number of years anyway (Schwab, 2011; WTO, 2015). Although this has so far not transformed into an official outcome, if it ever will, this may effectively mean a fairly ignoble end to the first and so far only multilateral negotiation round under the auspices of the WTO. The possible consequence, in terms of the internal WTO negotiation principles, is a move away from the “single undertaking” scheme to the proliferation of various plurilateral agreements in which members may sign up individually. In sum, the stronger representation of BRICS, and their effective ability to block proposals by the United States and the EU, has established a new status quo in the trade regime. This frustrated established powers, which are now unable to effectively project their interests into new regulation. In consequence, the rule-making has for a number of years systematically failed to deliver new policy output (Stephen and Parízek, 2019). In the other pillars of the WTO, the Dispute Settlement Mechanism (DSM) and the Trade Policy Review Mechanism, the representation conflict is less notable. With regard to the DSM, China has consistently been among the most frequently targeted countries (with the exception of the EU and USA), but it has also itself developed into one of the most frequent litigators (WTO, 2017). Besides its obvious economic relevance for a number of actors, Chinese non-market economy status, held until 2016, has prompted a number of cases, especially challenging China’s opponents’ anti-dumping measures (Manjiao, 2012). The other BRICS seem to have acquired

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the capacity to fully participate in the DSM as well, distinguishing them clearly from many other developing countries and especially LDCs (Busch, 2007; Vickers, 2012). In the Trade Policy Review Mechanism, the position of China, India, and Brazil, has been also found to be close to equal to that of the traditional powers in recent years (Karlas and Parízek, 2019, appendix), as compared to the first decade of the WTO (Ghosh, 2010). This suggests that in the everyday business of the organization BRICS are today effectively (close to) equally represented as the established powers. Symbolically, this may be represented by the current Director General, Brazilian diplomat Roberto Azevêdo. Nonetheless, one side effect of greater BRICS representation has been that the rule-making pillar of the WTO essentially fails to perform. This is clearly a state which is helping to drive the very prominent trend of regionalism and the focus of a number of states on the creation of preferential trade agreements (PTAs). This trend of the fragmentation of the global trade order has been clearly driven by the established powers’ dissatisfaction with the “new” status quo in the WTO, whereby they are unable to effectively project their interests into new regulation. However, BRICS have not been completely left behind in this process either, and especially China is developing a network of PTAs, such as with Australia, Chile, Peru, or notably ASEAN. Similarly, India has several new PTAs with e.g. Japan, Korea and with ASEAN as well as Mercosur. Brazil enjoys the preferential relations negotiated by Mercosur. South Africa and Russia then mostly develop preferential relations with their close neighbors, without a clear global reach. Greater BRICS representation in the WTO can be associated with greater input legitimacy but has come at the cost of policy output, at least in one of its core functions. This has fueled a trend towards fragmentation in the trade regime.

International Financial Stability: The IMF The WTO demonstrated flexibility in adapting to the rise of the BRICS. The situation is radically different in the case of the IMF, the primary multilateral institution for the international monetary and financial system. With its weighted voting system and the effective veto power of the United States and European Union, the IMF has been widely criticized for failing to represent BRICS appropriately. Representation Conflict The BRICS countries have made their dissatisfaction with their representation in the IMF well-known, and have made reform of the IMF one of their major priorities, calling for “reviewing the IMF role and mandate so as to adapt it to a

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new global monetary and financial architecture” (BRIC Finance Ministers, 2009: 9). They have pushed for significant changes in the distribution of voting quota, a redistribution of representation on the Executive Board, and the selection of the IMF Director based on an “open merit-based processes, irrespective of nationality or regional ­considerations” (BRIC Finance Ministers, 2009: 9). As a shareholding institution, the IMF’s system of weighted voting means that any increase in representation for emerging economies must be redistributed from other IMF members. Representation in the IMF is a zero-sum game. Votes at the IMF are directly determined by the special drawing right quota allocation, which is in turn given by a formula including several economic i­ ndicators. The current quota formula of the IMF is a mixture of GDP (50%), economic ­openness (30%), variability (15%), and financial reserves (5%), with GDP blended 60% in market and 40% in purchasing power terms. The very composition of the formula, however, is far from economically obvious, and already in the 1940s its construction was guided primarily by political considerations (Woods, 2006). While the current formula includes, for example, the variable of economic openness and variability (favoring small open economies), the BRICS have argued that such variables as “contribution to global growth” should be included instead (Vestergaard and Wade, 2015). Thus at the IMF, not only the distribution of representation is contested, but the criteria for allocating representation are contested too. The current allocation gives the United States 16.5%, followed by Japan and China with around 6% each. Because many important decisions (such as voting quota reallocation) require an 85% supermajority, this accords the United States disproportionate representation. At the same time, the voting total of EU members, even excluding Britain, exceeds the 15% threshold as well (International Monetary Fund, 2017). This gives the United States but also the EU de facto veto power. Furthermore, while the formula is supposed to undergo a periodic review, its results do not get implemented automatically, but instead need to be ratified by the IMF membership. The last 2008−2010 14th General Review of Quotas took until December 2015 to be ratified by the United States, postponing the reform implementation by a staggering 5 years (International Monetary Fund, 2015). Moreover, despite the appointment of a Chinese deputy managing director in 2011, the BRICS have not been very successful in gaining positions amongst IMF staff (Ferdinand and Wang, 2013). Representation conflicts in the IMF case have been both protracted and contentious. Institutional Outcome What institutional outcomes have followed from this severe representation ­conflict? Rather remarkably in the light of bombastic rhetoric connected with the quota

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allocation reform mentioned previously, the actual redistribution of voting power in response to the BRICS’ demands has been low (Vestergaard and Wade, 2015). Moreover, it has already been surpassed by new economic realities. Overall, ­according to the IMF’s own simulations, if the quota were applied using contemporary economic data (2014), the quota share for “emerging markets and developing countries” would increase by 13 percentage points to 49.3%. China alone would gain 5.6 percentage points, India 1.0, Russia 0.7, and Brazil 0.6 percentage points (International Monetary Fund, 2016: 6). The standard line in IMF publications goes (rather euphemistically) that “[t]he quota formula is typically used to inform discussions on the allocation of quota increases, but other considerations are also taken into account” (International Monetary Fund, 2016). Due to rapid growth and increased openness in major emerging economies, the extent of “out of lineness” currently resembles that prevailing before the previous quota reforms, agreed in 2008 (ibid., 17). Even by the established criteria for quota allocation, generally considered to favor small open economies, the BRICS (excluding South Africa) are greatly under-represented, and China is woefully underrepresented. This “descriptive” representativeness of the IMF is deeply unbalanced. Second, the prominent position of the established powers is also visible in the composition of the IMF Executive Board. Among the 24 directors on the Board, only eight are held by an individual country, the remaining 16 by often very heterogeneous country groups. The individual directorships are held by the United States, Japan, Germany, France, and United Kingdom on the one hand, but only by China and Russia on the side of the BRICS. Both India and Brazil are dominant members in their respective constituencies, while two other seats are occupied by constituencies of smaller European members, meaning that the EU/European Economic Area states completely control five directors (Woods and Lombardi, 2006). This erodes the “PA” representativeness of the IMF’s apex body further. Quota and decision-making power have not been the only concerns with the IMF raised by the BRICS. The policy output has been consistently under criticism as well. None of the BRICS has been in urgent need of an IMF loan itself for more than 15 years. The fallout from the Asian financial crisis of 1997, and the United States’ (ab)use of its influence in shaping the IMF’s response, still carries a sizeable deterrent effect for the rising powers, with regard to the economic as well as political costs of the loans’ conditionality (Henning, 2017). The BRICS are concerned that their under-representation may lead IMF policy output to favor the established powers and their allies (Qobo and Soko, 2015: 281). In other words, the BRICS fear that the IMF is a jointly funded tool under a direct control of and promoting the interests of the United States and the key European members (Momani, 2004; Copelovitch, 2010). More broadly, the IMF is seen as espousing a policy perspective that strongly

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corresponds to the domestic institutions and ideological predispositions common especially in the United States, and to a lesser extent in Europe and other OECD countries (Mukherji, 2014; Baker, 2010). This position, favoring a relatively small role of the state and “hands off ” forms of economic regulation, stands in opposition to the often strong involvement of central and local government authorities in  the  economies of many of the BRICS (Stephen, 2014; Nölke et al., 2015; Kurlantzick, 2016). The chronic institutional and ideological under-representation of the BRICS (except South Africa) in the IMF has translated, over time, into new initiatives of institutional innovation. Most notably, persistent dissatisfaction with the role of established powers in the IMF has led in July 2014 to the signing of the Treaty for the Establishment of a BRICS Contingent Reserve Arrangement, and in 2015 to the beginning of its operations (Ministry of External Relations of Brazil, 2014b). While allegedly not meant as a direct competitor to the IMF in the area of short balance of payments adjustment lending, the BRICS Contingent Reserve Arrangement was explicitly motivated by the lack of reform of the IMF governance (Ministry of External Relations of Brazil, 2014a). This represents a clear case of parallel regime creation, triggered by the unfavorable treatment of the BRICS within the Bretton Woods institutions (Eichengreen, 2014; Qobo and Soko, 2015; Morse and Keohane, 2014). More directly, frustration with the lack of reform of the IMF appears to be a contributing factor to the pursuit of the ASEAN+3 Macroeconomic Research Office (AMRO), which in conjunction with the multilateralization of the Chiang Mai Initiative, reproduces the IMF’s two core policy functions of multilateral economic surveillance and crisis lending (Sussangkarn, 2011; Rana et al., 2012). For these reasons, the AMRO is sometimes perceived as an Asian Monetary Fund (The Japan Times, 2016). All of this further contributes to the development of supplementary “regional financial arrangements” that diversify and potentially fragment the ­institutional landscape (Henning, 2017).

Development Finance: The World Bank Another area of GEG in which the BRICS have become critically important is development finance. Key institutions in this field of GEG are multilateral development banks: “institutions that provide financial support and professional advice for economic and social development activities in developing countries” (World Bank Group, 2013). The International Bank for Reconstruction and Development (IBRD) and its associated agencies (together known as the World Bank Group, or simply World Bank) in particular has played the major role in development finance since the Bretton Woods conference of 1944.

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Representation Conflict Much of what has been said specifically about the IMF applies also to the World Bank. The Bank operates on a comparable decision-making system: a Board of Governors, an elected Board of Directors with 25 seats, both adopting decisions by weighted voting, and a President. Like the IMF, established powers are typically privileged relative to the BRICS in terms of voting rights, seats on the Board of Directors, and in appointing senior staff members. While basing its voting share allocation on a modified version of that adopted by the IMF, in reality, there are systematic departures from the principle that voting power should reflect in large measure the relative importance of member countries in the global economy (Vestergaard and Wade, 2015: 7). Moreover, voting quota reform requires a supermajority of 85%, which creates a large reform threshold that includes a de facto veto for the United States as well as the EU. As established powers have obvious interests in preserving their privileges, the World Bank has largely failed to avoid criticism for failing to adequately represent the BRICS and other emerging and developing countries. The BRICS have been consistently dissatisfied with their representation at the World Bank. At one of their earliest meetings, the BRICS called for a “speeding up” of voice and representation reform at the World Bank, to ensure that it “fully reflect[s] changes in the world economy” (BRIC Finance Ministers, 2009: 10). They also called for equal representation between emerging/developing and advanced economies, without any losses to individual developing countries, and an end to the collusion between the United States and its allies to always favor the American nominee for World Bank President (BRIC Finance Ministers, 2009: 10). In terms of the capacity and funding decisions of the Bank, the BRICs also called for it to perform a counter-cyclical role to compensate for private investor jitters, including raising new resources on global capital markets, relax the single borrower limit, and invest more in infrastructure projects in low and middle-income countries (BRIC Finance Ministers, 2009: 10). As at the WTO, the historical lack of BRICS representation has led to the Bank being guided by a set of principles advocated by the established powers and often regarded as inappropriate and unacceptably intrusive by the developing world and the BRICS. India and China, along with other developing countries, also expressed opposition to perceived liberal biases in the World Bank’s annual Doing Business Report, introduced in 2004 (Bretton Woods Project, 2013). Having noted that, the Bank has undergone a more profound reform than the Fund, being the faster of the two organizations to downplay the Washington consensus rhetoric of the 1990s in favor of a more open development paradigm (Barnett and Finnemore, 2004; Rodrik, 2006).

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The principle disagreement of the BRICS with the established powers’ ­insistence on conditionality is perhaps most directly prominent in their refusal to adopt the ‘Western’ standards in their own donor practice. In other words, as the BRICS have acquired the capacities to become themselves donors of development assistance, they challenge the existing rules and standards as so far defined and upheld especially through the policies of the Development Assistance Committee of the OECD (OECD/DAC). While over the decades the developed countries have adopted a set of best practices supposed to improve the effectiveness of development assistance, with a focus on its long-term effects, the BRICS explicitly challenge these standards (Tierney, 2014). This holds not only for the OECD/DAC rules, but also for not strictly inter-governmental arrangements, such as the International Aid Transparency Initiative where none of the BRICS participates (see Chapter 7; Tierney, 2014; International Aid Transparency Initiative, 2017). Institutional Outcome Reforms at the World Bank may be classified as marginally more significant than at the IMF (Lipscy, 2015), yet ultimately, they share a similar profile by failing to incorporate the BRICS in positions commensurate with their capabilities or aspirations (Vestergaard and Wade, 2013; Reisen, 2015). In response to the growth of emerging economies including the BRICS, established powers conceded a reform process at the World Bank known as Voice Reform, which was approved at the World Bank’s Board of Governors in March 2010 (World Bank Development Committee, 2010). This centrally involved the addition of an extra seat to the Executive Board of Directors for Sub-Saharan African countries, taking the total from 24 to 25, and a reallocation of voting quota that improved the positions of emerging and developing countries. Yet, as Vestergaard and Wade show in detail (Vestergaard and Wade, 2013; 2015; Wade, 2013), these changes were more cosmetic than surgical. They conclude that while the IBRD’s official guiding principle is that voting power “should reflect members’ weight in the world economy” (World Bank Development Committee 2010: 3), this is more rhetoric than reality. As Reisen summarizes, “the BRICS were right to conclude that developed countries have no intention of losing voice and voting power in the established multilateral institutions” (Reisen, 2015: 300). In response to inadequacies of World Bank reform, the most direct institutional outcome of the BRICS’ effort to make their views represented in development finance has been the establishment of two new multilateral development banks, first the “BRICS” New Development Bank (NDB) in 2014 and then, in 2015, the Asian Infrastructure Investment Bank (AIIB) (Biswas, 2015). Especially the latter has attracted widespread attention, as the AIIB quickly attracted as new members

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a number of traditional donor countries, including the United Kingdom and all other European major donors (Peng and Tok, 2016). The lack of adequate representation of BRICS in the World Bank is widely seen as a core reason — alongside a desire for more infrastructure investment, the accumulation of large financial reserves, and a desire to pursue national interests — for them to establish these institutional alternatives (see Chapter 14; Chin, 2016; Faude and Stephen 2016; Larionova and Shelepov, 2016; Pratt, 2017). The increased number of development assistance arrangements may mean more plurality in aid, not necessarily more fragmentation (Han and Koenig-Archibugi, 2015). At the same time, to the extent to which there exists a development assistance regime, it is hard to see it as not being challenged by the establishment of new bodies which may or may not refuse the rules the regime has applied (or purported to apply) so far. At a minimum, the creation of new multilateral development banks by the BRICS creates room for institutional choice and increases the bargaining leverage of borrowing countries. This further fragments the institutional landscape.

Conclusion and Future Research This survey of BRICS representation in GEG is far from comprehensive, and many other institutions could have been included. Nonetheless, our focus on the major economic multilaterals suggests that dissatisfaction with their representation in existing institutions is a major hallmark of the rise of the BRICS, although the specific nature of the representation conflicts that ensue is heavily mediated by features specific to individual institutions. The “need” to make GEG more representative in response to the rise of the BRICS appears driven partly by power considerations (the need to co-opt new powers who could challenge the status quo), partly by performance concerns (the need to ensure systemically significant countries have a say), and partly by normative questions of legitimacy (the perception that major developing countries and new world powers ought to have a commensurate role in international institutions). One avenue for future research could be to formulate and assess more specific claims about which of these factors is most important in explaining institutional adaptation to new demands for representation. We speculate that in light of the historically protracted legitimacy deficits of existing institutions, the roles of power and (especially) functional performance appear primary in driving institutional responses to emerging powers. Another observation flowing from this survey is inter-institutional variation. Some institutions such as the G20 and the WTO have reformed and accorded the BRICS greater representation fairly rapidly, while others, such as the IMF and World

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Bank, have done so only slowly and reluctantly. Given the more informal nature of the representation hierarchies in the cases of the G20 and WTO, this suggests that more formal institutions with lower veto thresholds will have a harder time at adjusting to international power shifts. Lack of representation of the BRICS in GEG more broadly has the potential to undermine both the performance and legitimacy of existing institutions. In the longer term, this tendency is likely to lead to greater institutional fragmentation, as dissatisfied powers — either rising or established — seek alternatives to multilateral institutions (Acharya, 2016; Stephen, 2017). This raises concerns regarding interinstitutional coordination (Kahler, 2016). An overview of representation conflicts and subsequent institutional outcomes in GEG is provided in the Table 1 below. By way of suggesting further avenues for future research, we highlight several inductive observations that would benefit from more rigorous investigation. First, under what conditions do international institutions respond to the rise of new powers by according them increased representation? Based on the four cases

Table 1:   Representation conflicts and institutional outcomes in global economic governance. Representation Conflict

Institutional Outcome Representation

Policy Output

Fragmentation None: policy tasks migrated from G7 to G20

G7

Membership in the Major policy functions Successfully coordinated focal institution shifted from the G7 response to for informal GEG to the newly created GFC G20

WTO

Membership in the inner circle of multilateral negotiations

Shift from the old ‘Quad’ to new negotiation circles involving Brazil, India, and China

Increased tendency Yes: shift towards Preferential and towards Regional Trade negotiation Agreements deadlock (RTAs)

IMF

Voting quota, seats on the Executive Board, selection of Managing Director

Minor redistribution of voting quota, move to all-elected Executive Board, Managing Director still European

Minor adjustments Yes: BRICS’ CRA, to policy output ASEAN+3 AMRO

World Voting quota, seats Bank on the Board of Directors, selection of President

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Minor adjustments Yes: BRICS’ NDB, Minor redistribution to policy output China’s AIIB of voting quota, addition of new seat to the Board of Directors, President still American

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examined in this chapter, it would appear that informal institutions which embody membership-based representational inequalities are more responsive than formal institutions with zero-sum representational inequalities. The integration of India and Brazil into the inner negotiation circles of the WTO membership during the Doha Round required only an adaptation of pre-existing negotiation practices, rather than any formal procedural amendments. The shift to the G20 as the focal institution of GEG also required no formal changes to existing institutions. At the same time, each of these adaptations entailed an expansion of membership rather than any redistribution of power among members. As such, both the formality of existing institutions and the nature of representational inequalities (club-based vs. zero-sum) appear to affect institutional responsiveness. Informal, club-based institutions appear most adaptable to international power shifts, while formal institutions with hierarchical voting rules appear least adaptable. Second, how does the promotion of rising powers within existing institutions affect policy outcomes? In the case of the WTO, adaptation to rising powers appears to have exacerbated negotiation deadlock, while in the G20 and the other institutions, this was not the case. This may be a result of the WTO’s special institutional structure, which combines a requirement for consensus with binding and legally enforceable policy commitments and a strong dispute settlement mechanism. Both the need for consensus, and the need to find agreement on highly legalized forms of policy output, may negatively affect institutional adaptation to new representation demands. This combination of institutional features only appears in the WTO case. Third, under what conditions has the rise of the BRICS contributed to institutional fragmentation via the creation of new institutions? Of our cases, it is only the G7 that largely avoided fragmentation (by shifting to the G20). The G20 is also the only institution to have successfully increased the BRICS’ representation and continued to deliver on its (loose) policy mandate. While the WTO successfully accorded rising powers increased representation, its trade liberalization mandate was paralyzed in the process, increasing the incentive for dissatisfied countries to pursue outside options. The IMF and World Bank, by contrast, have largely failed to increase representation for the BRICS, which in turn has given rise to BRICS’ own pursuit of outside options through institutional creation. From these observations, it would appear that institutions need to pass a double test to avoid fragmentation under conditions of external power shifts. They need both to accord new powers increased representation, and maintain their policy effectiveness. While these speculations need to be further explored (Pratt, 2017; Faude and Stephen, 2016), this would appear to be a tough hurdle for global economic governance to meet.

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Acknowledgements Michal Parízek acknowledges funding by Peace Research Center Prague, the Charles University Research Centre programme UNCE/HUM/028.

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Index

B balance of payment, 210, 212 Balassa−Samuelson effect, 220 Bandung principles, 145 BASIC, 291–292, 294–295, 298–304 Bay of Bengal Initiative for Multi-Sectoral Technical and Economic Cooperation (BIMSTEC), 45 Big Mac Index, 215 Big Three, 230–231, 233–234, 237, 239–240, 242, 244–245, 248–249, 251 bilateral currency swap agreements, 70 bilateral investment treaties (BITs), 70, 91, 97–98, 181, 184–188, 190, 193–196, 200, 259–261, 263–264, 266, 269, 272, 274–278, 281 bilateral relations, 122–124, 131 BIT denunciation, 185 Blanchard, Jean-Marc, 60 Brazil, 3, 85, 87, 185–186, 196, 198–201, 259, 261, 268, 271–272, 279, 282, 314 Brazilian aid, 146 Brazilian aid allocation, 148 Brazilian aid data, 147–148 Brazilian aid history, 146 Brazilian aid institutions, 147 Brazilian aid projects, 147 Bretton Wood, 207, 214, 345 Bretton Woods institutions, 38

A advanced economies, 343 aid, 55–56, 65, 72 aid, conditional, 142, 144–145 aid effectiveness, 143, 159, 161, 164–165 aid motives, 142–143, 148, 152, 156, 164–165 aid, non-conditional, 149, 155, 159 aid, project tied, 144, 154 aid transparency, 142, 147, 151, 154, 164 approaches to regionalism, 116, 125–126, 130, 132 arbitration, 260–265, 267, 275 Argentina, 265–266, 271, 273, 275, 277 ASEAN Plus Three (APT), 75 Asian Development Bank (ADB), 66, 354 Asian financial crisis, 210, 232–233, 235 Asian Infrastructure Investment Bank (AIIB), 34, 56, 66, 72–74, 339, 349–351 Asian regionalism, 122–123 Association of Credit Rating Agencies in Asia (ACRAA), 237–238 Association of South−East Asian Nations (ASEAN), 38, 44 asymmetrical responsibility, 121 authority, 229, 233, 235, 247, 251, 253 automotive industry, 19 award, 266, 269, 277 391

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392  Index

BRF, 28 BRICS, 3, 47, 66, 83–85, 96, 183–185, 337, 361–369 BRICS aid, 139–144, 165–166 BRICS Business Council, 318 BRICS cable, 17 BRICS Contingency Reserve Agreement (CRA), 17, 36, 351 BRICS Development Bank, 17, 318 BRICS donors, 144 BRICS payment system, 17 BRICS summit, 318 BRICS Think Tank Council, 318 Bridge-Builder, 88, 94 Broad-Based Black Economic Empowerment (BBBEE), 98 C capital account, 347 capital account opening, 63 capital controls, 346 central bank independence, 216, 218 China, 84–85, 87, 194–198, 201, 261, 266, 268–270, 279, 311, 346, 350 China−ASEAN, 62 China−Australia FTA, 62 China Inc. model, 63 Chinese aid, 156 Chinese aid allocation, 158 Chinese aid data, 157 Chinese aid history, 156 Chinese aid institutions, 156 Chinese aid projects, 158 Chinese demands for commodities, 103 Chinese outward foreign direct investment (COFDI), 71–72 Chin, Gregory, 65, 69 CIS, 22 Clean Development Mechanism (CDM), 302 climate change, 56, 58, 67–68 coalition-building, 74

b3508_V2_Index.indd 392

coexistence, 48 Cold War, 41, 150 Collective Security Treaty Organization, 26 Common Economic Space, 23 common market, 42 Commonwealth of Independent States, 18 companies (see also firms), 261, 263, 266–270, 273, 275 Competitive Regionalism, 119 comprehensive regional agreements, 120 conditional preference theory, 221 conflicts of interest, 236 convertibility, 63 Copenhagen Accord, 297 corporate bond, 231, 233, 235–236, 238, 241 cost-benefit calculations, 60 countercyclical financing, 66 counter-sanctions, 21, 28 crawling peg, 209–210 creative compliance, 64 credible commitment, 217 credit lines to the IMF, 348 credit risks, 236, 242, 250–251 creditworthiness, 232–233, 242–243, 245, 247, 251–253 critical transition, 13 cross-border terrorism, 44 currency peg, 209, 211 currency swaps, 352 current account balance, 211 current account deficit, 212 current account surplus, 223 D DAC aid principles, 143–144, 147, 157, 166 DAC donors, 141–145, 158, 161, 166 DAC OECD aid, 140 democracies, 4, 199–200 democratization, 104 Department of International Relations and Cooperation (DIRCO), 95

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Index 393

Deripaska, Oleg, 19 developing countries, 6, 209 development aid, 61, 67 developmental state, 97 development financing, 56, 61 direct power, 68–69 dispute settlement mechanism (DSM), 59, 259, 264, 278 Doha Round, 57, 61, 74 dollarization, 211 domestic politics, 58, 62, 64, 67, 126, 128 dominant network, 14 donor, non-traditional, 141–146, 148, 165–166 double devaluation, 212 downgrade, 231–232, 243, 245–249 Dreher, Axel, 70 Drezner, Daniel, 68–69 dual-currency basket, 211 Dutch Disease, 222 E EAEU, 18, 22 East Asia Summit, 75 economic growth, 222 economic interdependence, 125, 127–128, 130 economic liberalization, 33, 38 economic regionalism, 120, 127–128 economic statecraft, 68–69 Emerging market economies (EMEs), 34, 183, 186–187, 196–197, 199, 201 Energy Charter Treaty (ECT), 187, 189 Energy Governance, 317 Energy Markets, 311 Energy security, 307–308 energy transitions, 315, 326 environmental standards, 72, 75 Eurasian Customs Union, 22–23 Eurasian Economic Commission (see also EEC), 24

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Eurasian Economic Community, 23 Eurasian Intergovernmental Council, 24 European Monetary System, 209 European Monetary Union, 209 European Securities Market Authority (ESMA), 230, 239, 241, 245 European Union, 42 exchange rate regime, 208, 215 exchange rate policy, 207 Executive Board, 341 exit, 339–340, 347 exorbitant privilege, 69 expropriation (see also nationalization), 263, 268, 280–281 external innovation, 73–74 externalities, 222 external tariffs, 27 Exxon, 276 F fair and equitable treatment (FET), 181, 186, 188, 191–193, 195 FDI stocks, 91 federal systems, 218 Ferdinand, Peter, 59 finance, 56, 67–68 financial crisis, 338, 349 financial disintermediation, 251 financial globalization, 250 financial intermediation, 234 financial markets, 230, 232, 240, 252–253 financial stability, 352 financial statecraft, 69 firms, 259–269, 273, 275, 278–282 first face, 69 fiscal interventions, 104 fiscal policy, 224 fiscal transfers, 104 fixed-but-adjustable exchange rate, 208 fixed-but-adjustable regime, 210 fixed exchange rate, 208–209, 213, 219

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394  Index

flexible regimes, 209 floating exchange rate, 208, 212 Flores-Macías, Gustavo, A., 71 Foot, Rosemary, 67 foreign aid, 72 Foreign Direct Investments (FDIs), 40, 61, 71, 181–183, 187, 189–191, 193–195, 197–200 foreign exchange reserves, 347 foreign policy, 4 Fradkov, Mikhail, 21 fragmentation, 363, 365, 372, 378–380 free trade agreements (FTAs), 40, 62, 70, 190–191, 194–195, 201 French, Erik, 57 G G4, 45 G7, 361–368, 379–380 G8, 366–367 G20, 47, 57–58, 338, 361–363, 365–368, 378–380 GATT Uruguay Round, 90 Geithner, Timothy, 346 General Agreement on Tariffs and Trade (GATT), 9, 39, 56 General Agreement on Trade in Services (GATS), 64 geoeconomics, 25 geopolitical, 43 Germain, Randall, 61 global economic governance, 65, 67–68, 72, 74, 309 global energy governance, 307, 310, 323 global energy markets, 307 global financial crisis (see also GFC), 66, 231, 236, 241, 243, 245–246, 251 global governance, 92 global investment regime, 181–186, 189, 193–196, 198–199 globalization, 84, 96, 261, 264, 278, 282 global liberal order, 105 global order, 115, 131

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gold window, 208 governance, 229, 236–237 governance models, 71–72, 75 Grabel, Ilene, 65 great power, 361, 363, 365 Green Revolution, 38 Gref, German, 20 Growth, Employment, and Redistribution — GEAR program, 89 Gujral Doctrine, 39 Gulf Cooperation Council (GCC), 39 H Harpaz, Marcia, 59, 61, 64–65, 67 He, Alex, 61 hegemonic stability theory, 126 Hindu rate of growth, 33 Hirschman, Albert, 66 home bias, 244–249, 251, 253 I identity conception, 89 Ikenberry, John, 64, 73–74 imported inflation, 219 Impossible Trinity, 215, 217 inclusiveness, 101 income inequality, 103 India, 85, 190–193, 197–201, 259, 261, 268, 270–272, 279, 282, 312 India−Brazil−South Africa Dialogue Forum (IBSA), 93, 367 Indian aid, 153 Indian aid allocation, 154–155 Indian aid data, 155 Indian aid history, 153 Indian aid institutions, 153 Indian aid projects, 154–155 Indian Ocean Rim, 44 inequalities, 362–363, 366, 380 inflation targeting, 212, 214–215, 217 integration, 282 intellectual property rights, 56, 68 interest group politics, 27

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Index 395

interest groups, 60, 62–63 international macroeconomic policy s­ urveillance, 63 international agreements, 260–262, 264–265, 277–279, 281 International Bank for Reconstruction and Development (IBRD), 34, 344 International Criminal Court (ICC), 99 International Development Association (IDA), 344 international financial governance, 67, 69 international investment agreements (IIAs), 181–183, 185, 188, 190, 194–195, 197–199 internationalization of the RMB, 69 International Labor Organization, 101 international law, 276, 277 international law firms, 260 International Monetary Fund (IMF), 34, 38, 56, 59, 66, 337, 356, 362–363, 368, 372–380 international order, 307, 326 international reserve currency, 61 international trade, 5 international tribunals, 281–282 intra-regional trade, 117, 122 investment, 55, 61–62, 65, 260–267, 269–273, 275–281 investor-state dispute settlement (ISDS), 181–186, 188, 190, 192–198 Inward Foreign Direct Investment, 90 Israel, 275–276 issuer-pays, 233, 236, 251 J Japan, 354 Johnson Line, 41 K Kaplan, Stephen B., 71 Kastner, Scott, 67, 71 Kasyanov, Mikhail, 20 Katada, Saori, 69

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Kent, Ann, 59 Khodorkovsky, Mikhail, 20 Kobayashi, Yuka, 64 Kosyanov, Mikhail, 21 Kreps, Sarah, 71 Kudrin, Aleksey, 20 Kyoto Protocol, 289, 292–294, 298–299 L labor standards, 75 large-N research design, 56, 75 lawsuit, 260, 274 leader-oriented cost-benefit framework, 60–61 leadership, 355 leading player, 44, 47–48 learning curve, 57–59 legalization, 278 lending, 353 level of exchange rate, 208 Liang, Wei, 63 Liao, Steven, 70 liberal economic order, 84 liberal international economic order, 56, 65 liberal international order, 64 liberalization, 89, 93 liberalizing trade, 95 like-minded developing country group (LMDC), 302–303 Lim, Darren, 73–74 Li, Xiaojun, 59 Lomé Convention, 90 Look East policy, 38, 44, 121 Lukashenko, Alexander, 27 M MacMohan line, 41 macroeconomic surveillance, 67 majoritarian systems, 218 managed float, 208, 212–213 Mandela, Nelson, 99 manufacturing, 101

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396  Index

Mbeki, Thabo, 87 McDowell, Daniel, 70 median voter, 217 Medvedkov, Maxim, 20 mergers and acquisitions (M&A), 71 micro-foundations, 225 middle-power, 84, 94 military regimes, 219 mineral commodities, 88 mineral reserves, 88 Missile Technology Control Regime (MTCR), 45 Model BIT, 183, 188–190, 192–193 monarchies, 219 monetary bilateralism, 63 Mordashov, Aleksey, 19 most-favored nation (MFN), 42, 181, 186, 188, 190, 192–193, 195–196 multilateral order, 357 multinational corporations (MNCs), 182, 185, 188–189, 193, 198, 201, 260, 269, 281 multi-polarity, 115 mutual benefits, 144–145, 149, 165 N Narlikar, Amrita, 57 nationalizations (see also expropriation), 264, 276 Nationally Recognized Statistical Rating Organization (NRSRO), 240 Nazarbayev, Nursultan, 27 negative game, 42 negative sum game, 41 negotiation strategies, 348 neo-colonial, 49 neo-institutionalism, 105 NEPAD (the New Partnership for Africa’s Development) program, 92 Netherlands, 263, 265, 270, 272, 274, 276–277 New BRICS Bank, 34

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New Development Bank (NDB), 36, 56, 66, 72–73, 139, 318, 339, 351 New International Economic Order, 38 non-alignment, 37 Non-Annex I, 289, 297–298, 300, 302–303 non-discrimination, 64 nongovernmental organizations, 280 non-interference, 99 non-tariff barriers, 27 non-tradables, 222 non-traditional donor, 140 normative approaches, 67 normative influences, 58, 65 norms, 55, 57–59, 61, 64 norms-driven approach, 59 norm-shaper, 66 norm-taker, 66 NSG, 44 nuclear capability, 42 O OECD aid, 151, 166 Official Development Assistance (ODA), 70 oligopoly, 230–231, 233–234, 242 “One Belt, One Road” (OBOR) initiative, 29, 72, 321, 327 O’Neill, Jim, 361, 364, 366 one-way socialization, 66 “one-way” to “two-way” socialization, 66 openness variable, 344 Organisation for Economic Co-operation and Development (OECD), 38 outward foreign direct investment (OFDI), 62, 88 overlapping treaties, 264 overvaluation, 209, 220 P paper compliance, 68 Paris Agreement on Climate Change, 289, 291–294, 298–299, 303, 307, 320, 323

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Index 397

Paris Declaration, 143 par-value system, 212 Pearson, Margaret, 63 People’s Bank of China (PBoC), 61, 70 Pigovian remedies, 222 plutocratic regionalism, 120 post-colonial sovereignty, 40 post-hegemonic regionalism, 117–118 post-war order, 340 power-based approaches, 125–126, 130 power transition theory, 21 preferential trade agreements (PTAs), 12, 70 Primakov, Yevgeny, 20 principal-agent, 351 principle of non-interference, 145, 149, 160, 164, 166 principle of non-reciprocity, 39 promote regionalism, 118, 126 proportional representation, 218 protracted conflict, 40 public health, 68 purchasing power parity (PPP), 208, 343 Putin, Vladimir, 20, 25 Q quota formulae, 342 quotas, 342 R ratification, 279 rating shopping, 236 rationalist approach, 60, 67 rationalist state-centric approach, 61 real effective exchange rate, 211 real exchange rate (RER), 210, 222 reciprocity, 64, 71 REDD+ (Reducing emissions from deforestation and forest degradation), 302 redistribution, 44 reform, 340, 349, 356 regime type, 126, 128–130

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Regional Comprehensive Economic Partnership (RCEP), 72 regional cooperation, 118, 122–123, 125–126, 128–130 regional hegemony, 119, 125 regional institution-building, 116–117, 119, 125, 127–128 regional integration, 117, 125, 129–130 regional leadership, 116–117, 121–122, 124, 127, 130–131 regional power, 94, 100, 105 regional trade cooperation, 122 regulation, 235, 237, 239, 246 Ren, Xiao, 57 representation, 362–376, 378–380 reserve asset, 345 reserves, 343 responsible stakeholder, 58 reverse causation, 223 rising powers, 46 rival, 352 RMB, 61, 63, 70 RMB internationalization, 61 rule breaker, 65 rule follower, 65 rule maker, 65 Russia, 87, 186–189, 197–199, 261–262, 265–266, 268–269, 279, 311 Russia−China relations, 319 Russian aid, 150 Russian aid allocation, 151 Russian aid data, 152 Russian aid history, 151 Russian aid projects, 152 Russian Chamber of Commerce and Industry, 19 Russian Union of Industrialists and Entrepreneurs, 19 S sanctions, 21 Schwartz, Herman, 61

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398  Index

SDR basket, 345 second face, 69 secular nationalism, 41 self-interested regionalism, 121, 124 Setser, Brad, 68 Shanghai Effect, 75 shell companies, 263–264, 266–270, 275, 280 Shih, Victor, 62 Shi, Weiyi, 62 Silk Road, 43, 353 Singapore Resolution, 342 social assistance cash transfer programs, 104 Sohn, Injoo, 69 South Africa, 83–85, 184–186, 196, 199–201, 261, 268, 271–272, 314 South African aid, 162 South African aid allocation, 163 South African aid data, 162 South African aid history, 162 South African aid institutions, 163 South African aid projects, 164 South African Treasury, 104 South Asian Association for Regional Cooperation (SAARC), 43 South Asian Free Trade Arrangement, 43 South Asian Preferential Trading Arrangement, 43 South-East Asia, 44 southern hegemon, 10 South−South cooperation, 69, 143–145, 155, 163 sovereign bonds, 233 sovereign debt crisis, 231–233, 242, 246, 249 sovereignist agenda, 85 sovereignist turn, 97–98 sovereign rating methodology, 242 sovereign ratings, 231–233, 239, 241, 243–250, 252–253

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sovereignty, 275 Soviet aid, 150 Soviet aid allocation, 150 Soviet aid projects, 150 Special Drawing Right (SDR), 345 speculative attacks, 214 SPS and TBT committees, 11 spuriousness, 223 standards, environmental, 160 standards, labor, 160 state capitalism, 63 state capture, 100 state-owned enterprises (SOEs), 62, 198–199 State Regulatory Space (SRS), 183, 186, 190, 192 status quo, 55, 58–59, 64–65, 70 status quo power, 58 status quo stakeholder, 73 Steinberg, David, 62 Strand, Jonathan R., 73 strategic alignment, 34, 40, 44, 47–48 strategic restraint, 34, 37, 40 structural power, 69 structural reform, 212 Supreme Eurasian Economic Council, 24 swing-state, 46 system-maker, 46–47 system-shaper, 46 system transformer, 58 T taxation, 260–262, 264, 266–267, 269–271, 281 technical standards, 68 telecommunications, 64 “third generation” theories, 208 time-inconsistency problem, 216, 223 Tingley, Dustin, 71 Tokios Tokeles, 265–266, 277 tradables, 222

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Index 399

trade, 55–56, 61, 65, 67–68 trade facilitation, 28 trade-related investment measures (TRIMs), 60 Trans-Pacific Partnership (TPP), 72, 182, 202 treaty shopping, 192–193, 260–282 Trump, Donald, 355 two-nations theory, 41 “two-way” socialization, 65–67

US Congress, 353 US-led order, 354, 356

U undervaluation, 207, 209, 215, 220, 222 unintended consequences, 260, 262 unitary systems, 218 United Nations, 34 United Nations Environment Programme, 59 United Nations Framework Convention on Climate Change (UNFCCC), 93, 289–290, 293–294, 296, 299–301, 303 United Nations General Assembly (UNGA), 70 United States aid, 141 UN Security Council, 45 UN’s Office of the High Commissioner for Human Rights, 99 USA, 87

W Washington Consensus, 34 World Bank, 38, 56, 66–67, 337, 368, 375–377, 380 World Trade Organization (WTO), 8, 18, 39, 56–57, 59–61, 63–65, 67, 90, 362–363, 368–372, 376, 378–380 WTO disputes, 60 WTO dispute settlement, 62 WTO membership, 19

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V Venezuela, 270–273, 276 veto players, 216 veto points, 221 voice, 339 “voice” and “exit” framework, 66 voting power, 341

Y Yukos, 265, 268–269, 279 Z zero-sum game, 49 Zuma, Jacob, 83–84, 87, 94, 96

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THE POLITICAL ECONOMY OF THE BRICS COUNTRIES  Political Economy of Informality in BRIC Countries

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THE POLITICAL ECONOMY OF THE BRICS COUNTRIES Editors-in-Chief

Edward D. Mansfield University of Pennsylvania, USA

Nita Rudra

Georgetown University, USA

 Political Economy of Informality in BRIC Countries



Editor

Santiago López-Cariboni

Universidad Católica del Uruguay, Uruguay

World Scientific NEW JERSEY

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Published by World Scientific Publishing Co. Pte. Ltd. 5 Toh Tuck Link, Singapore 596224 USA office: 27 Warren Street, Suite 401-402, Hackensack, NJ 07601 UK office: 57 Shelton Street, Covent Garden, London WC2H 9HE

Library of Congress Cataloging-in-Publication Data Names: Abraham, Biju Paul, editor. | Ray, Partha, editor. | Kim, Soo Yeon, editor. Title: The political economy of the BRICS countries / editor-in-chief: Edward D Mansfield (University of Pennsylvania, USA) and Nita Rudra (Georgetown University, USA); edited by Biju Paul Abraham (Indian Institute of Management Calcutta, India), Partha Ray (Indian Institute of Management Calcutta, India), Soo Yeon Kim (National University of Singapore, Singapore) and Santiago López-Cariboni. (Universidad Católica del Uruguay, Uruguay). Description: New Jersey : World Scientific, [2019-] | Includes bibliographical references and index. Contents: v.1.BRICS: The quest for inclusive growth -- v.2. BRICS and the global economy - v.3. Political economy of informality in BRIC countries. Identifiers: LCCN 2019011951| ISBN 9789811202179 (set : alk. paper) | ISBN 9789811202186 (v. 1: hc : alk. paper) | ISBN 9789811202193 (v. 2: hc : alk. paper) | ISBN 9789811202209 (v. 3: hc : alk. paper) Subjects: LCSH: Economic development--BRIC countries. | BRIC countries--Economic conditions. | BRIC countries--Economic policy. | BRIC countries--Social policy. | BRIC countries--Foreign relations. Classification: LCC HD82 .P5485 2019 | DDC 330.9172/4--dc23 LC record available at https://lccn.loc.gov/2019011951 British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library.

Copyright © 2020 by World Scientific Publishing Co. Pte. Ltd. All rights reserved. This book, or parts thereof, may not be reproduced in any form or by any means, electronic or mechanical, including photocopying, recording or any information storage and retrieval system now known or to be invented, without written permission from the publisher.

For photocopying of material in this volume, please pay a copying fee through the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, USA. In this case permission to photocopy is not required from the publisher.

For any available supplementary material, please visit https://www.worldscientific.com/worldscibooks/10.1142/11330#t=suppl Desk Editors: Dr. Sree Meenakshi Sajani/Jiang Yulin Typeset by Stallion Press Email: [email protected] Printed in Singapore

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Editor’s Note and Acknowledgments

Research on the politics of informality has been traditionally rare in political science. Despite attracting increasing attention, the topic is still today about many questions and few answers. Looking at the political economy problems of informality in BRICs (Brazil, Russia, India, and China) adds the additional challenge of dealing with tremendously diverse and complex nations. In this respect, a single volume can hardly cover all the relevant topics, approaches, and singularities of these cases. The aim of this book is to disseminate an organized description of theoretical and empirical puzzles around different political economy problems that are potentially relevant for anyone interested in informality in the developing countries. To that end, the volume follows different strategies. One strategy is departing from research based on BRIC specific cases to illuminate broad issues and global problems of informality in the developing world. A second strategy is considering political causes and consequences of informality in non-BRIC nations as informative to understanding the BRICs themselves. As a consequence, the volume treats the BRIC countries not in isolation but embedded in a more general context. Expectedly, this approach helps to reach a broader audience of students, academics, journalists, policymakers and activists interested in the topic. This volume largely owes to the Editors-in-Chief of the book series in which this book is included. I want to specially thank Edward Mansfield and Nita Rudra for their generous offer and the unique opportunity to participate in this important project. They have provided invaluable guidance, advice, patience, and support during the process, for which I am highly indebted. This book has been also possible thanks to the excellent work of outstanding scholars authoring the different chapters. I feel honored for having shared this effort with each one of them. They have made insightful contributions and showed remarkable commitment to the project. Thanks to their efforts, old and new debates around the political economy of informality will reach a broader international audience, v

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vi  Editor’s Note and Acknowledgments

hopefully promoting more discussion, academic research, and attracting increased attention to these issues in policymaking. The volume has also benefited from the important efforts by Sarah Berens and Irene Menéndez, who three years ago embraced the idea of promoting academic exchange between researches interested in political economy and informality in developing countries. Some examples of that effort were the organization of the panel “Insider–Outsider Politics in Developing Countries” at the 2016 Annual Meeting of the Midwest Political Science Association in Chicago, United States, and the workshop “New Approaches to the Political Economy of Social Policy” that took place on May 23rd–24th, 2016, at the Robert Ellscheid Saal of the Fritz-Thyssen Foundation in Cologne, Germany. These were insightful events that certainly helped to increase academic ties between scholars motivated by similar substantive questions and research interests. In this respect, this volume also owes a lot to Sarah and Irene, whom I deeply thank. Many others have also indirectly contributed with advice, ideas, and comments at different stages of the project. For these, I would like to thank Melina Altamirano, Xun Cao, German Feierherd, Alisha Holland, Achim Kemmerling, Fabiana Machado, Lucas Ronconi, Peter Starke, and Rachel Wellhausenand. Santiago López-Cariboni Montevideo, Uruguay

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About the Editors-in-Chief

Edward D. Mansfield is the Hum Rosen Professor of Political Science and Director of the Christopher H. Browne Center for International Politics at the University of Pennsylvania. His research focuses on international security and international political economy. He is the author of Power, Trade, and War (Princeton University Press, 1994); Electing to Fight: Why Emerging Democracies Go to War (with Jack Snyder) (MIT Press, 2005); Votes, Vetoes, and the Political Economy of International Trade Agreements (with Helen V. Milner) (Princeton University Press, 2012); and The Political Economy of International Trade (World Scientific, 2015). He is also the editor of 14 books and journal special issues, and has published articles in the American Political Science Review, British Journal of Political Science, Comparative Political Studies, International Organization, International Security, International Studies Quarterly, Journal of Conflict Resolution, World Politics, and various other journals and books. The recipient of the 2000 Karl W. Deutsch Award in International Relations and Peace Research, Mansfield has been a National Fellow at the Hoover Institution and his research has been supported by grants from the Harry Frank Guggenheim Foundation, the Mershon Center, and the United States Institute of Peace. He is the co-editor of the University of Michigan Press Series on International Political Economy and was the Vice President of the International Studies Association. He has been a Term Member of the Council on Foreign Relations, a member of the Graduate Record Examination Political Science Committee, Associate Editor of International Organization, and Program Co-Chair for the 2001 annual meeting of the American Political Science Association. Mansfield received his BA, MA, and PhD from the University of Pennsylvania; and before joining the faculty there, he taught at Columbia University and Ohio State University. vii

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viii  About the Editors-in-Chief

Nita Rudra is a Professor in the Department of Government at Georgetown University. Her research interests include the politics of globalization, trade, foreign investment, development, democracy, inequality, taxation, and redistribution. Her works appear in the British Journal of Political Science, Journal of Politics, American Journal of Political Science, Comparative Political Studies, International Organization, and International Studies Quarterly. Her most recent book with Cambridge University Press is entitled Democracies in Peril. She has been a recipient of the Woodrow Wilson International Center for Scholars Fellowship, the Fulbright–Nehru Foundation Academic Fellowship, and the International Affairs Fellowship by the Council on Foreign Relations.

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About the Editor

Santiago López-Cariboni is an Assistant Professor at the Universidad Católica del Uruguay. He writes on both comparative and international political economy. He received a Ph.D. in political science from the University of Essex in 2014. His primary research interests are in international and comparative political economy. His work focuses on the analysis of international trade and domestic policy in developing countries, labor informality and social policy, and informal access to basic services. His recent publications have appeared in the Review of International Organizations, Politics & Society, and Journal of Comparative Policy Analysis.

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About the Contributors

María Constanza Ayala is a Ph.D. candidate in Sociology at Pontificia Universidad Católica de Chile. She holds a Master of Science in Statistics from KU Leuven. Her research focuses mainly on educational outcomes, gender and racial discrimination, and quantitative methodology in the social sciences. Ida Bastiaens is an Associate Professor of Political Science at Fordham University. She received her B.A. from Davidson College and her Ph.D. from the University of Pittsburgh. She specializes in international political economy and international development. Her research analyzes questions on the political determinants of integration in the global economy, the impact of international integration on fiscal and social welfare in developing countries, and citizen preferences for global capital flows. She recently published a co-authored book with Cambridge University Press and journal articles in International Interactions, Journal of European Public Policy, and Review of International Political Economy. Sarah Berens is a postdoctoral research fellow at the Cologne Center for Comparative Politics at University of Cologne. She received her Ph.D. from the joint graduate program of the Max Planck Institute for the Study of Societies and University of Cologne. During her Ph.D., she spent a year at Columbia University. In her research, she focuses on the micro-foundation of labor informality, social policy, taxation, and the behavioral impacts of crime experience in low- and middle-income countries. Her work has been published in Socio-Economic Review, Political Behavior, Political Studies, the Journal of Politics in Latin America, and Social Policy & Administration.

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xii  About the Contributors

Luis Maldonado is an Assistant Professor in the Department of Sociology at the Pontificia Universidad Católica of Chile, with affiliation to The Research Center for Integrated Risk Management (CIGIDEN), Chile. His research focuses on economic inequality, disasters, and quantitative methods. His recent studies have been published in Public Health, the International Journal of Educational Development, Journal of Politics in Latin America, and Computers in Human Behavior. Irene Menéndez is an Assistant Professor of International Political Economy at the IE School of Global and Public Affairs She obtained a Ph.D. at the University of Oxford (Nuffield College) in 2015. Her research interests include international and comparative political economy, the political consequences of globalization, the political economy of labor markets, and redistribution and the effects of electoral institutions on political representation. Her work appears in various journals such as the American Political Science Review, International Studies Quarterly, and the Socio-Economic Review. Jonathan Phillips is an Assistant Professor in the Department of Political Science at the University of São Paulo, specializing in comparative politics and the political economy of development. He received his Ph.D. in Government from Harvard University in 2017, an M.Sc. in Development Economics from the School of Oriental and African Studies, University of London, in 2008, and a B.A. in Politics and Economics from Oxford University in 2005. His research seeks to explain the political roots of effective governance, clarifying the incentives that lead some politicians to focus on enforcing clear programmatic rules while others condition access to public resources on political support. Through subnational comparisons across primary fieldwork sites in Brazil, Nigeria, and India, he is developing new datasets, tools, and theories to explain the wide variation in the quality and form of public service delivery. Soledad Artiz Prillaman is an Assistant Professor of Political Science at Stanford University. She received a Ph.D. in Government at Harvard University in 2017 and a B.A. in Political Science and Economics from Texas A&M University in 2011. Her research interests lie at the intersections of comparative political economy, development, gender, and the politics of the welfare state, with a focus in South Asia and Latin America. She is motivated by questions such as the following: What are the political consequences of development and development policies? How are minorities democratically represented and where do inequalities in political engagement persist? How are voter demands, particularly of underrepresented populations, translated into policy and governance? In answering these questions, she utilizes mixed methods, including field experiments, primary surveys, and in-depth qualitative fieldwork, to identify empirical relationships as well as the underlying causal mechanisms.

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About the Contributors xiii

Guadalupe Rojo is an invited Professor at the Universidad Torcuato Di Tella. She holds a Ph.D. in Political Science (Duke University 2017), an M.A. in Economics (Duke University 2014), and an M.A. in Latin American studies (Stanford University 2010). Guadalupe has conducted research on the effect of social capital on public services and the electoral return on government investments in infrastructure in shantytowns, both in Argentina and India. She currently works in the housing and urban development division at the IADB, with a focus on impact evaluations for slum upgrading programs. Armin von Schiller is a research fellow at the German Development Institute/ Deutsches Institut für Entwicklungspolitik (DIE). His research is focused on taxation, tax morale, and fiscal decentralization in developing countries with a special emphasis on how political factors shape the use of different tax instruments and the willingness of citizens to pay taxes. Before joining DIE, he worked at the German Institute for Human Rights and the GIZ (Deutsche Gesellschaft für Internationale Zusammenarbeit) in Colombia. He has done consulting work for GIZ, the European Commission, and UNU-WIDER among other organizations. Armin holds a Ph.D. from the Hertie School of Governance in Berlin. Laura Seelkopf is an Assistant Professor of Political Science (W1) at the Geschwister Scholl Institute, Ludwig Maximilians University Munich, Germany. Her substantive research focus is on the political economy of taxation (tax competition, tax evasion, and the transformation of tax states around the world) and comparative social policy (inside and outside developed economies, by non-state actors, and via non-traditional policies). Yujeong Yang is an Assistant Professor in the Political Science Department at the State University of New York, Cortland. She received her Ph.D. in Political Science from the University of Michigan. Her research focuses on comparative political economy, welfare policies, and labor politics, with a regional expertise in China. Wei-Ting Yen is an Assistant Professor at Franklin and Marshall College with a concurrent appointment as a Mellon High Impact Emerging Scholar. She studies political economy issues and social policy development in the developing world. Her main research is to understand the demand side politics of social protection in young democracies, where a majority of citizens have job insecurity and income instability. She earned her Ph.D. in Political Science from the Ohio State University.

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Contents

v

Editor’s Note and Acknowledgments

About the Editors-in-Chiefvii About the Editor

ix

About the Contributors

xi

Chapter 1

I ntroduction: Political Economy Approaches to Informality and Recent Trends in BRIC Countries Santiago López-Cariboni

PART I Tax Revenue, Globalization, and Informality in BRIC Countries Chapter 2

1

29



 Comparative Analysis of Tax System in the BRICs and the A Challenges Ahead: Informality and the Fiscal Contract 31 Laura Seelkopf  and Armin von Schiller

Chapter 3

Is Informal Work Eroding Compliance? 53 Sarah Berens and Irene Menéndez

Chapter 4

 an Tax Aid Broaden the Base? International Assistance, C Taxation, and the Informal Sector in the BRICs 81 Ida Bastiaens and Laura Seelkopf



PART II  Informal Settlements and Basic Service Provision Chapter 5

S ocial Capital, Leadership Accountability, and Public Services in the Slums of India Guadalupe Rojo

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xvi  Contents

Chapter 6

I nformal Electricity Consumption and Political Regimes: Implications for Political Change in BRIC Countries Santiago López-Cariboni

PART III  Labor Market Informality, Mobilization, and Preferences Chapter 7

 ow the Labor Force is Mobilized: Patterns in Informality, H Political Networks, and Political Linkages in Brazil Soledad Artiz Prillaman and Jonathan Phillips

Chapter 8

Redistributive Preferences in Contemporary Brazil Luis Maldonado and María Constanza Ayala

Chapter 9

 nderstanding Informality in China: Institutional Causes U and Subsequent Measurement Issues Yujeong Yang and Wei-Ting Yen



Chapter 10 I nsiders, Outsiders, and the Politics of Employment Protection: Insights from the Brazilian Case Santiago López-Cariboni

139 155 157 193

219

243

Chapter 11 Conclusions 277 Santiago López-Cariboni Index281

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CHAPTER 1

Introduction: Political Economy Approaches to Informality and Recent Trends in BRIC Countries Santiago López-Cariboni Department of Social and Political Science, Universidad Católica del Uruguay, Uruguay

For a long time, the view that informality, broadly defined,1 is only a consequence of economic development dominated the positions of academic experts, national governments, and international organizations. However, about 30% of the gross domestic product (GDP) generated in the developing world, and 70% of workers belong to the official economy (Palmade and Anayiotos, 2005). With the recent trends of income growth in developing countries, the integration of world markets at a global scale, and the diffusion of democracy, the persistence of the informal sector in developing nations posited important theoretical puzzles and a difficult political challenge: it was necessary to find new explanations of informality that could guide effective policymaking. Social scientists challenged the dominant account and started to think about informal economic activity as a phenomenon that may also be the product of social structures, institutions, and more recently, political behavior. Initial accounts, while potentially accurate, became insufficient for those motivated by the goal of improving  Later, I discuss different aspects of informality and operational definitions in the section “Social and Economic Realizations of Informality”. 1

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the living conditions of large swaths of population excluded into the informal s­ ector. For example, some of these explanations pointed out the consequences of legal origins and institutions inherited from colonizer countries (Botero et al., 2004). The limit of such answers is that they often emphasize variables that cannot be directly affected by current political actors. However, they offered two important lessons. First, they provide guidance of the contexts in which informality is more persistent. Second, and more crucially, the logic by which the size of the informal sector correlates with particular institutions tell us that, above all, informality is political. Subsequent research in the area emphasized several consequences of informality. Much of this work analyzes its effects on economic growth. However, there is also increasing evidence of the political consequences of informality. Important debates exist around labor informality and political mobilization (Baker and VelascoGuachalla, 2018; Hummel, 2017; Rudra, 2002). Also, in electoral democracies, the size of the informal sector may provide grounds for the expansion of political clientelism undermining the expansion of programmatic politics, while at the same time, programmatic policies may stop clientelistic behavior (Altamirano, 2016; Stokes, 2005; Swamy, 2016; Weitz-Shapiro, 2012; Wibbels, 2017). Another important consequence is the formation of political coalitions that shape protection for outsiders, i.e. non-contributory programs that provide insurance to those holing an informal job (Carnes and Mares, 2014, 2015; Holland and Schneider, 2017). Finally, many argue that informality itself, or the enforcement level, is a policy that depends on government choices (rather than state capacity alone). This assertion has been increasingly analyzed in the context of globalization (Dix-carneiro et al., 2018; Milner and Rudra, 2017), labor market regulations (Almeida and Carneiro, 2005; Kanbur and Ronconi, 2018), street vending and squatting (Álvarez-Rivadulla, 2017; Holland, 2016, 2017), and basic services (López-Cariboni, 2018; Min and Golden, 2014). This volume brings these and other debates about informality to the context of BRIC countries (Brazil, Russia, India, and China). Moreover, BRIC nations are also special cases in the developing world, which helps to illuminate the current questions and existing controversies around the political causes and consequences of informality.

Why (The Politically Economy of) Informality in BRIC Matters The focus on BRIC countries in this volume does not follow from a design-based strategy of case selection for making causal inferences based on a comparative analysis. Instead, this volume has the aim of describing and disseminating a number of theoretical and empirical puzzles around the politics of informality, which are potentially relevant for any developing country in the world. Brazil, Russia, India, and China are exceptionally important and heterogeneous economies, which provide

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very interesting variation to illustrate the different topics covered in the volume. Similarly, this volume brings attention toward broad debates and research on politics and informality, which are not always BRIC-specific but certainly relevant for anyone interested in the BRIC countries. Hence, this volume can be either read from a BRIC perspective or as a collection of political economy topics of politics and informality in developing countries. The growing economic and political power of Brazil, Russia, India and China has attracted important attention among scholars and policymakers. There is an increasing amount of research dedicated to understanding the reasons behind the economic growth of those countries as well as the political implications of these rising powers for fundamental issues such as global governance, democratization, trade policy and social provision (Friedberg, 2005; MacFarlane, 2006; Segal, 1999; Soares De Lima and Hirst, 2006). As noted by Vom Hau et al. (2012), it was hard to think 30 years ago that Brazil would become the main regional leader in Latin America, India was going to be a major player in the World Trade Organization (WTO), and that China would be the second largest economy in the world since 2010. The historically unprecedented economic growth of poor countries such as India and China (see Figure 1) has been largely responsible for slowing down and ultimately reversing a long-lasting problematic increasing world income inequality between nations (Korzeniewicz, 2012; Milanovic, 2010). Yet, the persistence of large shares of unofficial economic activity and vulnerable population in developing countries challenges simplistic views that only demand economic growth and democratic political institutions to ensure social wellbeing. As shown in Figure 1, high scores on the Polity II variable indicate more democratic regimes in India and Brazil, followed by Russia (arguably not democratic), while China remains being an authoritarian country. Important research finds that democracy does not always benefits the poor and those in the informal sector as expected (Ross, 2006). Many observers also think that this is indeed the case for large swaths of citizens in countries such as India and Brazil despite successful economic performance and conditions open political competition. Even so, income growth and democracy are still strong forces behind the reduction of extreme poverty and therefore should not be neglected. Another feature of BRIC that makes them both interesting and important is that they are major players in the international trade network as well as in other forms of economic globalization such as foreign direct investment (FDI). This is relevant because foreign trade has been found to be a major channel policy diffusion (Cao and Prakash, 2010; Elkins et al., 2006; Elkins and Simmons, 2005; Mosley and Uno, 2007; Simmons and Elkins, 2004). Given that these four countries are responsible for a large share of international commerce and globally contribute to the international interdependence, politics and policies in BRIC affecting domestic informality may have substantial consequences for informality in the rest of the world. As Figure 2

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Polity Score

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Figure 1:   GDP per capita and democracy in BRICs. Note: The dark-grey solid line and shaded area represent the mean trend in developing countries with a 95% confidence interval. Source: World Development Indicators (The World Bank) and Polity IV dataset from Marshall and Jaggers (2010). “6.5x9.75”

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shows, while BRICs may seem comparatively closed economies mainly due to the size of their markets (Figure 2(a) measures import plus exports as a percentage of GDP), the total income traded by these nations is well above the amount of traded goods and services by any other developing country alone. This is illustrated in Figure 2(b), which displays the log of total GDP traded since 1990 until 2015 by country. For instance, important research shows that Chinese import competition on the US causes higher unemployment, lowers labor force participation, and reduces wages in local labor markets that house import-competing manufacturing industries (Autor et al., 2013, 2016). Also, policies that are thought of directly affecting informal labor, such as labor standards, regulations, and social insurance policy, have been found to travel across international borders due to trade interdependence (Adolph et al., 2017; Greenhill et al., 2009; López-Cariboni et al., 2015; Mosley and Uno, 2007). Finally, all BRIC nations have considerably large informal sectors, and as a result, a large share of world’s informality is within the boundaries of these nations. However, they vary tremendously in terms of the nature and composition of informality. As the next section illustrates, the shadow economy, tax compliance, labor informality, informal settlements, and irregular access to basic services are some of the different although related manifestations of a broader phenomenon of informal economic activity.2 An important aim of this volume is to provide a variety of approaches that, taken together, emphasize the role of politics and institutions as both causes and consequences of informality.

Social and Economic Realizations of Informality There are different views and conceptualizations of the informal economy, which also refer to quite different economic and social realizations (Maloney, 2004; Schneider and Enste, 2000). Since the introduction of the concept in the 1970s, opinions diverge with respect to both the causes and the nature of the informal sector, as well as its links to the formal sector. These views may be categorized into three groups (La Porta and Shleifer, 2009, 2014). The first one is the dualistic approach (Harris and Todaro, 1970). In this view, the informal sector is an inferior segment of a dual labor market segregated from the formal economy. This residual sector arises because the formal economy is unable to offer employment opportunities to a portion of the labor force. This type of informality refers to informal firms that are too unproductive to ever become formal, even if entry costs (i.e. costly regulations  Other aspects of informality such as illegal activities and corruption are also relevant and may contribute to mentioned dimensions of informality. 2

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Figure 2:   Openness and total GDP traded by BRICs. Note: The dark-grey solid line and shaded area represent the mean trend in developing countries with a 95% confidence interval. Source: World Development Indicators (The World Bank).

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and taxes) were removed. Here, the informal sector follows a survival strategy and is expected to disappear, being ultimately absorbed by the formal economy, once superior stages of economic development are reached. A second view is the structuralist approach, which emphasizes the informal sector as a result of a process of productive decentralization. It has been also called the parasite view, insofar as firms are productive enough to survive in the formal sector, but they remain informal because is more profitable. Here, the two sectors are in interdependence to increase overall competitiveness of the economy (Moser, 1978; Portes et al., 1989). This account sees the informal sector as comprised of small firms and unregistered workers as suppliers of cheap labor and inputs to the formal sector and hence increasing the economic efficiency and competitiveness of the later. This view does not predict that informality will shrink with growth. To the contrary, modern firms react to globalization by introducing more flexible productive systems and by outsourcing to the informal sector to cut down production costs. A third view is the legalist account. Inspired in the work by de Soto (1989), this approach conceptualizes the informal sector as a group of self-employed workers and micro-entrepreneurs that prefer and choose to operate underground as a means of avoiding the costs of costly registration. In this account, firms would formalize their businesses if entry costs were eliminated, so they would be no longer constrained by the limitations of operating informally. The implication is that fexiblization of regulatory frameworks and reductions in the tax burden would reduce the size of the informal sector and contribute to income growth and living standards. The key theoretical introduction of this view is that informality is voluntary instead of a process of exclusion, such as in the other two previous accounts (Fiess et al., 2010; Maloney, 1999; Packard, 2007). However, recent research shows that even though these views are seen as competing frameworks, in fact they are not. In an analysis of Brazil, Ulyssea (2018) demonstrates that these three different views do in fact coexist in a single economy. The empirical evidence indicates that only a minority of 9.3% of all informal firms corresponds to potentially productive informal firms that are kept out of formality by high entry costs (legalistic or De Soto’s view). The structuralist, or parasite view, corresponding to those that could survive as formal firms once entry costs are removed but choose to remain informal to enjoy the cost advantages of noncompliance represent the 41.9% of all informal firms. The remaining, this is the 48.8% of informal firms, correspond to the dualistic or survival view, in which firms are too unproductive to become formal regardless of entry costs and regulation. Most notably, this is among the first work tackling the difference between firm informality and labor informality. An important policy implication of the evidence is that reducing formal sector entry costs for firms would have only a limited impact

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on labor informality because low-productivity firms that choose to formalize would hire a large share of informal workers to compensate their efforts of formalization (Ulyssea, 2018). Work that focuses on labor informality alone provides important stylized facts. First, there exists an important wage-gap between formal and informal workers (Gasparini and Tornarolli, 2006). This gap is mainly explained by the differences in the productivity (i.e. skills) between the two types of labor force. In general, poor informal workers are highly constrained in their capacity to make long- and mediumterm investments, and are therefore unable to make social security contributions. As a result, labor informality represents an important problem for the development of welfare states in many developing countries. Social security benefits are often ineffective to protect those in the informal sector because they have been traditionally targeted to a relatively narrow, urban, political clientele of workers in the formal sector (Huber et al., 2006; McGuire, 1999; Wibbels and Ahlquist, 2011). When welfare spending depends on benefits that are based on contributory systems, such as social security and pensions in most developing countries, this type of spending has regressive economic effects insofar as the eligibility for social protection is tied to formal employment (De Ferranti et al., 2004; Goñi et al., 2011; Huber et al., 2006). Despite BRIC having made some important advances toward the universalization of social protection, for example, through the introduction of non-contributory social policies (Liu and Sun, 2016), major challenges remain, such as protecting non-wage self-employed workers and tackling increasing inequalities due to informal withincountry migrant workers, among other important aspects. It is probably safe to say that extreme poverty is a sufficient condition for falling into the informal sector of the economy either because of holding an informal job or living in precarious houses embedded in irregular settlements. The poor, who are excluded and likely to correspond to the dualistic view of informality, crucially depend on income growth and non-contributory forms of social protection to achieve minimum living standards. There is important evidence showing that development and income growth do matter for reducing extreme poverty and the size of the population living in slums (Un-Habitat, 2003). A lesson from the BRIC experience, specially Brazil, India, and China, is that sustained growth has helped these countries to reduce the share of urban population living in slums, reaching levels of below the 30% since the 2000s (see Figure 3). As also shown in Figure 3, extreme poverty has been declining since the 1990s. In this regard, China has been exceptionally successful in comparison with the mean global trend. In 1981, extreme poverty in China (population living with less than 2 dollars a day) was over the 80% of the population. This rate decreased to a 67% in 1990 and it was lower than 2% in 2013. India and Brazil have also steadily reduced their poverty rate over the period,

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Figure 3:   Poverty headcount ratio and population living in slums in BRICs. Note: The dark-grey solid line and shaded area represent the mean trend in developing countries with a 95% confidence interval. Source: World Development Indicators (The World Bank).



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which is consistent with the income growth trends observed in Figure 1. However, as also shown in Figure 3, the share of population living with less than 2 dollars a day in India was still above 20% after 2010, and the population living in slums in Brazil, India, and China is today about one-fifth of the total.3 This evidence suggests that a great deal of informality due to exclusion mechanism remains in BRIC countries. Other manifestations of informality are the so-called “shadow” economy and the informal self-employment. The shadow economy is usually defined as all the legal economic activities that contribute to the GDP, but escape detection in official GDP estimates4 (Schneider and Enste, 2000). In developing countries, small ­enterprises — like bars, restaurants, or haircutters — make up the vast majority of the total number of enterprises and they usually engage in underground activity (Gerxhani, 2003; Johnson et al., 1997; Schneider, 2005). The shadow economy does not take into account the number of informally employed self-employed workers, but instead considers the economic value that is produced underground. The size of the shadow economy has important consequences for development (Elbahnasawy et al., 2016) and tax revenues to the state, which results in decreased funding for social welfare policies, and other important national priorities (Loayza, 1996). Figure 3 shows the size of shadow economy, measured as a percentage of a country’s GDP, is slowly decreasing over time in developing countries. Brazil and Russia, the BRICs with larger shadow economies, remain significantly above the mean of developing countries since 1990. China, on the other hand, has the smallest shadow economy relative to other BRIC nations and is at the bottom of the distribution over the analyzed period. The picture of the size of unofficial economy, however, contrasts with labor market data on informality. Measuring labor informality is relatively difficult. Yet, there exist different proxies for the size of the informal labor and are widely used in the development economics literature (Botero et al., 2004; Eilat and Zinnes, 2002). One proxy is the self-employed workers as a percentage of total employment. These non-salaried workers are essentially the own-account workers, which often operate informally. This proxy is imperfect although commonly used in the scholarship on labor informality (Fiess et al., 2010; Loayza and Rigolini, 2011; Maloney, 2004). At the aggregate level, the correlation coefficient between self-employment and the  For partisan explanation of slum growth in Brazil, see Alves (2018).  The unofficial economic activity is the production and sale of goods and services that evade official registration and taxation. Such activity is undertaken by firms that are not r­egistered or by firms that are registered officially but produce part of their output ­unofficially. Schneider and Enste (2002) provide detailed discussion of various definitions of the ­concept and estimates of aggregate national magnitudes. 3 4

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size of the unofficial GDP from Schneider’s 2010 estimates is 0.78. Admittedly, the proxy is incomplete because it excludes informal salaried workers. However, this variable proves to be well behaved against direct measures of labor informality taken from household survey data. In most developing countries, there is a strong association between own-account work, self-employment, and informal activity, as most of these non-salaried workers tend to be in low-skill, unregistered jobs (Loayza and Rigolini, 2011). Figure 2(b) shows that India has a pervasive level of self-employment with tremendous persistence. A more precise estimate of labor informality in India suggests that more 90% of workers were informal in 1999–2000 (Bairagya, 2012). China has experienced a secular downwards trend in selfemployment, partially explained by reduction of the agricultural sector. This picture, however, masks the recent rise of urban informality in that country (Wang et al., 2016). Brazil, in turn, has reduced labor informality and self-employment during the 2000s, but it is growing again since 2010. Lastly, Russia is the country with the smallest share of self-employed workers and informal labor over the period. In fact, most of the informal employment in Russia is informal salaried work (Gimpelson and Kapeliushnikov, 2014). These precisions make clear the importance of accurate conceptualization and measurement of informality. Nevertheless, as it can be noted from Figure 4, the size of the unofficial economy and labor informality need not move in the same direction. Hence, theoretical and empirical approaches explaining causes and consequences of informality also need to consider the different ­dimensions of the problem.

Political Economy Approaches to Informality A traditional view is that informality depends on development. Many authors find that informal employment is associated with lower GDP per capita. Loayza and Rigolini show that 80% of the variation in informal employment can be explained by the variation in GDP per capita in a sample of 42 countries. The same connection between self-employment and GDP per capita has also been documented by Blau (1987), among others. Others have used Schneider’s measures of informal production. For instance, Loayza et al. (2005) also find a strong relationship between informality and national income. The relationship between growth and formalization is consistent with the dual view of informality. Those who follow the development tradition of Lewis (1954) and Harris and Todaro (1970), see informality as a byproduct of poverty: economic growth comes from the formal sector firms (run by educated entrepreneurs and exhibiting much higher levels of productivity) and therefore the expansion of the formal sector leads to the decline of the informal s­ ector. The macro-correlates support the idea that informality shrinks

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Figure 4:   Shadow economy and self-employment in BRICs. Note: The dark-grey solid line and shaded area represent the mean trend in developing countries with a 95% confidence interval. Source: Medina and Schneider (2018), and World Development Indicators (The World Bank). “6.5x9.75”

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with development (La Porta and Shleifer, 2014). In Figure 5, I show that this also the case for the BRIC economies when within-country variation is considered. Both selfemployment and the shadow economy decrease as income per capita increases. This evidence, although descriptive and lacking of an identification strategy, challenges the view that informality promotes development or increases the competitiveness of an economy. Political economy approaches incorporated the effects of institutions to the understanding of the size of the informal sector. The institutional quality may affect different outcomes such as corruption and informality (Dreher et al., 2009). One argument is that enterprises in the formal sector receive a higher payoff in terms of public services for complying with the regulations and taxation. For example, increases in institutional quality generate lower firm-specific thresholds of tax toleration (Hibbs and Piculescu, 2010). Similarly, scholars have systematically found that the “regulation of entry” to the formal economy, i.e. how costly it is to register a firm, is a strong predictor of the size of the shadow economy (Djankov et al., 2002). At the micro level, Auriol and Warlters argue that the key determinant of micro-enterprises to engage in informality in developing countries is the presence of high fixed costs involved in becoming formal (Auriol and Warlters, 2005). Excessive bureaucracy, greater corruption, and a weaker legal environment are all factors associated with a larger unofficial economy (Friedman et al., 2000). Importantly, this literature also emphasizes that employment protection legislation (EPL), sometimes controversially called as “rigid” labor market regulations that limit the employer’s ability of hire and fire, has been found to increase the size of the unofficial economy (Botero et al., 2004; Ulyssea, 2010). Some of these assertions have been corroborated in countries such as India. For instance, Indian states with higher corruption are associated with higher levels of employment in the informal sector (Dutta et al., 2013). It remains unclear, however, that other regulations such as employment protection legislation are really an obstacle for reducing informality and promoting development in India (Betcherman, 2015). In the case of China, it is also quite doubtful that EPL harms labor by excluding workers in the informal sector. The old system of household registration (hukou), designed to ensure enough agricultural labor to produce for the urban industrial sector, has certainly segmented the Chinese labor market between rural and urban workers. After the flexibilization of labor mobility in the 1970s, rural–urban migration increased. Yet, low- and middle-class migrants without urban hukou status do not have access to social welfare programs such as social insurance, schooling and subsidized housing. Together with the major economic reforms since 1997, in which state-owned enterprises (SOE) would no longer ensure formal employment for all urban labor, increasing migration without jobs contributed to an important

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Figure 5:   GDP per capita, shadow economy and self-employment in BRICs. Note: The dark-grey solid line and shaded area represent the smooth fit with a corresponding 95% confidence interval. Source: Medina and Schneider (2018), and World Development Indicators (The World Bank).

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rise of informal work in urban China.5 Interestingly, all this new informal labor rise occurred in the absence of EPL. Only in recent years, the Chinese government has instituted a series of labor legislations and also encouraged collective bargaining and workers’ unionization through the All-China Federation of Trade Unions (ACFTU). Labor market dualization, the difference of job protection between formal and ­informal workers, may be increasing in urban China. In comparing China with Brazil, Chapter 10 discusses how different paths of development produce different types of informality and measurement challenges. An important debate in political economy literature is whether institutions such as EPL contribute to exclusion in the labor market, and as a consequence, divide political preferences between insiders and outsiders. Moreover, outsiders should support policies that either protect them against employment vulnerability or help them to become insiders (Rueda, 2005, 2006). In close relation with the insider–outsider theory of the labor market, an important emerging literature in political science analyzes whether labor informality in developing countries has political consequences in terms of formal–informal differences in political behavior and policy preferences (Baker and Velasco-Guachalla, 2018; Berens, 2015a, 2015b; Berens and Kemmerling, 2016; Carnes and Mares, 2014, 2015, 2016; Singer, 2016). One relevant question is whether informal workers effectively support governments that provide social protection for outsiders, such as non-contributory programs of conditional cash-transfers (Baker and Velasco-Guachalla, 2018; De La O, 2013; Zucco, 2013; Zucco and Power, 2013). For many, those in the informal sector are unable to overcome collective action problems and elevate political demands (King and Rueda, 2008; Kurtz, 2004; Naylor, 2004; Perry et al., 2007; Rudra, 2002). Yet, there is no clear-cut evidence that informal workers are politically different than their formal counterparts (Baker and Velasco-Guachalla, 2018). Moreover, recent research suggests that when the state is proactive, informal workers can organize and mobilize as much as formal workers do (Hummel, 2017). In sum, analyses about the consequences of institutions and informality on workers’ preferences are flourishing in developing countries, but have not yet reached unambiguous conclusions regarding the political consequences of labor market divisions. Another novel political economy approach builds on the idea that ­informality is the product of strategic considerations of politicians that provide deliberate non-enforcement of the law. Against the view that considers development and state

 Athukorala and Wei (2018) document that the number of workers employed by Chinese SOEs dropped from 113 million workers, 20% of the country’s total labor force in 1995, to 65 million workers in 2005. 5

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capacity as the main explanation of informal economic activity,6 politicians may avoid enforcement of regulations when they possess the capacity to do so (Almeida and Ronconi, 2016; Holland, 2015, 2016). Recent research suggests that poor individuals have a coherent material interest in “forbearance”, or deliberate nonenforcement toward property laws they tend to violate. Because informal welfare benefits are provided through state inaction, politicians can send more credible electoral cues of their affinity with poor and dislocated voters through forbearance than through traditional social policy promises (Holland, 2015). Experimental survey evidence shows that even larger segments of society (i.e. not only the poor) support politicians signaling non-enforcement as insurance against income volatility (López-Cariboni, 2017). In the area of basic service provision, existing research provides support for the claim that electricity service can be politically manipulated (Min, 2015; Min and Golden, 2014; Nagavarapu and Sekhri, 2014), especially when there is limited capacity to affect fiscal and monetary policy (López-Cariboni, 2018; Min and Golden, 2014). Min and Golden (2014) find electoral cycles in the incidence of electricity theft and line losses in the state of Uttar Pradesh in northern India. Specifically, the discrepancy between power supplied and billed increases in periods immediately prior to general elections. Recent work also emphasizes the existence of deliberate non-enforcement of employment protection legislation and consequential persistence of labor informality.7 Some argue that governments that promote globalization benefit from the political support of informal workers and therefore have no incentive to enforce employment legislation (Milner and Rudra, 2017). Similarly, trade openness has been found to reduce government’s labor enforcement effort in Latin America (Ronconi, 2012). These findings suggest that non-enforcement of labor regulations may be a policy tool to cushion trade losers against increased international trade competition. For example, had enforcement of EPL been stricter in Brazil after the trade liberalization reforms in the 1990s, the effect of import competition on trade-displaced workers”  Consistent with the development story, many political economists noted the distance between the norm and reality in developing countries (Levitsky and Helmke, 2006; O’Donnell, 1993). Weak enforcement may be a result of extractive and rent seeking behavior by state officials who lack institutional constraints (Robinson and Acemoglu, 2012). 7  The larger literature on informality and globalization relates international trade with labor informality through market-based mechanisms (Arias et al., 2018; Bacchetta et al., 2009; Coletto, 2010; Goldberg and Pavcnik, 2003, 2007; Pham, 2017). See also, Blanton et al. (2018) for an argument regarding the effect of trade (incentives for upgrading and firm formalization) and IMF contracts (reduction of state capacity) on the size of the shadow economy. 6

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employment outcomes could have been much more adverse than it actually was (Dix-Carneiro and Kovak, 2017; Ponczek and Ulyssea, 2017). The crux of the problem of enforcement of labor market rules is what Boeri and Garibaldi (2005) have explained as the “shadow-puzzle”, which implies that informality is tolerated because it helps to reduce unemployment and its undesirable political consequences. These authors find a strong positive correlation between shadow employment and unemployment using Brazilian data. Ulyssea (2010) further expands this view and shows that enforcement alone would increase unemployment in a model calibrated for the Brazilian labor market during the 1990s and early 2000s. There is an important line of work analyzing the political economy of enforcement of labor laws and its social and economic outcomes (Almeida and Carneiro, 2009, 2012; Almeida and Ronconi, 2016; Amengual, 2014; Antunes and Cavalcanti, 2007; Boadway and Sato, 2009; Gimpelson et al., 2010; Ronconi, 2010, 2015). One micrologic of this has to do with the implementation of labor inspections. Labor inspectors in Brazil (as well as in the Dominican Republic) tend to have discretion that they use it to balance society’s demand for protection with the economy’s need for efficiency (Pires, 2011). An alternative account is that inspectors are not independent but controlled by the executive power and therefore politicized (Holland, 2015; Ronconi, 2012), or mobilized around pro-enforcement coalitions (Amengual, 2014). The previous discussion revises only some of the most prominent debates regarding the politics of informality. Different chapters in this volume are directly linked to these literatures while others are more inclined to open entirely new questions and research agendas.

Overview of the Volume Part I of the volume is dedicated to tax revenue, globalization, and informality in BRIC countries. Chapter 2, by Laura Seelkopf and Armin von Schiller, analyzes domestic tax collection in BRICs. From a growth perspective, the experience of the BRICs can be considered a success story, but it is unclear whether the BRICs use this expanded revenue potential. The authors ask several questions regarding alternative tax instrument and their consequences and future challenges. In the context of high informality, the authors discuss how to deal with tax revenue from a broader sociopolitical perspective: there are major challenges in developing and strengthening the fiscal contract in these countries. Chapter 3, by Sarah Berens and Irene Menéndez, asks how labor informality affects compliance with the law, understood as the adherence to tax regulations (as well as civic responsibilities). When informal labor involves work without the payment of income taxation or social security contributions, it cannot automatically be equated with general non-compliance with

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the fiscal contract. Because informal hiring is frequently decided at the employer side, individuals who find themselves involuntarily in informal employment may not behave in ways that characterize deliberate tax evaders. Building on research on tax compliance and labor market dualization, the authors theoretically explore the channels through which lack of compliance in labor regulations may affect broader patterns of non-compliance. They pay particular attention to implications for BRIC countries, and discuss the ways in which voluntary versus involuntary informal workers may differ in patterns of compliance with tax regulation and other types of collective action. Chapter 4, by Ida Bastiaens and Laura Seelkopf, analyzes the consequences of international tax aid on domestic recipient countries’ tax revenue and informality. The expectation of international aid is that additional revenue would be spent on pro-poor policies and used to extend formal labor market rights and protection to the wider population. However, while international technical assistance may maximize domestic tax revenue, there is no guarantee for this trickle-down effect to happen. The authors analyze international assistance programs for tax reform in the BRICs and illustrate the international approach to support the increase of domestic revenue. They also test the direct effect of tax aid on tax revenue and its indirect effect on the shadow economy. The finding that tax aid is effective in generating revenue, but it does nothing to reduce the size of the informal economy in BRICs, raises important trade-offs regarding the design and balance between different types of aid for developing countries. Part II of the volume is dedicated to the problem of informal settlements, public goods, and basic service provision. Chapter 5, by Guadalupe Rojo, presents a theory of slum-level social organization and its implications for electoral behavior and access to and the quality of public services. Rojo argues that the ability of slum dwellers to effectively demand local public goods is contingent on the level of their social capital. Her work illustrates how communities that are empowered with social capital are able to successfully raise demands to politicians through bloc-voting. As a consequence, slum dwellers with strong social networks gain access to better neighborhood infrastructure and higher-quality public services. The author presents evidence from a unique household survey in 30 slums in the Indian city of Udaipur, which allows her assess the ways in which communities organize themselves to fulfill their needs. Chapter 6, by Santiago López-Cariboni, discusses how democratization may increase the informal provision of insurance for the lower class. The chapter builds on recent research showing deliberate non-enforcement of the law may be a cost-efficient and politically viable strategy to increase levels of decommodification of dislocated and poor voters during negative income shocks. In particular, the chapter analyzes the extent to which irregular access to electricity service is countercyclical under different political regimes. The chapter shows that in democratic

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cases, such as Brazil and India, electricity losses are more counter-cyclical than in non-democracies such as Russia and China. Part III of the volume analyzes different aspects of labor informality, political mobilization, and preferences. Chapter 7, by Soledad Artiz Prillaman and Jonathan Phillips, looks at informal workers’ political networks. The authors argue informal and formal workers have different political networks. They show that informal workers have fewer political ties in the workplace given the fragmented and insecure nature of their jobs. Because they are relatively harder to identify, coordinate, and monitor, informal workers will have less access to clientelistic offers by politicians. Interestingly, the argumentation and data analysis of a panel of Brazilian municipalities show that contextual informality (local share of informal labor) changes the ways politicians seek to mobilize different types of workers (i.e. formal and informal). Informal workers are individually less likely to be exposed to clientelistic offers than their formal counterparts, and the aggregate local level of informality further increases clientelism targeted to formal workers. The chapter makes an important contribution in describing entirely different political experiences of labor market participants depending on the labor market status and contextual labor market conditions. Chapter 8, by Luis Maldonado and María Constanza Ayala, evaluates, redistributive preferences in contemporary Brazil. The authors analyze redistributive preferences focusing on the heterogeneity of attitudes between formal and informal workers. They argue that informal and formal sector workers have similar redistributive preferences. Their challenge to the formal–informal division in redistributive preferences comes accompanied by an alternative account suggesting that new cleavages, such as age and ethnic boundaries, have emerged. The study combines a qualitative analysis of the Brazilian institutional context with an original analysis of survey data from the Latin American Public Opinion Project (LAPOP) for the period 2008–2017. The authors conclude that Brazil is a least-likely case in which traditional cleavages, such as formal–informal sector divide, are expected to shape redistributive preferences in the society. Chapter 9, by Yujeong Yang and Wei-Ting Yen, analyzes the transformation of the Chinese labor market documenting the rise of labor informality. The chapter is dedicated to the debate of measuring informality in China and its implications. A main important lesson is that the proxies used in Latin America might not be useful in Asia because labor informality is defined differently. Interestingly, the conceptualization of labor informality has its political root in China and, hence, leads to distinctive measurement challenges. The chapter develops a thorough analysis of the institutional origin of labor informality in China and compares it with other parts of the world. The authors argue that, compared to countries such as Brazil, China’s labor informality is the result of (1) the emphasis on labor contracts under its socialist doctrine, and (2) the trajectory of the welfare state development. The first factor may hide a subgroup of

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informal sector workers who hold labor contracts but still suffer from employment insecurity. The second factor leads to the suggestion that the “social insurance access” is not a suitable criterion to measure the size of labor informality in China. In contrast, the authors argue that the possession of labor contract and participation in social insurance programs are important aspects of formal employment in Brazil, identifying informal employment using the same criteria may yield inaccurate estimates of informal employment in China. Chapter 10, by Santiago López-Cariboni, analyzes workers’ preferences for EPL in Brazil. The insider–outsider theory makes a clean and strong political prediction: labor market outsiders tend to have more preferences for deregulation and active labor market policies that enables them becoming insiders. However, there is little systematic analysis of this prediction in developing countries, not to mention the BRIC cases. The evidence on differences between formal and informal Brazilian workers with respect to their policy and political preferences provides only marginal support to the insider–outsider model. This is puzzling given that Brazil has strict labor regulations, though imperfectly enforced, and a large informal sector. A potential implication is that some theoretical and empirical challenges to the insider–outsider model are underlying the small political differences between formal and informal workers. The volume concludes in Chapter 11 with a summary of the findings and policy implications for the BRIC, and developing countries in general, that arise from the various chapters in this book.

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López-Cariboni, S. (2018). “Informal service access in pro-cyclical welfare states: A comparison of electricity theft in slums and regular residential areas of Montevideo,” Journal of Comparative Policy Analysis: Research and Practice, 1–19. https://www.tandfonline. com/doi/full/10.1080/13876988.2018.1462604. López-Cariboni, S., X. Cao, S. Lopez-Cariboni and X. Cao (2015). “Import competition and policy diffusion,” Politics & Society, 43(4): 471–502. http://pas.sagepub.com.proxy.timbo. org.uy:443/content/43/4/471.abstract#fn-1 (November 12, 2015). MacFarlane, S. N. (2006). “The ‘R’ in BRICs: Is Russia an emerging power?” International Affairs, 82(1): 41–57. https://academic.oup.com/ia/article-lookup/doi/10.1111/j.14682346.2006.00514.x (June 26, 2018). Maloney, W. F. (1999). “Does informality imply segmentation in urban labor markets? Evidence from sectoral transitions in Mexico,” The World Bank Economic Review, 13(2): 275. Maloney, W. F. (2004). “Informality revisited,” World Development, 32(7): 1159–1178. Marshall, Monty G., K. Jaggers, and T. R. Gurr (2010). “Polity IV project — Political regime characteristics and transitions, 1800-2010.” Center for Systemic Peace, 10: 24–37. McGuire, J. W. (1999). “Labor union strength and human development in East Asia and Latin America,” Studies in Comparative International Development (SCID), 33(4): 3–34. Medina, L. and F. Schneider (2018). “Shadow economies around the World: What did we learn over the last 20 years?” IMF Working Papers, 18(17): 1–76. https://papers.ssrn. com/sol3/papers.cfm?abstract_id=3124402. Milanovic, B. (2010). The Haves and the Have-Nots: A Brief and Idiosyncratic History of Global Inequality. New York: Basic Books. https://scholar.google.com/ scholar_lookup?title=The Haves and the Have-Nots%3A A Brief and Idiosyncratic History of Global Inequality&author=B. Milanovic&publication_year=2010 (June 26, 2018). Milner, H. V. and N. Rudra (2017). Globalization and the Political Benefits of the Informal Economy. Philadelphia, PA.: Paper presented at the Annual Meeting of the American Political Science Association. http://onlinelibrary.wiley.com/doi/10.1111/misr.12268/ full (December 9, 2015). Min, B. and M. Golden (2014). “Electoral cycles in electricity losses in India,” Energy Policy, 65: 619–625. http://dx.doi.org/10.1016/j.enpol.2013.09.060 (May 15, 2015). Moser, C. O. N. (1978). “Informal sector or petty commodity production: Dualism or dependence in urban development?” World Development. Mosley, L. and S. Uno (2007). “Racing to the bottom or climbing to the top? Economic globalization and collective labor rights,” Comparative Political Studies, 40(8): 923–948. http://cps.sagepub.com/content/40/8/923.abstract. Naylor, R. T. (2004). Wages of Crime: Black Markets, Illegal Finance, and the Underworld Economy. Ithaca, NY: Cornell University Press. https://books.google.com/books?h l=en&lr=&id=mr6q4zNufC0C&oi=fnd&pg=PR7&dq=Wages+of+crime:+Black+ markets,+illegal+finance,+and+the+under-+world+economy.&ots=VzDj3Zv6EJ& sig=XNQpKzYx6nTCvaUGnGlA5jYlgFQ (June 28, 2018).

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Rueda, D. (2006). “Social democracy and active labour-market policies: Insiders, outsiders and the politics of employment promotion,” British Journal of Political Science, 36(03): 385. http://www.journals.cambridge.org/abstract_S0007123406000214. Schneider, F. (2005). “Shadow economies around the world: what do we really know?” European Journal of Political Economy, 21(3): 598–642. Schneider, F. and D. H. Enste (2000). “Shadow economies: Size, causes, and consequences,” Journal of Economic Literature, 38(1): 77–114. http://pubs.aeaweb.org/doi/10.1257/ jel.38.1.77. Segal, G. (1999). “Does China matter?” Foreign Affairs, 78(5): 24–36. https://www.jstor.org/ stable/10.2307/20049448?origin=crossref (June 26, 2018). Simmons, B. A. and Z. Elkins (2004). “The globalization of liberalization: Policy diffusion in the international political economy,” American Political Science Review, 98: 171–189. Singer, M. M. (2016). “Informal sector work and evaluations of the incumbent: The electoral effect of vulnerability on economic voting,” Latin American Politics and Society, 58(02): 49–73. https://www.cambridge.org/core/product/identifier/S1531426X00002053/type/ journal_article. Soares De L., M. Regina and M. Hirst (2006). “Brazil as an intermediate state and regional power: Action, choice and responsibilities,” International Affairs, 82(1): 21–40. https://academic.oup.com/ia/article-lookup/doi/10.1111/j.1468-2346.2006.00513.x (June 26, 2018). De Soto, H. (1989). The Other Path: The Invisible Revolution in the Third World. New York: Harper & Row Publishers. Stokes, S. C. (2005). “Perverse accountability: A formal model of machine politics with evidence from Argentina,” American Political Science Review, 99(3): 315–325. http:// www.jstor.org/stable/30038942. Swamy, A. (2016). “Can social protection weaken clientelism? Considering conditional cash transfers as political reform in the Philippines,” Journal of Current Southeast Asian Affairs, 35(1): 59–90. Ulyssea, G. (2010). “Regulation of entry, labor market institutions and the informal sector,” Journal of Development Economics, 91(1): 87–99. Ulyssea, G. (2018). “Firms , informality and development: Theory and evidence from Brazil,” American Economic Review, 108(8): 2015–2047. Un-Habitat (2003). Earthscan publications on behalf of UN-habitat. In The Challenge of Slums — Global Report on Human Settlements. http://www.unhabitat.org/pmss/ listItemDetails.aspx?publicationID=1156%5Cnhttp://www.loc.gov/catdir/toc/ecip045/ 2003013446.html. Wang, J., F. L. Cooke and Z. Lin (2016). “Informal employment in China: Recent development and human resource implications,” Asia Pacific Journal of Human Resources, 54(3): 292–311. Weitz-Shapiro, R. (2012). “What wins votes: Why some politicians Opt Out of clientelism,” American Journal of Political Science, 56(3): 568–583. Wibbels, E. and J. S. Ahlquist (2011). “Development, trade, and social insurance,” International Studies Quarterly, 55(1): 125–149.

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Wibbels, E. (2017). “Informal work, risk and clientelism: Evidence from 145 slums in India,” In Paper presented at the Annual Meeting of the American Political Science Association, Philadelphia, PA. Zucco, C. (2013). “When payouts pay off: Conditional cash transfers and voting behavior in Brazil 2002–2010,” American Journal of Political Science, 57(4): 810–822. http:// onlinelibrary.wiley.com/doi/10.1111/ajps.12026/full (February 24, 2015). Zucco, C. and T. Power (2013). “Bolsa familia and the shift in Lula’s electoral base, 2002–2006: A reply to Bohn,” Latin American Research Review, 48(2): 3–24.

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PART I

Tax Revenue, Globalization, and Informality in BRIC Countries

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CHAPTER 2

A Comparative Analysis of Tax System in the BRICs and the Challenges Ahead: Informality and the Fiscal Contract Laura Seelkopf * and Armin von Schiller† Geschwister-Scholl-Institute of Political Science, Ludwig-MaximiliansUniversity (LMU) Munich, 80539 München, Germany † Hertie School of Governance, 10117 Berlin, Germany

*

Introduction As far as the modern state is a “tax state” (Schumpeter, 1917), modern societies are tax societies (Martin et al., 2009). What policies governments can implement and how effectively they can do so depends on the level and structure of tax revenue. This in turn shapes the societies governments govern. It determines who has to pay for the state and who does not, who gains and who loses, who is empowered and who is disempowered. To the extent that states are tax states, informality is tax evasion. Working, consuming and saving outside the formal sector without paying taxes — either deliberately or out of necessity — illustrates the weakness or unwillingness of the state to include its people and firms into the formal sector. Hence, tax evasion constitutes a large part of informality and is often used to define and measure it (Schneider, 2005; De Paula and Scheinkman, 2011). So, if informality is largely taxation, how does informality in taxation look like both theoretically and empirically in the BRICs?

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In this chapter, we first discuss the different challenges international and comparative political economy, development economics, and fiscal sociology have identified for the tax state and how this relates to informality. We then locate the BRIC’s tax states comparatively, illustrate their development and structure and discuss the impact of informality on important goals of the tax state, such as revenue generation, steering of the economy, and redistribution. Brazil, China, India, and Russia are crucial cases in the study of informality and taxation. Following the United Nations (2017), they are not only home to more than 40% of the world population, but are also key countries for the international system. Especially since the 1990s, they have been main drivers behind the changing equilibrium of the international system. For instance, as members of key international bodies such as the G20, they already shape international policy processes and continue to demand more power in influencing also the international dialogue on tax issues and informality. At the same time, their national politics impact other countries. High-income economies, but also increasing economies of low-income developing countries, are dependent on and also vulnerable to the economic and political development in the BRIC (IMF, 2011a). Hence, an analysis of taxation and informality in Brazil, China, India and Russia sheds light on important developments not only for the population living in these countries but also for the rest of the world. With this development in mind, we analyse the historical evolution of tax s­ ystems in the BRIC as well as their characteristics today. We place a strong emphasis on how they have dealt with challenges since the 1990s and the challenges they are facing today. Among these, we stress the element of informality and the lack of proper fiscal contracts. It is important to highlight that although we deal with the BRIC as a group to identify joint challenges, we also aim to illustrate the differences among them.

National and International Hindrances to Taxation and Informality How are taxation and informality related? For many economists, not paying taxes is informality, either by definition or measurement. The shadow economy consists of “all economic activities that would generally be taxable were they reported to the tax authorities” (Schneider, 2005: 600). Yet, the reasons why people and firms do not — or are not asked to — pay taxes are manifold. Hence, to understand how taxation and informality are connected, we first need to understand the goals of taxation and what domestic and international challenges modern tax states face. In the literature, the goals of the tax state are typically threefold (see, e.g. Musgrave, 1959). States use taxes to steer the economy, e.g. to discourage or encourage certain activities, to generate enough revenue for their policies and use

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the revenue to redistribute income. While many political scientists focus on conditions under which governments want to redistribute (e.g. Boix, 1998; Scheve and Stasavage, 2016), economists argue about the correct size of the state (e.g. Oates, 1985) and what tools to best use for taxation (see, e.g. Steinmo, 2003). Given that much of the discussion is based on OECD countries after the Second World War, the capability of the government is always assumed. Hence, even informality becomes almost a choice of the government rather than a problem of its ability to include everyone in the tax net. In this scenario, if governments do not crack down on tax evasion, it is because they do not want to for ideological reasons, think it is too expensive to crack down on a mostly relatively small number of evaders, or even deliberately allow informality to help the economy in a recession. This is different for developing and emerging economies, where the ability to tax is much lower. In fact, for many scholars, the share of (direct) tax revenue is actually the best measure of state capacity (e.g. Tilly, 1975; Levi, 1989; Besley and Persson, 2009; Dincecco and Katz, 2014). Mostly based on the development of the (tax) state in Europe, authors argue that states could raise their revenues because they managed to implement broad taxes, which allowed them to effectively tax all their citizens and firms across regions, sectors, and income groups. In less developed countries, where both administrators as well as citizens are less able to extract or pay taxes, the size and structure of the tax state are much less a conscious decision of the government, but more an outcome of its lower ability to tax. Hence, governments rely on easy tax handles (Aizenmann and Jinjarak, 2009) to generate revenue in a world with low administrative capacity. These are usually trade and corporate taxes. The government only needs to monitor a few ports, roads and airports or the major companies in a country rather than a myriad of citizens and small shops as would be necessary for general taxes on consumption (GST or VAT) or income (PIT). While most countries in the world have also introduced these more modern taxes (Seelkopf et al., 2019; Genschel and Seelkopf, 2019), less developed economies still rely heavily on trade and corporate income taxes (Genschel and Seelkopf, 2016b) due to their low ability to tax the rest. This of course implies huge informality on all other tax bases, namely, on the income of individual citizens and their consumption. Whether this informality is illegal (people do not pay the tax they should and administrators cannot coerce them) or legal (the government has set the thresholds so high that the majority of poor income earners and small shops fall below it) is somewhat arbitrary. It does however — and this is where developing and emerging economies are different to their rich counterparts — indicate the same problem: low government capability to control and convince their tax base. While international organizations assist countries to overcome these issues (see, e.g. Chapter 4), globalization in general has made the problem worse. This is

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mainly due to the fact that globalization almost by definition hits those two taxes the hardest, on which lower income countries mainly rely: trade and corporate taxes (Keen and Mansour, 2010a, 2010b). An increase in trade liberalization implies a lowering of barriers to trade and for many developing countries, this implied mainly a­ bolishing tariffs. While this potentially increases the overall welfare, it undermines tax ­revenues at least in the short to medium run. The IMF has advised the introduction of value-added taxes to offset the revenue loss from liberalization and this has at least partially worked (Baunsgaard and Keen, 2010). The VAT is also seen as the solution to the downfall of the other important revenue source: the corporate tax. With increased globalization, multinational corporations can choose where to invest (or at least where to park their profits). This induces competition for foreign investment between countries via lower corporate tax rates. While most countries worldwide engage in it, this is particularly harmful for developing countries as a much larger share of their tax revenues stems from corporate taxation and as such sacrificed on the altar of corporate tax competition. Given that the BRIC are large countries, they are the potential losers of tax competition (Genschel and Seelkopf, 2016a). The size of their economies is good because foreign firms will keep investing into the BRIC despite potentially higher tax rates. But it is also bad because they will not be able to undercut smaller tax havens in their surroundings and hence cannot turn lower corporate taxes into a viable business model. Hence, they need to go for an alternative revenue source. Replacing both trade and corporate taxes with the VAT potentially decreases the redistributive capacity of the tax state as consumption taxes are generally seen as regressive. While this might be different in instances of high informality, where only the rich consume in the formal economy, the VAT is still more regressive than corporate or personal income taxes. Also, a strong reliance on consumption taxes logs in a tax system that becomes ever more regressive, the more the informal tax base is included in the tax net. Hence, an efficient VAT, which broadens its base to the (former) informal economy, provides more revenue, but increases inequality, especially if the spending side is not very redistributive. In sum, informality can stem from deliberate as well as unintended choices on the side of both lawmakers and people. Tax evasion is a form of unintended informality on the side of policymakers, but a deliberate step on the side of taxpayers. People that hide their income or assets in secrecy jurisdictions or consumers and firms that do not report their taxable activity are evading taxes. This tax evasion is often used as a measure of informality itself. Yet, informality can also be a deliberate consequence of policy choices, whereby governments exclude large parts of the population from paying taxes because they are aware of their own low capacity to tax and hence rather rely on easy-to-tax revenue sources such as trade or corporate

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income. Globalization has made this strategy harder and hence governments try to rely more on internal taxes, mostly on consumption, but formally also on income.1

Taxation and Informality in the BRIC To understand the extent of informality in the tax system, it is important to ­understand how much tax a state can raise in terms of revenue and where this revenue stems from (tax mix). Hence, this section will discuss the development and current state of the tax systems in the BRIC and place them in the wider context. We will start with the general revenue capacity of the BRIC before we place the tax systems in their historical context and then delve deeper into the tax mix. Tax Revenue and Economic Development: Placing the BRIC in Their Geographical and Historical Contexts While developed economies differ quite substantially in the amount of taxes evaded, they all manage to collect substantive revenues. Even Italy, which has a VAT gap of almost 30% (CASE, 2016: 19), raises more than 40% of GDP in taxes (OECD, 2017). Advanced economies that collect significantly less such as the United States or Switzerland do this as a deliberate policy choice favouring a smaller state. Yet, they all easily raise more than the 20% of GDP in taxes deemed necessary to provide basic public goods (OECD, 2013). This is different for developing and transition economies such as the BRIC. Here, the revenue-to-GDP-ratio already indicates the capacity of the state to collect taxes (and hence fight informality and its negative consequences on society). As Figure 1 illustrates, the level of development and the size of the tax state are closely connected. Richer countries have the larger tax states. This is in line with the finding that informality is lowest in advanced economies and much higher in transition and developing countries; whereas the size of the shadow economy in OECD countries is estimated around 10% of GDP, it accounts for more than 50% in some transition and developing countries on average (Palamade and Anayiotos, 2005). Based on recent data, it is safe to say that compared to countries at a similar level of economic development, the tax performance of the BRIC does not appear to be particularly bad. The BRIC are good tax performers compared to countries  A third type of tax base is assets. We do not discuss them explicitly, as they do not amount to much revenue, require usually high administrative capacity and are — with the potential exception of property taxes — declining worldwide (see, e.g. Seelkopf et al., 2019). 1

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60

Total Revenue

50 40

Russia Brazil

30 20

India China

10 4

6

8

12

10

GDP p.c. 95% CI rev_average

Fitted values rev_average

Figure 1:   Economic development and the tax state. Note: Indicators represented averages over the period 1990–2010. Source: IMF (2016).

Table 1:   Tax revenue in 2014 and introduction year of major taxes. Total Revenue as a % of GDP (2014)

Tax Revenue as a % of GDP (2014)

INH

PIT

CIT

SSC

GST

VAT

Brazil

34

31

1809

1922

1926

1923

1923

1967

China

29

19

1939

1936

1950

1951

1931

1994

India

20

17

1953

1886

1940

1952

Never

2017

Russia

37

28

1882

1916

1885

1912

Never

1992

Country

Year of First Permanent Introduction

*

*

*

Note: *Introduced under Colonial Rule. Sources: IMF (2016), Seelkopf et al. (2019), and Genschel and Seelkopf (2019).

in their geographical area (see also Ivanyna and Haldenwang, 2012). While India and China seem to be doing slightly less well than Brazil and Russia in terms of revenue for their level of economic development, the sole focus on tax revenue is somewhat misleading, at least in the case of China. As the first two columns in Table 1 show non-tax revenue is very relevant in Russia and China while less crucial in the case of India and Brazil (as it is in most countries around the globe). In particular, Russia earns a lot of revenues from its natural resources and China’s budget is increased by the profits of its state-run enterprises.

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Yet, the capacity of a tax system is not only gleaned by comparing it with other countries in the world. We also need to understand where the BRIC came from to see their contemporary tax systems in their historical context. In general, the BRIC developed their first modern taxes relatively early. All four countries introduced at least one out of six modern taxes before the Second World War (see last six columns in Table 1). With the exception of China, the development of the modern tax state already started in the 19th century. In India and Brazil, some taxes even have colonial roots and remained in place after independence till date (Genschel and Seelkopf, 2019). The tax policies in China and Russia are different. They introduced all their taxes as sovereign states, yet their pre-Cold War tax states were interrupted by communism. While taxes were still formally in place, the meaning changed significantly and became more of an accounting exercise rather than a tax as we understand it. With the return to a capitalist economy in the 1990s, China and Russia reintroduced modern taxes. Especially at the beginning, this was very challenging as administrators were few and untrained, citizens were not used to paying taxes, and the economy was not monetized (Appel, 2011). Yet, currently all BRIC countries, including both Russia and China, hit the UN target of 20% — albeit India only just so. Comparison of the data in Table 1 to the clearly lower revenues at the beginning of the 1990s in Figure 2 points to some remarkable developments in terms of revenue collection over the last decades.

Figure 2:   The development of the tax state in the BRIC. Source: IMF (2016).

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In all of the BRIC, the collection trends have been positive. With the exception of Brazil, which is well known historically to be a relatively high performer in tax collection (Ivanyna and Haldenwang, 2012; Le et al., 2012), all the other countries started at low levels. In the case of China, the tax revenue collected was even well below 10% of GDP in the early 1990s.2 The most positive trends are in the two post-communist countries, Russia and China, hinting at the strong ability of the communist states to transform their economies to capitalism and then also tax them. Unsurprisingly, Brazil has not increased its intake as much, given that it already was at a relatively high level in 1990. It is, however, steadily increasing its tax revenue. India instead is mostly stagnant and is struggling hugely to increase its tax intake. In general, it can be said that the tax state had quite strong roots in the BRIC and that the administrative setup was already in place for some decades. Following communism and also changes in the international economy, the BRIC have also introduced more modern tax instruments recently. In this respect, India represents a latecomer, at least when it comes to consumption tax reform.3 In the next part, we will take a closer look at the tax mix in the BRIC. The Tax Structure in the BRIC Since the 1990s, the process of globalization accelerated and deepened. From a revenue perspective, globalization creates a number of challenges for developing countries. Keen and Mansour (2010a, 2010b) emphasize two most prominent challenges: the reduction in trade tax revenues and the potential erosion of corporate tax revenues by international tax competition. It is relevant to highlight that these ­challenges took place in a context where the spending needs were high, whereas the levels of domestic resource mobilization, as discussed above, were relatively low. Adding to this complexity, if we also look at the challenges from within, it is safe to say that at the beginning of the 1990s, the state capacity in most of these countries was low. And so was the size of the tax net and the number of individuals and firms which have been contributing regularly to the tax revenue. Overall, as in many developing and emerging economies, the BRICs have been relying on tax instruments that were under pressure and needed little administrative capacity. Hence, the ability to enforce new taxes on a population, with which revenue bargaining had been very limited so far, was low. The options for the countries were mainly three: not complying to the international pressures and trying to keep the system as

 This was presumably similar for Russia, for which we unfortunately only have data from the mid-1990s onwards. 3  See https://www.foreignaffairs.com/articles/india/2017-08-17/indias-tax-reform. 2

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it was; losing some revenue without trying to compensate; or losing some revenue and actively trying to activate new tax bases. Given the pressure, and also the potential gains from liberalizing, the option to try to stick to the old system was hardly reasonable. Only in Russia, partly explained by its peculiarity as exporter of natural resources, were trade taxes an option. And given the revenue needs of the population — often even increased due to globalization — simply forgoing the revenue was also not possible. Hence, all BRIC — similar to most countries worldwide — tried to reform their tax systems to access their national tax bases. Here, the problem of informality becomes crucial. Informality — working and consuming outside the formal economy — makes it much more difficult for states to substitute lost revenue via other tax instruments, such as sales or income taxes. Moreover, informality can not only be seen as a problem of low administrative capacity but also as a systematic lack of tax morale. High levels of informality could be interpreted in this sense, as the final prove that citizens and enterprises only contribute via taxes if forced. In this sense, new sources of revenue would demand either investment in higher extractive capacities to force tax payments or investments in quasi-voluntary compliance to lower resistance to taxation. How did the BRIC fare in switching from trade and corporate taxes to consumption and personal income taxes? As illustrated above international organizations such as the IMF recommended compensating lost trade revenues through a stronger use of indirect taxation on goods and services. Indirect taxation, especially VAT, was praised internationally as the best way forward. It is argued to be a less distortive tax and, if not designed in a complex way, be characterized by relatively low administrative and compliance costs. We hence first take a closer look at the ratio of revenue collected through indirect taxes on goods and services and the revenue from trade taxes (Figure 3). Were the BRIC able to switch from easy to tax trade to harder to tax consumption? Especially in China and Brazil, the trend is very positive. In the case of Brazil, the development is very strong. For every dollar of tax collected through trade taxes, Brazil was getting approximately 7 dollars through taxing goods and services in 1990. That number gradually jumped up to above 38 in the mid-2000s. It indicates the end of a process that was already well under way in the 1990s, namely, the complete move away from tariffs as revenue source. Different from Brazil, China started the 1990s with a ratio below 1, indicating that China was collecting more revenue trough trade taxes than through domestic taxes on goods and services. This is not surprising considering the recent change to a capitalist economy. What is remarkable is the speedy increase of the ratio, which seems to now be stabilizing at high 20s. In the case of India and Russia, the evolution is far less strong. In the mid-1990s, both countries had a ratio of around 3, which in the case of India has slightly increased to around 5. Compared to China and Brazil, this appears rather small, nevertheless, it

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30 20 10 0

Ratio of indirect taxes to trade taxes

40

40  L. Seelkopf  & A. von Schiller

1990

2000

Year Brazil China

2010

2020

India Russia

Figure 3:   Ratio of taxes collected through indirect taxes to taxes collect through trade taxes. Source: IMF (2016).

represents a remarkable increase for a country so plagued by low capacity and high regional diversities. In the case of Russia, the number has even decreased since the 2000s and at the end of the 2000s, Russia was collecting only slightly more through indirect taxes than through trade taxes. This is not due to a decline in consumption taxation as Figure 4 illustrates, but due to an increase of trade tax revenues because of the resource boom in this period. As our analysis of the ratio between trade and general consumption taxes show, we see not only a trend towards the latter but also remarkable differences between the BRIC. We now turn to Figure 4, which further illustrates these divergences and trends in term of tax composition by showing the revenue collection of taxes on goods and services, trade taxes, individual taxes and corporate taxes in every individual BRIC. A common denominator is that taxes on goods and services, under which the VAT is subsumed, are crucial for all the countries and, except for India, clearly increasing in performance. We also see modest yet significant increases in collection from individual taxes and corporate taxes.4 As mentioned above, with the expectation of Russia, the collection of trade taxes is decreasing or stagnant.  Of course, the average over decades partly cover development that happen later in a period. For instance, it seems evident that the China has increased recently collection from personal income tax in a far more effective way than, for instance, India (Piketty and Qian, 2009). 4

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0

5

10

15

20

A Comparative Analysis of Tax System in the BRICs and the Challenges Ahead 41

90s

00s

Brazil

90s

00s

China

Taxes on goods & services Personal income taxes

90s

00s

India

90s

00s

Russia

Trade taxes Corporate income taxes

Figure 4:   Tax collection as percentage of GDP in the BRIC by different tax instruments in the 1990s and 2000s.

The challenge of potential pressure on corporate income taxation appears to not have materialized strongly in BRIC. As Figure 4 shows, income from those taxes has increased. It is however relevant to highlight that the vast level of economic growth in these countries might have compensated for the pressures from tax competition. It is certainly right to say that compared to other countries, taxes on corporations in BRICS are not particularly high. Beyond the overall trends, the analysis of the tax composition enriches the picture of the reality of taxation in the BRIC. In India, the country with the longest time series, there appear not to be any major shifts in the tax composition. Collection through indirect taxation has remained stable over the last three decades at around 12% and direct taxation increased at the end of the 2000 to over 5%, albeit mostly via corporate rather than individual income taxation. Overall, the tax collection remains rather low and reflects the low capacity of the Indian state(s) to tax its citizens. In Brazil, although direct taxation has also experienced a modest upward trend, the step that brought tax collection well above 30% of GDP was indirect taxation. In China, the collection of the different taxes has run in parallel. Indirect taxation is dominant, but direct taxation has also increased remarkably (IMF, 2016). The jump in tax collection we see in Figure 3 seems to indicate that the VAT introduction in 1994 was immediately successful (see Table 1). This is a strong indication of the high capacity of the Chinese state to collect taxes (and of firms and citizens to pay them).

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In the case of Russia, in stark contrast to the other BRIC countries, trade taxes and revenue from natural resources continues to be a significant contributor to revenue generation. Yet, Russia has also managed to more than double its tax intake from corporate taxes and turn individual income taxes into a real revenue source. In sum, all BRIC have increased their tax intake, although with high degrees of variation. Indirect taxation continues to be the biggest revenue source, although we see a shift from trade to consumption taxation. While income taxes are also increasing, they are only a small share of the overall tax mix. These findings indicate that the BRIC were somewhat successful in increasing the size of their tax states. Yet, despite the varied positive trend, the tax intake is still relatively low compared to developed economies and informality still poses a huge problem. To triangulate and understand taxation and informality in the BRIC better, we now turn to survey data to shed light on the taxpayer side.

Challenges in the BRIC: Informality, Capacity, and the Social Contract Understanding the development and the current state of the tax system in the BRIC is an important step in understanding informality in taxation, especially given that there hardly exist any comparative estimates on actual tax gaps in advanced economies, let alone developing and transition economies such as the BRIC. But the challenges faced by the BRIC are not only technical. Another important feature is whether citizens are willing to enter into quasi-voluntary compliance (Levi, 1989) and pay the taxes the government asks of them. This is why it is so relevant to complement the information on revenues with survey data on taxpayers and administrations. We first illustrate how firms judge the BRIC’s tax systems and then discuss how citizens fare inside and outside the tax system. Beyond the policy element, a crucial dimension of tax policy and tax performance in developing countries is tax administration and its enforcement capacities. The level of interdependence between tax policy and tax administration, especially in the context of developing countries, which tend to be characterized by weak state capacity, has been summarized by Casanegra de Jantscher when she claimed that “tax administration is tax policy” (1990: 179). It is undeniable that in many developing and transition economies, the major challenge towards more tax revenue is the administration (see, e.g. Chapter 4). Over the last years, we have seen the limitations that tax administration in the most developed countries face, when it comes to tracking and enforcing legislation. Not surprisingly, these limitations are even more profound in the BRICs. Here, the

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difference between what would be technically optimal or politically desired and what is reasonable and feasible is even bigger. This has a dimension of efficiency given that certain taxes are administratively more demanding, or that certain legislation might be to cumbersome to implement and track. It is in this setting that governments themselves have a difficult balance to achieve between what is expected of them, what tax theory says is reasonable, what goals they want to achieve and what reforms are enforceable. Administrative capacity and the problem of informality are closely related, especially when it comes to exploiting more tax sources such as corporate and personal income taxes as well as the VAT. The governments have not hired enough tax administrators and those officials are often badly trained and do not have the necessary equipment, such as computers and modern accounting software. In addition, people and firms alike are not used to being taxpayers. Overall, there is a need to bring more citizens as well as medium- and small-sized enterprises into the tax net. Firms Given the importance of firms for tax collection (IMF, 2011b), we first focus on the opinion of firms on what constitutes major constraints for them. We use two different questions as measures for tax administrations, namely, the percentage of firms which directly state that tax administrations are a major constraint and then the percentage that report a visit by tax officials. We use another question on tax rates to compare these two measures of perceived and actual administrative activities (World Bank, 2018). Figure 5(a) shows the percentage of firms worldwide that see tax rates (on the y-axis) and tax administrations (x-axis) as major constraints for their ability to do business. Interestingly, both are highly correlated. To dislike tax rates is to dislike tax administrations. The BRIC differ widely, but with the exception of Russia, all fall on the regression line. Russia is an outlier, where much more firms perceive rates to be a constraint rather than the administration. This is especially interesting given that Russia has the lowest rates of all the BRIC. The actual tax rates (see Table  A.1) and the actual perception about them as major constraints differ widely. High (or low) tax rates alone do not seem to be a good indicator as to why taxpayers choose informality over taxation. This also becomes clear when we compare the two graphs. Whereas the percentage of firms that sees tax administrations as problematic is highly correlated with the percentage of those that see tax rates as a major constraint, the actual activity of tax administrations, namely, paying the taxpayers a visit, seems almost not correlated at all. This seems to indicate that a firm’s perception might not be such a good measure

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Figure 5:   A business view on the tax state.

to qualify the efficiency of tax administrations. The actual work of tax controllers is not seen as an obstacle. China, the country which is to be seen by firms as a prodigy in tax terms, is the BRIC which has the largest percentage of firms that were visited by tax officials. Hence, a country with medium tax rates, a rising tax intake and an effective administration is actually perceived as the one with the fewest constraints in tax terms by firms. A country such as Brazil, which relies much less on income taxation as revenue source and sends fewer administrators to check firms, is seen as much more problematic. This might of course stem from the fact that business men and women expect more of the democratic Brazilian government than of autocratic China or are disappointed by the performance on the spending side. To delve deeper into this question, we now turn to citizens and their perceptions. Citizens The increased economic development in the BRIC has not only increased the tax base but also changed who is taxable. Thanks to the high number of people who no longer live in (absolute) poverty in many developing and emerging economies, the number of people that are in a position to make a contribution to the society in the form of (direct) taxes has increased. This creates the challenge for BRIC as well as other emerging economies to move from a tax system relying on few taxpayers, which pay the vast share of the revenue, to a system based on a broader tax base, with more but also smaller individual contributions. This has economic but also political

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implications. First, the government has to convince or force many more people to pay. Second, the government has to anticipate that turning citizens into taxpayers will make them demanding a say in what is done with their money (Moore, 2004; Brautigam et al., 2008). Overall, we know that the nature of government financing affects the relationship between governments and citizens, and that enhancing revenue mobilisation might drive politicians’ responsiveness to citizens, citizens’ engagement in public affairs and, ultimately, more accountable and inclusive government institutions (e.g. Paler, 2013). Taxing individuals might therefore not be the best strategy for governments, although the idea of governments as pure revenue maximizers continues to be strongly present in many discussions (see, e.g. Piracha and Moore, 2016). The political cost of taxation can be high and even more importantly, given capacity constraints, the success of any policies aiming at sustainably increasing and maintaining tax collection at higher levels will demand some degree of quasi-voluntary compliance (Levi, 1989). This means that in order to tax more and establish modern effective and efficient tax systems, BRIC are faced with the challenge to transform not only their tax policies and the way they handle them, but more profoundly the revenue bargaining, on which the public finance system is based and legitimatized. With higher levels of economic development, the scope to tax more broadly and different economic actors increase (Ravaillon, 2009). While in poorer countries, the decision to rely solely on a much reduced number of taxpayers can be sensible given the small tax base and the reduced number of persons with capacity to contribute, this natural constraint loosens with economic growth. This opens the possibility to engage in revenue bargaining with the broader tax base and consolidate a more inclusive fiscal contract. Survey data show that BRIC are far from consolidating a fiscal contract involving citizens through quasi-voluntary compliance. Table 2 highlights the percentage of the population over time, who consider that cheating on taxes is never justifiable.

Table 2:   Percentage of population supporting that cheating taxes is never justifiable. 1989–1993

1994–1998

1999–2004

2005–2009

2010–2014

Brazil

60%

—

—

39%

65%

China

81%

78%

76%

58%

43%

India

80%

74%

76%

53%

77%

Russia

48%

43%

43%

46%

41%

Note: Percentage of respondents who consider that cheating on taxes is never justifiable. Source: World Values Survey, various waves. Inglehart et al. (2014).

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The numbers vary strongly among the BRIC. India systematically shows pretty high numbers, while Russia seems to have the smallest amount of people considering cheating unacceptable under any circumstances. Beyond differences between countries, the trends within countries are intriguing. In China, the numbers are decreasing rapidly. China represents an extreme case, but in general, it is safe to say that there is no upward trend in any of the countries. Consolidation or decrease in the number of people that see taxation as just is far more common. This might be taken as a major sign of eroding (rather than forming) fiscal contracts. The BRIC have apparently not been able or willing to convince taxpayers that their contribution is meaningful and relevant. Rather, it appears that in taxing, the BRIC have used the stick rather more than the carrot. In this line, the numbers point at a non-technical but highly crucial dimension for developing countries, which are trying to tax more and better. A modern, effective and efficient tax system will not function against the will of the taxpayers. Even if technical and administrative solutions are found to extract more resources, these efforts will not be sustainable. Economic development changes the options for states to finance themselves. This refers to the tax potential in absolute terms as well as the amount of actors with the economic capacity to contribute. Most often, the perspective of the state is taken and scholars, advisers and policymakers discuss what the state needs to tax more effective and efficiently. Yet, a real transformation can only happen, when the discussion is complemented by looking into what taxpayers want. Only by creating quasi-voluntary compliance will administratively constrained countries, such as the BRIC be able to extend their tax base and transform the way they tax (see, e.g. Berens and von Schiller, 2017). This is a more socio-political than a purely economic process and it appears to have been neglected or at best been only very moderately successful in the BRIC. Cases of clientelism and corruption with increased public budgets have certainly not helped in this regard and give a good excuse for taxpayers to distrust government officials. It is also in this context, where the level of informality should not be seen only as a technical and administrative challenge, but also as a sign of weak tax morale and lack of a fiscal contract. At least some part of informality can be expected to be motivated by the perceptions of many economic actors that the exchange of revenue for services received from the state is not attractive for them (see, e.g. von Schiller, 2018).

Conclusion: The Challenge of BRIC and Understanding the Informality on Taxation BRIC are now key actors in the international economic and political system. From a historical perspective, the BRICs were in very different positions at the beginning of the 1990s. They however faced a similar set of challenges. Globalization put pressure

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on certain revenue sources such as trade taxes that had played a major role in the tax collection. BRIC were under a lot of pressure to reform the way they tax and in order to substitute lost revenue, they were forced to use tax instruments that they had neglected so far. At the same time, their rapid economic growth enabled them to employ tax strategies which before that had been economically inviable. As taxation is at the core of the state, the challenge to transform the way that the BRIC taxed was far from only a technical one. The transformation affected and is still affecting administrative, political, and social dimensions. The reforms can be tracked in the data. In this chapter, we have described the trends in revenue collection and revenue composition. Generally ­speaking, the changes go in the expected direction, but the reforms have been more ­modest than many could have anticipated and the level of heterogeneity between the BRIC countries is huge. As economic growth was high, revenue was easier to collect and the pressure to engage in the reforms that were demanded was lower. The BRIC do have average collection for their respective level of economic ­development. BRIC countries could to a certain degree change little to fulfil the expectations. Administrative capacity seems to have increased, but the development of a broad-based fiscal contract seems far from having become a reality. Lower level of poverty increases a tax potential that many of these countries are apparently neglecting. Also, the existence of individuals with higher incomes to be taxed is not being sufficiently exploited.5 A key battleground in this endeavour to higher revenue based on strong fiscal contract is informality. Informality, as this chapter has highlighted, should be at the core of the reform agenda. It is a challenge for higher revenue, but also a symptom of a poor fiscal contract. As the OECD highlights: “Persistent and high levels of informality reduce tax revenues and the ability to develop contribution-based social security systems. Furthermore, those workers who are rationed out or excluded from formal jobs and who depend on informal employment, either as micro-entrepreneurs or informal wage workers, for income generation represent a huge challenge for public expenditure (OECD, 2004). Ultimately, the prevalence of informal employment is not only a fiscal issue: it can be interpreted as a sign of a dysfunctional social contract between the state and its citizens. The state is not delivering the public goods in the quantity and quality  As Ravallion (2009) calculates, there is some scope to fight poverty redistributing to the poor revenue generated by increasing tax pressure on higher incomes. He analyses specifically the cases of three of the BRIC (Brazil, India, and China) and shows how the scope is very big in Brazil, remarkable in China and very limited in India. 5

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desired by its citizens, while in parallel citizens are evading taxes, social security contributions and the like in actions which undermine the capacity of the state to deliver those goods” (Jütting and de Laiglesia, 2009: 19).

The previous analysis suggests that the BRIC are increasing their tax revenue — China is certainly the country with the quickest growth, whereas India is lagging behind. On the technical side, efficiency of administration and increasing the tax net appear most relevant. Yet, a more balanced tax composition would be politically and economically desirable and possible. Most importantly, politically there is a lack of fiscal contract and little indications of developments to consolidate it. Overall, tax reforms in BRIC have taken place over the last two decades, but the effects have been far less impressive than could be expected. Most reforms have focused on a technical and administrative dimension and neglected the sociopolitical dimension of public finance. The new economic strength in these countries creates potentials that are not being exploited. This leaves the BRIC as well as the international community ample scope to engage in this area in order to materialize the fiscal and governance dividends that more ambitious reform might generate.

Appendix Table A.1:   Tax rates 2016. Brazil

CIT

PIT

VAT

INH

34

27.5

19

8

Russian Federation

20

13

India

34.6

35.5

14.5

0

0

China

25

45

17

0

Source: Limberg (2018) (PIT, VAT, INH); KPMG (2018) (CIT).

References Aizenman, J. and Y. Jinjarak (2009). “Globalisation and developing countries — A Shrinking tax base?” Journal of Development Studies, 45(5): 653–671. Appel, H. (2011). Tax Politics in Eastern Europe: Globalization, Regional Integration, and the Democratic Compromise. Ann Arbor: University of Michigan Press. Bastiaens, I. and L. Seelkopf (2019). “Can tax aid broaden the base? International assistance, taxation, and the informal sector in the BRICs.” Baunsgaard, T. and M. Keen (2010). “Tax revenue and (or?) trade liberalization,” Journal of Public Economics, 94(9–10): 563–577. https://doi.org/10.1016/j.jpubeco.2009.11.007.

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Berens, S. and von Schiller, A. (2017). Taxing Higher Incomes — What makes the highincome earners consent to more progressive taxation in Latin America? Political Behavior, 39: 703–729. Besley, T. and T. Persson (2009). “The origins of state capacity: Property rights, taxation, and politics.” The American Economic Review, 99(4): 1218–1244. https://doi.org/10.1257/ aer.99.4.1218. Boix, C. (1998). Political Parties, Growth and Equality: Conservative and Social Democratic Economic Strategies in the World Economy. Cambridge: Cambridge University Press. Brautigam, D., O.-H. Fjeldstad and M. Moore (eds.) (2008). Taxation and State-Building in Developing Countries: Capacity and Consent. Cambridge: Cambridge University Press. Casanegra de Jantscher, M. (1990). “Administering the VAT.” In M.*S. Gillis, C. S. Shoup, and G. P. Sicat, Value-Added Taxation in Developing Countries: A World Bank Symposium, Washington, D.C: The World Bank, pp. 171–179. http://documents. worldbank.org/curated/en/107821468764724876/Value-added-taxation-in-developingcountries-a-World-Bank-symposium. CASE (2016). “Study and Reports on the VAT Gap in the EU-28 Member States: 2016 Final Report.” Warsaw: Center for Social and Economic Research. De Paula, Á. and J. A. Scheinkman (2011). “The informal sector: An equilibrium model and some empirical evidence from Brazil,” Review of Income and Wealth, 57(May): S8–S26. https://doi.org/10.1111/j.1475-4991.2011.00450.x. Dincecco, M. and G. Katz (2014). “State capacity and long-run economic performance,” The Economic Journal, 126(590): 189–218. https://doi.org/10.1111/ecoj.12161. Genschel, P. and L. Seelkopf (2016a). “Winners and losers of tax competition.” In Thomas Rixen and P. Dietsch, (Eds.), Global Tax Governance What Is Wrong with It and How to Fix It, Colchester: ECPR Press, pp. 55–76. http://press.ecpr.eu/book_details. asp?bookTitleID=374. Genschel, P. and L. Seelkopf (2016b). “Did they learn to tax? Taxation trends outside the OECD,” Review of International Political Economy, 23(2): 316–344. https://doi.org/10.1 080/09692290.2016.1174723. Genschel, P. and L. Seelkopf (2019). Codebook — Tax Introduction Dataset (TID). tid. seelkopf.eu. IMF — International Monetary Fund IMF (2011a). “New Growth Drivers for Low-Income Countries — The Role of BRICs.” IMF Policy Paper, Washington. IMF — International Monetary Fund IMF (2011b). “Revenue Mobilization in Developing Countries.” IMF Policy Paper, Washington. IMF — International Monetary Fund (2016). World Revenue Longitudinal Dataset (WoRLD). Washington, DC: IMF - http://data.imf.org/revenues. Inglehart, R., C. Haerpfer, A. Moreno, C. Welzel, K. Kizilova, J. Diez-Medrano, M. Lagos, P. Norris, E. Ponarin and B. Puranen et al. (eds.) (2014). World Values Survey: Round One to Six - Country-Pooled Datafile Version: www.worldvaluessurvey.org. Madrid: JD Systems Institute.

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Ivanyna, M. and C. von Haldenwang (2012). “A comparative view on the tax performance of developing countries: Regional patterns, non-tax revenue and governance”, Economics: The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy (IfW), 6, 2012–2032. Jütting, J. and J. R. de Laiglesia (2009). Is Informal Normal? Paris: OECD. Keen, M. and M. Mansour (2010a). “Revenue mobilisation in sub-Saharan Africa: Challenges from globalisation I — Trade reform,” Development Policy Review, 28(5): 553–571. https://doi.org/10.1111/j.1467-7679.2010.00498.x. Keen, M. and M. Mansour (2010b). “Revenue mobilisation in sub-Saharan Africa: Challenges from globalisation II — Corporate taxation,” Development Policy Review, 28(5): 573–596. https://doi.org/10.1111/j.1467-7679.2010.00499.x. KPMG (2018). Corporate Tax Rate Tables. https://home.kpmg/sg/en/home/services/tax/ tax-tools-and-resources/tax-rates-online/corporate-tax-rates-table.html. Le, T. M., B. Moreno-Dodson, and N. Bayraktar (2012). “Tax Capacity and Tax Effort Extended Cross-Country Analysis from 1994 to 2009”, World Bank Policy Research Working Paper 6252. Levi, M. (1989). Of Rule and Revenue. University of California Press. Limberg, J. (2018). “Tax the Rich”? The Financial Crisis, Fiscal Fairness, and Progressive Income Taxation. Paper Presented at the 2018 ECPR General Conference in Hamburg, Germany. Martin, I. W., A. K. Mehrotra and M. Prasad (2009). The New Fiscal Sociology: Taxa­­ tion in Comparative and Historical Perspective. Cambridge University Press. http:// www.cambridge.org/us/academic/subjects/law/taxation-law/new-fiscal-sociologytaxation-comparative-and-historical-perspective. Moore, M. (2004). “Revenues, state formation, and the quality of governance in developing countries,” International Political Science Review, 25(3), 297–319. Musgrave, R. A. (1959). The Theory of Public Finance: A Study in Public Economy. McGraw-Hill. Oates, W. E. (1985). “Searching for Leviathan: An empirical study,” The American Economic Review, 75(4): 748–757. OECD (2013). “Tax and Development: Draft Principles for International Engagement in Supporting Developing Countries in Revenue Matters.” Paris: OECD. http://www.oecd. org/ctp/tax-global/Principles_for_international_engagement_May2013.pdf. OECD (2017). Revenue Statistics (comparative tables), OECD tax statistics. Palamade, V. and A. Anayiotos (2005). “Rising Informality.” World Bank Public Policies for the Private Sector, No. 298. http://siteresources.worldbank.org/EXTFINANCIALSECTOR/ Resources/282884-1303327122200/298Palmade_Anayiotos.pdf. Paler, L. (2013). “Keeping the public purse: An experiment in windfalls, taxes, and the incentives to restrain government,” American Political Science Review, 104(7): 706–725. Piketty, T. and N. Qian (2009). “Income inequality and progressive income taxation in China and India, 1986–2015,” American Economic Journal: Applied Economics, 1(2): 53–63. https://doi.org/10.1257/app.1.2.53.

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Piracha, M. and M. Moore (2016). “Revenue-maximising or revenue-sacrificing government? Property tax in Pakistan, The Journal of Development Studies, 52(12): 1776–1790. Ravallion, M. (2009). “Do Poorer Countries Have Less Capacity for Redistribution?” Policy Research Working Paper 5046. Washington, DC: World Bank. Scheve, K. and D. Stasavage (2016). Taxing the Rich: A History of Fiscal Fairness in the United States and Europe. Princeton, NJ: Princeton University Press. Schneider, F. (2005). “Shadow economies around the world: What do we really know?” European Journal of Political Economy, 21(3): 598–642. https://doi.org/10.1016/j. ejpoleco.2004.10.002. Schumpeter, J. A. (1917). “The crisis of the tax state.” International Economic Papers, 4: 5–38. Seelkopf, L., M. Bubek, E. Eihmanis, J. Ganderson, J. Limberg, Y. Mnaili, P. Zuluaga and P. Genschel (2019). The rise of modern taxation: A new comprehensive dataset of tax introductions worldwide. The Review of International Organizations (Online First): http://dx.doi.org/10.1007/s11558-019-09359-9. Steinmo, S. (2003). “The evolution of policy ideas: Tax policy in the 20th century,” The British Journal of Politics and International Relations, 5(2): 206–236. https://doi. org/10.1111/1467-856X.00104. Tilly, C. (1975). The Formation of National States in Western Europe. Princeton: Princeton University Press. https://it.scribd.com/doc/39743115/Tilly-Charles-The-Formation-ofNational-States-in-Western-Europe. United Nations (2017). World Population Prospects: The 2017 Revision, Volume I: Comprehensive Tables. ST/ESA/SER.A/399. Department of Economic and Social Affairs, Population Division, New York: United Nation. von Schiller, A. (2018). “Party system institutionalization and reliance on personal income taxation in developing countries,” Journal of International Development, 30(2): 274–301. World Bank (2018). Doing Business 2018: Reforming to Create Jobs. Washington, DC: World Bank. DOI: 10.1596/978-1-4648-1146-3. License: Creative Commons Attribution CC BY 3.0 IGO.

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CHAPTER 3

Is Informal Work Eroding Compliance? Sarah Berens* and Irene Menéndez† Cologne Center for Comparative Politics, University of Cologne, Germany † IE School of Global and Public Affairs, Madrid, Spain *

Introduction Tax revenue is vital for the state to work and to fulfill its legitimizing function. Taxation ushered in democratic representation and paved the way for prosperous and fully-fledged democracies (North and Weingast, 1989; Queralt and Mares, 2015). This dynamic, however, is mostly a narrative of western democracies. Many developing countries struggle with both a sound fiscal footing and democratic quality. Compliance (and lack thereof) lies at the very heart of this trajectory. Compliance refers to cooperative behavior among citizens and the state and the willingness to fulfill a direct or indirect agreement. This means that citizens pay taxes as politically agreed upon, go to the ballot on election day to fulfill the most vital task of democracy and generally abide by the rule of law. But low turnout rates and unequal representation, chronically underfinanced public authorities, booming informal labor markets and high rates of criminal violence often make fulfilling this task difficult for many citizens in the developing world. In this chapter, we emphasize that understanding the nature of compliance is vital to understand and find solutions for these challenges. We zoom in on two central problems of compliance, compliance with labor market regulations (or the lack of it, which essentially refers to informality) and compliance with civic responsibilities, understood as compliance 53

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with the fiscal contract (or the lack of it, which refers to tax evasion). Because the decision to comply is not always at the discretion of the individual, especially in the realm of labor markets (e.g. informality), different types of motivations may be at play. We discuss these and other mechanisms driving compliance across both areas, and make the general argument that forced non-compliance in one realm can erode compliance in other relationships. Standard arguments in economics typically view compliance as payment of tax duties and largely subsume labor informality as part of the concept. The academic discourse on tax compliance is vast and can be mainly categorized along two branches: the enforcement literature and the fiscal contract perspective. Early explanations for compliance emphasized deterrence and fear of punishment, modeling compliance as a clean cost–benefit calculation (Becker, 1968; Allingham and Sandmo, 1972). Subsequent empirical research revealed that fear of punishment cannot fully explain the high levels of compliance that go much beyond the predictions of returns to taxes in rational choice models (Alm et al., 1992) even though current studies still attribute a substantial share of compliance to risk perception (see, e.g. Dwenger et al., 2016). The second strand of research theorizes tax compliance as rooted in the fiscal contract between taxpayers and the state (Levi, 1989). In exchange for the taxpayer’s contributions, the state provides public goods, such as infrastructure, public safety, and the welfare system. In addition to the vertical fiscal relationship, horizontal reliability is equally important. Social norms that limit free-riding behavior are considered as vital for tax compliance. Tax compliance is also positively related to tax morale (defined below) that deems evasion an unjustifiable behavior and thus overcomes the collective-action problem of free-riding (Torgler, 2005; Torgler and Schneider, 2009). Similarly, the concept of informality has been defined along a number of dimensions. The International Labor Organization (ILO) defines workers as informal “if their employment relationship is not subject to standard labor legislation, taxation, social protection, or entitlement to certain employment benefits” (ILO, 2002: 126). Research relates the phenomenon of informality to regulatory barriers to the formal labor market (De Soto, 1989; Loayza, 1996; Johnson et al., 1998), low institutional quality (Saavedra and Tommasi, 2007), the quality of the legal system and existing loopholes (Dabla-Norris et al., 2008; Carnes, 2014), and low social trust (D’Hernoncourt and Méon, 2011). Yet while tax evasion and informality share some characteristics, they are analytically distinct phenomena. Indeed, what sounds as a tautology at first sight is a much more complex set of notions. One reason for this is that the scholarly debate has tended to overlook the heterogeneity within the group of informal workers. When informal labor is understood as work without the payment of income taxation or social security contributions, it cannot automatically be equated with general noncompliance with the fiscal contract. For instance, a worker who is not paying income

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tax and social security contributions due to informal employment may at the same time accurately pay consumption or property taxes. Moreover, because informal hiring is frequently decided by employers, the link between (and evaluation of) the fiscal contract and compliance may break down. In a recent contribution, Ronconi and Zarazaga (2015: 453) find first evidence for the deteriorating effect of withheld benefits and labor rights for informal workers’ civic engagement in Argentina, concluding that “employer non-compliance with labor regulation erodes workers’ citizenship responsibilities”. Echoing O’Donnell (1993), this suggests that lack of legal protection can compromise the pursuit of further interactions with the state. We pursue this effort further and theoretically unpack the causal links between informality and compliance to illustrate the complexity of behavioral consequences linked to labor market exclusion. We highlight the importance of heterogeneity among informal workers. In particular, we emphasize the importance of voluntary and involuntary informality, and argue that this has implications for compliance decisions. Ultimately, we aim to provide a theoretical overview of the conditions under which labor market participants may be more or less likely to comply with various aspects of the social and fiscal contract. We point out some empirical implications about the likelihood of compliance in different state-society relationships and possible causal links between them. We proceed as follows. We start with a discussion of the concept of informality, review the literature on the informal sector and discuss issues and challenges of measurement. We then discuss the compliance literature on taxation and distinguish different mechanisms of compliance. Next, we provide some theoretical considerations on the links between informality and compliance, bringing together insights from the compliance and informality literatures and laying out our core argument. We conclude by spelling out some broader implications and discussing a number of themes in need of further research.

Informality: Concept Clarification and Measurement Issues The informal sector consists of a very heterogeneous set of individuals (Portes and Hoffman, 2003; Perry et al., 2007). The ILO defines workers as informal “if their employment relationship is not subject to standard labor legislation, taxation, social protection, or entitlement to certain employment benefits” (ILO, 2002: 126). A large share of informal sector workers are self-employed or own-account workers, which usually refers to forms of occupations such as street vendors or owners of a microbusiness. In Latin America, this type of informality accounts for approximately 24% of urban workers within this sector, while between 30% and 50% of informal workers are in an employment relationship, e.g. in occupations such as domestic work, small firms in the agricultural sector, production or the construction industry (Perry et al., 2007: 4).

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15

15

Empirically assessing the effect of informal labor on individual compliance attitudes and behavior is problematic, largely due to the very limited data availability on such sensitive issues. In this chapter, we mainly focus on analyzing how informal employment relates to the payment of taxes and the sustainment of the fiscal contract from a theoretical and conceptual perspective. However, to motivate some of the theoretical considerations offered below, we provide some descriptive insights using aggregate national statistics on the percentage of informal sector workers (from the International Labor Organization, ILO) and tax revenue as share of GDP for different types of taxes (OECD, 2018), for a cross-section of Latin American countries. We calculate averages from the period 2006–2012 since the ILO data on the size of the informal sector is only available for a handful of years. Because data on tax revenue are rather limited for developing countries, we start by focusing on this regional context with a particular emphasis on Brazil. Figure 1 illustrates the macro-level relationship between the size of the informal sector (in % of the working population) and income tax revenue (Figure 1(a)) and consumption taxes (Figure 1(b)) in Latin America. We use a fractional polynomial to avoid imposing a linear relationship on the two variables. Compared to most other countries in the

Brazil Peru Colombia Uruguay El Salvador Honduras Bolivia Costa Rica Ecuador Dominican Guatemala Republic

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20

40

60

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100

20

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Share of informal workers (%)

Share of informal workers (%)

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Figure 1:   The share of informal workers and different types of tax revenue statistics. Sources: OECD (2018).

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sample, Brazil is located at the lower bound regarding the size of the informal sector; only Uruguay and Costa Rica exhibit lower shares according to the ILO statistic. At the same time, Brazilian tax revenue levels on both consumption tax and income tax are the highest in the region. Low rates of informality seem to correspond with a simultaneously high level of tax returns. But referring to an informal sector of above 40% of the workforce as low does not seem to be a proper description. Overall, neither income tax revenue nor tax revenue of goods and services is perfectly negatively correlated with the size of the informal sector. Also, while the level of consumption tax revenue is naturally higher compared to income tax revenue, we see that the pattern of the correlations is different. Of course, these correlations are only bivariate and could be biased by the omission of key covariates such as the actual tax rates. But given severe data constraints (data on tax gaps are not available), we use these descriptive statistics carefully to nourish the notion that compliance and informality are distinct phenomena. Next, we explore data at the individual level. The World Values Survey makes it possible to illustrate the relationship between informality and the individual’s tax morale (arguably a much closer approximation of the concepts discussed in this chapter) for a large set of developing countries. As we are particularly interested in the location of Brazil, Russia, China, and India, we mark these countries in dark circle in Figure 2. Again, a number of caveats apply. While the survey data provide a frequently used item to measure tax morale (how justifiable is cheating on taxes on a scale of 1 — not justifiable to, 10 — very justifiable) we can only approximate informality with the rather crude category of “self-employed” as an answer to the question on employment status (V229). Of course, we cannot rule out that some respondents who chose this category are simply self-employed professionals such as journalists or entrepreneurs. For the developing country context, self-employment correlates highly with informality, but this limitation needs to be kept in mind when interpreting the data. Figure 2 illustrates the share of respondents who report being self-employed relative to the working population on the x-axis and the percentage of respondents with low tax morale on the y-axis. As the answer to the tax morale item is naturally highly skewed to the bottom due, among others, to social desirability bias, we consider respondents who chose a category above 3 as indicating lower levels of tax morale (1—3 coded as 0 or high tax morale; 4—10 coded as 1, or low tax morale). We aggregate the information to the country level. Higher values indicate lower tax morale in the population. Russia reveals the lowest level of tax morale in BRIC countries with a share of around 35%. In contrast, Brazil scores around 23%, India at 21% and China reveals the lowest level with 18%. However, cultural differences and other important covariates of tax morale might account for these differences. Notably, the correlation between self-employment and low tax morale is far from being positive, which

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0.5

South Africa Philippines

Algeria

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Malaysia Kyrgyzstan BrazilZimbabwe Poland Tunisia India EstoniaUzbekistan Yemen Mexico Hong Kong China Sweden Armenia Romania Taiwan Netherlands Peru United States Ecuador Pakistan New Zealand Spain Chile Australia Slovenia South Korea Libya Egypt Cyprus Jordan Colombia Uruguay Morocco Azerbaijan Ghana Trinidad and Tobago Georgia Rwanda Japan Turkey

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Figure 2:   The percentage of self-employed workers relative to the working population and the share of respondents with lower tax morale (WVS wave 6, 2010–2014).

would be expected if informality and tax evasion were to be one and the same. The relationship is even slightly negative, suggesting that countries with a larger informal sector exhibit at the same time a sound tax morale. But again, the negative relationship might be driven by the crudeness of the measure of informality. To get at a more precise measure of informality, Figure 3 focuses on a smaller set of countries in the WVS where a better identification of informal workers is possible. The survey item on the employment sector (V230) contains a specific category for informal/autonomous workers next to the category of self-employment, but the item has only been surveyed in a very small set of countries. We use this category to calculate the share of informal workers in the working population and correlate the values with information on tax morale. Now, the pattern is slightly positive though with very large confidence intervals. But again, this exercise reveals that the correlation between informality and a tax compliant attitude is far from being perfect, consistent with our claim that both phenomena are distinct. With this measurement of informal workers, China exhibits a much higher informal sector, above 25%, compared to the previous measure displayed in Figure 2. These differences further emphasize the challenges of measurement.

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0.2 China Peru

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Mexico

Yemen Ecuador Egypt

0

0.25 0.35 0.45 0.55 0.65 Informal/Autonomous Workers as Share of Working Pop. (Mean Value in %)

Figure 3:   The percentage of informal/autonomous workers relative to the working population and the share of respondents with lower tax morale (WVS wave 6, 2010–2014).

Working in the informal sector is intertwined with the notion of non-compliance. But in contrast to tax evasion, which is a deliberate deed to achieve a distinct goal such as maximizing income or benefits, informal labor is more complex in nature. As discussed earlier, informal labor is defined by the lack of payroll tax payment, contributions to social security schemes and the generally higher degree of vulnerability due to the lack of any kind of working contract or legally binding agreement that allows the enforcement of labor regulations, such as not working more than the legally defined hours, security at the worksite, having leisure time on legal holidays or even regular payments. Well-known arguments in the literature on informality argue that regulatory costs — high registration costs, the regulatory burden to becoming formal or the ongoing costs of a formal relationship — dissuade firms from entering the formal sector (De Soto, 1989; Djankov et al., 2002; Loayza et al., 2005). Looking at the impact of labor market institutions (e.g. minimum wages), tax rates and monitoring costs on the size of the informal sector from an efficiency perspective, research in economics reveals chain effects to be at work. Informality in one area can drive informality in others. De Paula and Scheinkman (2010) provide evidence of such chain effects regarding informality and the payment of VAT among firms in Brazil. Studying

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the impact of a new credit scheme for VAT collection in the production process, they show that how VAT is collected changes the costs of capital and production and consequently the likelihood of formality/informality among clients and suppliers. The general logic of chain effects can be extended to individuals deciding to comply with the state. Regulations may involve complex administrative procedures associated with compliance, increased costs of complying with government-imposed standards for particular services and the “red tape” associated with having to obtain government licenses. Moreover, compliance is in many cases not a matter of choice for the individual worker. For those individuals in an employment relationship, it is typically the employer who decides to pay payroll taxes for the employee and to make social security contributions. Similarly, street vendors who presumably decide by themselves not to register their business and to insure in a public pension scheme are in many cases “forced” by their personal economic constraints to withhold such payments. Perry et al. (2007: 2) poignantly state: “A microentrepreneur concluding, through a cost–benefit analysis, that formality is not worth the high registration costs may be explicitly excluded or self-excluded — either way, the effect is much the same.” In contrast, Maloney (1999, 2004: 1159) argues that informality can be understood as an “analogue of the voluntary entrepreneurial small firm sector found in advanced countries, rather than a residual comprised of disadvantaged, workers rationed out of good jobs”. He promotes the idea that much of informal employment is voluntary in nature, as workers see a benefit in the status of self-employment. It grants more flexibility and power to decide about one’s own effort. Moreover, when social policy programs are designed in a way, so that, e.g. the spouse of a formal worker is automatically covered, this generates incentives to seek work in the informal sector and, thus, to avoid “unnecessary” additional costs of social security contributions (see Levy, 2010). Loayza and Rigolini (2011) illustrate that informality also acts in many cases as a buffer zone in times of economic recession. The informal sector increases counter-cyclically to economic ups and downs and can therefore become for some workers a desirable option relative to unemployment. However, even though Maloney (1999, 2004) dismisses the dualization hypothesis, he also emphasizes the heterogeneity of this labor market segment. Focusing on Côte d’Ivoire, Günther and Launov (2012) provide one of the first theoretical and empirical investigations on voluntary versus involuntary informal labor. Applying a cost–benefit framework, the authors show that the actual share of workers employed in the informal sector is higher than rational decision-making would predict. Taking into account a set of important covariates, they conclude that the difference between the optimal size of the informal sector and the actual size of the informal points to the existence of “entry barriers” (Günther and Launov 2012: 94).

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While research on the determinants of informality is still in a nascent phase, partially due to the difficulties of identifying informal employment, studies on labor market dualization reveal that formal and informal sector workers are much less distinguishable in their preferences and behavior than the segmentation hypothesis would predict. Altamirano (2015), Berens (2015b) and Baker and Velasco-Guachalla (2018) do not detect any marked differences in preferences for redistribution or voting behavior for the Latin American context. This might be either due to formal and informal sector workers simply preferring similar levels of social protection — both face greater economic vulnerability in a globalized world — or measurement problems, with neither group correctly identified. We argue here that differences in the ways in which individuals enter the informal labor market need to be taken into account. Differences in the deliberateness of entry may influence future compliance as well as compliance in other collective activities, and this is where differences in preferences and behavior might obtain. One important limitation of existing research revolves around the difficulty of conceptualizing the phenomenon and its clandestine nature. A number of definitions have been advanced when thinking about informality. The ILO, for example, relies both on a legalistic definition of informality, which focuses on compliance with labor law (for example, the existence of a written contract among workers or the registration of firms with the relevant tax authorities), and a benefits definition, which focuses on the extent of social security coverage. In turn, the productive view defines workers as informal if they work in a micro-firm. This has made the task of empirically identifying informal work a challenging one, and suggests that more than one instrument is required to empirically identify informal work. The ILO makes use of countries’ regular household or labor force surveys to estimate the share of informal labor of the working population (e.g. the India Human Development Survey or the Employment and Unemployment Survey in India or the Russia Longitudinal Monitoring Survey of HSE used in the Russian Federation). Since 2015, reducing informality is one of the United Nation’s Sustainable Development Goals (ILO, 2018). Increasing international awareness of the problem of informal labor has led to the improvement of the specification of household and labor force surveys in the last decade as well as to better data on national employment statistics (ILO, 2018). While national statistics on informal labor are an important source to study informality, they lack information on individual attitudes and preferences, which are important variables to provide microfoundations on which macro-level models of informal work are built. Standardized public opinion surveys such as the Americas Barometer (Latin American Public Opinion Project, LAPOP) Latin America and the Caribbean, the Afrobarometer or the World Values Survey (WVS) are, therefore, crucial additional data sources and an alternative

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to household surveys. But they have been either inconsistent in including survey instruments for identifying informal labor or completely neglected to incorporate such instruments at all. For instance, in 2006, LAPOP included a question about social security (seguro social) through the employer, in order to identify informal workers under the benefits definition. Yet in 2008 this question changed to health insurance (referring to seguro de salud/seguro social) and varied by country (Baker and Velasco-Guachalla, 2018). Questions like these were discontinued thereafter, undermining identification of informal labor based on the benefits definition. The WVS improved the questionnaire of the latest available wave 6 (2010–2014) in this regard with an item asking whether individuals were registered through their employer with the national social security agency of their country. However, the question was only asked in a handful of Middle Eastern and North African countries. In addition to items on the coverage through social security, public opinion surveys usually contain an item that enquires about the respondent’s labor market status. The main item measuring labor market status used since 2006 in the LAPOP (similarly in the WVS item V229, or Q96A in the Afrobarometer) asks about respondent occupation, with response items including self-employed and unpaid worker. In combination with the aforementioned items about social security or health insurance status, these categories are currently used to identify informal workers in the Latin American and Caribbean context (Baker and Velasco-Guachalla, 2018; Altamirano, 2015; Berens, 2015b). But given the heterogeneity within the informal sector, these categories do not capture the entire set of informal work. Although used extensively to proxy for informality, measures of self-employment do not capture large numbers of informal salaried workers, and overlook the fact that some self-employed individuals make social security contributions. Some country surveys in Latin America such as the Argentine Panel Election Study (APES) or the Brazilian Electoral Panel Study (BEPS) provide more elaborate survey instruments to study informality. However, they are currently bound to the respective country context. In Brazil, determining whether individuals possess a signed booklet (carteira assinada) makes it possible to determine whether an employment relationship is subject to standard labor legislation. Although this provides a solid basis for operationalizing informality, the use of different definitions of informality (a legalistic definition for the BEPS and a benefits one underpinning the APES) make comparisons difficult. The APES, in turn, asks respondents who declare to be self-employed or own a business whether they have registered with the relevant tax authorities. However, this (legalistic) definition does not capture contributions made by entrepreneurs, who may resort to private insurance. Given the complex nature of the phenomenon, the formality–informality divide may be thought of as a continuum rather than a binary state (ILO, 2013). In this

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sense, identifying household effects — whether individuals share a household with a formal or informal worker — would provide crucial information on the breadth and depth of the phenomenon. Understanding the extent to which an informal worker shares a household with a formal worker and is thus insured through a (formal) family member is key to understanding the links between labor market status and access to social benefits. Many individuals choose informality because they can get health coverage through their spouse (Galiani and Weinschelbaum, 2012; Levy, 2008). Indeed, omitting this information is likely to lead to biased estimates of the effect of informality. Equally important, available evidence suggests that individuals transit from formal to informal and back relatively frequently (Maloney, 1999, 2004). Research on labor market churning between informality and formality remains limited, given the obstacles to identifying informal workers (Maloney, 1999; Perry et al., 2007). The next step in this field of research would be to explore how “new” informal or formal workers differ from “experienced” formal and informal ones. Obtaining information on an individual’s employment history would thus be crucial to better understand the different dimensions of informality and its potentially diverse political and economic implications. Panel data over several years seems to be the gold standard to reach these goals, but while such data is already extremely costly for one country, it is a very high bar to reach for a cross-section of countries.

Tax Compliance: The Classical “Umbrella” for Informality Tax compliance can be approached from a set of different perspectives. Evasion has been portrayed as “a problem of public finance, law enforcement, organizational design, labor supply, or ethics, or a combination of all of these” (Andreoni et al., 1998: 818). Disentangling these different perspectives, and cautioning researchers against the risks of concept stretching, is one of the tasks that we pursue in this chapter. The scholarly discourse on tax compliance is vast. One of the main contributions from the public finance perspective is the influential argument on deterrence regarding criminal activity from Becker (1968) and Allingham and Sandmo (1972), who theorize tax payers as utility-maximizers that comply when the benefits of doing so are greater than the costs, which are based on the risk of being caught and the respective punishment. The deterrence model predicts that fear of punishment induces compliance, so that citizens are incentivized to abide by the law. Applied to tax behavior, taxpayers are predicted to pay their tax duties truthfully as long as the punishment is sufficiently costly (and the likelihood of penalties to be enforced sufficiently real, even though this is taken as given in the Allingham and Sandmo model) and the probability of being caught sufficiently high. However, early studies

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revealed that individuals tend to comply with taxation even in contexts of very low penalties and a negligible likelihood of audit (Alm et al., 1992). Alm et al. (1992) show in a laboratory experiment that individuals comply more than what a cost–benefit calculation, which factors in the correct risk of audit and cost of the fine, would predict. Some of the over-compliance can be explained by differences in cognitive responses such as individuals’ tendency to over-predict the risk of audit (see Casey and Scholz, 1991). But a large share of the variation in compliance can be explained by the receipt of a return in the form of a public good, the size of which is determined by compliance of all group members. The seminal work of Alm et al. (1992), thus, inspired a second prominent argument that expanded the deterrence model and theorized the productive role of rewards for tax compliance. Despite this broadening of the analytical lens toward a more encompassing theory of tax compliance, recent field experiments show that deterrence remains an important mechanism to stimulate payment of taxes (see Dwenger et al., 2016; Ortega and Scartascini, 2015). Taxpayers are more willing to pay their legally defined duties when they receive a return for their paid contributions. What is also known as fiscal contract literature nurtured the thought that threat is not a sufficient means to induce compliance, particularly in a context where institutional weaknesses make upholding the credibility of threat difficult, such as in the developing world. Margaret Levi (1989) introduces the seminal concept of “quasi-voluntary compliance”. Citizens are more willing to pay when they perceive the state as a reliable player who makes meaningful use of their tax contributions (Levi, 1989; Levi et al., 2009). Payment of taxes is thus a game of credible commitments (Timmons, 2010). Coercing individuals into compliance is simply too costly, as the costs of monitoring each and everyone’s tax behavior exceeds the benefits of taxes. This suggests that compliance is at least partly voluntary in nature, and depends on the type and quality of returns the state can offer. Although more prone to evade, the rich are also the key contributors in the already narrow tax bases in many developing countries. Berens and Gelepithis (2018) show for advanced-industrial democracies that support for progressive taxation is much higher among middle- and high-income earners when social policies redistribute back to those who are paying the larger share and for the Latin American context, the rich are much less antagonistic toward taxation when trust in public institutions is high (Berens and von Schiller, 2017). In turn, fraudulent governmental behavior such as observable corruption can destroy the fiscal contract and lead to severe reduction in compliance (Timmons and Garfias, 2015). The institutional context is therefore particularly important in low state-capacity contexts. When taxpayers doubt that state institutions are sufficiently equipped to redistribute wealth and to provide public goods such as schools, infrastructure or a functioning health care

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system, tax evasion becomes much more likely (Feld and Frey, 2007; Frey and Torgler, 2007). Finally, a well-established literature in behavioral economics also emphasizes the role of factors usually labeled social norms in fostering compliance. The concept of tax morale falls into this category. The attitude that Torgler (2007: 136) vaguely describes as “instrinsic motivation to pay taxes” is positively correlated with the actual payment of taxes (see also Torgler and Schneider, 2009). In a field experiment in the UK, Hallsworth et al. (2017) find support for the role of norms (knowledge of other taxpayers’ behavior) on tax compliance but the evidence in the literature is mixed. Blumenthal et al. (2001) do not find support for a treatment effect of normative appeals on American taxpayers’ behavior. Dwenger et al. (2016) show in a natural field experiment on church taxes in Germany that moral suasion and nudging has only limited impact or can even backfire and lead to a reduction in compliance (see also Ariel (2012) on a similar effect at the firm level). Further factors include, but are not restricted to, notions of fairness or reciprocity, whether towards the state or towards fellow citizens. In this view, individuals take into account perceptions of fairness and government competence in the provision of (or willingness to provide) services when choosing to comply with regulations (see also Gintis et al., 2005). For instance, holding the view that the tax structure is unfair by placing too high a burden on one group while another group pays much less can crowd out the willingness to pay (see Roberts and Hite, 1994; Wenzel, 2002). The same holds for information on how tax money is subsequently spent on public goods. If the redistributive scheme is considered unfair, support for taxation declines (Stanley and Hartman, 2017). Levi’s (1989) concept of “quasi-voluntary compliance” not only factors in vertical relationships between taxpayer and state but is also based on horizontal relationships among taxpayers. Akin to a collective action problem in large groups and high-benefit low-risk environments, taxation induces the desire to benefit from public goods without contributing to pay for them and, thus, to free-ride on other taxpayers’ compliance. Trust in other people’s compliance is therefore a key element for contribution of tax payments (see Scholz and Lubell, 1998). Prosocial behavior is marked by the human trait to take other people’s behavior into account, i.e. to be other-regarding. Inequity aversion, shown to be a frequent driver of equal splits in dictator games in the laboratory, can increase the willingness to comply with tax regulation (Gintis et al., 2005). Furthermore, Frey and Torgler (2007) argue that compliance is based on conditional cooperation. The underlying mechanism essentially describes reciprocity at the vertical level. According to Fehr and Falk (2002: 690) reciprocity “induces agents to cooperate voluntarily with the principal if the principal treats them kindly”. The response is not based on the expectation

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to receive a return for one’s own contribution or act, or the expectation of future returns. It is not linked to a tangible reward, but to kindness in a more general sense. Using survey data for a set of high-income economies, Frey and Torgler observe that the willingness to pay taxes is conditional on the perception of other people’s tax compliance. Believing that others pay their duties as well markedly increases the willingness to comply. Further support for conditional cooperation is offered by Traxler (2010) and Traxler and Winter (2012). The latter illustrate with survey data for the case of Austria that social norms can induce compliance depending on how widespread the norms to comply are. If the individual believes that a majority believes tax duties must be paid, punishment and social sanctions of tax evasion will be high. If, however, the share of evaders is high, defection seems much less costly. But findings from the economics literature also reveal that prosocial behavior can be crowded out (Bénabou and Tirole, 2006). Individuals who are predisposed to comply might respond with a reduction in compliance when treated with extrinsic motivations, such as threat of punishment or reward. To summarize, the literature on tax compliance finds support for the deterrence mechanism which attributes payment of taxes to individual cost–benefit calculations of the risk of being caught, the cost of punishment and the type of reward received. However, there is still sufficient variation in compliance which cannot be explained by the deterrence rationale. Social norms such as civic duty, fairness and reciprocity operating both horizontally and vertically are key drivers that encourage payment of taxes.

Theoretical Considerations The above review of the tax compliance literature allows us to identify where tax compliance and informality overlap and where these two notions differ. We believe that existing literature has paid insufficient attention to the complex phenomena of compliance and informality within and across countries. We focus on two relevant dimensions of compliance across developing countries: compliance with labor market regulations and compliance with civic responsibilities, understood as compliance with the fiscal contract (or a willingness to contribute to public goods). These two dimensions are related, but theoretically distinct. Next, we theoretically examine the channels through which lack of compliance in labor regulations may affect broader patterns of non-compliance and possibly entail “chain reactions”. We draw on the insights from the literature on compliance and informality discussed above to spell out how different motivations may play out among workers and thereby illustrate that noncompliance in one area does not mean noncompliance across the board. In

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doing so, we emphasize the importance of heterogeneity among informal workers (voluntary and involuntary informality) and argue that this has implications for compliance decisions. Arguments in the literature on tax compliance suggest that lack of legal recognition and protection might trigger further non-compliance. Different mechanisms seem possible, the most prominent one being the mechanism of reciprocity. In an important study of the trickle down effects of informality, Ronconi and Zarazaga (2015) provide evidence consistent with the reciprocity mechanism in the developing-country context. The authors argue that involuntary informal workers reciprocate by withholding consumption taxes and by refusing to participate in the collective action of voting. The state defects by not enforcing labor law, allowing the employer to withhold payment of social security contributions for the employee and thus forcing the worker to be informal. Involuntary informal workers play tit-for-tat and defect by reducing tax compliance and civic duties such as voting. Ronconi and Zarazaga (2015) use household survey data from CAF for nine Latin American countries in 2011 and operationalize citizenship responsibilities with a set of variables thought to cover the main “tasks” of individuals in modern states. These are tax compliance (evasion of VAT) and voting in previous elections (in addition, knowledge about candidates and their campaigns). Finally, they create an overall measure of “citizenship” based on information on the respondent’s tax and voting behavior and corroborate their findings with a list experiment survey conducted in Argentina in 2014. One of the strengths of Ronconi and Zarazaga’s contribution is rooted in the measurement of informal sector workers. The CAF data make it possible to identify workers who are informal due to their employer’s decision (workers are coded as informal “if they report that the employer is not making legally mandated contributions to the social security system” (455). The authors find that informality and thus, lack of enforcement capacity of the state, reduces tax compliance and the likelihood of complying with civic responsibilities such as voting. This finding is consistent with research showing that involuntary informality is particularly salient among informal salaried workers, who appear to be excluded from more desirable jobs (Perry et al., 2007: 5). For many of these workers, informality is driven by their employer’s ­decision — typically microfirms working informally — not to comply with social security regulations, and evidence shows that such workers express a stronger preference for an equivalent job in the formal sector (Arias and Lucchetti, 2007). Incorporating labor market informality — and the role of exclusion — in explanations about compliance leads to crisp predictions about when individuals may be expected to comply and why. However, it overlooks the fact that informality

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is heterogeneous, and workers have different motivations to enter the informal labor market. We build on the aforementioned literature and focus our discussion on two sources of variation driving more or less compliant behavior. We first emphasize that different motivations (voluntary or involuntary) may shape entry into informality, with different consequences for overall patterns of compliance. A worker who is not paying social security contributions may at the same time pay consumption taxes or engage in civic activities. We then focus on involuntary informal workers and explore the role of different mechanisms driving compliance, paying particular attention to attribution of responsibility in contexts where governments cannot enforce employer compliance, as well as a number of psychological mechanisms. Voluntary and Involuntary Entry into the Informal Labor Market A longstanding view in the literature on labor markets argues that markets are segmented by wage setting in the formal sector, excluding more traditional sectors from jobs with state-mandated benefits. As a result, informal workers are (self) employed in marginal economic activities or employed in small firms with low productivity levels (Hart, 1973; Sethuraman, 1976; Tokman, 1978).1 Consistent with the “exclusion” view of labor market segmentation, Ronconi and Zarazaga (2015) argue that individuals who do not receive legally mandated benefits due to employer non-compliance blame the state for non-enforcement of social security regulations and choose not to comply with their duties as citizens. One implicit assumption in arguments that causally link informality and compliance is that workers are effectively excluded from formal jobs — thus involuntarily employed in the informal sector. As discussed above, however, recent research in development economics argues that much of the entry into informal employment is based on implicit cost–benefit calculations on whether to become formal or informal (Levy, 2010; Maloney, 1999; Maloney, 2004; Perry et al., 2007). In the “exit” view, workers choose their preferred level of engagement with the state, depending on their assessment of the net benefits associated with formality and the state’s capacity to enforce. This resonates with arguments about the importance of non-pecuniary considerations reviewed above, and suggests that workers that voluntarily opt out of formal employment may be driven by a different set of motivations. Moreover, evidence shows that workers switch from informal to formal and back over the course of their working lives (Maloney, 1999). Thus, the relative importance of  As discussed above, another view argues that costly entry regulations prevent small firms from becoming ­formal (De Soto, 1989). 1

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different motivations on compliance may plausibly vary depending on the type of employment that workers have.2 The exit view of informality emphasizes that workers may opt out of formal employment for a number of reasons, amongst which are high employment contributions relative to the expected benefits and quality of services, excessive bundling of benefit packages or high opportunity costs, particularly if medical or other insurance is available through a family member who is formally employed (Maloney, 2004). Workers may find that the expected benefit from a formal job (for which they are typically not qualified) does not outweigh foregone current consumption (in the form of lower wages linked to a formal job) or the flexibility of an informal job. Recent evidence from Latin America shows that some workers are more likely to enter self-employment than others. For instance, Perry et al. (2007: 63–65) show that a majority of independent (self-employed informal) workers value the benefits of autonomous work considerably and voluntarily exit formal employment. To the extent that the locus of responsibility for labor market status is shifted from the state or employer to the individual, self-employed workers (voluntary informal workers) may be intrinsically motivated to comply out of a willingness to fulfil civic duties associated with voting or tax compliance. We may thus expect voluntarily self-employed workers may be less likely to engage in tax evasion and more likely to vote relative to informal salaried workers. Or, to put it differently, voluntary informal workers might apply the same judgment that motivated the choice of informality to other compliance issues and behave accordingly. If the motive is mainly pecuniary, then avoidance of costs, such as VAT or property taxes, is the logical consequence. If individuals value greater flexibility in informality, we have no reason to assume that the individual is a non-complier in other areas. Although insightful, extant views of informality also tend to assume a static view of informality and thus tend to overlook important aspects of the dynamics of worker mobility across sectors. Frequent switches between formal and informal ­sectors should have important consequences for compliance in other areas. A growing body of research documents a high level of mobility from informal to formal sectors and vice versa in Latin American countries (Maloney, 1999). Informal salaried workers, for example, do not remain so for long periods of time, usually transiting to formal sector jobs or self-employment, and back to informal salaried work. One can imagine individuals as maximizing utility over the course of their working life (which may include being employed as an informal salaried worker, self-employed or in the formal sector). Anticipating that they will move to formal employment in  Countries may also differ in terms of history, institutions and legal frameworks, so that tax morale patterns may be more dominant in some contexts than others. 2

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the near future, informal salaried workers may be less prone to evade taxes out of a concern that such behavior may have adverse consequences for their labor market trajectory in the future. Future employers may be reluctant to employ individuals who engage in dishonest behavior. Individuals might also factor in future benefits associated with formal employment. Assuming that individuals understand the benefits of compliance in other areas of taxation (paying VAT or property tax duties and thereby contributing to the provision of public goods) or civic duties (such as voting and thereby being represented in politics), short periods of informal labor might be discounted as brief high-cost periods where non-compliance across the board does not outweigh the overall benefit in the long run. Indeed, research suggests that informal salaried work is a point of entry to the labor market for many young workers (Perry et al., 2007). In the absence of human capital, accumulating experience in the informal sector often enables workers to get a formal job later (Maloney, 2004). We may thus expect informal salaried workers to contribute to public goods through taxes (in the form of indirect taxes) or civic engagement because they hope to be able to benefit from the benefits of formal employment (in the form of public schools or health). More broadly, whether driven by fairness or self-interest, or whether they are voluntarily or involuntarily informal, workers may have reasons to engage in ­activities — such as voting — that improve their economic prospects in the present or future period. As emphasized by Maloney (2004: 1160), being voluntarily informal simply means that, given preferences and constraints in terms of human capital, entry into informal employment is often the optimal decision. It does not imply that workers are not living in poverty or that they would not benefit from policies that redistribute income in their favor. Similarly, an involuntarily informal (informal salaried) worker may be induced to vote against the current government in order to change the status quo. Singer (2016), for example, finds evidence that informal workers in Argentina hold their government to account for economic performance. One may thus plausibly expect (in)voluntarily informal workers to engage in forms of compliance — such as political or civic participation to change the status quo — that may directly affect their labor market and economic outcomes in the mid-term. In a similar vein, when considering the reciprocity mechanism, playing tit-for-tat is costly in the long run and not fully rational if we assume that individuals are not purely myopic. Not voting for a political party that could change the system just because of the desire to punish the state for not living up to its duty of enforcing labor market regulation would seem to be an irrational strategy for both voluntary and involuntary informal workers. Although abstention is indeed a form of protest, such forms of protest behavior may be more effective in advanced industrial democracies than in weak state capacity contexts.

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Involuntary Informality, Responsibility Attribution and Disenchantment We next focus on the links between involuntary informal employment and ­compliance. As discussed above, a growing body of literature emphasizes the role of reciprocity behind compliant behavior. Yet, given the importance of assigning responsibility inherent in this mechanism, we believe that a better understanding of how, precisely, workers that involuntarily enter the informal labor market attribute responsibility to the state is an important task. A large literature on economic voting argues that the extent to which individuals attribute responsibility to the state for economic performance is shaped by a number of characteristics related to political or institutional context (Powell and Whitten, 1993; Duch and Stevenson, 2000). However, less is known about how differences in the degree to which states can legally enforce compliance affects the extent to which individuals hold the state to account. While most governments enjoy authority to enforce labor regulations, differences exist in the extent to which they can enforce other types of regulations — such as social security regulations — that drive employer non-compliance. For example, in Argentina, enforcement agencies can punish employers who do not comply with labor regulations (such as vacation time or annual extra wage) and do not register employees in the social security system, but cannot fine employers who do not make social security contributions (and thus evade payroll tax) (Ronconi, 2010).3 In contrast, politicians can also purposefully neglect enforcement of labor standards to increase electoral gains, as the work of Holland (2017) and Feierherd (2017) reveals for the Latin American context, making the issue of responsibility attribution a highly complex one. Given that attribution of responsibility is premised on prior capacity to act, we may expect informal workers to be less likely to reciprocate in contexts where the state cannot legally punish employers for violation of social security regulations. In such contexts, the assumption that individuals might hold the government to account for labor market outcomes for which they are (not) responsible is less likely to hold, paving the way for other mechanisms based on information imperfections. They may, for instance, lack information on the benefits and functioning of social protection systems (Perry et al., 2007). Alternatively, as research on unemployment perception emphasizes, ­individuals may attribute responsibility for their own economic fate less to the state or the employer, and more to themselves. Sharone (2013) illustrates that unemployed workers in the United States blame themselves for losing a job while Israelis blame the state and explains the divergence with different institutionally driven job search  In this case, enforcement agencies can notify the national government and recommend that employers comply (Ronconi, 2010). 3

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structures. Therefore, depending on the type of labor market institutions, the visibility of employer discretion and the recognizability of enforcement failure by state authorities, variation in responsibility attribution among employer, state and oneself might be observable and, hence, lead to different responses of compliance. If involuntary informal workers blame themselves for their labor market status, there is no reason to assume that they will generally be low compliers. In a slightly different vein, research in social psychology finds that adverse life experiences such as unemployment, negative shocks to health, or crime experience can lead to withdrawal and apathy (see Janoff-Bulman and Frieze (1983) on the psychological responses to violence experience; McKee-Ryan, et al. (2005) on unemployment). Individuals who experience such negative events are more likely to have difficulties in family relationships, experience a loss of self-esteem and personal efficacy and, through this mechanism, are less likely to be politically active and engaged. Available evidence shows that experiencing unemployment can reduce the likelihood of voting (see Rosenstone, 1982; Carreras and Castañeda, 2016). Because informality translates into increased economic vulnerability, involuntary informality might be viewed as such an adverse life experience. We do not wish to fully review this strand of literature here, but it is worthwhile to take into account possible cognitive effects of involuntary informality for behavioral responses in other areas of compliance. When the experience of involuntary informality gives rise to disenchantment, frustration, loss of hope, or the feeling of exclusion, non-compliance in other areas of taxation or in civic duties might result. While the outcome is the same as for the reciprocity mechanism, the nature of the mechanism differs. Being forced into informality despite one’s efforts and wishes can be perceived as a negative event in the form of “down grading”, reducing the individual’s general motivation to be engaged and shattering feelings of self-efficacy. Believing that one does not have control over one’s fate, or more broadly, feeling helpless or disenchanted (see Peterson and Seligman (1983) on the consequences of crime), is likely to reduce the motivation to engage in other civic duties which are based on the premise that action is perceived as meaningful and effective. Moreover, being excluded from employment-related benefits and having no recourse to labor law protection (e.g. having no legal backing to demand payment of minimum wage, to have free time on holidays or to receive an overtime premium) can also induce the feeling of outsiderness and social exclusion (for a discussion, see Berens and Kemmerling, 2019). Perceiving oneself as an out-group member of society should reduce the motivation to engage in collective actions such as voting or payment of other types of taxes that also benefit insiders or in-group members (see Luttmer (2001) on the case of ethnicity and redistributive preferences). The

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feeling of exclusion can thus influence horizontal bonds (individual-society) as well as vertical ones (individual-state).

Discussion and Conclusions In this chapter, we have provided a theoretically driven discussion that seeks to disentangle the links between informal employment and compliance. We have posited that informality and compliance are related, but theoretically distinct phenomena which deserve to be examined separately. Building on a nascent body of work that looks at the implications of labor market insecurity on broader aspects of the social contract, we have theoretically examined the extent to which lack of compliance in labor regulations may affect broader patterns of non-compliance. The above discussion illustrates that non-compliance in one area does not mean non-compliance across the board. We have emphasized the importance of heterogeneity among informal workers and argue that this has implications for compliance decisions. We have focused on two aspects of compliance, but there may be more that we do not discuss here. We see this as a very first attempt in a broader agenda of elucidating the links between informality and compliance. The above discussion suggests a number of fruitful avenues for future research. Clearly, there are good reasons to expect individuals to respond to life-changing circumstances (such as informality) in different ways. Available evidence suggests that individual responses are likely to be affected by both context (for example, levels of enforcement, or whether governments have authority to punish non-compliers) and individual characteristics (are individuals motivated intrinsically or extrinsically?). This is consistent with recent research. For example, Dwenger et al. (2016) report variations in responses depending on differences in “complier type”. Similarly, Brockman et al. (2016) find evidence in the lab that men and women respond differently to deterrence and reward treatments. In turn, Castro and Scartascini (2015) observe a robust effect of deterrence on payment of property taxes in a field experiment in Argentina, but report heterogeneous treatment effects of reciprocity and peer-group treatments. Future research should focus on exploring heterogeneous treatment effects that shed light on different patterns of compliance across different groups. In addition, the above discussion highlights the potential for dynamic effects. While relatively few studies provide evidence of such effects, observing dynamic effects could help to identify some of the channels through which informality might affect compliance. A number of countries in Latin America, such as Brazil, have experienced improvements in formalization in the wake of the commodity boom.

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Such positive shocks to reciprocity might trigger a spiral of compliance. Similarly, negative shocks to tax morale more broadly in the aftermath of the commodity boom may lead to downward spirals in compliance. We conclude by spelling out some broader implications that derive from the above insights. A growing body of literature suggests that governments can potentially shape patterns of compliance through a number of instruments that go beyond detection probabilities and sanctions. This research has made great progress in understanding the conditions under which individuals are more likely to obey state regulations. We emphasize that a more complete understanding of the links between informality and compliance requires taking into account the types of informality and the motivations that drive workers to enter into or opt out of informal employment. Our focus on the links between labor market informality and compliance with the law also echoes a nascent literature examining the political consequences of non-compliance with labor market regulations. This literature emphasizes that nonenforcement of labor regulations is politically motivated (Feierherd, 2017; Holland, 2017). The above discussion highlights that the salience of the electoral gains from non-enforcement may depend on the motivations driving workers into informality. When workers are involuntarily informal, the electoral gains of non-enforcement may be limited. Lastly, a better understanding of the links between informality and compliance also has implications for policy. While lack of enforcement has substantial social costs (Ronconi and Zarazaga, 2015), our discussion implies that this is likely to vary among labor market groups. Although heterogeneous treatment effects may make policy more difficult to design, they make effective design of policy all the more important. Perhaps even more importantly, and in line with extant research, our discussion suggests that a set of various strategies may be needed to increase tax compliance. Of course, this is not to say that external incentives, in the form of enforcement, do not matter. Rather, we concur with Luttmer and Singhal (2014: 155) in emphasizing that “what matters for policy is not so much what role tax morale plays in current compliance, but whether it is feasible to improve tax moral on the margin and whether a given increase in compliance can be achieved at a lower cost by improving tax morale than by increasing enforcement.” For this task, understanding the mechanisms through which informality affects compliance is key.

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De Paula, A. and J. A. Scheinkman (2010). “Value-added taxes, chain effects, and informality,” American Economic Journal: Macroeconomics, 2(4): 195–221. De Soto, H. (1989). The Other Path: The Invisible Revolution in the Third World. New York: Harper and Row. D’Hernoncourt, J. and P.-G. Méon (2011). “The not so dark side of trust: Does trust increase the size of the shadow economy?,” Journal of Economic Behavior and Organization, 81: 97–121. Djankov, S., R. La Porta, F. Lopez-de Silanes and A. Shleifer (2002). “The regulation of entry,” The Quarterly Journal of Economics, 117(1): 1–37. Duch, R. M., and R. Stevenson (2006). “Assessing the magnitude of the economic vote over time and across nations,” Electoral Studies, 25(3): 528–547. Dwenger, N., H. Kleven, I. Rasul and J. Rincke (2016). “Extrinsic and intrinsic motivations for tax compliance: Evidence from a field experiment in Germany,” American Economic Journal: Economic Policy, 8(3): 203–232. Feierherd, G. (2017). “Does the Left Breed Economic Informality? Party Strategies and Selective Enforcement in Brazil,” Unpublished Manuscript. Fehr, E., and A. Falk (2002). “Psychological foundations of incentives,” European Economic Review, 46(4–5): 687–724. Feld, L. P., and B. S. Frey (2007). “Tax compliance as the result of a psychological tax contract: The role of incentives and responsive regulation.” Law and Policy, 29(1): 102–120. Frey, B. S. and B. Torgler (2007). “Tax morale and conditional cooperation,” Journal of Comparative Economics, 35: 136–159. Galiani, S., and F. Weinschelbaum (2012). “Modeling informality formally: Households and firms,” Economic Inquiry, 50(3): 821–838. Gintis, H., S. Bowles, R. Boyd and E. Fehr (2005). Moral Sentiments and Material Interests: Origins, Evidence, and Consequences. The Foundations of Cooperation in Economic Life, Vol. 6, Cambridge: MIT press. Günther, I. and A. Launov (2012). “Informal employment in developing countries: Opportunity or last resort?,” Journal of Development Economics, 97(1): 88–98. Hallsworth, M., J. A. List, R. D. Metcalfe, and I. Vlaev (2017). “The behavioralist as tax collector: Using natural field experiments to enhance tax compliance.” Journal of Public Economics, 148: 14–31. Hart, K. (1973). “Informal income opportunities and urban employment in Ghana,” The Journal of Modern African Studies, 11(1): 1–89. Holland, A. C. (2017). Forbearance as Redistribution: The Politics of Informal Welfare in Latin America. Cambridge University Press. Inglehart, R., C. Haerpfer, A. Moreno, C. Welzel, K. Kizilova, J. Diez-Medrano, M. Lagos, P. Norris, E. Ponarin and B. Puranen et al. (eds.) (2014). World Values Survey: Round Six — Country-Pooled Datafile Version: http://www.worldvaluessurvey.org/ WVSDocumentationWV6.jsp. Madrid: JD Systems Institute. International Labour Office (2002). “Decent Work and the Informal Economy”. Technical report, International Labour Office.

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International Labour Organization (ILO) (2013). “Measuring Informality: A Statistical Manual on the Informal Sector and Informal Employment,” Geneva, ILO. ILOStat (2018). “Informal Employment” Retrieved from http://www.ilo.org/ilostat/faces/ oracle/webcenter/portalapp/pagehierarchy/Page3.jspx?MBI_ID=524and_afrLoop= 1048675257032531and_afrWindowMode=0and_afrWindowId=null#!%40%40%3F_ afrWindowId%3Dnull%26_afrLoop%3D1048675257032531%26MBI_ID%3D524%26_ afrWindowMode%3D0%26_adf.ctrl-state%3Dh8zn6mnll_209 Janoff-Bulman, R. and I. H. Frieze (1983). “A theoretical perspective for understanding reactions to victimization,” Journal of Social Issues, 39(2): 1–17. Johnson, S., D. Kaufmann and P. Zoido-Lobaton (1998). “Regulatory discretion and the unofficial economy,” The American Economic Review, 88(2): 387–392. Levi, M. (1989). Of Rule and Revenue. Berkeley: University of California Press. Levi, M., A. Sacks and T. Tyler (2009). “Conceptualizing legitimacy, measuring legitimating beliefs,” American Behavioral Scientist, 53(3): 354–375. Levy, S. (2010). Good Intentions, Bad Outcomes: Social Policy, Informality, and Economic Growth in Mexico. Washington, DC: Brookings Institution Press. Loayza, N. V. (1996). “The economics of the informal sector: a simple model and some empirical evidence from Latin America,” Carnegie-Rochester Conference Series on Public Policy, 45: 129–162. Loayza, N. V., A. M. Oviedo, and L. Servén (2005). The Impact of Regulation on Growth and Informality: Cross-Country Evidence, 3623. World Bank Publications. Loayza, N. V. and J. Rigolini (2011). “Informal employment: Safety net or growth engine?,” World Development, 39(9): 1503–1515. Luttmer, E. F. (2001). “Group loyalty and the taste for redistribution,” Journal of Political Economy, 109(3): 500–528. Luttmer, E. F., and M. Singhal (2014). “Tax morale,” Journal of Economic Perspectives, 28(4): 149–168. Maloney, W. (1999). “Does informality imply segmentation in urban labor markets? Evidence from sectoral transitions in Mexico,” World Bank Economic Review, 13(2): 275–302. Maloney, W. (2004). “Informality revisited,” World Development, 32(7): 1159–1178. McKee-Ryan, F., Z. Song, C. R. Wanberg, and A. J. Kinicki (2005). “Psychological and physical well-being during unemployment: A meta-analytic study,” Journal of Applied Psychology, 90(1): 53. Menéndez, I. (2017). “Explaining support for non-contributory social policy: Evidence from a survey experiment in Argentina”. In Presented at EPSA, Milan. O’Donnell, G. (1993). “On the state, democratization and some conceptual problems: A Latin American view with glances at some postcommunist countries,” World Development, 21(8): 1355–1369. OECD Statisticts (2018). “Tax revenue.” Retrieved from https://stats.oecd.org/ Ortega, D. and C. Scartascini (2015). “Don’t Blame the Messenger: A Field Experiment on Delivery Methods for Increasing Tax Compliance.” Working Paper, Inter-American Development Bank.

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Torgler, B. (2007). “Tax Compliance and Tax Morale: A Theoretical and Empirical Analysis,” Cheltenham, UK: Edward Elgar Publishing. Torgler, B. and F. Schneider (2009). “The impact of tax morale and institutional quality on the shadow economy,” Journal of Economic Psychology, 30(2): 228–245.
 Traxler, C. (2010). “Social norms and conditional cooperative taxpayers,” European Journal of Political Economy, 26(1): 89–103. Traxler, C., and J. Winter (2012). “Survey evidence on conditional norm enforcement,” European Journal of Political Economy, 28(3): 390–398. Wenzel, M. (2002). “The impact of outcome orientation and justice concerns on tax compliance: The role of taxpayers’ identity,” Journal of Applied Psychology, 87(4), 629.

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CHAPTER 4

Can Tax Aid Broaden the Base? International Assistance, Taxation, and the Informal Sector in the BRICs Ida Bastiaens* and Laura Seelkopf † Department of Political Science, Fordham University, NY 10458, USA † Geschwister-Scholl-Institute of Political Science, Ludwig-MaximiliansUniversity (LMU) Munich, Bavaria, Germany *

Introduction As signatures of the International Covenant on Economic, Social and Cultural Rights, all four BRICs guarantee their citizens safe and healthy working conditions and access to social security (United Nations, 1966). Yet, as Table 1 shows, they lack the financial means to fight inequality and poverty.1 BRICs and other low-income countries collect between 10% and 20% of GDP in taxes in comparison to 40% for high-income countries (see Besley and Persson, 2014; OECD, 2017, Table 1). Correspondingly, absolute poverty, the percentage of the population living with less than $3.10 a day, is still rife (see Table 1). In India, for example, the poor constitute over half of the population. The informal economy is also pervasive: in Brazil and Russia, it is close to 40% of GDP, while it is between 10% and 25% in China and  The UN estimates that developing countries need to raise at least 20% of GDP as revenue to cut poverty in half and improve the living situation of their citizens (OECD, 2013). 1

81

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China

India

Russia

2012

1990

2012

1990

2012

2000

2012

36.6 (2007)

13.2 (1999)

11.9 (2007)

23.2 (1999)

20.7 (2007)

47 (1999)

40.6 (2007)

Gini (various measuresa)

60.6b

56c

34.6b

47.4c

29.7d

35.9d

25.1b

41.6d

Income share top 20%

64.61

57.18

—

47.9

—

44 (2010/11)

—

48.3

Poverty (% under $3.10 a day)

35.8

9.3

89.2

22.2

—

57 (2010/11)

—

0.5

Total tax revenue % GDP (including SSCs)

27.1

33.2

16.2

20.1

15

15.7 (2010/11)

37

35.3

Tax revenue (% GDP) (excluding SSCs)

12.0

13.9

8.6 (2005)

9.9 (2013)

9.8

10.8

11.2 (1999)

14.0

Income tax revenue (% GDP)

4.7

6.1

2.4 (2005)

3.1 (2013)

1.8

5.7

1.4 (1998)

0.5

Goods and service tax revenue (% GDP)

5.5

6.7

7.8

6.3 (2013)

4.4

3.3

7.2 (1999)

5.9

Aid (excluding tax aid) % GDP (5 year average)

0.37

0.31

0.76

0.10

1.6

0.74

0.5

0.02

Tax aid % GDP (5 year average)

0

0.01

0.002

0.0002

0.0003

0.004

0.0002

0

Tax aid per capita (5 year average)

0

1.19

0.01

0.01

0.001

0.07

0.01

0

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1990 40.8 (1999)

Informal economy (% GDP)



Brazil

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Table 1:   Income, informality, and taxation in the BRICs.

Notes: aData on the same gini measures for all four countries is not available, bgross income gini, cdisposable income gini, dconsumption gini. Source: UNU-WIDER (2017), World Bank (2017), Prichard et al. (2017), Schneider et al. (2010), Tierney et al. (2011). “6.5x9.75”

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India. A large share of the population thus is free of (direct) taxation,2 but at the same time has no rights to social security benefits or even basic working regulations. The taxation–representation nexus does not exist for a large number of citizens in developing and transition economies such as the BRICs. This is, of course, not a new development. In historic terms, states, where all citizens pay taxes on their economic activities and receive rights and benefits in turn, are an exceptional development. In the 19th century, Western European countries had lower tax revenues than the BRICs today (Seebohm, 1983). And, similar to less developed economies today, taxing trade played an important role for government revenues and was only slowly replaced by income taxes (Seelkopf et al., 2016). Again, the majority of the population was excluded from paying these taxes. Income taxes were introduced by elites to secure their political power and to keep newly emerging elites as well as the poor majority of citizens out (Ansell and Samuels, 2014; Mares and Queralt, 2015); for example, the Prussian three-class franchise system, which gave more votes — and hence more control over government spending — to richer citizens, gained legitimacy by their higher tax payments. While such an institutionalized exclusion is no longer viable, informality works de facto very similarly. Working and consuming outside the formal economy leads to no tax payments,3 which, in return, reduces the incentive and capacity of the government to extend formal protection to these informal workers. Thus, in the BRICs, a vicious cycle of no taxation and no rights and benefits among the poorer part of society is manifested. It is not only the stated intention of the BRIC governments to provide basic ­public goods for their citizens, but also the goal of the international donor community to help them raise enough tax revenue to achieve this. Yet interestingly, overcoming the large-scale informality is not what tax experts are most worried about. They see an extension of tax payments to the middle and lower classes either as not very effective (IMF, 2011) or even outright harmful (Schneider, 2005) for tax collection and economic development. Furthermore, governments face a dilemma on enforcing tax collection. Tax enforcement, while revenue-generating, can bring political costs: higher unemployment and potentially lower growth often occur in economies that rely on micro-firms (Joshi et al., 2014). Enforcement can reduce  The majority of poorer people in the BRICs do not have to pay any income tax. While more have to pay consumption taxes when purchasing products, the poor often also do not pay these as they live in a barter economy, evade the tax outright or buy from small firms that are below the VAT thresholds. 3  In India, for example, it is estimated that only 1% of individuals paid income taxes in 2013 (Srivastava, 2016). 2

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the size of the informal sector, but at the expense of increased unemployment and welfare losses. Boeri et al. (2005) “shadow-puzzle” in Brazil, for example, explains that informality is tolerated because it reduces unemployment and undesirable political consequences (see also Ulyssea, 2010). Standard taxation principles thus dictate that it should be those that can pay — not the poor subsiding in the informal sector — that should be targeted for paying taxes. In fact, across most countries, individuals and firms are often not required to pay taxes below certain direct and indirect tax thresholds. Hence, most foreign assistance to increase tax collection is not geared towards the majority of the population living outside the formal economy. Experts focus on a small number of wealthy individuals and — more importantly large firms — to maximize revenue.4 In turn, international aid earmarked for assistance in tax revenue generation focuses on combating tax evasion (i.e. informality) by the rich rather than the poor. Ideally, the additional revenue gained via the monetary and technical assistance of international donors would be spent on pro-poor policies and used to extend formal labor market rights and protection to the wider population. Yet, a potential problem with this technical assistance approach geared towards the maximization of domestic tax revenue is that there is no guarantee for this trickle-down effect to happen. Precisely because formalization gives taxpayers access to productivity-enhancing goods and services (Straub, 2005), richer individuals and firms have an incentive to keep others out of the formal taxation–representation nexus just like a century ago in Prussia. Hence, international tax assistance might as well achieve increased fiscal capacity and raised revenues, but still keep the poorer part of the population locked in the informal economy — not paying taxes, but also not receiving benefits. This chapter discusses current debates on informality, government r­ egulations, and tax revenue. We first discuss the varied components of informality and taxation. Then, we dive deeply into international assistance programs for tax reform in the BRICs and illustrate the international approach to support the increase of domestic revenue. Ultimately, we test the direct effect of tax aid on tax revenue and its indirect effect on the shadow economy. Much of the debate centers on the entry costs of firms to the formal economy. Djankov et al. (2002), for example, show that firms face significant “entry costs,” such as registration and license fees, to operating in the formal economy. Strict entry regulation is therefore associated with a larger informal  Inequality concerns have very recently added a second argument in favor of targeting the wealthiest taxpayers. The IMF, for example, advocates the need to “raise more revenue from the top of the income distribution” because of the “steep cuts” in top tax rates since the 1980s (Tax the Rich? IMF Sparks a Mini Revolution, 2013). Yet, this remains a secondary concern in less developed countries, where revenue generation remains too low for even public good production, not even mentioning redistributive spending. 4

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economy; lowering entry costs should decrease informality and expand the tax base (Ulyssea, 2010; Djankov et al., 2002). We find, however, that tax aid raises revenue without reducing the size of the informal economy. We show a trade-off in international assistance: while tax aid is effective in generating revenue, it does nothing to reduce the size of the informal economy. Other forms of aid do help people out of the informal sector, but that assistance does not increase the BRICs’ domestic tax revenue generation capabilities. Hence, a careful balancing of aid projects is needed for sustainable development out of informality.

Taxation and Informality in the BRICs In developed economies, raising taxes usually involves increasing value added tax (VAT) rates or broadening the corporate and personal income tax base (i.e. reducing deductions and exemptions). Bringing informal activity into the tax net is not the priority because it is quite costly and the size of the informal sector is relatively small in advanced industrialized nations.5 Typically, those who work in the informal sector do so willingly to evade taxation or other government regulations. In contrast, in developing and emerging economies, informality is a much larger and more endemic problem (Schneider, 2005) with severe negative consequence for economic growth and productivity. As this book highlights, when analyzing informality in developing countries, scholars usually focus on the vast number of relatively poor people forced to — rather than deliberately choosing to — work in the shadow economy without the regulation and social protection of jobs in the formal economy. Typical policy recommendations to overcome informality often include expensive government programs, which inevitably require greater mobilization of tax revenue. National governments and international donors should thus be very concerned with integrating more people in the formal economy. Given that tax evasion is a cornerstone characteristic of the informal economy, it seems straightforward to assume that tax experts would advocate to include as many people as possible in the tax system. Yet, this is far from the advice we see. The focus of international tax experts is advocating for a reduction in tax evasion at the top of the income distribution. To understand why, we need to take a closer look at the underlying characteristics of the tax base and tax administration in developing and emerging economies. Strategies to increase tax revenue in less developed economies such as the BRICs differ from advanced economies for two reasons. First, the income distribution  In economic recessions, however, the calculus changes because the informal economy can act as a countercyclical balancing force, stimulating the formal economy. This mechanism does not hold for developing economies (Gërxhani, 2004: 277). 5

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is more unequal in the South than in the North. While it has been rising in both country groups, the increase in inequality the BRICs has been dramatic; inequality after taxes and transfers (as measured by the disposable or consumption gini in Table 1) is as high as the average inequality in the OECD before taxes and transfers (gross gini in Table 1).6 This makes the situation in the BRICs comparable to that of Western European countries at the end of the 19th century, where the only taxpayers were the wealthy (Kemmerling, 2014: 153). Because income is very unequally distributed in the BRICs, taxing the rich is the easiest, most cost-effective way to increase revenue (see Table 1). Even in Russia, where absolute poverty is basically eradicated, the top 20% of the population earn almost half of the income (in Brazil, it reaches 57%). Hence, the type of tax evasion or avoidance is of great importance in discussions on revenue generation. Rather than bringing the poor into the official tax net (Wallace and Latcheva’s (2006) “household economy”), tax officials and policymakers go where the money is and hence target tax evasion at the top of the income distribution. Engaging in such tactics is of particular importance in developing countries because of their weak tax administration and bureaucratic capacities (the second difference between North and South tax collections systems). The informal sector is incredibly difficult to tax because of the plethora of small firms, shops, and vendors and absence of formal records (Besley and Persson, 2014). Tax administrations in developing countries have limited resources, including less technological support (e.g. computers and software). The personnel in these tax bureaucracies are also less educated and fewer in number. De Jantscher goes even so far as to say, “in developing countries, tax administration is tax policy” (Casanegra de Jantscher, 1990 cited in IMF, 2011: 19). While such deficiencies are less severe for the BRICs, their tax administrations still face serious hurdles. China and Russia, in particular, relative to their income levels, face severe bureaucratic inefficiencies because of their communist legacy. As Appel (2011) explains, under communism, the Russian tax administration only managed a few state-owned firms. Then, after liberalization, the same understaffed tax authorities suddenly needed to deal with a complex set of newly privatized firms and individuals in a not even fully monetized economy. How can a government tax a company that pays its employees in vodka or toilet paper (Appel, 2011: 28–35)?

 Please note that in 2010 the average gross gini in the OECD was approximately 47 and it reduces to 30 after accounting for taxes and transfers (OECD, 2016). Unfortunately, we do not have equally good data for the BRICs and hence rely on different measures of (gross and net) inequality in Table 1. 6

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International Tax Aid in the BRICs Of course, Russia’s tax administration did not have to face these challenges alone. International organizations such as the IMF, World Bank, and OECD offered their assistance. They sent experts, computer equipment, and organized training courses for old and new bureaucrats (Appel, 2011: 34; World Bank, 1995). As the other BRICs transitioned to an open, market economy, they also received tax aid from the international donor community (World Bank, 1995b). Table 1 documents the average tax assistance to the BRICs between 1990 and 2012. We measure tax aid as aid with the “tax assessment procedures” activity code (under “public sector financial management”) in Tierney et al. (2011). This indicates foreign assistance clearly marked to enhance the domestic tax revenue raising capacity of the recipient country. In general, the disbursement of tax aid has increased over the last three decades. In light of continuously low aid commitments by developed countries and a new focus on sustainable development, international development agencies increasingly support tax reforms to enhance domestic revenue generation, for example, goal 17.1 of the Sustainable Development Goals (United Nations, 2015). While firmly below 1% of total development assistance in the 1980s, tax aid in developing countries has increased to over 3% of total development assistance in the 2010s (see Figure 1). The BRICs have also seen an increase in tax aid over time, although much of the assistance did occur in the late 1990s and early 2000s.

Figure 1:   Tax aid (% total aid) to developing countries and BRICs.

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Interestingly, while China and Russia received the most tax aid in the 1990s — with China receiving some assistance in the 1980s — tax assistance to India and Brazil follows the general developing country trend of more disbursements since the late 1990s. This timeline fits the previous discussion on China and Russia’s challenges in the late 1980s and early 1990s in transitioning from a communist economy to market-based economy. Brazil and India, most likely, needed assistance later in the 1990s as the competitive pressures from globalization and inability to tax trade ravaged their revenue generation capabilities (see Bastiaens and Rudra, 2018; Bastiaens and Rudra, 2016; World Bank, 2003). Comparing the levels of tax aid across the BRICs, Table 1 indicates that India and Brazil receive the most tax assistance, while Russia receives the least. Who are the donors assisting developing countries in raising domestic tax revenue? Despite calls for the harmonization and multi-lateralization of aid allocation, two-third of overall official development assistance is still given bilaterally (Seelkopf, 2012: 64). However, this picture changes once we examine tax aid. The primary donors of tax assistance are multi-lateral development institutions such as the World Bank and IMF. Less than 15% of tax aid is given bilaterally to the BRICs, compared to close to 30% for general aid. As Figure 2 highlights, the World Bank as well as regional development banks are the most important tax aid donors to the BRICs. Helping developing countries tap into their domestic revenue sources is seen as a technical matter (Di John, 2006: 1), best solved by international experts.

Figure 2:   Tax aid to developing countries and BRICs by various donors.

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What do the tax experts advise? Following critiques of the Washington Consensus (Di John, 2006), the IMF and World Bank are no longer just efficiencyoriented; they now also acknowledge the importance of equity and redistributive taxation in their technical policy advice (IMF, 2014: 36–43). Yet, the focus does remain squarely on maximizing tax revenue. Other development issues, such as fighting poverty or reducing informality, are seen as problems for the spending side of the welfare state — often via non-contributory social assistance programs financed by tax collections (IMF, 2014: 22). For example, the twin goals of strengthening tax administration and providing public goods for the poor are cornerstones of assistance from the World Bank to Brazil in 2003 (World Bank, 2003). Yet, importantly, this project does not directly tie tax reform to poverty reduction. Instead, the o ­ bjective of tax reform is reducing fiscal strains and providing a favorable environment for growth, poverty reduction is then a product of this growth and efficient social spending. Virtually, all tax aid projects include training measures for the (weak) tax administrations in developing and emerging countries. For example, in India, the World Bank has argued, “Tax administration reforms are perhaps more important than tax reforms” itself (World Bank, 2004: 1). The issue becomes even more pressing in the BRICs due to their large size and corresponding need to collect taxes throughout the territory with multiple tax administrators. Even in authoritarian China, for example, the World Bank has financed projects focusing on standardizing tax procedures across the provinces via staff training and unified software (World Bank, 1995b). Given the unequal income distribution and the low administrative capacity in developing countries, the IMF strongly advises focusing on taxing upper-income individuals to maximize revenue: “controlling the largest enterprises (usually a few hundred or thousand), can secure 60–80% of domestic taxes” (IMF, 2011: 20). These firms pay not only corporate taxes on their profits, but they are also the main source for personal income taxes and consumption taxes as they withhold these taxes on behalf of their (formal sector and relatively rich) employees and customers. In line with this focus on rich taxpayers, international experts regularly advise countries to simplify their tax codes and introduce high payment thresholds. For instance, in their mission to support China’s big tax reform in the 1990s, the World Bank strongly criticized the myriad tax rates and exemptions (World Bank, 1995b). Simplifying the tax code reduces the burdens on a country’s tax administration and makes tax evasion more difficult for taxpayers. The introduction of high tax thresholds as a common feature to keep tax systems simple is also a tactic to maximize revenue in a cost-effective manner. This approach concentrates on tax reform and compliance from a few rich taxpayers rather than the majority of poor people and small firms in the informal economy. Authorities focus on evasion at the top end of the income distribution. Informality in the middle and lower end of the spectrum is not addressed by international tax

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experts to save resources and prevent disruptions to the broader economy. The logic is that incorporating the informal economy into the formal tax system would be quite costly and time-consuming because of the administrative and operational difficulties (Keen, 2012; see also Joshi et al., 2013).7 It is expensive to ensure both effective tax collections and taxpayer compliance when taxing the informal economy (Loeprick, 2009). This is not to say that lower thresholds could not lead to increased revenue collection. In India, for example, the tax revenue foregone because of high income tax thresholds is estimated to be 1.3% of GDP (IMF, 2006). Yet, focusing on the potential top taxpayers is first priority. This is in line with the policy choices of recipient governments themselves. Auriol and Warlters (2005) argue that governments choose high entry costs to the formal economy (e.g. level of the registration fees, the complexity and the length of the procedure) as a deliberate policy for raising tax revenue. Many micro-enterprises stay informal in developing countries because becoming formal involves large fixed (and/or sunk) costs. Official registration is simply beyond the reach of these poor entrepreneurs. Such barriers to entry to the formal sector generate market power for formal firms. Market power rents can then be confiscated by the government through entry fees and taxes. These tax instruments have relatively low administrative cost. Yet, while the fixed cost of market entry increases the tax revenue for the government, it increases rather than decreases the size of shadow economy at the same time (Auriol and Warlters, 2005). International tax aid potentially strengthens this policy. In sum, the expected effects of international tax aid on the informal economy are not clear. While tax evasion is a core characteristic of the informal sector, tackling this widespread evasion is not a major goal of tax assistance programs. Instead, international agencies such as the World Bank or the IMF advise and support policies that maximize revenue from the small number of taxpayers at the top of the income distribution. What is the impact of tax aid on tax revenue and informality in the BRICs?

The Impact of Tax Aid on Revenue and Informality in the BRICs We test the effect of tax aid on government revenue generation and the size of the informal sector in the BRICs. Our dependent variables on tax revenue are total tax  La  Porta and Shleifer (2014) discuss the problems associated with taxing the informal sector — informal firms often cannot compete in the formal economy and so greater formality leads to poverty and job loss. In contrast, others point to how taxing the informal sector is critical to broader tax morale and compliance or economic growth (see Joshi et al., 2013). 7

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revenue (excluding compulsory transfers such as fines, penalties, and social security contributions) as a percent of GDP, taxes on income, profits and capital gains (i.e. income tax revenue) as a percent of GDP, and taxes on goods and services (i.e. goods tax revenue) as a percent of GDP (World Bank, 2017).8 The informal economy is measured as the size of the shadow economy as a percent of GDP (Schneider et al., 2010) and labor force participation rate (World Bank, 2017). We operationalize our independent variable using Tierney et al. (2011) dataset: tax aid as a percent of GDP. Some examples of tax aid projects in this dataset include the National Program for Fiscal Administration in Brazil from the Inter-American Development Bank in 1996, Russian–Swedish Co-operation Programme for Financial Reforms in 2003, Tax Training Programme to China from the United Kingdom in 1998, and World Bank Technical Assistance for Economic Reform to India in 2000. We employ an ordinary least squares panel regression with robust standard errors clustered by country. The sample is the BRIC countries: Brazil, China, India, and Russia. The years represented in the shadow economy regressions are 2000–2007. The tax revenue models have data between 1975 and 2013. More specifically, our model specification lags the independent variables by 2 years, as we do not expect a simultaneous relationship between aid and revenue or informality. Tax aid assistance programs typically last between 2 and 4 years (Michielse and Thuronyi, 2010). We operationalize our dependent variables as an annual change. We are thus assessing the lagged impact of tax aid on the changes in tax revenue and shadow economy.9 Our basic model is ∆Y = Bo + B1*Xt-2 + e. In addition to tax aid, we also include general aid (i.e. all aid minus tax aid) as a percent of GDP. While parts of foreign aid are allocated to further the donors’ interests (see, e.g. Alesina and Dollar, 2000), much of it is geared towards economic development of the recipient countries. It is spent on pro-poor projects and towards improvement of the general public infrastructure. Hence, we would expect a positive effect on both the revenue generation via general capacity enhancement and also on the shadow economy via pro-poor policies. Following Genschel and Seelkopf (2016), we control for economic, demographic, and political factors in our estimations. To account for the internal growth and development conditions as well as integration in the global economy, we include GDP per capita (logged), GDP growth, and trade (percent of GDP) (World Bank, 2017). Population (logged) controls for the size of the country and the associated  Tax aid is not statistically significant in predicting social security contributions.  See Allan et al. (2004) for a similar model specification.

8 9

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challenges (or opportunities) in collecting tax revenue and managing the informal economy (World Bank, 2017). Finally, we include democracy, measured by Marshall and Gurr’s polity index (Marshall et al., 2017) to account for the differing revenue raising capacities across regimes. Table 2 presents our estimation results. Our findings provide evidence that tax aid is effective. A one-unit increase of tax aid (as a percent of GDP) is associated with a statistically significant 5.3 unit change in tax revenue (as a percent of GDP) two years later. Yet, 2 years after its disbursement, tax aid has no statistically significant impact on the size of the shadow economy or labor force participation rate. The opposite applies to general development assistance. A negative, yet statistically insignificant coefficient indicates that general foreign aid does not help tax collection. It does, however, reduce informality. Given that foreign aid is targeted at those in need (although a substantial part is also given to further donors’ interest, for example, see Alesina and Dollar (2000)), this is not surprising. We further distinguish between income and consumption taxes to understand the underlying mechanisms at work when it comes to foreign aid, tax revenue, and informality. Similarly, we see very different effects for tax aid and general aid. While tax aid is statistically significant in increasing income tax revenue, its effect on consumption taxation is not statistically significant (although the coefficient is positive). General aid, on the other hand, plays a much different role. It is statistically significant in increasing revenue from consumption taxes, but statistically significant in decreasing revenue from income taxation. These results indicate a general aid curse (Djankov et al., 2008), where donor funds are consumed and not invested, and where the indirect tax gains from the additional funds take the pressure off the government to tax domestic resources. On the other hand, international assistance to increase tax payments by wealthy firms and individuals seems to be effective. Efforts to train and equip the tax administration to battle tax evasion at the top (and middle) seem to have paid off. If progressive income taxation is the gold standard of a capable tax state (Besley and Persson, 2009), tax aid has helped the BRICs get closer to achieving it. Our control variables provide some insight on additional factors impacting tax revenues and shadow economies in the BRICs. Democracy and trade are associated with declines in the size of the shadow economy, while GDP growth is positively associated with changes in the informal economy. GDP per capita and population (while having an expected negative sign) are statistically insignificant in predicting the size of the shadow economy. In predicting tax revenue, trade has a statistically significant positive impact, corroborating standard international economic theory on the revenue generating impacts of trade. GDP growth, on the other hand, is negatively associated with changes in tax (and income and goods tax) revenue. Population is often statistically insignificant

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Can Tax Aid Broaden the Base? 93 Table 2:   OLS regressions of tax and general aid on tax revenue and the shadow economy in the BRICs.

Tax aid (% GDP)t–2 Aid (excl. tax aid) (% GDP)t-2

∆Labor Force Participation

∆Tax Rev.

∆Shadow Economy

5.283**

5.234

8.467 (7.907)

(2.348)

(4.793)

-0.0169

-0.116***

0.0855

(0.0372)

(0.0213)

(0.0813)

∆Income Tax Rev.

∆Goods Tax Rev.

4.692*

4.463

(2.403)

(3.500)

-0.0646*** (0.0172)

0.0737** (0.0360)

0.132

-0.145

-0.436**

(0.153)

(0.220)

(0.178)

(0.0175)

(0.0538)

GDP per capita (logged)t-2

-0.0793

-0.218

-0.00459

-0.0131

0.0308

(0.159)

(0.170)

(0.156)

(0.0180)

(0.0642)

GDP growtht-2

-0.105***

0.0227*

0.0424

(0.0400)

(0.0126)

(0.0281)

(0.0154)

(0.0152)

-0.00255

-0.0337**

-0.0134**

-0.00367

-0.0115

(0.0313)

(0.0164)

(0.00675)

(0.00630)

(0.0217)

-0.0132***

2.35e-05

-0.000329

(0.00136)

(0.000676)

(0.00218)

8.877**

Population (logged)t-2

Democracyt-2 Trade (% GDP)t-2

0.0144*** -0.0143** (0.00439)

Constant

(0.00594)

-1.830

4.644

(3.915)

(5.824)

0.148***

0.0174

-0.0402*** -0.0316**

-2.502***

-0.433

(4.404)

(0.323)

(1.660)

Observations

84

32

87

78

77

Number of countries

4

4

4

4

4

Notes: Robust standard errors in parentheses. *** p < 0.01, ** p < 0.05, * p < 0.1.

in our models (in accordance with structural theories of taxation, see Genschel and Seelkopf (2016)), although we do see support for countries with larger populations have larger increases in income tax revenue. Similar to Genschel and Seelkopf (2016), regime type is statistically insignificant in predicting tax revenues.10 As an alternative measure, we employ the cumulative sum of tax (and non-tax) assistance to the BRICs over a 5-year period.11 Tax aid is intended to enhance state capacity and reform tax administrations and, so, once in effect, the impact could  Bastiaens and Rudra (2018) find a conditional relationship of democracy and trade tax revenue on tax revenue in developing countries. Given our very small country sample, the insignificance of the slowly changing independent variables is not surprising and should be taken with caution. 11  Alternative measurements, such as the sum of aid over 2 years, are also robust. 10

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94  I. Bastiaens and L. Seelkopf  Table 3:   OLS regressions of 5-year sum of tax and general aid on tax revenue and the shadow economy in the BRICs.

5-yr sum of tax aid (% GDP)t–2

∆Shadow Economy

6.683***

1.370

0.385

(2.522)

(2.060)

(2.092) 5-yr sum of aid (excl. tax aid) (% GDP)t-2

∆Labor Force Participation

∆Tax Rev.

0.00915 (0.00636)

-0.0754***

0.0441

(0.0243)

(0.0524)

∆Income Tax Rev.

∆Goods Tax Rev.

5.693***

1.790

(2.137) 0.000825 (0.0138)

(2.319) -0.0108 (0.0179)

0.0472

-0.360

-0.353***

(0.136)

(0.351)

(0.130)

(0.0180)

(0.107)

GDP per capita (logged)t-2

-0.135

-0.436

0.0727

-0.0488**

-0.0789

(0.141)

(0.266)

(0.192)

(0.0212)

(0.116)

GDP growtht-2

-0.104***

0.0167

0.0318

(0.0379)

(0.0149)

(0.0348)

(0.0160)

(0.0144)

-0.0219

-0.0421

-0.0120**

-0.0212*

-0.0192

(0.0351)

(0.0271)

Population (logged)t-2

Democracyt-2 Trade (% GDP)t-2

0.0156*** -0.0155** (0.00441)

Constant

0.130

(0.00730) 10.87

0.0898*** -0.0568

-0.0412*** -0.0314**

(0.00582)

(0.0116)

(0.0288)

-0.0118***

0.00149

-0.00216

(0.00164)

(0.00150)

(0.00294)

6.554*

-1.223**

2.066

(3.374)

(9.230)

(3.670)

(0.543)

(3.298)

Observations

84

32

85

78

77

Number of countries

4

4

4

4

4

Notes: Robust standard errors in parentheses. *** p < 0.01, ** p < 0.05, * p < 0.1.

be long-term. In Table 3, we estimate the impact of the cumulative sum of tax and non-tax aid on tax revenue and the shadow economy. The results are robust and mirror the findings in Table 2. An extension of these models to a sample of all developing countries presents an interesting comparison (see Seelkopf and Bastiaens, 2019). Just as above, we find that tax aid is effective in raising total tax revenue across all developing countries. However, in contrast with the BRIC results, tax aid is effective in raising goods and service tax revenue, but not income taxation in developing countries more broadly. For example, a one standard deviation increase in tax aid — an amount received, for example, by Mozambique in 2002 or Niger in 1998 — is associated with a decrease in income tax revenue by 0.02 units, but an increase in goods and service tax revenue by 0.16 units the following year. These changes in revenue are similar to the average

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annual change of income tax revenue and double the average annual change of goods and service tax revenue in developing countries. On the relationship between tax aid and informality across all developing countries, we find that tax aid has a positive and statistically significant impact on the size of informal employment and is statistically insignificant in increasing labor force participation. Therefore, in contrast to the BRIC findings, the situation appears more challenging and dire in the wider sample of developing countries: tax aid does not broaden the number of taxpayers and, in fact, encourages individuals into the informal economy.

Conclusion Looking at the effect of international tax aid on tax revenues in the BRICs from 1975 to 2013, we find that tax aid increases the overall tax revenue, especially via direct taxation. Given that direct taxes are seen as a good indicator of fiscal — if not general government — capacity (Besley and Persson, 2009), this is good news. Also, regarding equity concerns, international aid directed towards increasing direct taxation is sorely needed as less redistributive consumption taxes are the biggest revenue source for all BRICs today (see Table 1). Although the VAT is potentially progressive (IMF, 2011) due to the large informal economy in the BRICs, it is much less redistributive than direct taxes. The VAT’s potential progressive effect relies on the fact that the poorer part of the population does not consume within the formal economy and the government is therefore directly taxing higher income earners more. Furthermore, relying on consumption taxation could make the tax system much more regressive in the future if more people become part of the formal economy. So far, only China seems to have turned the personal income tax into a general tax (at least for the middle classes) (Piketty and Qian, 2009). India and Russia still rely to a relatively large extent on easy-to-collect taxes, such as trade and corporate taxes (see also Besley and Persson, 2014). In sum, tax aid includes rich individuals and firms in the tax net and increases tax revenue generation. Also, tax aid seems to be counterbalancing the aid curse: while general aid decreases income tax revenue and increases consumption tax revenue, tax aid helps to increase income tax revenue, which is mostly paid by the rich. Yet, there is no trickle-down effect of tax aid on the shadow economy. Tax aid increases revenue by taxing already formalized taxpayers more, not by bringing in new taxpayers (see also Auriol and Warlters, 2005). Following the taxation–­representation link, the government is much more inclined to spend the additional funds on the formal economy rather than on non-contributing citizens. This mechanism explains also, why we do not find an indirect effect of increased government spending on the size of the informal economy. If at all, tax aid increases the number of people in the shadow economy rather than decrease it.

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Future research should look to examining further mechanisms linking tax aid to the informal economy and revenue generation. For example, do domestic politics mediate the efficiency of tax assistance in developing countries? What other variables help explain the variation in the success of tax assistance across developing and emerging market economies? Bastiaens and Rudra (2016) provide one such answer: tax assistance is more effective in generating domestic tax revenue in liberalized non-democracies. They argue and find evidence that democratic politicians are more susceptible to constituent demands for lower taxes in a competitive global economy. Additional research could explore the role of state capacity, partisanship, and/or economic structure and diversification on the effectiveness of tax aid. Scholars should also further assess the economic, social, and political implications of tax aid. For instance, has tax aid affected the cost of entry for firms in recipient countries? Other questions could assess the impact of tax aid’s effective revenue generation on broader societal welfare and public good provision. After all, this is the manifested aim of international donors. The decision to enter the formal economy not only depends on the costs (enforcement and barriers of entry), but also on the benefits of formalization, which is access to public goods. Formality grants firms and individuals access to productivity-enhancing goods and services (Straub, 2005; Loayza, 1996; Friedman et al., 2000; Johnson et al., 1997). Our findings point to the observation that governments are not using the gains in extractive capacity to incentivize firms into the formal sector with productive goods and services. Treating tax aid as a technical matter and ignoring the wider political economy of taxation and informality overestimates the positive impact of increased revenue from rich taxpayers and underestimates the non-revenue related impact of widening the taxpayer base. What are additional broader implications of the failure of tax assistance to reduce the size of the informal economy? As a large percentage of the population remains in the informal sector — not paying taxes — the democratic accountability and representation of these citizens could be harmed. Evidence indicates that taxing the informal economy is critical to good governance because the state is more responsive to taxpayers, citizens are likewise more likely to demand accountability from the state, and collective action for more effective bargaining may be spurred (see Joshi et al., 2013; Joshi and Ayee, 2008; Prichard, 2009). Prichard (2009: 36) aptly explains, “Raising tax revenue has forced processes of implicit and explicit bargaining between state and society, and has been an important factor in causing political change.” Helping the BRICs target their wealthy domestic taxpayers provides revenue needed for (potentially) pro-poor spending policies, yet helping them include the less well-off informal workers into the tax net can help lift the voices of the poor.

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OECD (2016). “Revenue Statistics.” https://stats.oecd.org/Index.aspx?DataSetCode=REV. Piketty, T. and N. Qian (2009). “Income Inequality and Progressive Income Taxation in China and India, 1986–2015,” American Economic Journal: Applied Economics, 1(2): 53–63. https://doi.org/10.1257/app.1.2.53. Prichard, W. (2009). “The Politics of Taxation and Implications for Accountability in Ghana 1981–2008.” IDS Working Paper 330. Accessed May 16, 2019 at https://onlinelibrary. wiley.com/doi/abs/10.1111/j.2040-0209.2009.00330_2.x. Prichard, W., A. Cobham and A. Goodall (2017). “The ICTD Government Revenue Dataset.” ICTD Working Paper, No. 19. http://www.ictd.ac/datasets/the-ictd-government-revenuedataset. Schneider, F. (2005). “Shadow Economies Around the World: What Do We Really Know?,” European Journal of Political Economy, 21(3): 598–642. https://doi.org/10.1016/ j.ejpoleco.2004.10.002. Schneider, F., A. Beuhn and C. E. Montenegro (2010). “Shadow Economies All over the World: New Estimates for 162 Countries from 1999 to 2007.” World Bank Policy Research Working Paper 5356. Accessed May 16, 2019 at http://documents.worldbank. org/curated/en/311991468037132740/pdf/WPS5356.pdf. Seebohm, K. S. (1983). “Public Revenues.” In P. Flora, F. Kraus and W. Pfenning, (Eds.), State, Economy and Society in Western Europe 1815–1975. A Data Handbook in Two Volumes. Volume I: The Growth of Mass Democracies and Welfare States, Frankfurt/Main/London/ Chicago: Campus, pp. 257–343. https://dbk.gesis.org/dbksearch/sdesc2.asp?no=8379& db=e&doi=10.4232/1.8379. Seelkopf, L. (2012). The Political Economy of Foreign Aid Allocation: Arguments and Applications. Colchester: Essex. Seelkopf, L. and I. Bastiaens (2019). “International Taxation Assistance in Developing Countries.” Working Paper. Seelkopf, L., H. Lierse and C. Schmitt (2016). “Trade Liberalization and the Global Expansion of Modern Taxes,” Review of International Political Economy, 23(2): 208–231. https:// doi.org/10.1080/09692290.2015.1125937. Srivastava, S. (2016). “Guess How Many People Pay Taxes in India.” May 3. CNBC. Accessed May 16, 2019 at: https://www.cnbc.com/2016/05/03/guess-how-many-people-pay-taxesin-india.html. Straub, S. (2005). “Informal Sector: The Credit Market Channel,” Journal of Development Economics, 78(2): 299–321. https://doi.org/10.1016/j.jdeveco.2004.09.005. Tierney, M. J., D. L. Nielson, D. G. Hawkins, J. T. Roberts, M. G. Findley, R. M. Powers, B. Parks, S. E. Wilson and R. L. Hicks (2011). “More Dollars than Sense: Refining Our Knowledge of Development Finance Using AidData,” World Development, 39: 1891-1906. Ulyssea, G. (2010). “Regulation of Entry, Labor Market Institutions and the Informal Sector,” Journal of Development Economics, 91(1): 87–99. https://doi.org/10.1016/ j.jdeveco.2009.07.001.

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United Nations (1966). “International Covenant on Economic, Social and Cultural Rights.” http://www.ohchr.org/Documents/ProfessionalInterest/cescr.pdf. United Nations (2015). Transforming Our World: The 2030 Agenda for Sustainable Development. http://www.un.org/ga/search/view_doc.asp?symbol=A/RES/70/1&Lang=E. UNU-WIDER (2017). “WIID — World Income Inequality Database.” https://www.wider. unu.edu/project/wiid-world-income-inequality-database. Wallace, C. and R. Latcheva (2006). “Economic Transformation Outside the Law: Corruption, Trust in Public Institutions and the Informal Economy in Transition Countries of Central and Eastern Europe,” Europe-Asia Studies, 58(1): 81–102. World Bank (1995). “Russian Federation — Tax Administration Modernization Project.” P6473. The World Bank. http://documents.worldbank.org/curated/en/391761468336571940/ Russian-Federation-Tax-Administration-Modernization-Project. World Bank (1995a). “Russian Federation - Tax Administration Modernization Project.” P6473. The World Bank. http://documents.worldbank.org/curated/en/391761468336571940/ Russian-Federation-Tax-Administration-Modernization-Project. World Bank (1995b). “China — Fiscal Technical Assistance Project.” T6552. The World Bank. http://documents.worldbank.org/curated/en/142141468769263014/ChinaFiscal-Technical-Assistance-Project. World Bank (2003). “International Bank for Reconstruction and Development Program Document for a Proposed Second Programmatic Fiscal Reform Loan (Fiscal Responsibility and Tax Reform) in the Amount of US $404.04 Million to the Federative Republic of Brazil.” May 14. Accessed May 16, 2019 at http://documents.worldbank.org/ curated/en/700681468769771354/Brazil-Second-Programmatic-Fiscal-Reform-Loan. World Bank (2004). “India — State Fiscal Reforms in India - Progress and Prospects.” 28849. The World Bank. http://documents.worldbank.org/curated/en/464751468771276830/ India-State-fiscal-reforms-in-India-progress-and-prospects. World Bank (2017). “World Development Indicators.” http://databank.worldbank.org/data/ reports.aspx?source=2&Topic=11.

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Informal Settlements and Basic Service Provision

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CHAPTER 5

Social Capital, Leadership Accountability, and Public Services in the Slums of India Guadalupe Rojo Duke University, and Universidad Torcuato Di Tella (UTDT), Belgrano, Argentina

Introduction Two random slum dwellers in the Indian city of Udaipur (Rajasthan) share most of their concerns. One lives in Shivaji Nagar Kachchi Basti and the other one in Sukhadiya Nagar Kachchi Basti. Ethnographic and socioeconomic conditions are quite similar in these communities, but one enjoys access to water, electricity and better roads, whereas the other one does not. What makes these homologous cases so different when it comes to services provided by the government? Why are some slums successful at demanding local public goods while others just receive inexpensive handouts the day before an election? How does social capital improve the quality of infrastructure and public services for the urban poor? The answer resides in the intersection of social capital, electoral coordination, leadership responsiveness and the nature of non-excludable Local Public Goods (LPG).1 Along these pages, I examine the effects of the neighborhood’s social structure on the capacity of the urban poor to gain access to higher-quality public  Throughout this work, examples of Local Public Goods include, but are not limited water sanitation, waste disposal or sewage system, local health services, road pavement, electricity, public bathrooms and legal recognition of the entire slum territory. 1

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services. More explicitly, my theory suggests that, due to their political organization, communities with more social capital successfully articulate their demands to the government. Network connectedness empowers residents in slums. More and stronger ties represent higher likelihood for electoral coordination, hence allowing them to hold slum leaders2 accountable. I argue that denser networks — rather than sparse ones — are able to improve their living conditions by channeling their demands through responsive leadership. Drawing on unique households survey in 30 slums in the Indian city of Udaipur,3 I assess the ways in which communities organize themselves to fulfill their needs. Urbanization has been growing rapidly in India, and rural migration has particularly affected the development of children (Henderson, 2002). Chandra and Potter (2016) noted that “the absolute increase in persons living in urban areas in the 2001–2011 decade was greater than the absolute increase in persons living in rural areas for the first time since independence (Census of India, 2011a)”. Most lowincome households in urban India live in environments characterized by housing shortage, lack of hygiene, overcrowding facilities and the presence of preventable diseases due to poor sanitation and lack of garbage disposal. According to the World Bank, Indian poverty rates4 are decreasing steadily. Nonetheless, living conditions remain broadly unsafe in most urban slums. More than 33,000 slums exist in urban India, where 8.8 million households share most of their concerns in terms of infrastructure and sanitation. For instance, in the State of Rajasthan, about half of the slums have no toilets and about one-third no electricity connections. At the national level, this later figure drops to 7% (Times of India, December 23, 2014). As reported by the “Rapid Baseline Assessment for Udaipur City” in October 2013, none of Udaipur slums had access to drainage or sewerage, and about 18% of those resorted to open defecation. This scenario is shared by millions of slum dwellers across the globe. More precisely, about 1 billion people live under inadequate conditions, either experiencing overcrowding, or drinking unsafe water, poor sanitation and construction materials  I use the words broker, leader, community leader and slum leader interchangeably. They to refer to a politically influential person residing in the neighborhood, who behaves as an intermediary between residents and politicians. 3  A two-wave survey was conducted in Udaipur during 2013, as part of a joint project with Prof. Wibbels. We thank Anirudh Krishna, Janat Shah, Mahesh Kapila, Seema Mishra, KP Singh and all of the supervisors and survey enumerators at Chitra Management for invaluable help on this project. We also recognize the financial support of the Duke-IIMU Research Collaborative. 4  Please see data.worldbank.org for measures of poverty headcount ratio (as a percentage of population). 2

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(UN-Habitat Slum Almanac, 2015–2016). Although governments, non-profit and multi-lateral organizations, all channeled their efforts to stop slum growth, absolute numbers continue to rise and the slum challenge is still relevant. For example, in developing regions, the urban slum population (in thousands) was 689,044 in 1990 and 881,080 in 2014, according to the UN-Habitat (2015). During the same period, the number of urban slum dwellers (in thousands) increased from 93,203 to 200,677 in Sub-Saharan Africa; from 204,539 to 251,593 in eastern Asia; from 180,960 to 190,876 in southern Asia; and from 69,567 to 83,528 in southeastern Asia. Perhaps, the only region with no clear pattern is Latin American and the Caribbean, where the urban slum population has shown an erratic behavior from the early 1990s to date. Starting in 1990, the number in thousands was 106,054, increasing steadily and peaking in 2000 (116,941), then remaining about 112,500 to increase later again in 2012 (116,227). Now, the last available figure is 104,847 for 2014; all according to the UN-Habitat (2015). Take Brazil for example. In spite of the fact that poverty rates have been decreasing steadily,5 this Latin American country has experienced an expansion in the informal settlements — so-called favelas — due in part to growth in urban population. As people move to cities searching for higher wages, the total number of urban working households without basic water and sanitation grew from 5.3 million in 1991 to 5.7 million in 2010 (Alves, 2016). Although the main focus in this study are slum dwellers in the Indian city of Udaipur, across the globe, we find one-eighth of the population living in similar conditions. Hence, the relevance of this chapter exceeds any geographical boundary. I argue that the world’s urban poor share most of their concerns, regarding drinking unsafe water, or dealing with preventable diseases, due to poor sanitation. How do we empower slum dwellers so that they can improve their quality of life? Under what conditions urban poor communities are better equipped to effectively demand from public officials? These are relevant questions not only in India, but also in many developing regions, where about one-third of the urban population live under unsafe conditions. This chapter’s primary goal is to present a theory of slum-level social organi­ zation and its implications for (1) electoral behavior and (2) access to and the quality of public services. My argument departs from traditional theories, which only consider citizens’ individual behavior. Put succinctly, I argue that the ability of slum dwellers to effectively demand LPG is contingent on the level of their social capital. Social trust and connectedness at the slum level enables community-led enterprises, such as electoral coordination, which translates into what I define as the good-type partisan homogeneity. When slum dwellers are able to cooperate with  According to the World Bank, the poverty headcount ratio at $3.20 a day (2011 PPP), in percentage of the population, fell from 36.4% in 1993 to 23.5% in 2001 to 8% in 2015. 5

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their neighbors and agree upon a common political behavior, they increase the odds that they will be rewarded with public investment. Alternatively, when social capital is low and slum dwellers are isolated, they only receive private goods in exchange of their political support — no significant public investment in their territory. I refer to this scenario as the bad-type partisan homogeneity; unresponsive candidates win in the districts by large margins. Partisan homogeneity might appear to imply that slum residents are coordinating their votes, but in fact in these cases there is no collective initiative present. Typically, these situations are dominated by the distribution of inexpensive private goods during electoral periods. Bad-type partisan homogeneity is a consequence of the lack of social tools to demand that public officials provide improvements in their living conditions. In this type of community, electoral homogeneity does not provide with means to negotiate, but it even hurts the urban poor. As politicians do not feel an electoral threat, just distributing handouts is enough. Living conditions for the urban poor are often characterized by overcrowding, high exposure to crime and violence and many other social problems. Yet, this chapter focuses on deficient infrastructure and social services within the slum perimeter. Likewise, the urban poor are the principal target of clientelistic practices to the detriment of the provision of Local Public Goods (Brusco et al., 2004; Calvo and Murillo, 2004; Remmer, 2007; Keefer, 2007). Due to the diminishing returns of consumption, low-income constituencies derive higher marginal utility from handouts than do middle-income voters.6 Given that these groups are electorally more responsive to direct transfers, we should expect that the provision of public goods will be lower in poor communities. Yet, variations in levels of public investment do exist across similarly impoverished populations and the current literature has failed to explain these divergences. The trade-off between clientelistic practices and the allocation of resources to services and infrastructure is undeniably relevant (Remmer, 2007). While one may argue that receiving rice and beans is a priority for populations suffering from hunger, it is also necessary to consider the crucial importance of LPG in raising slum dwellers’ living standards. Having access to drinking water or a proper closed sewage system may draw the line between life and death in some metropolises.  Although clientelistic practices are not only limited to the distribution of private goods, when I refer to clientelism throughout this chapter, I do not consider allocation of anything else but goods for immediate consumption (short-lived goods). The point of doing so is to clearly differentiate between the apportionment of significant government funds towards Local Public Goods vis-à-vis the minor allocation of resources towards consumable goods. 6

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1000

800

600

400

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0

Community

Gis

Peers

Country

Party

Leader

Tradion

Ideas

Figure 1:   Reasons for which slum dwellers vote in Udaipur, India.

According to the Abdul Latif Jameel Poverty Action Lab (J-PAL), 21% of infant mortality in developing countries is caused by diarrhea, a disease that could be prevented through access to better sanitation. Across the globe, 2.5 million children die each year because of exposure to pathogens due to poor treatment of solid wastes (J-PAL, 2012). Although less dramatic, deficient public services oftentimes translate into a higher economic burden. As shown in Rojo and Wibbels (n.d.), the urban poor often place higher value on LPG (e.g. waste disposal system) than is often assumed. Figure 1 shows that when slum dwellers in Udaipur were asked in surveys to prioritize their reasons for how they voted, the option “the services that my community is receiving” (community) ranks higher than “private benefits that my family is receiving” (gifts).7 The existing literature on slum politics has mostly studied the distribution of private goods (food, medicine, personal favors, jobs, etc.) in the context of a ­political bargain (Auyero, 1999; Calvo and Murillo, 2004; Remmer, 2007; Kitschelt and Wilkinson, 2007; Stokes et al., 2013, among many other authors). However, scholars so far have failed to address the ongoing variation in terms of the provision of LPG. Current research has underestimated the importance of identifying the factors that  Figure 1 reports raw number of respondents that mentioned each issue (either as their first or second priority) for reasons on how to vote. 7

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may contribute into the improvement of slum infrastructure and services. In poor informal settlements, access to a sanitation system or clean drinking water is often mediated by local politicians. Still, the traditional literature on public goods (e.g. Olson, 1965; Hardin, 1982) has weak explanatory power, particularly in regard to shantytowns, where patronage prevails. The urban poor tend to be clustered in informal settlements, and an entire settlement — not an individual — is the recipient of water, electricity, or natural gas. This feature of LPG has implications for the study of “collective clientelism” (Kitschelt and Wilkinson, 2007), which is embedded in a neighborhood context, and thus should be studied at the slum level using group-based models rather than solely considering individual-level exchanges. By shifting the paradigm from the individual to the neighborhood level, my goal is to bring attention to the local decision-making process. This chapter takes community as the main unit of analysis. The scope is not the individual voter but a group of voters residing in the same poor locality. The chief contribution is to shed light on the dynamics of local organizations (e.g. neighborhood associations) as the key factors that empower the urban poor. This work illustrates how communities that are empowered with social capital raise demands to politicians by calling their attention through bloc-voting. Ultimately, well-connected slum dwellers gain access to better neighborhood infrastructure and higher-quality public services. More recently, we have witnessed a new trend in development studies that focuses on participatory practices within local decision-making process (e.g. Olken, 2010), such as the delegation of budget suggestions to local assemblies: the Gram Panchayat in India or the Conselho do Orcamento Participativo in Brazil. Still, in the case of slum dwellers, the scope of these participatory alternatives is often limited, as they reside within informality — particularly when they dwell on land for which their possession is illegal. Theorizing along these lines, I propose to redirect the attention to other forms of political participation that could empower these communities through the acquisition of more and better government services. Namely, I study the interaction between social capital and electoral coordination, and the impact of this relation on the provision of LPG. There are three features of Local Public Goods that make them particularly interesting, they are: (i) non-contingent on individual vote choice; (ii) non-excludable from any resident of the community; and (iii) non-rival among neighbors. Namely, LPG are similar to club goods, where residency functions as the membership to the club. This portrayal assumes non-excludability as a necessary condition for the theoretical framework. However, I do recognize that there is a growing concern for the diffuse distinction between public and private goods. In other words, local politicians could limit access to services arbitrarily, transforming (in theory) local

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public goods into (de facto) private goods. Along these lines, Min (2015) argues that political schemes often interfere with the delivery as well as the implementation of public programs. Thus, by no means I am stating that pork-barrel politics are absent in the allocation of LPG. In fact, this work seeks to explain how these political schemes play within social and political organizations of the slums. In most of the cases analyzed here, services and infrastructure are indeed non-excludable within the locality. For instance, when a government decides to allocate funds to build a sewage system, the most significant part of the investment goes to the central branch, and each individual household can easily enjoy the benefit subsequently. It is not impossible, but quite difficult for the government to prevent a family to access the newly-built sewage. Then, it is precisely the non-excludability feature of LPG — “impossibility of exclusion” (Hardin, 1982) — that introduces the need to examine coordination problems and that also makes bloc-voting relevant. Recent evidence supports the theory that resource-constrained politicians target communities that demonstrate collective action skills (Rueda, 2016; Gottlieb and Marx, 2016; Pierskalla, 2016; Gottlieb and Larreguy, 2016; Grossman et al., 2017). These theories build upon the assumption that electoral strategies are chosen in cost–benefit terms and that politicians require a group of voters who can credibly commit to reward public investment. Because the provision of local public goods is relatively expensive, parties will only provide them when they can be sure of consistently attaining a large share of support from any given slum over a period of years. Serving as a large vote bank for a single party implies a coordination problem for citizens who live in slums. If the community can solve this collective action problem, its ability to attract local public goods increases. Along these pages, I provide a slightly simplified version of local political ­dynamics, in which I emphasize on the importance of bottom-up demands. Although I argue that social and political organizations at the slum level are the key elements here, by no means I propose that outside-slum politics are irrelevant. In fact, I recognize a good portion of negotiations between community leaders and politicians does not take place inside the locality, but probably in some external political office (e.g. Udaipur Municipal Government). However, this chapter proposes to zoom in at the origins of the slum’s political representation, which is — as my argument goes — social capital formation and community internal organization. Further research within this project should aim to address the interactions between slum leaders, political brokers and outside politicians, and how leverage oscillates among these actors depending on both internal dynamics (e.g. slum dwellers electoral coordination) and also on external economics and political circumstances. How do neighborhood associations and internal organizations contribute to improving the quality of infrastructure and public services for the urban poor?

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Does partisan homogeneity increase the likelihood that a slum will receive LPG? Or is it always the case that political competition enhances responsiveness? The short answer: it depends on the level of social capital. The long answer is that community-led electoral coordination — enabled by social capital — translates into what I define as the good-type partisan homogeneity. When slum dwellers are able to cooperate with their neighbors and agree upon a common political behavior, they increase the odds that they will be rewarded with public investment. Alternatively, when social capital is absent within the community, partisan homogeneity hinders electoral accountability. The chapter is organized as follows. First, I present a review of the state-of-theart on the related literature. Second, I describe the core of the chapter’s argument. This includes a discussion on the justification of why voting behavior is more of a collective than an individual experience and social capital’s central role in community empowerment. Third, in order to address the empirical analysis, I describe the dataset. Fourth, I present the statistical models results — divided into two subsections — providing empirical support for the “good type partisan homogeneity”. Fifth, I conclude with a discussion on the contributions, policy implications and future steps.

Theoretical Framework India has long-lasting roots of clientelistic politics (e.g. Chandra, 2004; Wilkinson, 2006). Yet scholarship has mostly underestimated the social influence embedded in the process. Political brokers not only distribute private goods. In poor informal settlements, access to sanitation system or clean water is often mediated by local politicians. Considering the extant interaction of patronage dynamics with the provision of LPG, we need a comprehensive understanding of what Kitschelt and Wilkinson (2007) named “collective clientelism”. From a different perspective, the traditional scholarship on public goods has weak explanatory power in the particular case of shantytowns, where patronage prevails. Classical explanations from the field of economics depict public goods as the summation of individual contributions. Yet, access to LPG for the urban poor, is mainly determined by political dynamics and non-contingent on taxation. Nonetheless, traditional literature on public goods does not address any slum politics or patronage logics. This study comes to address the existing gap in the literature in terms of providing an all-embracing analysis of social capital and public goods provision under a context of political clientelism. By shifting the paradigm from the individual to the neighborhood level, my goal is to bring attention to the local decision-making process, and its repercussions on the quality of LPG. This chapter intends to contribute

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to a better understanding of the mechanism linking social capital and leadership accountability. In other words, how social capital induces slum leaders to behave more responsively when it comes to acquiring investment from higher-ranked politicians. The literature on clientelism is quite extensive, in particular regarding the description of the direct exchange of material benefits for political support between voters and politicians (Calvo and Murillo, 2004; Chandra, 2004; Kitschelt, 2000; Kitschelt and Wilkinson, 2007; Levitsky, 2003; Nichter, 2008; Remmer, 2007; Robinson and Verdier, 2013; Stokes, 2005, among many other authors). Originally, scholars considered the exploitative aspect of the asymmetric relationship between voters and politicians (e.g. Brusco et al., 2004). Whereas, from a quite different approach, some works focused on the mutually beneficial side of the association (e.g. Auyero, 1999). Recently, scholars redirected the attention towards the micro-level, scrutinizing the relationship between voters and brokers (e.g. Stokes et al., 2013). Building upon this framework, clientelism is conceptualized as a repeated game, in which, on the one hand, voters provide political support; and on the other hand, brokers deliver goods such as handouts, food, cash, access to subsidies, welfare programs, health assistant, clothes, construction materials and among others, jobs in the government, etc. These linkages are part of a problem-solving network where favors are exchanged bi-directionally. Quite different from an anonymous machine only present during elections, relational clientelism portrays the voter–broker relationship as an on-going and durable one (Nichter, 2010). Yet, studies so far have not considered the allocation of LPG as part of these continuous exchanges between neighbors and their slum leaders. The basic argument in this chapter is that the provision of LPG within the urban poor cannot be studied independently from clientelistic dynamics. Building upon Dixit and Londregan (1996), scholars have emphasized the relevance of the machine in order to minimize the dead-weight losses in the distribution of private goods. In general, machine voters are defined as those loyal to the broker, from whom she is able to gather accurate information, and thus target resources more effectively. In this sense, uncertainty is significantly lowered if brokers are well informed about the handout-recipients. However, existing studies have mostly examined the broker’s network of loyal voters in terms of the distribution of private goods. This chapter departs from traditional literature in clientelism by redirecting the attention to the role of the brokers as a go-between within the nodes of her own network. The importance of her connections not only relates to her one-to-one exchange job, but also is linked to the social organization of the community as a whole. By understanding the leader’s role as a coordinator, the machine is no longer portrayed as an asymmetrical and vertical structure. Social networks — my argument goes — influence

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more than just informational flows, but constantly shape voters’ political choices. In consequence, by coordinating their electoral preferences, communities are empowered to demand LPG more effectively. In the context of poor informal settlements, I emphasize three features of LPG: first, that they are non-contingent on individual vote choice, departing from the natural dynamics of vote buying or electoral clientelism; second, that they are non-rival among the neighbors,8 as it is assumed in this work that once the core of the sewage system is built for the entire slum territory, there cannot be overconsumption on this good; And last, that LPG are non-excludable from any resident in the community. The “impossibility of exclusion” in Hardin’s words, introduces the need to examine collective action and coordination problems. Once public investment is allocated to a specific locality, everyone in it enjoys free access to it. Hence, a comprehensive study of this phenomenon needs to evaluate the interaction between clientelistic linkages, coordination efforts and bloc-voting. The traditional literature on collective action and public goods (e.g. Olson, 1965; Hardin, 1982) fails to explain cases where clientelism regulates resource allocation. Indeed, the mainstream understanding is that any agent will contribute to a public good as long as the marginal benefit for this contribution compensates its marginal cost. This framework applies to those LPG that result from adding up everybody’s contribution (for a complete review on this perspective see Andreoni and McGuire, 1993). However, in most poor informal settlements, residents’ access to LPG is entirely independent from individuals’ costly participation or income contributions. All in all, there is a void in the current scholarship as rarely do studies try to understand clientelistic dynamics and public goods provision jointly. In general, scholars have paid more attention to materialistic incentives than to those related to community solidarity with the notable exception of Ostrom (2000). Nevertheless, to address LPG at the slum level, social trust and neighbors’ cooperation are essential components. Existing research on clientelism analyzes dyadic (broker–voter) relationships, paying little attention to the group dimension, and even less to the collective decision-making process at the neighborhood level — Calvo and Murillo (2013) is an exception worth mentioning. Models for clientelism usually portray agent actions as individual-level choices. Yet, behavioral scholars have shown that the act of voting is, to some extent, a collective activity (Baker et al., 2006; Gerber et al., 2008; Nickerson, 2008; Remmer, 2010; Abrams et al., 2010; Fowler, 2006).

 I do not consider “crowding effects” in the consumption of local public goods at the slum level.

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Normally, local politicians retain degrees of freedom to decide where exactly (in which locality), they will allocate public investment, making this strategic decision quite relevant for the human well-being of poor constituencies. Hence, the distribution of LPG across similarly impoverished settlements cannot be studied independently from clientelistic dynamics. The typical exchange of political support for favors — generally ruling redistributive politics in the developing world — does not just entitle private goods. More often than not, local politicians reward localities with more than just handouts, making necessary for scholars to understand the provision of LPG embedded in a context of political clientelism. Along this line, Auerbach (2013) argues that squatter settlements in India aligning with multiple political parties have lower levels of local public goods because rival parties undercut each others’ projects and avoid infrastructure investments in neighborhoods with ambiguous loyalties. Last, but not least, there is a solid consensus in current development scholarship that social capital fosters improvements in living conditions. Some examples include Narayan and Pritchett (1999), who study village-level social capital’s positive effect on household income in Tanzania. Isham and Kähkönen (1999) argue an increase in efficiency in water services is due to social capital in Indonesian villages. Reid and Salmen (2002) propose that in Mali community cohesion enhances the effect of agricultural extension services. As shown in Mitra (2009), social capital makes the difference within the urban poor, particularly by providing job market information. However, Mitra finds no evidence that stronger social networks imply higher earning and consequently, upward mobility. Finally, Krishna and Uphoff (1999) show how social capital promotes community-led water projects in Rajasthan, India. Notwithstanding the extensive literature, most of the studies involve rural villages. With this chapter, not only I bring attention to the urban poor, but I also disentangle the underlying mechanism that explains such positive effects of social capital, in a context of political clientelism. Fundamental Rationale: Social Capital and Agency During electoral campaigns, urban poor localities experience a bargaining process between politicians and beneficiaries. This negotiation is mediated entirely by the figure of the broker. Since political actors are resource constrained, they build a portfolio diversification strategy and decide how much to invest in each electoral district. In order to maximize their vote share, they allocate public and private goods accordingly. For this study, I assume politicians are free to decide where to build a clinic or a sewage system according to their electoral strategies in spite of any legal or institutional arrangement that may limit the allocation. Because the provision of

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local public goods is relatively expensive, parties will only provide them when they can be sure of gathering a large share of support from any given slum consistently over a period of years. The mediator is a key actor in this argument. On the one hand, brokers ­negotiate with politicians for resources to distribute among slums’ residents with high discretion on how to allot particularistic benefits or handouts across households. On the other hand, these intermediaries are the recipients of claims from residents in terms of lacking basic services. Therefore, brokers have to balance their jobs to deliver votes for specific political parties, rewarding voters with private goods, and to help the community as a whole to attract public investment for LPG. Typically, poor voters live side by side with their local leaders or brokers. From an economic approach, voters maximize their well-being by evaluating the marginal utility of receiving private goods, and weighing the probability and the significance of LPG for their neighborhood. Traditional democratic channels are often insufficient for low-income voters, who rely heavily on direct transfers to get access to public goods.9 Precisely, to evaluate the chances of receiving public investment in a particular electoral cycle, residents estimate how many others will vote for their same candidate. Serving as a large vote bank for a single party represents a coordination problem for citizens who live in slums. In collective action problems when there are multiple equilibria, some kind of mechanism is often necessary for the interested parties to coordinate. Social conventions and shared expectations aid coordination towards higher social utility scenarios (Schelling, 1960; Young, 1996; Shepsle, 2006). In this case, the coordination problem resides in getting the majority of the slum behind the same candidate. Community leaders oversee aggregating individual preferences with respect to LPG (turning their suggestions into a focal point). On the one hand, voters take leaders’ actions as key information and cues. On the other hand, politicians realize these leaders are considered focal points and thus represent a central informational diffusion element across network’s agents. In sum, the core argument in this chapter is that both community and leadership characteristics determine the likelihood of success in demanding local public goods  In the words of Krishna (2011): “Some analysts expect political parties to perform the task of mediating between citizens and the state (e.g. Huntington, 1968; Kohli, 1987). In many new democracies, such as India, however, political parties are quite weakly organized, do not penetrate effectively to lower levels, have little or no presence at the grassroots, and may not provide much support for the tasks of interest articulation, demand representation, and political communication (Kohli, 1990; Krishna, 2002). Mediated transactions characterize an important part of citizen–state relations.” 9

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from the government. In order words, a positive involvement from the leader’s side, jointly with a highly connected community balance the bargaining process between voters, brokers and politicians, in favor of the community’s best interests. It is a double-folded argument. Firstly, leaders’ attitudes and network’s density shape the prospect of electoral coordination. Secondly, electorally homogenous localities are entitled with more — or higher-quality — public services. Is this always the case? Or are there exceptions for the association between electoral coordination and better LPG? This chapter’s argument is that the good-type partisan homogeneity yields positive results in terms of public investment if and only if it is rooted in community-led electoral coordination (enabled by social capital) and not determined by political clientelism. Voting as a Social Experience Particularly in small communities, citizens do not perceive turnout as an individual experience, for example, sometimes t-shirts with different colors are used to identify supporters which brings a sense of belonging (Remmer, 2010). Recent evidence shows that citizens are often persuaded by their immediate social contexts, when taking political decisions (Baker et al., 2006; Gerber et al., 2008; Nickerson, 2008; Abrams et al., 2010; Fowler, 2006). The neighborhood is the main environment where political communication thrives, either by word of mouth, yard signs or painted walls (Huckfeldt and Sprague, 1995). This territory is the sphere “in which individuals think collectively” (Sinclair, 2012). It is the interdependence among individuals what makes residents of the same locality permeable to other people’s political choices (Marwell and Oliver, 1993; Sinclair, 2012). The social network in a specific locality is conformed by those neighbors who are socially linked to each other and discuss every-day personal problems, as well as community issues and politics in general. The electoral process is conceptualized as a group activity. Voters’ political behavior is conditioned by the information at the very local level (Huckfeldt and Sprague, 1995). For instance, an individual has a presumption about a certain issue, then encounters a neighbor and talk about it, and they both form a new opinion. Citizens are interconnected and they maximize utility by reducing informational costs (Downs, 1957), and in this case, by matching their neighbors’ political preferences. As well, individuals derive utility by conforming to social norms (Festinger et al., 1954) and try to avoid disagreement within their main social environment (Sinclair, 2012). The underlying instrument is the need to seek for social approval (Lindenberg, 1991). Ergo, social influence at the neighborhood level drives incentives to coordinate electorally. The intrinsic belief is that public scorn may result from

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violating or avoiding them. In order to anticipate that peers will praise those who uphold to informal norms, the perception has to be that these political choices are public (Lerner and Tetlock, 1999; Cialdini and Goldstein, 2004). In other words, voters evaluate their political preferences individually, but look for consensus collectively; they do not enjoy expressing a vote choice different from the one the majority in the community is pursuing. Consequently, given that agents sanction or reward their neighbors for their political actions or opinions — filtered by their own points of view — behavioral contagion is understood as a learning process with social influence (McPhee, 1963; Huckfeldt and Sprague, 1995). Social capital intensifies informational flow on political behavior, aiding coordination. Although not in relation to clientelistic dynamics, social capital has been thoroughly studied (e.g. Coleman, 1988; Lin, 1982; Flap and Graf, 1986; Burt, 2000). As in Putnam (2000), social capital represents “the connections among individuals’ social networks and the norms of reciprocity and trustworthiness that arise from them”. To Cohen and Prusak (2001), it represents ties binding neighbors and enabling cooperation. More ties between neighbors increase the speed of social reward/ sanction, reinforcing the mechanism for peer pressure. By emphasizing the interdependence between nodes in a social network (Marwell and Oliver, 1993), we can clearly challenge the common assumption that under clientelism actors are isolated. Along these lines, a highly-connected social network simplifies the broker’s task of signaling and monitoring political behavior across the community. Politicians know that the electorate is interdependent, and to optimally diffuse information they will seek to influence the most central node in the network — the broker. More explicitly, the social network impacts the informational flow, the monitoring structure (inherent to clientelistic linkages) and, consequently, the leadership’s role as a focal point in coordination problems. In sum, a dense social network provides information on political behavior, promotes checking and supervising and facilitates a social-sanction system between agents. Scholars (e.g. Täube, 2004) have argued that weak ties often imply private goods, whereas collective goods, like trust itself, tend to derive from strong ties.10 Furthermore, the dichotomy between strong and weak ties often translates into the distinction between symmetric and asymmetric relations, respectively.  Homans (1974: 104) puts it this way: “If multiple individual exchanges among the members of a group are rewarding enough, that fact may increase the similarity among members in the sense that more of them conform to a group norm than we should have expected if the direct reward of conforming, that is, the attainment of a collective good, were the only one at work.” See also Flache (1996) for a discussion on the provision of collective goods within dense groups.

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Slum Leaders and Brokerage Roles Along these lines, the positive effect of social capital is enhanced by leaders’ efforts to function as a focal point in collective action problems. Leaders may engage due to their own incentives, but their efforts yield an electorally-homogenous locality. Through leaders’ engagement — my argument goes — communities are able to take advantage of their connectivity in a more effective manner. By coordinating their political behavior — by virtue of social capital — the urban poor are better positioned to effectively demand public investment from politicians. It is a double-folded process: connected neighbors prompt accountable leaders, who simultaneously are able to extract more resources from higher-ranked politicians by offering a stronghold or “vote bank”. In the long run, local politicians reward electorally-homogenous localities with government investment. According to Baldwin (2013) and Rueda (2016), successful community endeavors require the existence of leadership within a community. There is a wide-ranging literature focusing on the importance of actors who occupy central positions in social networks — brokers — and their role in diffusion processes (e.g. Burt, 2000; Marsden, 1982; Granovetter, 1973; Homans, 1974). In the words of Taube “brokers are actors that allow or enhance resource flows between otherwise unconnected or only weakly connected actors; as a result they able to gain advantage due to their strategies position in social networks.” (Täube, 2004: 30). In general terms, brokers or central nodes are decisive characters to boost connectedness and enable social capital throughout the network. Merton (1968) classifies brokers (or “influentials” in his terminology) into two categories: Local and Cosmopolitan. Cosmopolitan brokers are distinguished for their capacity of connecting across communities or clusters (in my theory, political actors who connect across slums). Local brokers, then, are specialized in the transmission of leveraging social capital within the community but are not considered brokers between different cliques. In relevance to this chapter, the main distinction for leadership typology is the following. On the one hand, Liaison is defined as a rent-seeking broker, in a context of fragile networks, and provided she is not part of the community. On the other hand, this chapter emphasizes the role of an accountable leader, somebody fairly close — and probably also a resident — to the locality neighbors, quite responsive to the residents’ demands. Gould and Fernandez (1990) classify this type of leader as a Coordinator, which — for this chapter — is associated with coordinating vote choice (focal point) in order to effectively achieve higher provision of LPG.11  Other types of leaders in the literature are Gatekeeper and Itinerant. See Gould and Fernandez (1990) and Taube (2004) for a complete overview. 11

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Responsiveness or accountability in leadership is closely related to the citizens’ power to force politicians to comply with their promises, as the following quote illustrates: “Accountability refers to the ability to ensure that public officials are answerable for their behavior, in the sense of being forced to justify and report their decisions, and of being eventually sanctioned for those decisions. […] The concept of political accountability refers instead to the responsiveness of governmental policies to the preferences of the electorate. Political accountability is intimately intertwined with the concept of democratic representation. […] A government is politically accountable if citizens have the means for punishing unresponsive or irresponsible administrations. It is usually assumed that elections are the central institution for this type of control (Przeworski, Stokes and Manin 1999). They provide a regular mechanism for citizens to hold governments responsible for their actions, forcing out of office those incumbents who did not act in the best interest of voters, or reelecting those who did.” (Peruzzotti and Smulovitz, 2002: 210–211)

In brief, slum dwellers employ societal mechanisms to hold leaders accountable by activating horizontal channels to threaten elected representatives to stop political support or even unelected ones with reputation costs (Peruzzotti and Smulovitz, 2002). For this chapter, for accountable leaders, I understand those who are forced to deliver their neighbors with more than just private goods. When deprived communities address their leaders with complaints on the lack of basic public services, this type of leader will have to respond to them with some type of solution. Otherwise, their continuity as leaders will be at risk. Moreover, when these leaders reside in the same neighborhoods (as they often do), not only political costs are at stake. Krishna (2011) finds empirical evidence in Indian villages that it is quite difficult for a leader (in his study: a panchayat) to cheat villagers because if the community is united, they can exert social sanctions (e.g. ostracism) to unresponsive leaders. Particularly in the Indian case, we can differentiate two types of local leaders: traditional bosses and young men (Naya Netas). The latter are characterized by their skills and education and are often specialized in terms of their abilities to deal with different governmental agencies. Hence, when in need of assistance with a particular issue, citizens recognize this differentiation system and approach Naya Netas according to their expertise. Most importantly, unmediated transactions are very rare; people generally rely on Naya Netas or other type of intermediaries (Krishna, 2011). In this work, I do not distinguish particular types or local leaders, and survey respondents in Udaipur identify both slum leaders and ward leaders as the central ones.

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Hypotheses H1: Well-connected communities — empowered with social capital — are more prone to voting together (electoral coordination). The rationalization for this argument is simple: more connectivity among slum dwellers allows them to coordinate their political strategy at the neighborhood level. This translates into a better negotiation with politicians, while an intermediary or broker is obliged to represent their interests to remain in that leadership position. The mechanism that enables political organization at the slum level is the informational flow resulting from the density of the social network. In other words, the dissemination of information is aided by the shared values and mutual trust in communities with high social capital. Interestingly, the positive effect that social capital exerts on electoral coordination is bolstered by the presence of an intermediary agent who effectively reaches out and gets resources for her community. Moreover, by signaling the suggested path, the mediator simplifies the task of aggregating neighbors’ preferences in terms of electoral choices. In Krishna’s words: “Social capital represents a potential — a propensity for mutually beneficial collective action. But potential needs to be activated and agency is important for this purpose. […] when intermediate links are weak, as they are when agency is not capable, social capital does not translate readily into good performance.” (Krishna, 2001: 934)

H2a: Communities voting together are more satisfied with their LPG, only under the presence of social capital (good-type homogeneity). H2b: In the absence of social capital, communities that vote together have lower levels of satisfaction regarding LPG (bad-type homogeneity). The second set of hypotheses refer to the interaction effect of electoral coordi­nation and social capital. My argument states that the effect of electoral coordi­nation — over LPG — is distinct conditional on the level of social capital. More explicitly, I hypothesize that when slum voters coordinate their vote choice — when the majority of the slum chooses the same political candidate — they raise the likelihood of enjoying better-quality LPG if and only if the community benefits from social capital. Alternatively, slums showing electoral homogeneity under the absence of social capital, tend to receive more private goods than LPG — within clientelistic practices. In the negative case (bad-type partisan homogeneity), communities appear

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to be coordinating at the ballot box, but not for the good reasons. Precisely because of the absence of social capital, slum dwellers are locked-in voters who tend to vote for the same political party as they are being persuaded with inexpensive handouts. It is worth mentioning that this argument differentiates between electoral coordination and partisan homogeneity. The former requires bottom-up community-driven political organization and agreement. Instead, homogeneity may appear as electoral coordination but could in fact represent the byproduct of very effective clientelism. Every case of electoral coordination results in partisan homogeneity (good-type), but not every case of partisan homogeneity implies electoral coordination. The connecting link between LPG improvements and the good-type partisan homogeneity is leadership responsiveness. Frequent interactions and strong ties between slum dwellers improve leadership accountability. Well-connected communities yield empowered citizens — instead of locked-in voters — who, if necessary, can pose a credible threat to disappointing leaders and politicians. Simultaneously, once a broker is able to demonstrate that she is capable of delivering “vote banks”, she increases her chances of demanding more investment from higher-ranking politicians. Not only is the community empowered through social capital, but through this process, leaders’ maneuvering skills are bolstered too. When posing demands to their local leader, the level of social connectedness in the residents’ social network impacts positively the power residing in these ­voters. That is, higher connectedness favors the likelihood of the group to organize themselves politically, coordinate electoral choices and hence, extract more resources during electoral campaigns. Along these lines, when a local leader or broker is not being responsive to the community, it is feasible for them to communicate — without the need for a leader — and to try to replace him.12 Networks with high degree of connectedness embody the most effective and successful undertakings in demanding for benefits bottom-up.

Empirical Analysis The data in this section come from original household surveys in 30 slums in the Indian city of Udaipur, located in the northern state of Rajasthan. Like all Indian cities, Udaipur’s main local government is a Municipal Corporation, formed by 55 wards leaders. As stated in the 2011 Indian Census, population in Udaipur is 451,100 (233,959 males and 217,141 females), and 100% urban. In 2009, the Udaipur  Presumably, there is some level of stickiness in leadership, and it might take several electoral periods, for a majority in the neighborhood to shift to a more dedicated leader. This is similar to what Magaloni (2006) recognized for the case of the Mexican electorate.

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Municipal Corporation (UMC) conducted a survey finding that 14% of slum population in Udaipur falls under the category of Below Poverty Line (BPL) population, in an upward trend since 1998. Furthermore, the UMC survey in 2009 reported that 47,636 people (9,529 households) lived in slums, which represented about 11% of the City’s total population at the time (Interim City Development Plan, 2014). During 2013, we interviewed over 1200 slum dwellers in Udaipur through two different waves of surveys. The first one — during June and July — covered all households13 in four slums (N = 750).14 Existing preliminary data on slum population in Udaipur, as well as previous qualitative fieldwork (March 2013), informed the selection of neighborhoods, assuring diversity across key variables. The selected slums provide the necessary variance in terms of population size, demographics, socioeconomic characteristics, and differences on the existence of clientelistic practices and the provision of local public goods.15 For the second wave — during November state elections — the strategy was modified, to represent the population in more than those four slums, covering 501 households. By a traditional stratified sampling,16 the survey covered a total of 30 slums across the city.17 This time, the key questions asked about names of most important leaders, as well as typical exchanges (of private and collective benefits) occurring during electoral campaigns. In both rounds, we asked about political and electoral monitoring (by the broker and among peers), vote coordination and the traditional components of social  The strategy required covering all residents of the neighborhoods because the goal was to estimate network analysis measures (connectedness and centrality). Thus, to avoid any possible bias in the present of sampling (Kossinets, 2006), interviewing all households in the four slums was the mandatory research design. 14  The four slums in the first wave are Bedwas Kachchi Basti, Bheelu Rana, Shivaji Nagar Kachchi Basti Sukhadia Nagar. 15  See the Interim City Development Plan (June 2014) for details on population size and ward distribution of Udaipur slums. 16  Samples sizes at slum level were proportional to their share of the overall slum population of the city. 17  In the second wave, the slums surveyed are: Amba Mata (Ambavgarh), Avri Mata, Banjara Basti, Bedwas Kachchi Basti, Bhagri Basti, Bheelu Rana, Bhopa Magri, Gandhi Nagar Harijan Basti, Gowardhanvilas Indira Colony, Hanuman (C) Roop Sagar, Indira Nagar Beeda, Kaumi Ekta Nagar, Kishanpol (N), Kishanpol (S), Lohiya Nagar Harijan Basti, Machhla Magra, Manoharpura, Math Madri, Neemach Khera, Neemach Mata, Od Basti, Parerion Ki Madri (Kc), Ram Singh Ji Ki Badi, Ratakhet, Sajjan Nagar Harijan Basti, Shaheed Bhagat Singh, Shanti Nagar, Shivaji Nagar Kachchi Basti, Sukhadia Nagar, and Vijay Singh Pathik Nagar. 13

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capital (trust within the community, solidarity between neighbors, etc.). As well, the survey includes assessment of satisfaction with public services quality in order to measure improvements in LPG. Since not all questions were asked in both rounds, the number of observations oscillates across models. As in any voting model and studies on clientelism, the unit of analysis is the individual. However, the incorporation of collective considerations shifts the lens to the slum level. This change is not in itself problematic, but aggregation can be detrimental of the statistical power by dropping the number of cases significantly. In order to increase statistical power, the analysis is conducted in a pooled cross-sectional dataset. For these cases, running a multi-level model is the most efficient technique to assess both within and across neighborhood variance. The advantage of this model over traditional ones is that it allows me to account for clusters in the data without loosing efficiency. According to Gelman and Hill (2007), multi-level works better with five or more groups. However, even in cases with less than five, these authors believe that multi-level models can be better than a simple regression because it is no longer necessary to arbitrarily decide a base group. Moreover, in terms of the sample size per group, Gelman and Hill (2007) do not establish a necessary minimum N. While recognizing there might be challenges to estimate a precise variance within group, the authors believe there might still be interesting information available by running multi-level models for these cases. Description of Relevant Variables from Survey Questions •• Electoral coordination: Do most members of your neighborhood vote for the same party? •• Leader’s engagement as an electoral coordinator: Has your neighborhood leader suggested that you vote for a specific candidate in the coming elections? •• Social Capital Index: Factor analysis18 with two variables:

1.  Community trust: Now, speaking of the people from around here, would you say that people in this community are very trustworthy, somewhat trustworthy, not very trustworthy or untrustworthy…? 2.  Solidarity within neighbors: How often do people in your neighborhood help each other with problems (e.g. taking care of a sick family member, finding a job, lending money, and assistance in general)? Never, Rarely, Sometimes or Regularly?  For diagnostics on factor analysis, please see Tables A.1 and A.2.

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•• Ask help neighbor: Suppose, you have an emergency. Beyond your family, who would you go to for help. This variable was created as a dummy for respondents who answered “neighbor” among other fixed choices. •• Frequency in discussing politics with main acquaintance: From time to time, most people discuss important matters with other people. Looking back over the last 6 months, about how often do you talk to [NAME19] about politics or public services: almost daily, at least weekly, at least monthly, at least yearly, less than yearly, or never? •• Satisfaction with public services: How satisfied are you with the quality of the following services: Primary Education, Secondary Education, Health Services, Roads, Access to Water, Waste disposal (or sewage), Electricity and Public Bathroom. •• First, I created a variable that averaged the satisfaction for all these services (Average Satisfaction). Here, the scale is 1–4, where the highest value represents the greatest satisfaction. The mean for this variable is 2.3 and the standard deviation is 0.7. Second, I created a variable adding up levels of satisfaction for the three most important public services: roads, access to water and waste disposal (sewage). The reason I chose these services is because when respondents in the survey were asked about priorities over government services, these were remarkably most important than any other.20 In this case, this variable (Key Services Satisfaction) ranges from 1 to 10, with a mean of 3.7 and a standard deviation of 2.3. •• Partisan homogeneity at the slum level: This refers to the share of the respondents in the same slum who mentioned affinity with the same political party as the majority of the slum residents. The question used here is: Which political party do you consider is doing good?

Results Leadership suggestions or subtle direction are one of the most powerful tools towards to coordinate political behavior (Rojo and Wibbels, n.d.). All models  In the first wave of the survey, we were able to ask each respondent the names of five acquaintances. Then for the question about frequency in discussing politics with main acquaintances, we mention the first and last names in their list of friends. 20  Respondents were asked to rank the three most important services. By adding up all first and second priorities, we get a total of 2,490 mentions. From those, 617 correspond to Water Sanitation, 603 to Sewage and 407 to Roads. The rest of the priorities were Health with 344 mentions; Public Bathroom with 251; Primary Education 122; Secondary Education 115 and Electricity with only 31 mentions. 19

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in Table A.3 provide evidence that there are two main forces working towards electoral coordination: (i) social capital; (ii) leader’s efforts as a coordinator.21 Now, Figures 2 and 3 present evidence on how social conditions within the community aid electoral coordination. In this case, the models include two variables that were part of the first round of survey (but not in the second one). Because there are only four slums in that dataset, the model includes fixed effects for the neighborhoods. Effects of leaders’ engagement and Social Capital are statistically significant and positive over the dependent variable (electoral coordination). The two new variables of interest in these models are “Help from Neighbor” and “Rarely/Frequently discuss politics with acquaintances”. The latter describes how often respondents discuss politics with someone beyond family members (dummy version) and the former indicates whether neighbors are the first ones to be contacted in case of an emergency. Although theoretically related, there is no statistical association between the Social Capital Index and these two variables (Pearson’s correlation is less than 0.05).

Figure 2:   Margins for electoral coordination by social capital and by help from a neighbor.

 In the fixed effect models, Sukhadia shows lower probability than Shivaji. In fact, these two basti originally presented as opposed are consistent examples of how electoral coordination is one path towards the improvement in living conditions. 21

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Figure 3:   Margins for electoral coordination by social capital and by frequency in discussing politics with acquaintances.

The aforementioned figures show the predicted probabilities of voting together by the Social Capital Index, but split into different groups. For instance, Figure 2 shows that the predicted probability of electoral coordination is about 0.2 for a person with the minimum level of social capital and who did not ask help from a neighbor. Whereas a person with the maximum score of social capital and who did ask for help from a neighbor has a 0.65 predicted probability of answering that the neighborhood votes together. Likewise, the most frequently respondents discuss political issues or public services with their neighbors, the higher the likelihood of coordinating their votes throughout the community. Namely, the predicted probability of electoral coordination is about 0.2 for a person with the minimum level of social capital and who rarely discusses politics with acquaintances. In contrast, someone with the maximum score of social capital and who frequently discusses political matters beyond family members has a 0.75 predicted probability of answering that the neighborhood votes together. All in all, as the hypotheses estimate, the three independent variables suggesting a tighter community — jointly with leadership engagement — have a positive and statistically significant effect on Electoral Coordination. The last part of the empirical analysis shows the interaction effect of social capital and electoral coordination on services satisfaction. Table A.4 presents the results of

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Figure 4:   Margins for key services satisfaction.

Multilevel Models for two different dependent variables: satisfaction with key services (roads, water and sewage) and average satisfaction with all services. The main findings are robust throughout the different model specifications, as Figures 4 and 5 illustrate. First, Partisan Homogeneity has a distinct effect on services, dependent on social capital. For those neighborhoods with low social capital levels, partisan homogeneity impacts negatively on services satisfaction. However, for those with high social capital, partisan homogeneity has a positive effect on services satisfaction. When social capital is low, what appears to be electoral coordination is actually an scenario of locked-in voters who receive private — instead of public — goods (bad-type partisan homogeneity). Alternatively, in the presence of social capital, partisan homogeneity is showing a successful case of electoral coordination, where neighbors are able to achieve better public services by voting together and being rewarded by politicians. In other words, in the absence of social capital, partisan competition is more rewarding than homogeneity for poor informal settlements. Also as expected, both leadership accountability and socioeconomic status have a positive statistically significant effect on satisfaction over public services. In previous work (Rojo and Wibbels, n.d.), we have provided empirical evidence that those communities coordinating their votes are statistically associated with leadership accountability and responsiveness.

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Figure 5:   Margins for average services satisfaction.

Concluding Remarks This chapter addresses the provision of local public goods for the urban poor by focusing on the decision-making process at the neighborhood level. The argument describes the need to shift the clientelistic paradigm from the individual to the community level, as well as turning the attention to the dichotomy between private transfers and the provision of local public goods. With empirical evidence from 30 slums in the Indian city of Udaipur, I explore how community organization raises the likelihood of electoral coordination, and consequently, their efficacy in demanding investment from the government. While political scientists have thoroughly studied clientelism, they have mainly overlooked group effects. From an economic perspective, slum politics are mostly absent in the study of LPG. Finally, albeit extensive, the literature on social capital and network analysis remains dissociated from the political clientelism pheno­menon. Shortcomings in the existing research on slum politics and electoral ­accountability motivate me to assess voting patterns in a collective form. This chapter’s contribution is to integrate different approaches into a single theory by exploring the positive impact of social capital on the capacity of the urban poor to improve their access to better infrastructure and public services.

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In sum, the level of connectedness in the neighborhood’s social network impacts positively on the power residing in these voters when posing demands to their local politician. Social capital — this chapter argues — enhances the most effective undertakings in demanding local public goods (bottom-up). A dense network poses a credible threat to a negligent broker, as it is feasible for a well-connected community to communicate and coordinate to replace her. Alternatively, the community may attract public investment if they manage to coordinate their vote choice and support the same candidate. On the one hand, local politicians reward electorally-homogenous localities, increasing the power of negotiation that the slum leader has in the political bargaining process. On the other hand, by coordinating their efforts, neighborhood residents are able to hold their leaders accountable. Both sides of the argument translate into better infrastructure and services provided by the government due to social capital. Social capital represents ties binding neighbors and enabling cooperation (Cohen and Prusak, 2001). Interconnections in the social fabric influence more than just informational flows, but constantly shape political choices. The analysis of slum dwellers voting behavior as a collective unit is particularly relevant because the urban poor tend to be clustered together in neighborhoods and to them, non-excludable goods (i.e. LPG) are central for the quality of life. When communities are socially organized, their recurrent interactions increase the likelihood that they will vote for the same political candidate. Ultimately, social capital brings the necessary tools for the urban poor to demand for better living conditions. Having argued elsewhere (Rojo, 2017), that politicians’ good behavior is induced by the potential risk of bloc-voting, this chapter describes under which conditions — i.e. social capital — communities are sufficiently empowered, so that they can punish (reward) governments’ poor (superior) performance. Again, the other side of the story here is clientelism. Those slums with stronger links among community members are able to escape the vicious cycle by effectively demanding LPG to local politicians. One of the forms they can induce responsiveness is through electoral sanctioning. Alternatively, in the absence of social capital, slum dwellers show lower levels of satisfaction with public services, even if their electoral choices appear to be coordinated. This scenario of poor accountability is typically associated to political clientelism (distribution of private goods). Despite seeing decay in their quality of lives, on election day, locked-in voters reward incumbents in response to the distribution of private goods. Communities that are socially organized, on the other hand, have the means to coordinate their votes regarding LPG. This has implications for the study of party switching.22 As empirically shown here, electoral accountability is a real alternative for the urban poor. Oftentimes, governments overlook certain neighborhoods’ basic needs,  On this regard, please see Rojo (2017) for the empirical evidence on Argentinean slums.

22

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and their residents fail to effectively call the attention from politicians, not even during political campaigns. Trapped under the logic of clientelism, slum dwellers are often locked-in voters. Now, the successful cases — those empowered with social capital — are actually able to sanction public officials’ performance. These communities enjoy the advantage of making their needs visible. There, the lack of public investment is duly noted. Even in a context of absolute informality, land irregularities and complete deprivation of basic necessities, governments can be forced to deliver more than private goods. Politicians will know then that if they do not show any effort to improve slum dwellers’ quality of life, they will lose elections. Yes, not every poor informal settlement is able to punish unresponsive governments, but some are. Patronage or other forms of clientelism tend to obstruct accountability. However, the good news is that, with the existence of social capital, we can expect governments to know their performance will be evaluated, and electoral sanctioning is not just a threat. Policy Implications The foremost contribution in this chapter is the importance of building strong communities, especially for low-income individuals. As recognized by existing research (e.g. Krishna, 2001), social capital is a fundamental tool to improve poor populations’ living standards. Now, the findings in this chapter contribute to expand the expertise in the topic. We learn that politicians should, in fact, fear social capital if they are planning to ignore slum dwellers’ demands. Interestingly, if consolidating community ties implies a good strategy for voters, it does not necessarily mean the best path for public officials. As recognized by the Principal–Agent theory, voters are principals without full information on policy implementation. Particularly for the case of the urban poor, informational asymmetries are broadened. This situation highlights the need of poor voters to do everything in their power to provide their agents with a package of incentives, so that they will increase responsiveness. As the majority of the electorate, urban and low-income voters have to hold representatives accountable based on actions and plans that they cannot themselves observe. Yet this is not always true, especially, for the case of LPG (highly observable in comparison to abstract policies). Moreover, for communities empowered with social capital, Principal–Agent problems can be battled. This is how social capital represents the partial resolution to Principal–Agent issues. According to my theory and findings, poor voters should forget about changing politicians’ incentives, and just concentrate their efforts in building social capital. As a byproduct of their internal organization, trustworthiness and solidarity, slum dwellers will provide the right incentives to public officials: the fear of electoral sanction through bloc-voting.

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Ironically, governments might not have any incentive to foster community-led initiatives. If they are reading between lines correctly, the statistical models in this chapter indicate that by promoting social capital within the urban poor, their electoral strategies will become costlier. This paradox represents an obstacle to accountability considering that many forms of communities’ social organizations originate from government-funded programs. However, there is always the power of civil society and non-profit institutions to promote community-driven endeavors, such as cooperatives. Above all, the power to modify their circumstances resides precisely in their own hands. During fieldwork, I repeatedly witness social organizations in the form of neighborhood association meetings or religious encounters, either in the streets or inside the house of some community member. Being a common feature within the slum’s landscape, these particular institutions — born within the community — have an immense power of strengthening the social fabric. That being the case then, can social capital only emerge by inspiration and dedication of the community itself ? This chapter proposes that other nongovernmental actors such as NGO or Development Agencies should take these findings as initial grounds to increase grassroots activities. Considering that International Organizations, such as the World Bank, often provide funding to slumupgrading programs, one may suggest that they pose conditions to their government counterparts. For example, development initiatives may require that one-third of the financial resources should be allotted to activities aiming to build stronger community ties. This way, they are not only helping governments build infrastructure in poor informal settlements, but they are also forcing them to build the fundamental bricks for accountability. Third-party entities fostering social capital is a simple form of compelling agents to empower principals precisely so that the former will ultimately have to respond to the latter’s demands. Future Research Subsequent studies should address the following points. First, as a robustness check, precinct-level electoral results should complement the existing dataset. Reported levels of satisfaction with LPG, as well as individual preferences on political parties, are fairly precise in the exercise to measure electoral accountability. However, it could be useful to corroborate these results with a different dataset. Geographically mapping electoral results at the slum level will be the starting point, supplementing then political behavior patterns with observational data on quality of services and infrastructure across slums. In this case, the unit of analysis would not be individual anymore, thus the importance of increasing the sample size to more than 30 slums.

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Second, there is an implicit assumption in this work that clientelism is the counterpart of LPG provision. Specifically, under the absence of social capital, the bad-type partisan homogeneity is linked to the distribution of private goods in detriment to improvements in LPG. Future work should test this assumption directly by incorporating clientelism variables in the models. Alternatively, public records on the distribution of government jobs could be accurate patronage indicators. Third, the scope of this study could be broadened significantly by extending its reach in time and geography. So far, this project considers 30 slums in Udaipur, only for the year 2013. By including, for example, a follow-up of the survey, findings would become more robust, as we would be exploring improvements/setbacks across a significant time lapse. In the same line, by expanding the jurisdictions to other cities in Rajasthan, such as Jaipur, I could claim to offer a more generalizable theory. Fourth, in this chapter, social capital mostly describes characteristics of connectivity and trustworthiness within the social network’s nodes. Therefore, incorporating new data to conduct network analysis would represent a clear improvement in the research design. Considering the complexity of collecting network data on slums, this project could not address this issue in the short term. But while hoping to include it in the long term, network analysis will allow me to consider more precise measures of social capital such as network’s density or level of connectedness. Fifth and last, Putnam (2000) describes different types of social capital, and these probably entitle dissimilar effects on slum-upgrading programs. I anticipate that both types of social capital — bonding and bridging — are relevant for this research agenda. For high-homogeneity neighborhoods (e.g. in terms of ethnic or religious cleavages), bonding ties should be sufficient to foster electoral coordination. However, when communities are characterized by different minorities (e.g. Muslim clusters), bridging social capital becomes necessary to enable cooperation across separate communities within the same neighborhood.

Appendix Factor Analysis for Social Capital Index Table A.1:  Diagnostics. Factor

Eigenvalue

Difference

Proportion

Factor 1

1.659

1.318

0.829

Factor 2

0.340

0.171

Note: LR test: Independent vs. saturated: χ2 (1) = 708.76, Prob > χ2 = 0.0000.

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Following the Kaiser criterion that suggests retaining those factors with eigenvalue equal or higher than one, I use Solidarity and Community Trust as loading in a single factor. Table A.2:   Correlation matrix. Social Capital Index

Community Trust

Solidarity

1.0000 0.9108 0.9108

1.0000 0.6591

1.0000

Social Capital Index Community trust Solidarity

Table A.3:   Fixed effect models. Electoral Coordination

Leader Suggests Social Capital Index BJP supporter Gender Muslim Socioeconomic Index Age Education Ask Help Neighbor Frequency discuss politics with acquaintance (dummy) Bedwas Kachchi Basti (omitted) Bheelu Rana Shivaji Nagar Kachchi Basti Sukhadia Nagar Constant Observations

(1)

(2)

0.696* (4.13) 0.286* (3.21) 0.299** (1.71) -0.0623 (-0.36) -0.753* (-1.98) 0.0841 (0.74) 0.00237 (0.36) 0.0130 (0.63) 0.720* (3.92)

0.603* (2.87) 0.377* (3.31) 0.0838 (0.40) -0.120 (-0.57) -0.812** (-1.70) -0.0204 (-0.15) 0.00511 (0.62) 0.0254 (1.01) —

— — — -0.157 (-0.60) 0.545* (2.00) -0.832* (-2.53) -2.617* (-4.13) 695

— 0.907* (4.50) — -0.253 (-0.78) 0.586** (1.70) -0.687** (-1.72) -2.772* (-3.58) 487

Note: t statistics in parentheses. **p < 0.10, *p < 0.05.

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(2)

Key Services Satisfaction

Average Satisfaction

Partisan homogeneity (SLUM)

-0.118* (-3.62)

-0.0500* (-4.17)

Social capital = 1 (slum dummy)

-6.208* (-3.24)

-2.258* (-3.33)

Social capital (slum dummy) × partisan homogeneity (SLUM)

0.134* (4.07)

0.0538* (4.50)

Leadership   accountability

0.275* (3.16)

0.187* (4.81)

BJP supporter

0.0136 (0.06)

0.103 (1.40)

Gender

-0.156 (-0.95)

0.0215 (0.51)

Muslim

0.346 (0.82)

-0.0118 (-0.16)

Socioeconomic Index

0.447* (3.94)

0.0677* (2.28)

Age

0.00186 (0.27)

0.000573 (0.30)

Education

0.00771 (0.36)

0.00218 (0.36)

Constant

7.433* (3.55)

3.539* (4.89)

1064

1010

Observations

Note: t-statistics in parentheses. + p < 0.10, *p < 0.05.

Random-effect parameters. Group-level Variance Individual-level Variance

0.772

0.032

(0.245)

(0.019)

3.309

0.213

(0.266)

(0.014)

Note: Std. Err. in parentheses

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CHAPTER 6

Informal Electricity Consumption and Political Regimes: Implications for Political Change in BRIC Countries* Santiago López-Cariboni Department of Social and Political Science, Universidad Católica del Uruguay, Uruguay

Introduction A large body of research demonstrates that democracy increases the provision of public goods and services (Ansell, 2008; Brown and Hunter, 1999; Segura-Ubiergo and Kaufman, 2001; Avelino et al., 2005; Stasavage, 2005; Rudra and Haggard, 2005; Huber et al., 2008). Democracy is also thought to improve outcomes of human development such as health, education, labor wages, and economic growth (Lake and Baum, 2001; Przeworski et al., 2000; Olson, 1993; Rodrik, 1999). The logic is that democracy has distributional effects because politicians who face electoral competition need to build larger coalitions of political support (Bueno De Mesquita et al., 2005; Lake and Baum, 2001; Przeworski et al., 2000). Democratic leaders also have more incentives to generate macroeconomic stability (Doucouliagos and Ulubasoglu, 2008) and provide insurance in volatile economies from the developing world. However, they often remain unable to protect the lower class against *This chapter extends the arguments presented by López-Cariboni (2018a) to the BRIC countries. 139

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negative income shocks. Policy tools to stimulate the demand side of the economy during the downside of the business cycle are non-existent (Lustig, 2000; Talvi and Vegh, 2005; Alesina et al., 2008), while governments have only scarce access to international credit markets to face income volatility (Wibbels, 2006). Given the absence of “decommodification” (Esping-Andersen, 1990; Huber and Stephens, 2001), automatic stabilizers, and counter-cyclical social spending (Darby and Melitz, 2008), governments cannot provide consumption-smoothing mechanisms for lower income groups even when politicians have incentives to do so. One possibility is to expect that democratic governments abandon the poor during economic crises (Segura-Ubiergo and Kaufman, 2001; Rudra, 2002; Wibbels, 2006). This is supported by evidence suggesting that democracies often neglect the economic interests of the poor and those in the informal sector (Ross, 2006). This fact, however, introduces the important puzzle of how democratic leaders build electoral support during bad economic times to secure political survival. Leaders who depend on electoral competition to win office must be sensible to the support or the acquiescence of the groups negatively affected by economic crises. I argue here that electoral politics increase the informal provision of insurance for the lower class. I build on recent research showing deliberate non-enforcement of the law, in the face of irregular access to basic services, may be a cost-efficient and politically viable strategy to increase levels of decommodification of dislocated and poor voters during negative income shocks (López-Cariboni, 2018b). While there is empirical evidence of the existence of ­ on-enforcement of law — in policy “forbearance” — government’s deliberate n areas such as squatting and street vending (Holland, 2016, 2015), less is known about its dynamics as a policy of social insurance. In this respect, the analysis of electricity theft has remained largely overlooked. This is surprising given that irregular electricity access is likely to be the largest program of informal social transfers around the world. The BRICs are at the heart of such assertion. It is estimated that emerging markets lose $58.7 billion per year and the rest of the markets, including the largest economies, lose $30.6 billion per year because of electricity theft. The total cost of electricity theft for the top three countries is about $31.8 billion per year: $16.2 billion in India, $10.5 billion in Brazil and $5.1 billion in Russia, respectively (Northeast Group, 2015). This ranking among the BRICs has remained unchanged since 1990, at least. Figure 1 shows transmission and distribution losses (TDL) of electricity as a percentage of total domestic electricity consumption, comparing the evolution of the BRIC countries with the rest of the developing world. The data confirm that India, Brazil, and Russia lose an important amount of resources in

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Figure 1.   Electricity losses in BRIC countries. Note: The dark-grey solid line and shaded area represent the mean trend in developing countries with a 95% confidence interval. Source: World Development Indicators (the World Bank).

TDL. The data not only include stolen energy but also technical, unavoidable losses due to the energy transmission and the infrastructure quality of the electricity grid. While technical losses are a stable or a rarely changing component of total electricity losses, non-technical losses are more variable over time and largely depend on the amount of electricity theft. As shown in Figure 1, in Brazil and Russia, the problem has remained almost unchanged during the period, if not worsening. In India, the amount of TDL increased dramatically until early 2000s and started to decrease since then but has been never lower than 18%. China, in turn, has a relatively low level of losses, most of them are technical, and they have been steadily decreasing over time. Electricity theft, and therefore the variable component of the description shown in Figure 1, is not only a matter of state capacity but also a political decision of low enforcement of the property laws. I dedicate this chapter to analyze how electoral politics affect the evolution of electricity losses. As argued elsewhere (López-Cariboni, 2018b), forbearance is likely to be a cyclical phenomenon. State flexibility enables governments in dire financial conditions to target a large amount of benefits to the poor when they most need it. While the

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demand for irregular access to basic services is counter-cyclical, the supply side of politics can expand the amount of informal transfers to provide insurance (López­ emocracies than Cariboni, 2017). This political non-enforcement may be higher in d in autocracies, which is consistent with theories linking political regimes and social protection. While theories of public goods provision predict differences across political regimes, there is little knowledge on how exactly electoral competition affects the provision of insurance in conditions under which fiscal policy is not an option.1 More specific research on the supply of basic services shows that in poor countries, democratization shifts the provision of electricity from the industry to households (Brown and Mobarak, 2009), and others document partisan and electoral-cycle effects on provision and electricity losses (Baskaran et al., 2015; Min and Golden, 2014). I add here that democracy increases the amount of counter-cyclical irregular electricity consumption as an insurance mechanism. The chapter also contributes to existing studies on electricity losses (Smith, 2004; Dal Bó and Rossi, 2007; Wren-Lewis, 2015), and provides a new political argument to the current understanding of the problem. Finally, the argument is more closely related to the view of Forteza and Noboa (2016), and linked to the idea that political non-enforcement results from insurance motivations rather than only a logic of income redistribution as in Holland (2015).

Economic Cycles and the Demand for Irregular Electricity Access In developing countries, social security benefits are often ineffective to protect those in the informal sector. Social insurance has been traditionally targeted to a relatively narrow, urban, political clientele in the formal sector instead of a wider coalition of workers (McGuire, 1999; Huber et al., 2006; Wibbels and Ahlquist, 2011). Consequently, welfare spending often has regressive effects (De Ferranti et al., 2004; Huber et al., 2006; Goñi et al., 2011), and its fiscal cost is partially socialized through general consumption taxes. In addition, progressive social spending, such as education, is the most pro-cyclical component of social policies (Wibbels, 2006). When welfare protection is pro-cyclical, informal transfers emerge as a policy tool to provide consumption-smoothing mechanisms (López-Cariboni, 2018b). Electricity theft is an important factor driving inefficient energy consumption in the developing world. This phenomenon may manifest by fraud, stealing power from the grid, billing irregularities, and unpaid bills (Smith, 2004; Depuru et al., 2011; Winther, 2012). Smith (2004) documents that for a large sample of developing  See, however, Brooks (2007) on the privatization of social security regimes.

1

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countries, non-technical losses (NTL) vary between 10% and 40% of the total generation capacity. Electricity theft also creates several inefficiencies in energy distribution and consumption (Jamil, 2013). Households that have informal access to the grid, or that only pay for a fraction of their actual consumption, tend to consume much more energy than regularized clients. Moreover, theft is costly and contributes to power disruptions, which in turn aggregates into costs for the overall economy and its various sectors (Lewis, 2015). Utility companies and regulation agencies often choose to increase electricity tariff rates in order to secure the sustainability of the supplying power, ending in higher electricity prices for legal customers (Jamil, 2013; Winther, 2012). The most important reason for irregular access to basic services is a­ ffordability. Those who cannot bear the cost of electricity are likely to secure their access through irregular ways, namely, illegal consumption or theft (Depuru et al., 2011; Smith, 2004; Winkler et al., 2011). Other factors such as house ownership status and precarious house constructions also play an important role in the propensity toward electricity theft (Mimmi, 2014). Despite the general agreement on the necessity of enforcement, inspections and sanctions alone are not entirely effective to reduce losses. Moreover, enforcement itself is a very politically contentious issue (Golden and Min, 2012; Holland, 2015, 2016), since irregular electricity consumption is a manifestation of a complex phenomenon of social exclusion. Importantly, electricity represents a considerable share of household income for members of the lower class. Given the risks of irregular electricity consumption, illegal behavior becomes increasingly more attractive as household income is lower. Yet, electricity theft is not just a social exclusion problem. Non-poor households can also consider irregular access as an available insurance mechanism in the face of an adverse economic shock. Moreover, an important share of electricity theft is present in urban areas where households have sufficient purchasing power (López-Cariboni, 2018b). Hence, political permissiveness of irregular access to energy can be an insurance policy targeted to a large segment of the population. Since household incomes in developing countries depend on profound business cycles and social policies cannot smooth consumption (Lustig, 2000; Talvi and Vegh, 2005; Alesina et al., 2008), incentives for electricity theft are likely to be counter-cyclical. Propensity to consume free but irregular energy increases with negative income shocks. On aggregate, the amount of electricity losses is expected to increase during economic downturns and decrease during periods of recovery. To illustrate the relationship between energy losses and economic cycles, I build on the logic proposed by Holland (2015) and López-Cariboni (2018b). In the absence of any political decision about enforcement, electricity losses are expected to be moderately counter-cyclical. This can be seen from changes in the demand

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Figure 2:   Effects of negative income shock and political enforcement on electricity theft. Source: Taken from López-Cariboni (2018b).

for free energy (theft) under a given institutional enforcement policy. As shown in Figure 2, the compliance curve has a negative slope as long as violations (quantity) decrease with the number of sanctions (price). The supply curve of institutional enforcement has the standard positive slope: the state increases the number of sanctions as the number of violations also rises. The first and immediate consequence of economic fluctuations is shifting the demand for illegal energy. This demand-side effect generates counter-cyclical movements of electricity theft as defined by changes shock Hence, the empirical implication in the level of violations between Ei.e and Ei.e is that macroeconomic fluctuations should be correlated with at least some change in the amount electricity theft, even when the government makes no change in the enforcement policy. In the next section, I look at the implications of political change, i.e. democratization, for this simple model of enforcement.

Political Regimes and Informal Insurance During bad economic times, democratic incumbents may implement a lower enforcement level than under authoritarian rule. Hence, a regime change from autocracy to democracy should be correlated with a reduction in the slope of the enforcement curve leading to larger counter-cyclical informal transfers. Such a

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political enforcement in developing country democracies meets known voters’ demand for state flexibility (Holland, 2016; López-Cariboni, 2017). Recent research in democratic contexts suggests that poor individuals have ­interest in “forbearance” toward property laws they are more likely to violate. Politicians, in turn, can transfer informal welfare benefits through state inaction, which can be an effecting form of sending credible electoral cues of their affinity with poor voters. Thus, politicians may strategically avoid enforcement of regulations when they possess the capacity to do so (Holland, 2016). Moreover, citizens also reward politicians who signal more state flexibility in the face of increased electricity theft during bad economic times (López-Cariboni, 2017). This is further supported by research showing that electricity service is politically manipulated due to democratic political competition (Brian Min, 2015), especially when there is limited capacity to affect fiscal and monetary policy (Min and Golden, 2014). Given politicians’ awareness of counter-cyclical consumers demand for irregular access to electricity, they can expand the insurance mechanism by affecting the level of enforcement in the negative side of the business cycle. This is likely to be the case when politicians have incentives to build political support among unprivileged groups in society. Therefore, I expect that a political regime change from autocracy to democracy should be correlated with more counter-cyclical fluctuations in electricity losses. This is again represented in Figure 2. An autocratic government always implements a given institutional enforcement with an associated level of cyclical shock ). In democracies, however, elecfluctuations in electricity losses (from Ei.e to Ei.e toral competition creates pressures for shifting toward a political enforcement effort during bad economic times. This change in enforcement allows for the provision of counter-cyclical informal transfers. Because economic crises have the effect of increasing the number of individuals willing to bear the costs of informal access to electricity (demand-side effect of the business cycles), deliberate non-enforcement is a tool for allocating even more resources when these are most needed. This is illustrated with the supply curve of political enforcement that has a smaller slope. The resulting cyclical variation in electricity theft due to a negative income shock shock . Therefore, as democracies are is represented by the change from Ei.e and Ei.e expected to respond to a larger selectorate (Bueno De Mesquita et al., 2005), informal transfers can be used as insurance policy.

Descriptive Evidence from Developing Countries and the BRICs Existing econometric analyses of the data show losses are counter-cyclical in the developing world (López-Cariboni, 2017; Balza et al., 2013). Here, I look at the cyclicality of transmission and distribution losses in different political regimes.

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Electricity losses are measured as the power lost over the total power output. Macroeconomic cycles are best described by the output-gap, which is the difference between real GDP per capita and the underlying growth trend measured as a percentage of that trend. A Hodrick–Prescott (HP) filter is used to estimate the growth trend. The HP filter implements long-run moving average to detrend the output series. Electricity losses and economic growth data come from the World Bank, World Development Indicators. Non-democracies are political regimes with “polity” scores lower or equal to six. This is a standard cutoff point used in the literature (see, for instance, Rudra and Haggard, 2005; Morrison, 2009; Kadera et al., 2003; Reiter, 2001; Rousseau et al., 1996). The data are from Marshall et al. (2010). The sample results from making use of all the available data on electricity losses, democracy, and real GDP per capita for developing countries between 1970 and 2015.2 In Figure 3, I show the correlation between business cycles and electricity losses. The shaded areas are 95% confidence intervals of a linear regression line  Developing countries are Afghanistan, Angola, Albania, Andorra, United Arab Emirates, Argentina, Armenia, Antigua and Barbuda, Azerbaijan, Burundi, Benin, Burkina Faso, Bangladesh, Bulgaria, Bahrain, Bahamas, Bosnia and Herzegovina, Belarus, Belize, Bolivia, Brazil, Barbados, Brunei Darussalam, Bhutan, Botswana, Central African Republic, Chile, China, Cöte d’Ivoire, Cameroon, Congo, the Democratic Republic of the, Congo, Colombia, Comoros, Costa Rica, Cuba, Cyprus, Czech Republic, Djibouti, Dominica, Dominican Republic, Algeria, Ecuador, Egypt, Eritrea, Estonia, Ethiopia, Fiji, Micronesia, Federated States of, Gabon, Georgia, Ghana, Guinea, Gambia, Guinea-Bissau, Equatorial Guinea, Grenada, Guatemala, Guyana, Honduras, Croatia, Haiti, Hungary, Indonesia, India, Iran, Islamic Republic of, Iraq, Israel, Jamaica, Jordan, Kazakhstan, Kenya, Kyrgyzstan, Cambodia, Kiribati, Saint Kitts and Nevis, Korea, Republic of, Kuwait, Lao People’s Democratic Republic, Lebanon, Liberia, Libya, Saint Lucia, Liechtenstein, Sri Lanka, Lesotho, Lithuania, Latvia, Morocco, Monaco, Moldova, Republic of, Madagascar, Maldives, Mexico, Marshall Islands, Macedonia, the former Yugoslav Republic of, Mali, Malta, Myanmar, Montenegro, Mongolia, Mozambique, Mauritania, Mauritius, Malawi, Malaysia, Namibia, Niger, Nigeria, Nicaragua, Nepal, Nauru, Oman, Pakistan, Panama, Peru, Philippines, Palau, Papua New Guinea, Poland, Democratic People’s Republic of Korea, Paraguay, Qatar, Romania, Russia, Rwanda, Saudi Arabia, Sudan, Senegal, Singapore, Solomon Islands, Sierra Leone, El Salvador, San Marino, Somalia, Serbia, South Sudan, Sao Tome and Principe, Suriname, Slovakia, Slovenia, Swaziland, Seychelles, Syrian Arab Republic, Chad, Togo, Thailand, Tajikistan, Turkmenistan, Timor-Leste, Tonga, Trinidad and Tobago, Tunisia, Turkey, Tuvalu, Tanzania, Uganda, Ukraine, Uruguay, Uzbekistan, Saint Vincent and the Grenadines, Venezuela, Viet Nam, Vanuatu, Samoa, Yemen, South Africa, Zambia, and Zimbabwe. 2

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(b)

Figure 3.   Electricity losses, economic cycles, and political regimes in developing countries between 1970 and 2015. Note: The dark-grey solid line and shaded area represent a linear fit with a 95% confidence interval. Source: World Development Indicators (the World Bank).

­ tted by least squares. Results confirm that losses are almost a-cyclical in autocrafi cies (Figure 3(a)) and strongly counter-cyclical in democracies (Figure 3(b)). As shown in Figure 3(b), losses increase when the output-gap is negative and decrease when the economy moves toward the upper side of the business cycle. The difference in the slopes between democracies and autocracies is statistically significant and economically relevant. While economic cycles have no significant effect on electricity losses in Latin American autocracies, democracies with income growth two points below the trend (i.e. 0 in the X-axis of the plot) are expected to have about 5% more of ­electricity losses than a democracy growing two points above the expectation. The evidence suggests some support to the theoretical logic outlined before. Electricity losses are strongly counter-cyclical in democracies but not in autocracies, which would indicate that political leaders pressured by electoral competition provide informal insurance in developing countries.

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Figure 4:   Electricity losses and economic cycles in BRIC countries. Note: The dark-grey solid line and shaded area represent a linear fit with a 95% confidence interval. Source: World Development Indicators (the World Bank) and Polity IV dataset from Marshall and Jaggers (2010).

Now, how do the BRICs square with the aforementioned logic? Figure 4 replicates the analysis for each of the BRIC countries. Interestingly, the two democratic countries over the period, Brazil and India, have the most countercyclical evolution of transmission and distribution losses, as indicated by the negative slopes. As also shown in Figure 4, the weakly democratic Russia and the authoritarian China have both lower levels of losses and lower counter-cyclicality of TDL. This is, of course, only very descriptive data and conclusions should be made with caution. Even so, one can speculate that democratization in China and Russia, involving more responsiveness of political incumbents toward their citizens, may also contribute with changes in the patterns in irregular transfers, as long as informal arrangements are a viable political strategy to protect different income groups. Moreover, this is a clear example of how political change in BRIC countries, when desirable, also involves several important challenges; while protecting vulnerable groups is always positive and often more likely under democracy, the politics of insurance under electoral competition may produce suboptimal outcomes such as the expansion of informal transfers.

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Concluding Remarks This chapter describes unconventional forms of social insurance and discusses the implications of political regime change for such policies in developing countries and BRICs. The main argument is that democratic incumbents from developing countries are challenged with the need to provide insurance in highly volatile contexts, where consumption-smoothing mechanisms are inexistent. In such contexts, I find some evidence pointing in the direction that democracies provide informal insurance while autocracies, if any, do it to a lesser extent. An example of this political strategy is the provision of irregular access to basic services. Irregular access to electricity may work as a program of informal transfers to smooth consumption in developing countries. I show descriptive evidence that electricity losses are counter-cyclical in democratic countries but not in autocracies. While the main purpose of this chapter is to discuss an argument about informal social insurance in developing countries, as well as to provide some descriptive evidence, more research is needed regarding both the robustness of the findings and the mechanisms implied in the causal chain. The implications of the logic proposed here are important for the authoritarian China and the not fully democratic Russia. As their other two BRIC counterparts Brazil and India demonstrate, democracy seems to be highly correlated with countercyclicality of electricity losses in these countries. Pensiveness of electricity theft, used as a consumption-smoothing policy, should warn about vicious traps and perverse consequences. The notion that informality provides outside options to smooth consumption is not new (Rosenzweig, 1988). When politicians stimulate such a type of behavior, the results are not only problematic in terms of aggregated efficiency, they also deepen existing inequalities between formal and informal sectors. Those who do not pay the bill and are informally allowed to consume irregular energy only get access to a lower quality service while increasing their risk to human life and material loss.

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PART III

Labor Market Informality, Mobilization, and Preferences

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CHAPTER 7

How the Labor Force is Mobilized: Patterns in Informality, Political Networks, and Political Linkages in Brazil Soledad Artiz Prillaman* and Jonathan Phillips† Nuffield College, University of Oxford, UK Department of Government, Harvard University, Cambridge, USA *

†

Introduction The 40–60% of Latin American workers in the informal sector experience the state very differently from their formal counterparts. But they also experience the political process in a markedly different way. As a result of their historical and spatial marginalization, economic vulnerability, and institutional barriers, informal workers have been mobilized into very different political networks. Yet, in recent decades, the boundary between the formal and informal labor forces has blurred. Workers transitioning into/out of formality find themselves exposed (1) to new sources of information about politicians and the experiences of other citizens; (2) to political actors with different motivations and resources; and (3) to new kinds of political ideas, technologies and promises. This chapter descriptively documents the relationship between informality and political experience with a particular focus on how labor market status shapes access to political networks. It additionally highlights the important spatial variation in the concentration of informality and documents the descriptive correlation of this variation with the nature of political ties and linkages.

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As a result, this chapter provides one of the first approaches to understanding informality as both an individual and a collective identity. Latin American labor markets have traditionally been segmented between those with formal employment and those without (Schneider, 2009). Since the late 1990s, however, there have been large and rapid changes in the structure of the labor force. This is due in large part to economic liberalization generating structural shifts in the economy and ushering in a wave of deindustrialization (Portes and Hoffman, 2003). Alongside these macroeconomic shifts, there have been massive changes in the macropolitical context, including the third wave of democratization and accompanying overhauls of the policy space. In most Latin American countries, this has led to the extension of the State through welfare programs. Prior to these macroshifts, the division between the informal and formal labor force was stable, with little movement of individuals between the formal and informal work forces. Over the last 30 years, however, this stark boundary has blurred, resulting in more flexible labor market boundaries. In general, this resulted in immediate declines in public sector and formal employment (Portes and Hoffman, 2003). As we will show, over time, however, formalization has again increased, in Brazil in particular. Changes in the structure of the labor force bear important consequences for macropolitics and political behavior. An established literature in the comparative political economy of industrialized democracies demonstrates how the division between those with secure employment — “insiders” — and those without secure employment — “outsiders” — affects political institutions, social policy, and party strategy (Rueda, 2005; Lindvall and Rueda, 2014; Palier and Thelen, 2010; Iversen and Stephens, 2008; Iversen and Soskice, 2009). A burgeoning literature in Latin America extends this to a developing context where informality defines a salient labor market cleavage separating insiders and outsiders. This literature documents the particular ways that informality shapes policy decisions and party organization (Carnes and Mares, 2013; Garay, 2017, and in the contributions to this volume). Class and employment status have long been considered the foundation of important political cleavages. Furthermore, the workplace has been shown to be a critical place for political socialization, discussion, and mobilization (Pateman, 1970; Elden, 1981; Collier and Collier, 2002; Frye et al., 2014). Because of the formative political influence of workplace and the socializing consequences of regular labor market interactions, informality can impact political behavior in meaningful ways. Previous work across Latin America has shown that informal workers have different political preferences, particularly as it pertains to non-contributory social policies (Carnes and Mares, 2013). In Mexico, Altamirano Hernandez (2015) documents how informality translates into partisanship and party strategy, arguing that informality is associated with both lower partisanship and greater use of clientelistic appeals by politicians. Baker and Velasco-Guachalla (2018), however, argue that

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the growing fluidity between the informal and formal labor markets (Schneider, 2013) and intrahousehold heterogeneity in labor market status (Maloney, 1999) result in few differences between informal and formal workers in terms of political participation and party and policy preferences. While these macropolitical outcomes, such as partisan affiliation and social policy preferences, have been identified, the micropolitical processes by which informality generates alternative policy frames, new linkages to politicians, and alternative political identities have received limited attention. Understanding how informality reshapes political connection, organization, and competition will help provide a more comprehensive model of political behavior as responsive to shifts in the labor market. Tracing the micromechanisms is also vital to separating the effects of individual labor market status from the effects of place and the local labor market environment (as Zucco et al. (2010) demonstrates for exposure to social policy). Reflecting a growing understanding of the role of personal connections and daily experiences in political mobilization and socialization, we argue that one important mechanism underlying the political differences between informal and formal workers regards access to and the composition of political networks. Specifically, we hypothesize that informal workers will have fewer political ties in the workplace as a result of the fragmented and insecure nature of informal work. We further argue that informal workers will have less access to clientelist offers because they are relatively harder to identify, coordinate, and monitor. These effects, however, are expected to be mediated by the local labor market context and the political power of informal workers. Changes in the structure of the labor market are likely to generate changes in the ways politicians seek to mobilize citizens and the political strategies that citizens themselves perceive as feasible. This chapter seeks to understand the distinct ways in which workers are mobilized into politics depending on the formality of their employment and its change over time. Using both census and survey data from Brazil, we demonstrate that informal workers have fewer political connections, less work-based political discussion, and less access to clientelist offers than formal workers. We further show that these effects are exacerbated in regions with the highest rates of informality in the labor force, but may be mitigated by temporal reductions in informality. These results compel a deeper understanding of informality as a political identity critical in the formation of micro-level political networks and linkages.

How the Labor Force is Mobilized In what some have deemed the “undermobilization hypothesis”, it has been argued that informal workers are less likely to be collectively organized because of the ­inherent challenges in coordinating socially atomized workers across generally low

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visibility, fragmented, and small enterprises (Roberts, 2002; Baker and VelascoGuachalla, 2018). This hypothesis is an extension of the robust evidence that the workplace has long been a key place for political mobilization (Collier and Collier, 2002). A primary example is evidenced by the historic role of unions in political ­mobilization (Dix, 1989; Leighley and Nagler, 2007; Rosenstone and Hansen, 1993), which is further argued to reinforce the particular mobilization of formal sector workers. Evidence documenting (or contradicting) this hypothesis tests the relationship between informality and political participation and partisanship (Baker and Velasco-Guachalla, 2018). However, this skips over the informal and non-institutional processes of ­political organization and network-building that are most likely to affect informal workers. What is lacking is an understanding of how informality mediates political discussion inside and outside of the workplace, political connections, and linkages with political elites. It is these processes which are likely to drive changes in participation and partisanship, and which allow us to explain those broader outcomes. We explore the link between individual informality and political ties directly and argue that informality affects the political mobilization of workers both through its effect on individual political discussion and network-building and also by conditioning the nature of political linkages with candidates and politicians. We further argue that labor market status should not be studied in isolation but instead labor market identity must be considered within the local labor market context. First, informality is likely to shape individual political behavior through its effect on social and political networks.1 We know that who you associate with matters for political engagement and preferences (Putnam, 2001). Furthermore, political connections are a function of social connections more generally (Sinclair, 2012) and therefore access to social and economic networks importantly conditions the availability of political ties (Artiz Prillaman, n.d.). Informal workers, we argue, face higher burdens to political connection than formal workers. This is a direct consequence of the social isolation of informal work. Informal workers tend to be self-employed or employed in small and marginal enterprises and many are employed in seasonal, contract, or transient work. This makes the development of stable social networks rooted in the workplace difficult and instead suggests that core social connections would happen outside of the workplace, such as in the household and the broader community. The non-existence or superficiality of workplace connections for informal workers further limits the potential for sustained political discussion in the workplace. Further, due to their  It is worth noting that there are many other ways in which informality is likely to shape individual political behavior, such as through exposure to political ideas and information. It is beyond the scope of this chapter to explore all of these possible mechanisms. 1

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distance from the state, they lack important shared experiences and identities, or a common reference point for framing political opinions. In aggregate, this suggests that as informality rises so does the likelihood of politics happening outside of the workplace. In part this is simply a function of the greater scale and visibility of informality in the local labor market as described above. However, informal workers also do not live in a vacuum but instead exist within household and communities of other informal and formal workers. As the concentration of informality increases, networks incorporating informal workers become more politically important. This therefore increases the potential political power of informal workers and allows for political coordination to occur in ways compatible with informal workers’ interests. Second, we argue that informality will also affect the ways that workers establish ties and linkages with politicians, and particularly will make it more difficult to engage in clientelistic linkages, even where there is a greater preference for clientelist offers. Informal workers have been shown to prefer clientelistic appeals over programmatic appeals (Levitsky, 2003; Altamirano Hernandez, 2015). Others have argued that informal workers have less of a stake in many programmatically delivered policies, particularly welfare policies that have historically been tied to formal employment in Latin America (Haggard and Kaufman, 2008; Carnes and Mares, 2013). Further, the fragmented nature and diversity of informal work makes it difficult to identify a common interest or policy preference among informal workers (Baker and Velasco-Guachalla, 2018). Despite the greater preference for clientelist appeals among informal workers, we argue that informal workers will receive fewer of these appeals than formal workers. The disparate and transient nature of informal work makes it difficult and relatively more costly for clientelist politicians to mobilize informal workers. Informal workers are (1) poorly connected within the informal workplace, (2) difficult to identify and contact, and (3) costly to monitor. In combination, this makes delivery of clientelist appeals more costly for informal workers as compared to their formal counterparts who are easier to identify and contact. Similarly, the difficulties of locating and monitoring informal workers suggest that politicians are likely to switch their mobilization strategies away from personal visits. As a result, we argue that informal workers will have less exposure to clientelist politicians and offers as compared to formal workers despite their relative preference for clientelist offers over programmatic offers.

Defining and Measuring Informality We center our empirical study in Brazil. As the largest economy in Latin America and having undergone significant political and economic shifts in recent decades, Brazil provides a fruitful testing ground to explore the linkages between labor

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market status and political networks. Brazil has a large informal work labor force and has experienced large changes in informality rates in recent decades (Portes and Hoffman, 2003). Furthermore, since democratization in 1985, Brazil has also experienced large changes in the structure of political networks. A distinct advantage, however, of working in Brazil is the availability of relevant data. A key challenge to the study of informality cross-nationally is creating a common definition of informality. Economic definitions of informality have focused on characteristics, such as enterprise scale, low pay, and employee productivity, but these traits do not connect naturally with theories of political engagement which are the focus of this volume (Maloney, 1999; Henley et al., 2006). Instead, it is how these economic activities are embedded in relationships between employees, employers and the state which provides the fuel for political contestation, identity, and discussion. Workers formulate their opinions on politics and politicians based on the gains and losses they perceive in their personal accounts with the state, and the collective experience of these gains and losses. Informality is characterized by the distance between economic activity and the state, with informal firms and enterprises predominantly falling outside the scope of any gains and losses in their transactions with the state. As Maloney and Saavedra-Chanduvi (2007) emphasize, this distancing may be the result of active exclusion by the state, or a form of “exit” (Hirschman, 1970), as economic actors evade the state. Either way, informal work is a multi-dimensional situation and a matter of degree rather than kind, reflecting the vast range of state regulations which businesses and employees can fail to comply with, and the multiplicity of state organizations to which they may be more or less visible (Hussmanns, 2004). To simplify the analysis and contextualize it within Brazil, we use a definition of informality which focuses on employees’ own circumstances rather than those of their employers, and on a single consistent and widely understood labor market boundary which reflects the social construction of informality in the local context. In Brazil, this boundary of demarcation is the possession of a signed work card (carteira de trabalho assinada) that both increases the visibility of employees to the state for purposes, such as taxation and labor rights enforcement, and entitles them to social protection, such as unemployment insurance. Related definitions have been used in academic research in Brazil for decades, including the work of Merrick (1976) in Belo Horizonte who studied worker membership of social security institutes, and more recently the work of Fairris and Jonasson (2016) and Baker and Velasco-Guachalla (2018) in explaining changes in the size of the informal sector. An additional benefit of this definition is its ease of measurement

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for the entire population using the Brazilian Census, described in detail in the following sections.

The Changing Patterns of Informality in Brazil Figure 1 plots the percentage of the labor force that is informal for each census weighting area in Brazil. The average census weighting area has an informality rate of 27.2%. This average rate, however, fails to capture the vast regional variation

% Informal Workers

20

40

60

Figure 1:   Map of 2010 informality rate by census weighting area.

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across the country in informality. This variation further reveals systematic patterns in the spatial distribution of informality. There is a clear division in labor market structures between the prosperous formal sectors in the South, Southeast and parts of the Center–West regions, where less than a quarter of the population are employed informally, and the relatively poorer North and Northeast where over half the population are employed informally. Local patterns are also visible, with the major cities of the littoral Northeast and the agro-industrial corridor of highway BR-364 running parallel to the Bolivian border exhibiting significantly higher rates of formal employment.

Reduction in % Informal 0 Workers 2000−2010

10

20

30

Figure 2:   Percentage reduction in the rate of informal employment between 2000 and 2010 by municipality.

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% Informality in 2010

0.6

0.4

0.2

0.00

0.25 0.50 0.75 % Informality in 2000 (a)

1.00

% Points Change in Informality from 2000 to 2010

Brazil has also seen significant changes in informality over the past decade. Figure 2 geographically maps the average reduction in the population rate of ­informality across municipalities in Brazil and demonstrates a remarkable formalization of the labor force over the decade. Changes in informality between 2000 and 2010 can only be consistently measured at the level of the municipality — a geographically larger unit than the census weighting sector. Figure 2 illustrates that during this period there was a nationwide process of formalization that affected every region (i.e. that the vast majority of municipalities saw a reduction in informality over the period.), albeit of varying degrees. Only in small pockets of the interior cerrado of the Northeast was informality unchanging, and only in the already-formalized region of Saũo Paulo did informality rates fail to fall substantially. In the average municipality, informality fell by 17.1% points from 2000 to 2010. This process of formalization was highly equalizing: Figure 3 highlights that this decline in informality was concentrated in the places that experienced the highest rates of informality in 2000. Figure 3(a) plots the municipality rate of informality in 2000 against the municipality rate of informality in 2010. Points along the dashed line would indicate no change in the informality rate. Instead, we see that most points fall below this line, signaling declines in the rate of informality from 2000 to 2010. Figure 3(b) plots the municipality rate of informality in 2000 against the change in the municipality rate of informality from 2000 to 2010. The negative correlation of this data demonstrates that the regions with the highest

0.25

0.00

−0.25

−0.50

0.00

0.25 0.50 0.75 % Informality in 2000

1.00

(b)

Figure 3:   Changes in the rate of informal employment between 2000 and 2010.

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% Excess Female Informality −10 0 10 20 30 40 Figure 4:   Difference between female informality rate and male informality rate in 2010 by census weighting area.

rates of informality in 2000 were also the regions with the greatest decline in informality from 2000 to 2010. It is worth noting that informality affects women more frequently than men. As Baker and Velasco-Guachalla (2018) notes, it is common for households to have members from both the formal and informal labor forces. Figure 4 plots the difference between the informality rate for women and the informality rate for men in a given census weighting sector in 2010. Positive values signal greater informality among women. The average census weighting area exhibits informality rates of

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8.7% points higher for women as compared to men. As Figure 4 further illustrates, this is a consistent national pattern affecting both the more advanced manufacturing and knowledge economy sectors in the South and the less developed economy of the North. The only exception to this uniform picture appears to be a narrow swathe of the interior of the Northeast away from the coast where formality rates are more equal.

Data and Method Brazilian Census Data The salience of the Brazilian signed work card means that it is a central measure in the national census, providing a rare opportunity to measure in detail the distribution, change, and concentration of informality. We draw on both the 2000 and 2010 censuses which explicitly ask respondents whether they have a signed work card (IBGE, 2000, 2010). For our measure of informality, in 2000 we use variable V0447 to create a binary indicator of informality indicating whether a respondent is employed without a signed work card or as an unpaid apprentice, domestic worker or subsistence producer (conditions which also entail the lack of a signed work card). In 2010, we use variable V0648 to create a binary indicator of informality indicating whether a respondent is employed without a signed work card or works without remuneration. While the data is a census of Brazilian residents, it is only available at aggregated geographic units. Wherever possible, our analysis uses the most geographically disaggregated version of the census data available — the census weighting area. Each unit therefore represents a geographic area that is more granular than a municipality. Further, the census weighting areas do not normally coincide with administrative boundaries within the municipality. This provides maximum variation, provides a more precise definition of the local labor market, and allows us to minimize the risk of confounding from the distinct political experiences of specific states or municipalities. To compare data from the 2000 and 2010 censuses and therefore changes in the rate of informality, however, the lowest unit of aggregation possible is the ­municipality — a larger geographic unit than census weighting units. Municipalities in Brazil are administrative units of local government with elected officials. In total, Brazil has 5,570 municipalities. In addition to capturing informality and change in informality from 2000 to 2010 at the municipality level, we additionally measure the average income in the municipality and include this as a control in all analyses.

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Brazilian Electoral Panel Study The data sources available to measure political experiences and networks are much thinner. This lack of availability of data linking labor market status and political outcomes has limited research to date. Our hypotheses require us to measure individual informality in addition to aggregate rates of informality, further restricting the suitable datasets. We use the Brazilian Electoral Panel Surveys, conducted as separate panels in 2010 (Ames et al., 2016) and 2014 (Rennó et al., 2016), as the most comprehensive and detailed data source for the outcome variables. The 2010 panel conducted a three-wave sample in March, August and November 2010 covering 4,611 unique respondents in 16 states and 60 municipalities. The 2014 panel conducted a seven-wave sample covering 3,151 unique respondents in 22 states and 118 municipalities. Both datasets were merged with the census data at the level of the weighting area. Given differences in variables across the two waves, we will focus our analysis on the 2010 panel. Limited results from the 2014 panel can be found in the appendix.2 The analysis considers two key sets of outcome variables: engagement in political networks and forms of linkage to political actors. The first allows us to evaluate how informality reshapes political networks and the location of political discussion. To measure political networks, we use a binary measure of whether the survey respondent personally knows a politician or someone campaigning for a politician.3 To measure the most salient political discussion networks, we utilize a question from the BEPS survey that asked respondents which people they discuss politics with, allowing only one answer.4 From this, we created three different binary measures of whether the respondent reports discussing politics at work, outside of work such as with friends and family, or whether they report never discussing politics.

 While the 2010 dataset includes variables more closely aligned to our outcome of interest of political experiences and networks, it provides only a subjective measure of individual informality, “unemployed but working informally”. While this is less precise than explicitly asking about the possession of a signed work card, we believe that in the Brazilian context there is a decade–long social understanding of informality that is tightly tied to possessing a signed work card. The 2014 dataset provides data from this more consistent definition of informal employment. 3  Respondent knows a politician or candidate personally or knows a person who is campaigning for a politician or candidate. 4  Person with whom the respondent talks about politics. 2

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The second set of political linkage measures allow us to evaluate how informality correlates with exposure to a range of political mobilization practices, particularly clientelist practices. To measure exposure to clientelist offers, we utilize responses to a question on frequency of encountering clientelist offers (offers of food, favor or other benefits in return for their vote or support). Additionally, we include a binary indicator of whether the respondent was offered money to campaign for a candidate. We also include binary indicators of other forms of contact with candidates during campaigns, including whether the respondent had been called by a candidate, been mailed a campaign flier, or received a home visit during the campaign. In addition, the appendices examine changes in participation and political interest. Empirical Approach The available data allow only for a descriptive evaluation of the relationship between informality, both at the individual and locality level, and political networks and linkages. We do not claim that any of the results we present are causal, but instead aim to paint a pattern of likely reinforcing relationships that provide deeper insights into the experiences of informality. The empirical models that follow are OLS regressions of individual informality, local informality rates, and their interaction on the above noted political outcomes. These regressions control for an indicator of being out of the labor force to ensure the base category is formal workers, gender, age, income, education, whether the respondent is a beneficiary of Bolsa Família (a conditional cash transfer welfare program), and municipality average income. Standard errors are clustered at the census sector level. We run an additional set of regressions to evaluate how the change in informality, as measured by the percentage point reduction in informality in a municipality from 2000 to 2010, is correlated with political outcomes. In these regressions, we additionally control for the base rate of informality in the municipality in 2000.

Informality and Political Mobilization in Brazil How does being informally employed correlate with the political networks and discussions in which Brazilians are engaged? Tables 1 and 2 report the regression coefficients linking informality with political networks and political linkages respectively. The results in Table 1 suggest that controlling for individual socioeconomic characteristics and neighbourhood characteristics, including average income and

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Talk Politics: Work

0.309 (0.192)

0.310 (0.207)

0.257*** (0.081)

Informally employed

-0.005 (0.048)

-0.004 (0.099)

-0.046* (0.024)

Local informality × informal worker

-0.003 (0.389)

Talk Politics: Friends

Never Talk Politics

0.334*** (0.091)

0.129 (0.093)

0.085 (0.103)

-0.142 (0.127)

-0.213 (0.139)

0.039 (0.045)

0.059** (0.027)

0.009 (0.054)

-0.103*** (0.034)

-0.181** (0.073)

0.201 (0.205)

-0.342** (0.160)

0.317 (0.258)

Not working

-0.058 (0.043)

-0.058 (0.043)

-0.050*** (0.018)

-0.051*** (0.018)

-0.001 (0.019)

-0.001 (0.019)

-0.013 (0.028)

-0.012 (0.028)

Female

-0.081** (0.036)

-0.081** (0.036)

-0.061*** (0.016)

-0.062*** (0.016)

-0.070*** (0.017)

-0.069*** (0.017)

0.084*** (0.025)

0.085*** (0.025)

Age

0.001 (0.001)

0.001 (0.001)

0.001** (0.001)

0.001** (0.001)

0.001** (0.001)

0.001** (0.001)

-0.001* (0.001)

-0.001* (0.001)

Income

0.021 (0.013)

0.021 (0.013)

0.009* (0.005)

0.009* (0.005)

-0.002 (0.006)

-0.002 (0.006)

-0.029*** (0.008)

-0.029*** (0.008)

Education

0.014** (0.006)

0.014** (0.006)

0.006** (0.003)

0.006** (0.003)

0.006** (0.003)

0.006** (0.003)

-0.026*** (0.004)

-0.026*** (0.004)

CCT beneficiary

0.124*** (0.042)

0.124*** (0.042)

0.042** (0.019)

0.042** (0.019)

0.088*** (0.023)

0.088*** (0.023)

-0.126*** (0.029)

-0.125*** (0.029)

Avg income in local area

-0.0001 (0.00004)

-0.0001 (0.00004)

-0.00001 (0.00002)

-0.00001 (0.00002)

-0.00003* (0.00002)

-0.00003* (0.00002)

0.0001** (0.00003)

0.0001** (0.00003)

Constant

0.387*** (0.116)

0.387*** (0.117)

-0.013 (0.045)

-0.029 (0.046)

0.043 (0.051)

0.052 (0.052)

0.860*** (0.073)

0.875*** (0.074)

792

792

1,766

1,766

1,766

1,766

1,766

1,766

R2

0.047

0.047

0.035

0.037

0.037

0.038

0.065

0.066

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Table 1:   Regression estimates of the relationship between the rate of informality and political networks using 2010 BEPS survey.

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Table 2:   Regression estimates of the relationship between the rate of informality and political linkages using 2010 BEPS survey. Frequency of Clientelist Offers

Received Phone Call

Received Mail Contact

Received Home Visit

Received Vote-Buying Offer

0.217** (0.107)

0.278** (0.118)

-0.103 (0.103)

-0.045 (0.107)

0.447*** (0.137)

-0.288** (0.146)

1.116*** (0.177)

1.111*** (0.196)

-0.082 (0.078)

-0.074 (0.083)

Informally employed

-0.076** (0.030)

0.0002 (0.059)

0.016 (0.029)

0.079 (0.062)

0.033 (0.042)

0.207** (0.082)

-0.006 (0.040)

-0.011 (0.084)

-0.047* (0.024)

-0.039 (0.033)

— —

-0.321 (0.216)

— —

-0.286 (0.185)

Local informality × informal worker

— —

-0.780*** (0.249)

— —

0.022 (0.356)

— —

-0.036 (0.095)

-0.079*** (0.024)

-0.080*** (0.024)

-0.009 (0.026)

-0.011 (0.026)

-0.022 (0.036)

-0.026 (0.036)

-0.002 (0.035)

-0.002 (0.035)

-0.011 (0.023)

-0.011 (0.023)

Female

-0.028 (0.021)

-0.029 (0.021)

-0.015 (0.023)

-0.016 (0.023)

-0.063** (0.031)

-0.066** (0.031)

-0.040 (0.030)

-0.040 (0.030)

-0.068*** (0.019)

-0.068*** (0.019)

Age

-0.003*** (0.001)

-0.003*** (0.001)

0.002** (0.001)

0.002** (0.001)

0.003** (0.001)

0.003** (0.001)

-0.0002 (0.001)

-0.0002 (0.001)

-0.003*** (0.001)

-0.003*** (0.001)

Income

0.003 (0.007)

0.003 (0.007)

0.015* (0.009)

0.014* (0.009)

0.020* (0.011)

0.020* (0.011)

0.011 (0.010)

0.011 (0.010)

-0.001 (0.008)

-0.001 (0.008)

Education

0.004 (0.003)

0.004 (0.003)

0.004 (0.003)

0.004 (0.003)

0.015*** (0.005)

0.014*** (0.005)

0.007 (0.005)

0.007 (0.005)

0.001 (0.002)

0.001 (0.002)

CCT beneficiary

0.107*** (0.025)

0.106*** (0.025)

0.001 (0.023)

0.001 (0.023)

0.005 (0.034)

0.006 (0.034)

0.022 (0.037)

0.022 (0.037)

0.017 (0.025)

0.017 (0.025)

Avg income in local area

0.00005* (0.00003)

0.00005* (0.00003)

0.00004 (0.00003)

0.00004 (0.00003)

0.0001 (0.00004)

0.0001 (0.00004)

0.00001 (0.00003)

0.00001 (0.00003)

-0.00001 (0.00003)

-0.00001 (0.00003)

Constant

1.227*** (0.063)

1.216*** (0.064)

-0.066 (0.078)

-0.075 (0.078)

0.039 (0.100)

0.017 (0.101)

-0.088 (0.096)

-0.088 (0.097)

0.244*** (0.059)

0.243*** (0.059)

N

2,957

2,957

800

800

798

798

800

800

797

797

R2

0.027

0.028

0.041

0.043

0.093

0.100

0.083

0.083

0.054

0.054

Notes: Local area clustered standard errors in parentheses. *p < 0.1; **p < 0.05; ***p < 0.01. 11-02-2020 13:46:07

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Not working

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informality rates in the labor market, those in informal employment are significantly more likely to discuss politics than formal sector workers, but when they have those discussions they are more likely to take place among friends and family and less likely to take place in the workplace. While they are no more or less likely to have personal political connections, these findings suggest that informal workers’ political engagements and interactions are at least equally as common as formal workers’ but less public. However, Table 1 also demonstrates that workplace political discussion is more common in areas with a higher rate of informality. While this might appear in ­c ontradiction to the negative correlation between individual informality and workplace discussion, an analysis of the interaction between individual and collective informality paints a clearer picture. Figure 5 plots the marginal effect of individual informality conditional on the rate of informality in the census weighting sector and shows that the the negative correlation between individual informality and ­workplace discussion is increasing in the percentage of the population that is informal. This suggests that workplace discussion among informal workers becomes even less frequent when the rate of informality is higher in the labor market. The gap in workplace discussion between formal and informal workers is concentrated among labor markets dominated by informal work. Symmetrically, it is only in the most informal labor markets that informal workers substitute for the lack of workplace discussion by increasing their discussion of politics among friends. Figure 6 further cements this relationship by demonstrating that the positive effect of the percentage of informality in a local area on workplace discussion is only significant for the formally employed. Areas with high rates of informality are the same areas where formal sector workers are most likely to discuss politics at work. In short, there are two responses to informality depending on the labor market context: where they are in the minority, informal workers behave similar to formal workers; where they are in the majority, informal workers simply shift the location of their political debate from the workplace to more private settings among friends. Table 2 considers the relationship between individual and collective informality on outcomes related to alternative political linkages. Controlling for the same potential confounders, Table 2 suggests that informal employees experience fewer clientelist and vote-buying offers but on average appear no more or less likely to be contacted by a politician either by phone, mail or in person. This is in line with the hypothesis that informal workers are harder to target and monitor for clientelistic exchanges. Figure 7 reports the marginal effect of individual informality conditional

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How the Labor Force is Mobilized 173 Personal Political Connections

Talk Politics: Work

0.2

Marginal Effect for Informality

Marginal Effect for Informality

0.1

0.0

−0.2

0.0

−0.1

−0.2

−0.3 0.2 0.4 0.6 % Informal in Local Area CI(Max − Min): [−0.424, 0.413]

0.2 0.4 0.6 % Informal in Local Area CI(Max − Min): [−0.362, −0.014] Never Talk Politics

Talk Politics: Friends

0.2

Marginal Effect for Informality

Marginal Effect for Informality

0.2

0.1

0.0

0.2 0.4 0.6 % Informal in Local Area CI(Max − Min): [−0.084, 0.296]

0.1

0.0

−0.1

−0.2

0.2 0.4 0.6 % Informal in Local Area CI(Max − Min): [−0.101, 0.441]

Figure 5:   Marginal effects of individual informality conditional on percentage of informality in local area.

on the percentage of informality in the census weighting area from the interaction regressions. It further highlights that this negative relationship is strongest when local informality is high. There is a positive correlation between the percentage of informality in the census weighting area and the frequency of receipt of clientelist offers. Looking at the marginal effect of local informality conditional on individual informality, Figure 8 demonstrates that this positive effect of local informality on frequency of clientelist offers only holds for those who are formally employed. Figure 8 also

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Personal Political Connections

Talk Politics: Work

Marginal Effect for % Local Informality

Marginal Effect for % Local Informality

1.0

0.5

0.0

0

0.4

0.2

0.0

−0.2

1 Individual Informality CI(Max − Min): [−0.779, 0.759]

0

Talk Politics: Friends

Never Talk Politics 0.6 Marginal Effect for % Local Informality

0.6 Marginal Effect for % Local Informality

1 Individual Informality CI(Max − Min): [−0.665, −0.025]

0.4

0.2

0.0

0

1 Individual Informality CI(Max − Min): [−0.155, 0.544]

0.3

0.0

−0.3

0

1 Individual Informality CI(Max − Min): [−0.186, 0.811]

Figure 6:   Marginal effects of percentage of informality in local area conditional on individual informality.

shows that all people are more likely to receive a home visit from a politician in areas with higher rates of informality. This supports the broader literature that notes the c­ oncentration of clientelism and personalized politics in informal settings, but s­ uggests that clientelist responses are targeted towards the easily identifiable formally employed. The null average effects of informality on interactions with politicians also disappear when we consider the influence of the local labor market (see Figure 5).

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How the Labor Force is Mobilized 175 Frequency of Clientelist Offers

Received Phone Call

0.1

0.0

Marginal Effect for Informality

Marginal Effect for Informality

0.1

−0.1

0.0

−0.1

−0.2

−0.2

−0.3

0.2

0.4 0.6 % Informal in Local Area CI(Max − Min): [−0.417, 0.062]

0.2

Received Mail Contact

Received Home Visit 0.2 Marginal Effect for Informality

0.2 Marginal Effect for Informality

0.4 0.6 % Informal in Local Area CI(Max − Min): [−0.395, 0.081]

0.0

−0.2

0.1

0.0

−0.1

−0.4

−0.2

0.2

0.4 0.6 % Informal in Local Area CI(Max − Min): [−0.775, −0.081]

0.2

0.4 0.6 % Informal in Local Area CI(Max − Min): [−0.333, 0.35]

Received Vote−Buying Offer

Marginal Effect for Informality

0.1

0.0

−0.1

−0.2 0.2 0.4 0.6 % Informal in Local Area CI(Max − Min): [−0.237, 0.193]

Figure 7:   Marginal effects of individual informality conditional on percentage informality in local area.

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176  S. A. Prillaman and J. Phillips

Frequency of Clientelist Offers

Received Phone Call Marginal Effect for % Local Informality

Marginal Effect for % Local Informality

0.50

0.25

0.00

−0.25

0.00

−0.25

−0.50

−0.75

−0.50 0

1

0

Individual Informality CI(Max − Min): [−0.767, 0.114] Received Mail Contact

1 Individual Informality CI(Max − Min): [−0.726, 0.15]

Received Home Visit Marginal Effect for % Local Informality

Marginal Effect for % Local Informality

0.0

−0.5

−1.0

−1.5

1.5

1.0

0.5

0.0 0

1 Individual Informality CI(Max − Min): [−1.424, −0.149]

0

1 Individual Informality CI(Max − Min): [−0.613, 0.644]

Received Vote−Buying Offer Marginal Effect for % Local Informality

0.25

0.00

−0.25

−0.50 0

1 Individual Informality CI(Max − Min): [−0.435, 0.355]

Figure 8:   Marginal effects of percentage of informality in local area conditional on individual informality.

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How the Labor Force is Mobilized 177

This average masks a bias towards targeting the minority labor segment with phone calls and mails. Thus, in formalized contexts, it is informal workers who are targeted, and in informal labor markets it is formal workers who are targeted. In sum, this suggests that when informal workers are few in number, they are just as likely to be the subject of clientelist appeals, but where they are in the majority it appears that politicians may prefer to target formal sector workers, perhaps reflecting their greater ability to influence broader networks of voters or the greater ease of mobilization through broader political networks and easier identifiability. Gender and Informality It is worth noting the significant differences in the political behavior of men and women. Table 1 reveals that women are less likely to have personal political connections or to talk about politics at work or with friends than men. Furthermore, Table 2 shows that women are less likely to receive clientelist and vote-buying offers than men. This is unsurprising given the vast literature on the gendered nature of political behavior (Burns et al., 2001; Artiz Prillaman, n.d.). Table A.1 further reveals that all significant effects of individual informality on political networks only hold for men. This is unsurprising given the disconnected and isolated informal work often borne by female workers. Furthermore, Table A.2 shows that the effects of individual informality and local informality on clientelistic offers also hold only for men. Essentially, this suggests that informality as a political identity may be more salient for men than for women (Tables A.3–A.7). Further research is needed and warranted to better understand the gendered dynamics of informality and its consequences for political behavior. Evaluating Changes in Local Informality Tables 3 and 4 supplement the above findings by focusing on how reductions in local informality from 2000 to 2010 at the municipal level have altered the different political experiences of the formally and informally employed, controlling for individual characteristics and the municipal percentage of informality and municipal average income in 2000. Table 3 highlights that where reductions in informality have been most rapid, all workers have been increasingly active in political debate, and have shifted that debate increasingly to the workplace and away from friends and family. Contrary to the results for levels of informality, Figure 9 demonstrates that these effects of reductions in informality hold for both formal and informal workers and the effect size is even substantively larger for informal workers.

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Informally employed Change in local informality × informal worker Not working Female Age Income Education CCT beneficiary Avg income in local area % informality in local area in 2000 Constant

-0.242 (0.340) -0.008 (0.052) — — -0.023 (0.046) -0.093** (0.039) 0.001 (0.001) 0.026* (0.014) 0.017*** (0.006) 0.107** (0.044) -0.00003 (0.00005) 0.393** (0.195) 0.316** (0.128)

0.086 (0.382) 0.159 (0.097) -1.214** (0.589) -0.023 (0.045) -0.094** (0.039) 0.001 (0.001) 0.026* (0.014) 0.017*** (0.006) 0.105** (0.044) -0.00004 (0.00005) 0.348* (0.197) 0.294** (0.127)

671 0.049

671 0.054

Women 0.452*** (0.164) -0.077*** (0.025) — — -0.072*** (0.020) -0.055*** (0.017) 0.001* (0.001) 0.013** (0.006) 0.004 (0.003) 0.044** (0.020) -0.00002 (0.00002) 0.211** (0.084) -0.055 (0.053) 1,510 0.057

Notes: Local area clustered standard errors in parentheses. *p < 0.1; **p < 0.05; ***p < 0.01.

Men 0.394** (0.187) -0.102** (0.042) 0.198 (0.316) -0.072*** (0.020) -0.055*** (0.017) 0.001* (0.001) 0.013** (0.006) 0.005* (0.003) 0.044** (0.020) -0.00002 (0.00002) 0.216** (0.085) -0.051 (0.054) 1,510 0.057

Women -0.699*** (0.155) 0.072** (0.029) — — 0.010 (0.022) -0.069*** (0.019) 0.002** (0.001) -0.003 (0.007) 0.008*** (0.003) 0.085*** (0.024) -0.00002 (0.00002) 0.169* (0.095) 0.069 (0.060) 1,510 0.047

Never Talk Politics

Men -0.496*** (0.178) 0.162*** (0.050) -0.700*** (0.249) 0.010 (0.022) -0.071*** (0.019) 0.002** (0.001) -0.003 (0.007) 0.008*** (0.003) 0.084*** (0.024) -0.00003 (0.00002) 0.153 (0.095) 0.052 (0.060) 1,510 0.051

Women -0.803*** (0.215) -0.075** (0.036) — — 0.011 (0.030) 0.084*** (0.026) -0.001 (0.001) -0.030*** (0.008) -0.025*** (0.004) -0.115*** (0.030) 0.00002 (0.00003) -0.189 (0.129) 0.979*** (0.080) 1,510 0.078

Men -0.852*** (0.247) -0.098 (0.061) 0.172 (0.347) 0.011 (0.030) 0.084*** (0.026) -0.001 (0.001) -0.030*** (0.008) -0.025*** (0.004) -0.115*** (0.030) 0.00002 (0.00003) -0.185 (0.130) 0.983*** (0.081) 1,510 0.078

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N R2

Men

Friends

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Women

Work



Talk Politics

Personal Political Connections

178  S. A. Prillaman and J. Phillips

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Table 3:   Regression estimates of the relationship between the change in informality and political networks using 2010 BEPS survey.

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Frequency of Clientelist Offers

Received Phone Call

Received Mail Contact

Men

Women

Men

Reduction in % informality in local area

-0.200 (0.232)

-0.524** (0.263)

0.067 (0.193)

0.030 (0.228)

0.351 (0.267)

Informally employed

-0.101*** (0.033)

-0.268*** (0.063)

0.024 (0.033)

0.006 (0.053)

0.069 (0.045)

Change in local informality × informal worker

Women

0.135 (0.330)

1.208*** (0.421)

Men

Received Vote-Buying Offer

Women

Men

0.218 (0.295)

-1.232*** (0.278)

-1.083*** (0.327)

-0.104 (0.127)

-0.017 (0.151)

0.001 (0.081)

-0.014 (0.045)

0.062 (0.077)

-0.047* (0.027)

-0.002 (0.047)

0.494 (0.506)

Women

-0.554 (0.428)

Men

-0.321 (0.213)

-0.104*** (0.027)

-0.100*** (0.027)

-0.009 (0.029)

-0.009 (0.029)

-0.001 (0.039)

-0.001 (0.039)

0.009 (0.040)

0.009 (0.040)

-0.006 (0.026)

-0.006 (0.026)

Female

-0.034 (0.023)

-0.033 (0.023)

-0.015 (0.025)

-0.015 (0.025)

-0.051 (0.034)

-0.051 (0.034)

-0.074** (0.034)

-0.075** (0.034)

-0.075*** (0.021)

-0.076* (0.021)

Age

-0.002** (0.001)

-0.002** (0.001)

0.002** (0.001)

0.002** (0.001)

0.003** (0.001)

0.003** (0.001)

0.00005 (0.001)

0.00002 (0.001)

-0.002*** (0.001)

-0.002* (0.001)

Income

0.003 (0.008)

0.003 (0.008)

0.014 (0.010)

0.014 (0.010)

0.017 (0.013)

0.017 (0.013)

0.008 (0.012)

0.008 (0.012)

-0.011 (0.008)

-0.011 (0.008)

Education

0.006* (0.003)

0.007* (0.003)

0.006 (0.004)

0.006 (0.004)

0.020*** (0.005)

0.020*** (0.005)

0.010* (0.005)

0.010* (0.005)

0.004 (0.003)

0.004 (0.003)

CCT beneficiary

0.116*** (0.028)

0.116*** (0.027)

-0.005 (0.026)

-0.005 (0.026)

0.006 (0.036)

0.006 (0.036)

0.036 (0.041)

0.036 (0.041)

0.022 (0.027)

0.021 (0.027)

Avg income in local area

0.0001** (0.00003)

0.0001** (0.00003)

0.0001 (0.00004)

0.0001 (0.00004)

0.0001*** (0.00004)

0.0001*** (0.00004)

0.00000 (0.00004)

0.00000 (0.00004)

-0.00000 (0.00003)

-0.0000 (0.0000)

% informality in local area in 2000

0.289*** (0.111)

0.323*** (0.112)

-0.084 (0.108)

-0.079 (0.111)

-0.303** (0.142)

-0.285** (0.144)

1.140*** (0.178)

1.120*** (0.179)

-0.078 (0.083)

-0.090 (0.085)

Constant

1.180*** (0.074)

1.205*** (0.073)

-0.094 (0.093)

-0.091 (0.092)

-0.097 (0.107)

-0.088 (0.107)

-0.075 (0.111)

-0.085 (0.111)

0.261*** (0.065)

0.255* (0.065) 675

N

2,482

2,482

678

678

676

676

678

678

675

R

0.033

0.037

0.047

0.048

0.108

0.109

0.097

0.099

0.061

2

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Notes: Local area clustered standard errors in parentheses. *p < 0.1; **p < 0.05; ***p < 0.01.

0.062

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Received Home Visit

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Table 4:   Regression estimates of the relationship between the change in informality and political linkages using 2010 BEPS survey.



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Personal Political Connections

0

−1

−2 0

1

Marginal Effect for Reduction in % Informal in Local Area

Marginal Effect for Reduction in % Informal in Local Area

180  S. A. Prillaman and J. Phillips

Talk Politics: Work 1.00

0.75

0.50

0.25

0.00 0

Talk Politics: Friends 0.0

−0.5

−1.0

−1.5

0

1 Individual Informality CI(Max − Min): [−1.292, −0.092]

Marginal Effect for Reduction in % Informal in Local Area

Marginal Effect for Reduction in % Informal in Local Area

Individual Informality CI(Max − Min): [−2.454, 0]

1 Individual Informality CI(Max − Min): [−0.333, 0.733]

Never Talk Politics 0.0

−0.5

−1.0

0

1 Individual Informality CI(Max − Min): [−0.642, 0.993]

Figure 9:   Marginal effects of reduction in percentage of informality in local area conditional on individual informality.

In addition, however, it appears that rapid reductions in informality have widened the gap between the formal workers who have sustained personal political connections and the informal workers who have lost those connections. Figure 10 shows that, for informal workers, reductions in local informality reduce the likelihood of receiving clientelist offers, however, for formal workers, reductions in local informality increase the likelihood of receiving clientelist offers. In this way, formalization appears to have homogenized the form and frequency of political debate across the two labor market sectors but has maintained a sharp barrier preventing informal workers from obtaining more personal political connections.

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0.5

0.0

−0.5

−1.0 0

1 Individual Informality CI(Max − Min): [0.48, 1.933]

Received Mail Contact 1.5

1.0

0.5

0.0

−0.5

0

1 Individual Informality CI(Max − Min): [−0.574, 1.532]

Marginal Effect for Reduction in % Informal in Local Area

1.0

Marginal Effect for Reduction in % Informal in Local Area

Frequency of Clientelist Offers

Marginal Effect for Reduction in % Informal in Local Area

Marginal Effect for Reduction in % Informal in Local Area

Marginal Effect for Reduction in % Informal in Local Area

How the Labor Force is Mobilized 181

Received Phone Call

0.5

0.0

−0.5 0

1 Individual Informality CI(Max − Min): [−0.629, 0.875]

Received Home Visit 0

−1

−2

0

1 Individual Informality CI(Max − Min): [−1.634, 0.5]

Received Vote−Buying Offer

0.0

−0.5

0

1 Individual Informality CI(Max − Min): [−0.986, 0.333]

Figure 10:   Marginal effects of reduction in percentage of informality in local area conditional on individual informality.

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Conclusion In much of the world, how you engage in the labor market conditions how you engage with the state. While attention has been paid to the ways that labor market status affects demand for policies, much less attention has been focused on the ways that formal and informal labor markets experiences shape the fundamental building blocks of political behavior — political discussion, political networks, and politician linkages. Furthermore, it is critical that we do not evaluate these labor market experiences in a vacuum. The experiences of formal and informal workers are importantly affected by the labor markets in which they live. This chapter provides an attempt to shine a light on these relationships by descriptively relating individual and local aggregate informality with measures of political communication, networks, and politician linkages. The findings in this chapter paint a clear picture of two entirely different political experiences depending on labor market status. For formal worker, politics as usual happens in the workplace, with strong political connections and access to politicians and clientelist offers. For informal workers, politics happens at home and in the community but without the same level of ties to political mobilizers. First, informal workers are less likely to be politically engaged in the workplace and this is especially true in geographic regions with highly informal labor markets. This does not mean that informal workers are less politically engaged than formal workers. To the contrary, the evidence suggests that informal workers are at least as engaged in political communication as formal workers but that this discussion happens outside of work with friends and family. Second, informal workers have less access to clientelistic linkages and offers and again this is especially the case in regions with highly informal labor markets. In contrast, formal workers appear to have greater access to clientelistic offers and greater workplace political discussion in regions with highly informal labor markets. Third, this political segmentation between formal and informal workers has declined in regions where informality has also declined. The results from this chapter highlight important patterns between the nature of political organization and labor market status. Many unanswered questions remain. Future research with access to more detailed and specific sources of data should detail the nature of political discussion and connection among formal and informal workers and aim to identify the causal linkages between labor market status and political mobilization. Our results also hint at important implications of gender in understanding the relevance of labor market identity for politics but further study is needed to more clearly articulate the differential experiences of male and female workers.

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Appendix A.1  Gender and Informality Table A.1:   Regression estimates of the relationship between the rate of informality and political networks using 2010 BEPS survey by gender. Talk Politics

% informality in local area Informally employed Local informality × informal worker Not working Female

Income Education CCT beneficiary Avg income in local area

Friends

Never Talk Politics

Women

Men

Women

Men

Women

Men

Women

Men

0.226 (0.280) -0.005 (0.149) 0.434** (0.154) -0.117** (0.058) 0.001 (0.002) 0.002 (0.018) 0.012 (0.007) 0.149*** (0.056) -0.036 (0.622) -0.00004 (0.0001)

0.405 (0.315) -0.006 (0.135) 0.285* (0.170) 0.015 (0.067) 0.001 (0.002) 0.038** (0.017) 0.015* (0.008) 0.095 (0.061) 0.066 (0.515) -0.0001 (0.0001)

0.212** (0.108) -0.020 (0.066) -0.033 (0.052) -0.037* (0.022) 0.001 (0.001) 0.006 (0.007) 0.005* (0.003) 0.016 (0.022) -0.043 (0.272) -0.00001 (0.00002)

0.505*** (0.156) 0.087 (0.064) -0.104 (0.075) -0.066** (0.031) 0.001 (0.001) 0.012 (0.008) 0.008** (0.004) 0.070** (0.033) -0.568*** (0.219) 0.00000 (0.00003)

0.015 (0.116) -0.021 (0.073) 0.037 (0.068) -0.011 (0.025) -0.0002 (0.001) -0.012 (0.008) 0.010*** (0.003) 0.100*** (0.028) 0.238 (0.291) -0.00000 (0.00003)

0.130 (0.178) 0.031 (0.076) 0.025 (0.077) -0.011 (0.030) 0.003*** (0.001) 0.005 (0.008) 0.001 (0.004) 0.067* (0.037) 0.134 (0.283) -0.0001** (0.00002)

-0.137 (0.179) -0.183 (0.119) 0.916*** (0.106) -0.007 (0.038) -0.0004 (0.001) -0.031*** (0.012) -0.024*** (0.005) -0.146*** (0.039) 0.177 (0.445) 0.00003 (0.00004)

-0.316 (0.220) -0.180* (0.095) 0.912*** (0.104) -0.013 (0.042) -0.002* (0.001) -0.025** (0.010) -0.028*** (0.005) -0.094** (0.044) 0.414 (0.332) 0.0001** (0.00004)

11-02-2020 13:46:13

N

438

354

923

843

923

843

923

843

R2

0.042

0.043

0.017

0.033

0.039

0.042

0.065

0.056

Notes: Local area clustered standard errors in parentheses. *p < 0.1; **p < 0.05; ***p < 0.01.

How the Labor Force is Mobilized 183

Age

Work

b3508_V3   Political Economy of Informality in BRIC Countries

Personal Political Connections

Women

Men

Received Phone Call Women

Men

Received Mail Contact Women

Men

Received Home Visit

Received Vote-Buying Offer

Men

Women

Men

0.071 (0.151)

0.561*** (0.189)

-0.137 (0.115)

0.135 (0.205)

-0.260 (0.161)

-0.278 (0.273)

0.883*** (0.256)

1.480*** (0.294)

-0.141** (0.071)

0.034 (0.169)

Informally employed

-0.009 (0.077)

0.045 (0.084)

0.069 (0.092)

0.099 (0.088)

0.280** (0.120)

0.118 (0.118)

0.084 (0.112)

-0.028 (0.118)

-0.039 (0.036)

-0.023 (0.057)

Local informality × informal worker

1.274*** (0.086)

1.107*** (0.093)

0.009 (0.093)

-0.185 (0.134)

0.033 (0.122)

-0.115 (0.168)

-0.081 (0.121)

-0.178 (0.147)

0.156*** (0.056)

0.253** (0.105)

Not working

-0.097*** (0.033)

-0.065* (0.037)

-0.049 (0.033)

0.053 (0.045)

-0.014 (0.047)

-0.024 (0.058)

-0.020 (0.045)

0.043 (0.057)

-0.015 (0.027)

0.011 (0.043)

Female

-0.002*** (0.001)

-0.003*** (0.001)

0.002 (0.001)

0.002 (0.001)

0.002 (0.001)

0.003* (0.002)

0.001 (0.001)

-0.002 (0.002)

-0.002** (0.001)

-0.004*** (0.001)

Age

0.007 (0.009)

-0.001 (0.010)

0.015 (0.011)

0.012 (0.013)

0.012 (0.015)

0.019 (0.016)

0.018 (0.013)

0.004 (0.014)

-0.004 (0.011)

0.002 (0.012)

Income

0.001 (0.004)

0.009** (0.004)

-0.0003 (0.003)

0.010 (0.006)

0.005 (0.006)

0.027*** (0.008)

0.005 (0.006)

0.011 (0.007)

0.002 (0.003)

0.001 (0.004)

Education

0.116*** (0.033)

0.096** (0.038)

-0.017 (0.027)

0.028 (0.039)

-0.035 (0.043)

0.051 (0.053)

0.025 (0.049)

0.036 (0.055)

0.025 (0.028)

0.010 (0.043)

CCT beneficiary

-0.366 (0.261)

-0.449 (0.309)

-0.189 (0.283)

-0.401 (0.270)

-0.650* (0.390)

-0.703** (0.353)

-0.498 (0.493)

0.158 (0.471)

0.036 (0.089)

-0.123 (0.173)

Avg income in local area

0.00003 (0.00003)

0.0001* (0.00004)

0.00003 (0.00004)

0.00005 (0.0001)

0.0001 (0.00005)

0.0001 (0.0001)

-0.00003 (0.00003)

0.0001 (0.0001)

-0.00002 (0.00002)

0.00000 (0.00005)

N

1,557

1,400

441

359

439

359

441

359

440

357

R2

0.027

0.031

0.059

0.047

0.084

0.131

0.061

0.119

0.030

0.051

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Notes: Local area clustered standard errors in parentheses. *p < 0.1; **p < 0.05; *** p < 0.01.

b3508_V3   Political Economy of Informality in BRIC Countries

Women

% informality in local area



Frequency of Clientelist Offers

184  S. A. Prillaman and J. Phillips

b3508_V3_Ch07.indd 184

Table A.2:   Regression estimates of the relationship between the rate of informality and political networks using 2010 BEPS survey by gender.

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b3508_V3_Ch07.indd 185

A.2  Alternative Participation Outcome Measures Table A.3:   Regression estimates of the relationship between the rate of informality and political participation using 2010 BEPS survey. Registered Voter

Requested Help from Local Government

Attended Protest

Worked for Election

Convinced for Election

0.227** (0.097)

0.244** (0.105)

-0.047 (0.091)

-0.094 (0.096)

0.030 (0.045)

0.035 (0.050)

-0.003 (0.085)

-0.008 (0.087)

0.082 (0.088)

0.118 (0.095)

Informally employed

0.050* (0.026)

0.073 (0.056)

0.003 (0.024)

-0.063 (0.058)

-0.023** (0.012)

-0.017 (0.024)

0.006 (0.031)

0.0004 (0.047)

-0.030 (0.024)

0.016 (0.050)

-0.025 (0.080)

— —

0.026 (0.170)

Local informality × informal worker

— —

-0.094 (0.209)

— —

0.264 (0.218)

— —

— —

-0.195 (0.186)

0.015 (0.020)

0.015 (0.020)

-0.009 (0.018)

-0.008 (0.018)

-0.010 (0.010)

-0.011 (0.010)

-0.047** (0.024)

-0.047** (0.024)

-0.060*** (0.018)

-0.060*** (0.018)

Female

-0.071*** (0.018)

-0.071*** (0.018)

0.008 (0.017)

0.009 (0.017)

-0.011 (0.009)

-0.011 (0.009)

-0.051*** (0.019)

-0.051*** (0.020)

-0.040** (0.016)

-0.040** (0.016)

Age

0.003*** (0.001)

0.003*** (0.001)

0.001 (0.001)

0.001 (0.001)

-0.0001 (0.0003)

-0.0001 (0.0003)

-0.001 (0.001)

-0.001 (0.001)

0.0001 (0.001)

0.00004 (0.001)

Income

0.007 (0.006)

0.007 (0.006)

0.0004 (0.005)

0.0002 (0.005)

0.003 (0.003)

0.003 (0.003)

-0.0004 (0.007)

-0.0004 (0.007)

0.001 (0.005)

0.001 (0.005)

Education

0.013*** (0.003)

0.013*** (0.003)

-0.003 (0.003)

-0.003 (0.003)

0.004*** (0.001)

0.004*** (0.001)

-0.0001 (0.003)

-0.0001 (0.003)

-0.004 (0.003)

-0.004 (0.003)

CCT beneficiary

0.049** (0.022)

0.049** (0.021)

0.021 (0.020)

0.021 (0.020)

-0.0005 (0.010)

-0.001 (0.010)

0.024 (0.026)

0.024 (0.026)

0.040** (0.020)

0.040** (0.020)

Avg income in local area

0.00000 (0.00002)

0.00000 (0.00002)

-0.00003* (0.00001)

-0.00003* (0.00001)

0.00001 (0.00001)

0.00001 (0.00001)

0.00001 (0.00002)

0.00001 (0.00002)

-0.00001 (0.00002)

-0.00001 (0.00002)

Constant

0.055 (0.057)

0.052 (0.057)

0.181*** (0.049)

0.191*** (0.050)

0.014 (0.027)

0.013 (0.027)

0.137** (0.060)

0.137** (0.061)

0.298*** (0.051)

0.291*** (0.052)

2,927 0.020

2,927 0.021

2,993 0.013

2,993 0.013

N R2

2,199 0.006

2,199 0.007

11-02-2020 13:46:14

Notes: Local area clustered standard errors in parentheses. *p < 0.1; **p < 0.05; ***p < 0.01.

798 0.028

798 0.028

2,975 0.011

2,975 0.011

How the Labor Force is Mobilized 185

Not working

b3508_V3   Political Economy of Informality in BRIC Countries

% informality in local area

Frequency of News Consumption

External Efficacy

Internal Efficacy

0.435** (0.186)

0.382* (0.201)

-0.159 (0.207)

-0.249 (0.216)

1.863*** (0.381)

2.041*** (0.405)

0.894*** (0.339)

1.029*** (0.366)

Informally employed

0.018 (0.049)

-0.049 (0.106)

0.043 (0.054)

-0.072 (0.121)

-0.033 (0.099)

0.197 (0.213)

-0.249*** (0.087)

-0.077 (0.189)

Local informality × informal worker

— —

0.284 (0.402)

— —

0.481 (0.445)

— —

-0.985 (0.839)

— —

-0.738 (0.693)

Not working

0.007 (0.038)

0.007 (0.038)

0.004 (0.040)

0.005 (0.040)

0.023 (0.079)

0.020 (0.079)

-0.107 (0.072)

-0.109 (0.072)

Female

-0.256*** (0.034)

-0.255*** (0.034)

-0.105*** (0.036)

-0.103*** (0.036)

-0.092 (0.070)

-0.094 (0.070)

-0.659*** (0.063)

-0.661*** (0.063)

Age

0.001 (0.001)

0.001 (0.001)

0.004*** (0.001)

0.004*** (0.001)

-0.002 (0.003)

-0.002 (0.003)

0.006*** (0.002)

0.006*** (0.002)

Income

0.056*** (0.012)

0.056*** (0.012)

0.037*** (0.011)

0.036*** (0.011)

0.052** (0.023)

0.052** (0.023)

0.021 (0.021)

0.022 (0.021)

Education

0.035*** (0.005)

0.036*** (0.005)

0.028*** (0.006)

0.028*** (0.006)

-0.032*** (0.011)

-0.032*** (0.011)

0.071*** (0.009)

0.071*** (0.010)

CCT beneficiary

0.089** (0.040)

0.089** (0.040)

0.121*** (0.045)

0.122*** (0.045)

0.065 (0.086)

0.065 (0.086)

-0.016 (0.075)

-0.017 (0.075)

Avg income in local area

-0.00001 (0.00003)

-0.00001 (0.00003)

0.0001** (0.00004)

0.0001** (0.00004)

-0.0002** (0.0001)

-0.0002** (0.0001)

-0.0001 (0.0001)

-0.0001 (0.0001)

Constant

1.546*** (0.105)

1.556*** (0.106)

2.848*** (0.115)

2.864*** (0.116)

3.104*** (0.222)

3.071*** (0.223)

2.877*** (0.196)

2.853*** (0.197)

2,988

2,988

3,004

3,004

2,871

2,871

2,899

2,899

R2

0.060

0.060

0.029

0.030

0.027

0.028

0.070

0.071

Notes: Local area clustered standard errors in parentheses. *p < 0.1; **p < 0.05; ***p < 0.01. 11-02-2020 13:46:14

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N

b3508_V3   Political Economy of Informality in BRIC Countries

% informality in local area



Political Interest

186  S. A. Prillaman and J. Phillips

b3508_V3_Ch07.indd 186

Table A.4:   Regression estimates of the relationship between the rate of informality and political interest using 2010 BEPS survey.

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b3508_V3   Political Economy of Informality in BRIC Countries

How the Labor Force is Mobilized 187

A.3  BEPS 2014 Analysis Table A.5:   Regression estimates of the relationship between the rate of informality and political interest using 2014 BEPS survey. Political Interest

External Efficacy

% informality in local area

-0.842*** (0.200)

-1.022*** (0.232)

-0.000 (0.000)

0.000 (0.000)

Informally employed

-0.022 (0.047)

-0.154 (0.095)

-0.000 (0.000)

0.000 (0.000)

— —

0.557 (0.349)

— —

-0.000 (0.000)

Not working

0.007 (0.046)

0.013 (0.046)

0.000 (0.000)

0.000 (0.000)

Female

0.183*** (0.036)

0.185*** (0.036)

-0.000 (0.000)

-0.000 (0.000)

Age

-0.006*** (0.001)

-0.006*** (0.001)

-0.000 (0.000)

-0.000 (0.000)

Income

-0.071*** (0.017)

-0.070*** (0.017)

-0.000 (0.000)

-0.000 (0.000)

Education

-0.050*** (0.008)

-0.051*** (0.008)

0.000 (0.000)

0.000 (0.000)

CCT beneficiary

0.0004 (0.042)

0.003 (0.042)

-0.000 (0.000)

-0.000 (0.000)

Avg income in local area

-0.0001*** (0.00004)

-0.0001*** (0.00004)

0.000 (0.000)

0.000 (0.000)

Constant

3.951*** (0.133)

3.982*** (0.134)

1.000*** (0.000)

1.000*** (0.000)

Local informality × informal worker

N

2,896

2,896

2,385

2,385

R

0.049

0.050

0.500

0.500

2

Notes: Local area clustered standard errors in parentheses. *p < 0.1; **p < 0.05; ***p < 0.01.

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b3508_V3   Political Economy of Informality in BRIC Countries

188  S. A. Prillaman and J. Phillips Table A.6:   Regression estimates of the relationship between the rate of informality and political networks using 2014 BEPS survey. Talk Politics Regularly: Family

Talk Politics Regularly: Work or Friends

Talk Politics Regularly: Social Media

% informality in local area

0.465*** (0.102)

0.512*** (0.114)

0.374*** (0.099)

0.338*** (0.111)

-0.127** (0.064)

-0.192*** (0.072)

Informally employed

0.032 (0.024)

0.066 (0.049)

0.016 (0.024)

-0.011 (0.048)

-0.056*** (0.018)

-0.103*** (0.034)

— —

-0.146 (0.180)

— —

0.113 (0.176)

— —

0.200* (0.108)

Local informality × informal worker Not working

-0.016 (0.024)

-0.017 (0.024)

-0.047** (0.023)

-0.046* (0.023)

-0.017 (0.018)

-0.016 (0.018)

Female

-0.029 (0.018)

-0.030 (0.018)

-0.081*** (0.018)

-0.081*** (0.018)

-0.013 (0.013)

-0.012 (0.013)

Age

0.002*** (0.001)

0.002*** (0.001)

0.002*** (0.001)

0.002*** (0.001)

-0.003*** (0.0004)

-0.003*** (0.0004)

Income

0.040*** (0.008)

0.040*** (0.008)

0.040*** (0.008)

0.040*** (0.008)

0.016** (0.007)

0.016** (0.007)

Education

0.031*** (0.004)

0.031*** (0.004)

0.030*** (0.004)

0.030*** (0.004)

0.017*** (0.003)

0.017*** (0.003)

CCT beneficiary

-0.001 (0.021)

-0.001 (0.021)

0.003 (0.021)

0.003 (0.021)

0.054*** (0.013)

0.055*** (0.013)

Avg income in local area

0.00004** (0.00002)

0.00004** (0.00002)

0.00003* (0.00002)

0.00003* (0.00002)

0.00002 (0.00002)

0.00002 (0.00002)

Constant

-0.130* (0.067)

-0.139** (0.068)

-0.074 (0.066)

-0.067 (0.067)

0.022 (0.043)

0.034 (0.044)

N

2,894

2,894

2,890

2,890

2,822

2,822

R2

0.050

0.050

0.061

0.061

0.088

0.089

Notes: Local area clustered standard errors in parentheses. *p < 0.1; **p < 0.05; ***p < 0.01.

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b3508_V3   Political Economy of Informality in BRIC Countries

How the Labor Force is Mobilized 189 Table A.7:   Regression estimates of the relationship between the rate of informality and political participation using 2014 BEPS survey. Attended Political Party Meetings

Attended Protest

% informality in local area

-0.393*** (0.094)

-0.345*** (0.104)

0.061 (0.062)

0.083 (0.073)

Informally employed

-0.025 (0.024)

0.010 (0.046)

-0.010 (0.016)

0.006 (0.031)

— —

-0.149 (0.182)

— —

-0.068 (0.105)

Not working

0.035 (0.022)

0.034 (0.022)

0.035** (0.017)

0.035** (0.017)

Female

0.017 (0.018)

0.016 (0.018)

-0.032*** (0.012)

-0.033*** (0.012)

Age

-0.002*** (0.001)

-0.002*** (0.001)

-0.001*** (0.0004)

-0.001*** (0.0004)

Income

-0.013 (0.008)

-0.013 (0.008)

0.022*** (0.007)

0.022*** (0.007)

Education

-0.019*** (0.004)

-0.018*** (0.004)

0.013*** (0.003)

0.013*** (0.003)

CCT beneficiary

0.025 (0.021)

0.024 (0.021)

0.006 (0.013)

0.005 (0.013)

Avg income in local area

0.00003* (0.00001)

0.00003* (0.00002)

0.0001*** (0.00001)

0.0001*** (0.00001)

Constant

3.083*** (0.063)

3.075*** (0.064)

-0.049 (0.045)

-0.052 (0.045)

Local informality × informal worker

N

2,884

2,884

2,848

2,848

R

0.023

0.023

0.056

0.056

2

Notes: Local area clustered standard errors in parentheses. *p < 0.1; **p < 0.05; ***p < 0.01.

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References Altamirano Hernandez, M. (2015). “Democracy and Labor Market Outsiders: The Political Consequences of Economic Informality PhD thesis. Ames, B., A. Baker and A. E. Smith (2016). “Social networks in the brazilian electorate.” In The Oxford Handbook of Political Networks. Artiz Prillaman, S. (n. d.) “Strength in numbers: How women’s groups close India’s political gender gap.” Forthcoming. Baker, A. and V. X. Velasco-Guachalla (2018). “Is the informal sector politically different? (null) answers from Latin America,” World Development, 102: 170–182. Burns, N., K. L. Schlozman and S. Verba (2001). The Private Roots of Public Action. Harvard University Press. Carnes, M. E. and I. Mares (2013). “Coalitional realignment and the adoption of noncontributory social insurance programmes in Latin America,” Socio-Economic Review, 12(4): 695– 722. Collier, R. B. and D. Collier (2002). “Shaping the political arena: Critical junctures, the labor movement, and regime dynamics in Latin America.” Dix, R. H. (1989). “Cleavage structures and party systems in Latin America,” Comparative Politics, 22(1): 23–37. Elden, J. M. (1981). “Political efficacy at work: The connection between more autonomous forms of workplace organization and a more participatory politics,” American Political Science Review, 75(1): 43–58. Fairris, D. and E. Jonasson (2016). “Determinants of changing informal employment in Brazil, 2000–2010.” Frye, T., O. J. Reuter and D. Szakonyi (2014). “Political machines at work voter mobilization and electoral subversion in the workplace,” World Politics, 66(2): 195–228. Garay, C. (2017). Social Policy Expansion in Latin America. Cambridge University Press. Haggard, S. and R. R. Kaufman (2008). Development, Democracy, and Welfare States: Latin America, East Asia, and Eastern Europe. Princeton University Press. Henley, A., G. R. Arabsheibani and F. G. Carneiro (2006). On Defining and Measuring the Informal Sector, Vol. 2473. World Bank Publications. Hirschman, A. O. (1970). Exit, Voice, and Loyalty: Responses to Decline in Firms, Organizations, and States, Vol. 25. Harvard University Press. Hussmanns, R. (2004). Defining and Measuring Informal Employment. Geneva: International Labour Office. Iversen, T. and D. Soskice (2009). “Dualism and political coalitions.” In Annual Meeting of the American Political Science Association. Toronto. pp. 3–6. Iversen, T. and J. D. Stephens (2008). “Partisan politics, the welfare state, and three worlds of human capital formation,” Comparative political studies, 41(4–5): 600–637. Leighley, J. E. and J. Nagler (2007). “Unions, voter turnout, and class bias in the US electorate, 1964–2004,” The Journal of Politics, 69(2): 430–441.

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Levitsky, S. (2003). Transforming Labor-based Parties in Latin America: Argentine Peronism in Comparative Perspective. Cambridge University Press. Lindvall, J. and D. Rueda (2014). “The insider–outsider dilemma,” British Journal of Political Science, 44(2): 460–475. Maloney, W. F. (1999). “Does informality imply segmentation in urban labor markets? Evidence from sectoral transitions in Mexico,” The World Bank Economic Review, 13(2): 275–302. Maloney, W. F. and J. Saavedra-Chanduvi (2007). “The informal sector: What is it, why do we care, and how do we measure it,” Informality: Exit and Exclusion, 21–42. Merrick, T. W. (1976). “Employment and earnings in the informal sector in Brazil: The case of Belo Horizonte,” The Journal of Developing Areas, 10(3): 337–354. Palier, B. and K. Thelen (2010). “Institutionalizing dualism: Complementarities and change in France and Germany,” Politics & Society, 38(1): 119–148. Pateman, C. (1970). Participation and Democratic Theory. Cambridge University Press. Portes, A. and K. Hoffman (2003). “Latin American class structures: Their composition and change during the neoliberal era,” Latin American Research Review, 41–82. Putnam, R. D. (2001). Bowling Alone: The Collapse and Revival of American Community. Simon and Schuster. Renno´, L., A. Huberts, C. Zucco, A. E. Smith, B. Ames, F. Machado and D. Samuels (2016). Brazilian Electoral Panel Study: 2014 Results. Technical report InterAmerican Development Bank. Roberts, K. M. (2002). “Social inequalities without class cleavages in Latin Americas n ­ eoliberal era.” Studies in Comparative international development, 36(4): 3–33. Rosenstone, S. J. and J. Hansen (1993). Mobilization, Participation, and Democracy in America. Macmillan Publishing Company. Rueda, D. (2005). “Insideroutsider politics in industrialized democracies: The challenge to social democratic parties,” American Political Science Review, 99(1): 61–74. Schneider, B. R. (2009). “Hierarchical market economies and varieties of capitalism in Latin America,” Journal of Latin American Studies, 41(3): 553–575. Schneider, B. R. (2013). Hierarchical Capitalism in Latin America. Cambridge University Press. Sinclair, B. (2012). The Social Citizen: Peer Networks and Political Behavior. University of Chicago Press. Zucco, C. et al. (2010). “Poor Voters vs. Poor Places: Persisting patterns and recent changes in Brazilian electoral patterns.” Ponencia presentada en el seminario Metropolis and Inequalities, San Pablo.

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CHAPTER 8

Redistributive Preferences in Contemporary Brazil Luis Maldonado and María Constanza Ayala Institute of Sociology, Pontifical Catholic University of Chile, Santiago, Región Metropolitana, Chile

Introduction Standard models of redistributive politics assume that the poor support has more redistribution than the non-poor (Korpi, 2006; Meltzer and Richard, 1981). Yet, Latin American countries present a different pattern. While Latin America is one the regions of the world with the greatest income inequality, studies show that preferences for redistribution do not clearly differ among income groups in the region (Blofield and Luna, 2011; Cramer and Kaufman, 2011). As Kaufman (2009) points out, this “inconvenient fact” has important implications for our understanding of behavioral assumptions of political economy models. Our chapter aims to evaluate this problem through an examination of redistributive preferences in contemporary Brazil. Following the distinction between old and new cleavages (Naumann, 2014), we focus on two main topics. First, prominent explanations of social policy attitudes focus on old cleavages that generated important social divisions in modern societies, such as conflicts between poor versus rich, disputes among different political ideologies and labor market segmentations (Huber and Stephens, 2001; Meltzer and Richard, 1981; Rueda, 2006). We consequently examine the roles of old cleavages in explaining the redistributive preferences of Brazilian citizens, focusing on the heterogeneity of attitudes between formal and informal 193

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workers. Following recent evidence for Latin American countries (Baker and Velasco-Guachalla, 2018; Berens, 2015), we argue that informal and formal sector workers have similar redistributive preferences. Furthermore, we develop a set of expectations for income and political ideology in Brazilian society. Second, studies suggest that new cleavages, such as age and ethnic boundaries, have emerged in several political economies during the last decades (Brooks et al., 2006; Naumann, 2014). These factors should be important predictors of voters’ preferences. Thus, we also evaluate the association of new cleavages with support for redistribution in Brazil.1 Given the relevance of racial cleavages in Brazilian politics (Bueno and Dunning, 2017), we focus on this social divide and expect significant associations with redistributive preferences. Our paper also explores interactions between race, labor market, and political segmentations. This study combines a qualitative analysis of the Brazilian institutional context with an original analysis of quantitative information from Latin American Public Opinion Project (LAPOP) surveys for the period of 2008–2017. The analysis of this information provides the opportunity to evaluate a case study that is especially interesting. Brazil is one of the most unequal societies in the world (CEPAL, 2017; Higgins and Pereira, 2014) and, thus, it should be a fertile social space for the emergence of polarized attitudes about redistribution. However, scholars have noted that cleavages, such as class, ideology or ethnicity, have not played major roles in shaping political outcomes in Brazilian society (Mainwaring, 1999; Samuels and Zucco, 2014). Given this political and social arrangement, Brazil is a least-likely case in which cleavages are expected to shape policy preferences. To the extent that income or ideology influences redistributive attitudes among Brazilian voters, we consequently gain confidence in the external validity of theoretical assumptions of prominent theoretical explanations in the literature. Finally, Brazil is a middle-income country that offers an evidence-rich environment in which most of the determinants that are important to redistributive preferences are measured in an accurate way and allows for cross-national comparison across Latin American countries. The remainder of this study is organized as follows. The first section discusses the main arguments in the literature of redistributive preferences and the empirical evidence in Latin America. The second section presents the case of Brazil, focusing on the main characteristics of this welfare model. The third section discusses the  We use the concept of cleavage in a weak sense (Goerres, 2009). Old cleavages are conflict lines along which actors align themselves and relevant political actors mobilize their ­voters. New cleavages — for example, age — are not the same kind of cleavage, but they are a necessary condition for the generation of a cleavage if, for example, preferences present a high level of stratification by generation. 1

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research design of this chapter. The fourth section presents the results, and the final section features the conclusions.

Literature Material interests and values are the most prominent determinants of social policy beliefs (Rehm, 2016). Both factors are implicitly linked to old cleavages. Regarding values, left–right ideology is as an important source of policy attitudes that emerged as a product of the state–market cleavage in industrial societies (Lipset and Rokkan, 1967). Citizens with left ideology support policies that reduce inequalities by ­promoting universal interventions of the state into the market. By contrast, right ideology is associated with supporting the market as source for solving social problems (Feldman and Steenbergen, 2001; Jaeger, 2006). With respect to material interests, power resources theory (PRT) and the Meltzer–Richard model (MRM) are two particularly important theoretical frameworks. For the PRT (Huber and Stephens, 2001; Korpi, 1989), the distribution of power resources between labor and capital is the key for the development of the welfare state, emphasizing the power of unions and left parties for the expansion of public benefits. Following PRT, we can expect that less affluent citizens who are dependent on wage labor support social spending to protect themselves against economic risks. Although income and class are different concepts, MRM formulates a similar proposition (Meltzer and Richard, 1981). The poor will support social spending, as they are the net beneficiaries. On the contrary, the rich will oppose support for state responsibility in welfare provision because this means higher rates of taxation that they will have to pay, making them net payers who contribute more than they consume. Put otherwise, the rich always lose from social policies, whereas the poor are the winners.2 In PRT and MRM, we consequently see that the conflict between labor versus capital or poor versus rich is a prominent cleavage that explains political preferences. On the basis of both theories, we can expect that support for redistribution should be higher among less-affluent voters. In the context of welfare state retrenchment, authors of previous studies ­suggest that the emergence of new conflict lines are important factors for explaining policy preferences in contemporary Western democracies (Pierson, 1996). The new cleavages represent conflicts between beneficiaries of the welfare state who defend their entitlements and the net payers who support reforms and cutbacks (Naumann, 2014). One of the most prominent new conflict lines is the intergenerational cleavage  Iversen and Soskice (2006) label this property of MRM the “non-regressivity assumption.”

2

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in advanced democratic societies, as they experiment with the process of massive population ageing. We consequently can expect that age affects political preferences. In fact, empirical evidence indicates significant age-related differences in welfare state preferences in OECD countries (Busemeyer et al., 2009). In the literature, other new lines of conflict are social groups with interests defined by gender or migrant status. Social groups defined by these categories have collective interests in ensuring that social benefits will be not cut (Lohmann and Zagel, 2016; Schmidt-Catran and Spies, 2016). Furthermore, political economists suggest that exposure to risk (understood as uncertainty regarding future income as a product of an economic shock) is what determines redistributive preferences in contemporary societies (Iversen and Soskice, 2001; Rehm, 2016). When individuals’ risk aversion is high, this theory predicts that the demand for insurance against future income shocks increases for those with a larger income, as those who are better off have more to lose than those who are disadvantaged. Redistributive Preferences in Latin America Latin American welfare states share a set of common elements that are relevant to understanding the demand for redistribution in the region. One of these is the high percentage of workers engaged in informal labor markets. Most self-employed ­people and those working in the informal sector either remain formally excluded from the social insurance system due to a lack of legal coverage or are excluded de facto due to their lack of effective contributions to the social security system (Huber, 1996). Because of this characteristic, when speaking about Latin American welfare states, some authors use terms such as “informal welfare regimes” or “truncated welfare states” (Huber and Stephens, 2012). In such institutional contexts, Holland (2016) argues that the poor should demand low redistribution because the access to benefits for them is very restricted. In other words, the “non-regressivity assumption” of MRM is not fulfilled. Another common element is the conservative profile of Latin American welfare states in the period leading up to the 1980s. The conservative profile seems to rely on the fact that Latin American welfare states have taken the shape of the male breadwinner family model that is common in southern European countries and have protected this model by introducing stratified and corporatist social insurance schemes and job protection (Barrientos, 2009). These schemes were granted between the early 1900s and 1925 to key occupational sectors in a group of pioneer countries (Argentina, Chile, Cuba and Uruguay). Over the next decades, this kind of welfare model spread to the rest of the region (Huber, 1996; Mesa-Lago, 1978).

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In the 1990s and 2000s, most Latin American welfare systems suffered a l­iberalization of their social policy profiles. Barrientos (2009) argues that such changes in social policy in Latin America provide a rare example of a shift in welfare regimes from a “conservative/informal” profile to a “liberal/informal” arrangement. In the 2000s, public discontent with reforms, combined with the political left turn in several Latin American countries, generated the expansion of the welfare spending in areas such as monetary transfers and health (Pribble, 2014). At this juncture of institutional change, redistributive preferences in the region present several very interesting characteristics. Regarding class or income cleavage, the evidence in the region is inconclusive. While some studies provide evidence in favor of PRT and MRM (Gaviria et al., 2007; Morgan, 2007; Pederson and Shekha, 2016), research suggests a null effect of income (Dion and Birchfield, 2010; Kaufman, 2009). More recent evidence indicates that the association between income and redistribution is not linear (Carnes and Mares, 2015). Furthermore, Berens (2015) shows that redistributive preferences do not differ between formal and informal workers in Latin America. Baker and Velasco-Guachalla (2018) argue that the standard views about the differences between both segments are grounded in a dualist conception of the labor market that assumes little overlaps between informal and formal sectors. These authors test expectations that are derived from dualist theories with survey data from 18 Latin American countries and find minimal evidence for dualist arguments. They suggest that their findings are consistent with a revisionist perspective of informality that sees formal an informal labor markets as highly integrated. Compared with income, the evidence about political ideology is clear. Studies indicate that left ideology increases the likelihood of supporting public welfare provision (Berens, 2015; Carnes and Mares, 2015; Kaufman, 2009). In respect to new cleavages, evidence about redistributive preferences in Latin American countries is limited, but studies of electoral behavior indicate that demographic characteristics — such as gender, race or age — have strong explanatory power (Carling and Love, 2015). Carnes and Mares (2015) found a positive but decreasing effect of age on policy preferences. Recent evidence for 10 Latin American countries with LAPOP data for 2012 indicates that age is not associated with redistributive preferences (Berens and von Schiller, 2017). Finally, studies of redistributive preferences in Brazil are scarce. Earlier research has found little evidence of associations between cleavages and political outcomes in Brazil (De Micheli, 2018; Mainwaring, 1999). However, studies about contemporary Brazilian politics suggests that income and race play a significant role in shaping political behavior (Bueno and Dunning, 2017; De Micheli, 2018). Yet, to

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our knowledge, studies that connect these findings with redistributive preferences do not exist.

The Brazilian Case and Hypotheses As with most of welfare systems in Latin America, the Brazilian social policy arrangement emerged in the first decades of the 20th century under corporatist lines (Huber, 1996). This policy profile persisted roughly until the 1980s. During the 1990s, Brazilian society experienced a liberal cycle under the government of Fernando Henrique Cardoso (1995–2002) that was characterized by reforms in favor of the market and expansions of social policy. The results of public investments during the last decades can be seen in ­contemporary Brazilian society. As Table 1 illustrates, public social spending in Brazil in 2014 is over the mean of Latin America, indicating that contemporary Brazilian welfare state ranks in the group of Latin American countries with the highest social spending (Draibe, 2007). However, it is lower than the public investment in OECD countries. Post-authoritarian governments also extended the coverage of social benefits to less affluent citizens, mainly through social assistance programs, such as the conditional cash transfers (CCTs) program Bolsa Familia (Hunter and Sugiyama, 2009). CCTs provide non-contributory benefits to the poor, supporting social service (education and health) and non-contributory pensions. Despite the extension of the coverage, social assistance benefits are characterized by low monetary size, limiting their socioeconomic impact (De La O, 2015). Recent evidence suggests that CCTs have an impact on the electoral behavior of segments of Brazilian voters (De Micheli, 2018).

Table 1:   Institutional characteristics of Brazil. Public Social Spending in 2014

Coverage of Contributory Social Insurance in 2012

Informal Employment in 2005

Income Inequality (GINI) in 2015

OECD

34.0

—

34.4

0.315

Latin America

10.0

38.9

49.3

0.467

Brazil

12.2

55.8

33.7

0.548

Notes: Informal employment is measured as a percentage of salaried workers without access to a pension. Public social spending as percentage of GDP. In the case Latin America and Brazil, public social spending is at level of central government. Expenditure data for OECD represent information of 28 members of European Union. Source: Keely (2015) for income inequality, Carnes and Mares (2013) for informal employment, CEPAL (2017) for public social spending, Levy and Schady (2013) for coverage of social insurance.

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Besides these important developments of welfare in Brazil, legacies of the corporatist system persist. Although the coverage of social security of Brazil is higher than the average coverage in Latin America, note in Table 1 that approximately one-half of workers do not have access to insurance benefits. The reason for this limited coverage lies in the fact that programs in the Brazilian social security system are based on contributions made by workers that are employed in specific sectors of the formal economy, leaving a significant portion of the labor force without access to these benefits (Huber and Stephens, 2012). As Table 1 shows, many of these workers are in the informal sector of the economy. Limited coverage and significant informality consequently suggest that the truncated character of Latin American welfare states persists as a feature of the contemporary Brazilian social policy profile. Despite the truncation of the welfare systems, workers do not persist in this labor status over the course of their lives. Perry et al. (2007) examine longitudinal data for Argentina, Brazil and Mexico collected for the period between 1980 and 2000. Their findings suggest that the probability that an informal worker has access to the formal sector is 0.45 in Brazil, which is the highest among the three analyzed countries. This characteristic of the Brazilian labor market indicates that a high mobility between the formal and the informal sectors interacts with a truncated welfare arrangement. On the basis of this institutional pattern, Baker and Velasco-Guachalla (2018) argue that political differences between formal and informal workers should not exist, as both groups share the same economic interests. This brings us to our first hypothesis: the redistributive preferences of Brazilian workers do not differ by sector of the labor market (H1). As a result of investment in social policy, the contemporary Brazilian welfare state also shows important effects on the social structure of the country. Brazil has one of the highest levels of inequality in Latin America. As Table 1 indicates, the Gini coefficient of this country is above the average of the other countries in the region. Over the last decade, however, inequality has decreased in Brazil. Holland and Schneider (2017) show that the Gini index and poverty rate decreased by 5.9 and 12.0 points, respectively, in Brazil during the period between 2000 and 2010. Higgins and Pereira (2014) analyze data on household incomes and taxes for 2008–2009 and find that all taxes and transfers (direct and indirect taxes, direct and in-kind transfers and indirect subsidies) reduce inequality by 24%. Compared with in-kind transfers in education and health, direct taxes and transfers have a low impact, however. Both income components reduce inequality only by 6%. One explanation for this pattern is the low level of tax collection. Income tax accounts for 1.4% of GDP in Latin America, compared to 8.4% in advanced democracies

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(Holland and Schneider, 2017). In Brazil, less than 10% of the economically active population pays personal income taxes (Higgins and Pereira, 2014). At this juncture of low tax collection, it is hard to think that the MRM mechanism justifies an effect of income on redistributive preferences in Brazil, as there are no net payers in the electorate who contribute more than they consume. However, this does not mean that structural effects are null. Studies indicate the relevance of education for the demand for redistribution, as credentials are associated with political knowledge. Citizens who present a high political sophistication also tend to support government involvement in policy areas (Bartels, 2016). These conjectures about income and education lead us to our second and third hypotheses: income does not affect redistributive preferences (H2), and people with high credentials support high redistribution (H3). In respect to the rest of the cleavages, our analyses are guided by the following expectations. As said in the literature section, the evidence for political ideology consistently shows that egalitarians and left ideology support demands for redistribution in Latin American countries. We consequently expect that citizens who have left-leaning political ideology will be more supportive of redistribution (H4). In respect to new cleavages, race appears to be a salient characteristic of Brazilian context.3 Despite Afro-Brazilians constituting approximately one-half of the total population, substantial race-based inequities are revealed in labor market discrimination and earning disparities (Bueno and Dunning, 2017; Telles, 2004). As a result of the high correlation between race and income, CTT programs strongly target Afro-Brazilians (black and pardo citizens). De Micheli (2018) shows that around 70% of CCT recipients during the period of 2014–2016 were Afro-Brazilians. It follows that this last group should have strong material interests for demanding redistribution. This leads us to our last hypothesis: Afro-Brazilians will be more supportive of redistributions (H5). In sum, contemporary Brazilian contexts are characterized by significant developments of social policy and important reductions of inequality. However, these social advances are embedded in a policy arrangement characterized by truncated welfare provision, informality, high labor market mobility and low taxation by the state. In such an institutional context, how are the redistributive preferences of Brazilian citizens displayed? How are the associations of old and new cleavages aligned with the displayed redistributive preferences of Brazilian citizens?

 Following the common practice in quantitative studies of race in Brazil (De Micheli, 2018), we use the concept of race in terms of individuals’ self-classification into categories based largely on skin color. 3

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We derived a set of expectations as a response to these questions. In the following section, we present the research design to evaluate the hypotheses.

Research Design Data Sources and Variables The analyses of this study are based on nationally representative survey data from the AmericasBarometer, collected by the LAPOP. This is a periodic survey that collected data from 34 countries in America. We use data only for Brazil from the 2016–2017 round, which had a sample size of 1,532 individuals. Its sample design is representative of the five major regions of the country, the size of municipalities, the urban and rural levels within municipalities and all individuals of voting age. Considering that some variables (e.g. income) were missing data, we applied multiple imputations to preserve the total sample (Van Buuren and GroothuisOudshoorn, 2011). Concerning the variables that are used in this study, the dependent variable is the preference of the individuals regarding the distributive role that the government should assume. The question used consigns the following: “The Brazilian government should implement strong policies to reduce income inequality between the rich and the poor. To what extent do you agree or disagree with this statement?” This question is the most common operationalization of redistributive demand in cross-comparative studies (Rehm, 2016). Respondents were presented a 7-point scale on which to indicate their answers, with one denoting strong disagreement and seven indicating strong agreement. We recoded the original variable into a dummy variable, distinguishing between those who show high support for a government policy of gap reduction (categories 6 and 7) from the rest (categories 1–5). We use several variables to measure old cleavages. Regarding the conflict lines among income groups, our measure is the total monthly income of the household. Respondents were classified in deciles,4 which we use as a continuous variable in our analyses. In addition to income, we capture material interests by using the educational level and employment status. Respondents’ education is measured with a set of dummies that captures primary (reference category), secondary and tertiary education. Regarding employment status, we identify the following categories: informal,

 We also test income groups in quartiles, where we aggregate a fifth category that denotes persons with missing income information. In this exercise, we use the first and second quartiles as the reference category. Findings are robust in this alternative specification. 4

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formal, unemployed, and other (students, housekeeping, and retired).5 These factors are used as dummies in the models, using “informal” as the reference category. We use the category “self-employed” to indicate informal employment. Although there are shortcomings in this measure — this variable does not capture informal workers who are salaried employees — studies indicate that there is a strong correlation between self-employment and informal activity (Loayza and Rigolini, 2011).6 In addition to income groups, we measure ideological conflict lines by using variables of political ideology. Respondents’ political orientation was measured originally based on their self-placement on a 10-point scale, with 1 indicating left and 10 specifying right. We recode answers into three categories: left (1–4; reference category), right (7–10) and center (5–6). In addition to political ideology, we incorporate a dummy variable in which one corresponds to individuals who identify with a political party. The last group of variables concerns new cleavages. We include gender and age to capture potential new sources of conflict. We measure this variable by using a linear specification plus a quadratic effect. In respect to H5, we include the following set of dummies to capture race: white (reference category), black (preto) or pardo (mixed-race) and other (such as Indian or Asian). Taking into account the literature, we add a set of control variables: household size (number of people), urban or rural areas and region of residence (central-west, north as reference, northeast, south, southeast). Additionally, we include a variable to measure social trust (“speaking of the people from around here, would you say that people in this community are very trustworthy, somewhat trustworthy, not very trustworthy or untrustworthy?”), individuals’ social mobility experience (downward mobility as reference, status quo and upward mobility), a scale of attendance to religious meetings (0 for individuals who never attend to one for individuals who attend weekly religious meetings, where monthly or yearly attendance are intermediate values) and a dummy variable to identify individuals who experience a lot or some fear of being a direct victim of homicide on a daily basis. Finally, we control for the marital status (married) and the household conditional cash transfer presence.

 We construct two versions of employment status considering the concerns in the literature toward the measure of informality. In the version used in this study, we measure informality as self-employed individuals. We also tested informality from self-employed and unpaid workers. The findings are consistent with our main results. 6  Berens (2015) also uses the category “self-employed” to measure informal work, but she adds an additional restriction based on information of access to health insurance. LAPOP 2016–2017, unfortunately, does not include this kind of information. 5

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Methods of Analysis The empirical findings of this chapter are generated from two different analyses. First, we present a descriptive overview of the variables under analysis: socioeconomic situation, political ideology and sociodemographic characteristics,7 segmented by the redistributive preference of the individuals. Second, we show a logistic regression analyses using imputed and weighted data. We estimate four models, one for each cleavage and one with all the variables, including controls. We also explore interactions with additional regression models.

Findings Cross-National Evidence and Profiles of Redistributive Preferences The first part of our analysis illustrates descriptive patterns of redistributive preferences in Brazil. An analysis of the last round of LAPOP surveys indicates that 56.39% of Brazilian voters represents a high demand for redistribution in 2016. Compared with other Latin American countries (Figure 1), Brazil ranks close to the mean of preferences in the region but lower than preferences in pioneer Latin American welfare states. Furthermore, the time series indicates significant changes in the recent past. LAPOP surveys registered a demand for redistribution of 70.66% in 2008 and 70.20% in 2012. Compared with 2016, high support for redistribution has consequently decreased 14 points during the last 8 years. To identify profiles of support for redistribution among Brazilian citizens, Table 2 shows descriptive information (proportions and means) about the associations between cleavages and redistributive preferences. As mentioned in the discussion of the literature, the socioeconomic differences between individuals are some of the most important sources of attitudes about redistribution. In Table 2, we observe, however, no strong differences among income deciles exist. Furthermore, the respondents’ mean income deciles are distributed in a similar manner between the group that shows greater support for redistribution and those who are less supportive (low and medium). In the case of educational level, the support for high redistribution resembles the distribution of this variable in the population in that the demand for government intervention is clearly higher in the case of persons with the highest credentials. The distribution of attitudes among occupations in the population also does not differ from the two groups under comparison. However, notice the presence of differences among students, housekeeping and retired persons. In this  Descriptive information for the control variables are listed in appendix Table A.1.

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Figure 1:   Redistributive preferences in Latin America in 2016/2017 Percentages. Notes: Values include population weights. High support is generated on the basis of the question “The Brazilian government should implement strong policies to reduce income inequality between the rich and the poor. To what extent do you agree or disagree with this statement?”. We transform the original 7 points response scale into a categorical variable with values of one (categories 6 and 7) and 0 (categories from 1–5). The value of one means high support. Source: Own elaboration on the basis of Brazilian LAPOP 2016/2017 round.

last case, the support for low/medium redistribution is higher than the demand for high redistribution at 37.40% vs. 28.95%, respectively. By contrast, the support for high redistribution is higher than the demand for low/medium redistribution in the case of formal and informal employees, 24.62% vs. 29.63% for the former, and 19.71% vs. 23.40% for the second. Regarding political ideology, the results are mixed concerning the literature. The support for distribution is lower for persons with right-leaning values and higher for respondents who position themselves in the center. However, the demand for redistributive interventions is not very high for persons with left political ideology. Moreover, the demand for redistribution is very low among people who identify with a political party. In respect to new cleavages, persons who identify as black or pardo present the highest demand for redistribution. Interestingly, white individuals have a greater presence in the group with lower support for redistribution. Regarding age, both groups of preferences present the same averages. The same happens with gender. In the next section, we test these associations, which are suggested by descriptive analyses, using a multivariate regression analysis.

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Redistributive Preferences in Contemporary Brazil 205 Table 2:   Redistributive preferences of individuals and the cleavages’ variables (proportions and means) in Brazil, 2016.   Income decile (mean)

Low or Medium Support

High Support

All

N

4.96

5.17

5.08

1443

Primary education

29.51

24.24

26.69

400

Secondary education

63.56

66.14

64.84

972

6.94

9.61

8.47

127

Educational level

Tertiary education Employment status Informal

19.71

23.4

21.82

334

Formal

24.62

29.63

27.43

420

Unemployed

18.27

18.01

18.01

276

Other

37.4

28.95

32.74

501

Left

27.22

27.99

27.59

390

Center

40.54

44.1

42.49

600

Right

32.23

27.91

29.92

422

Political party identification

15.38

9.39

17.2

264

Age (mean)

38.4

38.64

38.56

1532

White

33.76

28.03

30.51

461

Black or Pardo

54.28

61.38

58.37

882

Other

11.96

10.6

11.12

168

51.56 664

49.38 858

50.4 1522

772  

Political orientation

Race

Female Total N

Notes: Values include population weights. Proportions do not include missing data. High support is generated on the basis of the question “The Brazilian government should implement strong policies to reduce income inequality between the rich and the poor. To what extent do you agree or disagree with this statement?”. We transform the original seven points response scale into a categorical variable with values of one (categories 6 and 7) and 0 (categories from 1–5). The value of 1 means high support and 0 denotes low or medium support. Source: Own elaboration on the basis of Brazilian LAPOP 2016/2017 round.

Determinants of Redistributive Preferences Figure 2 shows the associations between indicators of cleavages and redistributive preferences. The dots of plots indicate point estimates (logit regression coefficients), and lines illustrate 95% confidence intervals from binary logistic

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(a)

(b)

(c)

Figure 2:   Determinants of redistributive preferences in Brazil, 2016. Note: Estimations based in regression models of Table A.2. Source: Own elaboration on the basis of Brazilian LAPOP 2016/2017 round.

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regressions with demand for redistribution as the dependent variable (one is high support). Here, the coefficients are interpreted as odds. Hence, a value greater than 0 indicates a positive effect, and a value lower than 0 indicates a negative effect. The vertical black lines in the plots denote the absence of association (coefficient equals 0).8 In general terms, the findings of regressions differ with descriptive analysis, as multivariate models show significant differences for several independent variables. Figure 2(a) provides evidence for material interest’s measures. The findings ­suggest that the coefficient of income is not statistically significant. Thus, our evidence is not consistent with standard models of redistributive preferences. Higher educational levels are associated with an increase in support for redistribution. Compared with persons with primary education, secondary and tertiary credentials clearly increase the odds of the demand for redistribution, but the coefficient is statistically significant only at 90% in the last model. In respect to employment status, formal and informal workers do not show statistical significance. This finding aligns with our expectations (H1). In contrast with the general pattern, findings for students, housekeeping and retired persons confirm our descriptive analysis. Being students, housekeeping or retired decreases the odds of demand for redistribution. Figure 2(b) shows estimates for political variables. Compared with people on the left of the ideology scale, being neutral is not associated with redistributive attitudes. But respondents who have right-leaning preferences show lower odds of supporting redistribution than individuals with left-leaning preferences. However, p-values indicates a high uncertainty in the estimates. These results clearly differ from existing evidence for Latin America (Berens, 2015; Carnes and Mares, 2015; Kaufman, 2009). Furthermore, findings suggest that party identification is also not associated with the demand for redistribution. Regarding new cleavages — Figure 2(c) — the estimate for gender is not s­ tatically significant. In contrast, age and age squared show a quadratic pattern. One more respondent’s year increases the demand for redistribution. Nevertheless, higher age is associated with a decrease in the support for redistribution. More interesting, we notice strong associations between race and redistributive preferences. Estimates of members of the black and the pardo group are highly significant (p < 0.01), and they  Lighter colored dots represent estimates based on models that include only cleavage ­ easures, and black dots denote regressions with all independent variables, including conm trols. For categorical variables, we omit the reference category. The full regression models are displayed in Table A.2. 8

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mean that being black or pardo increases the odds of the demand for redistribution by 84%. This finding is in line with research about the salience of race for politics in contemporary Brazil and confirms our hypothesis (H5). To further delve into the importance of individuals’ race in their attitudes toward redistribution, we tested interaction effects between race and socioeconomic and political cleavages, but no statistically significant interaction terms were observed. The models are available in the appendix (Tables A.3 and A.4). Finally, we also found interesting results for some control variables. 9 Our findings indicate that social mobility experience presents a statistically significant association with preferences. Furthermore, increases in the trustworthiness of the community are associated with higher support for redistribution. This last finding confirms studies that indicate the importance of social trust to evaluate redistributive preferences (Kuziemko et al., 2015).

Conclusions This chapter examined associations between cleavages and redistributive preferences in Brazil in recent years. In this respect, one of our main findings confirms our expectation about the null differences between the redistributive preferences of informal and formal workers. As Baker and Velasco-Guachalla (2018) point out, this result may reflect weak associations between policy beliefs and occupations, as labor biographies are characterized by high mobility rates in the course of the life of workers. Future research should evaluate this conjecture by using longitudinal information (e.g. microeconomic panel data). Furthermore, it is also necessary to understand how high labor mobility rates complement truncated welfare systems. Following Schneider (2013), these two macro characteristics may conform to an institutional complementary system that reproduces the hierarchical capitalism that characterizes the political economies of the region. In respect to income, we expected null effects. The findings confirm our hypothesis. Considering the literature, these results are not consistent with standard models of redistributive politics, such as the MRM. We suggest at least two alternative explanations for these results: truncation and risk. Regarding the first mechanism, following Holland (2016), the poor’s demand for redistribution is restricted because it is in the economic interests of the poor living in truncated welfare systems to  Coefficients for control variables were estimated but not shown in tables in the appendix.

9

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present this kind of attitude: the poor do not support more welfare benefits than the non-poor because transfers are not redistributed in their favor. The second explanatory mechanism focuses on the role of exposure to risk and suggests that the uncertainty of future income may explain the redistributive preferences of voters in Brazil. High labor mobility rates support not only the existence of poverty exits but descending social mobility. Therefore, the demand for insurance against unexpected shocks may affect motives for redistributive spending (Iversen and Soskice, 2001; Rehm, 2016). To our knowledge, studies that evaluate both explanatory mechanisms in Brazil and other Latin American countries do not exist. Future research should consequently produce developments in these fields. The results are consistent with our prognoses for education. The analysis indicates that high credentials are associated with support for redistribution. Following the literature in political science (Feldman and Zaller, 1992), this finding may reflect the relevance of political information as micro sources that capture the actual way citizens think about policy issues. Political awareness led us to the findings about political ideology. We found a weak association between the extreme poles of the ideological scale and the demand for redistribution. Political information may also explain this result. As Bartels (2016) shows, for the US, ideology translates into policy opinion, but only for people with high political sophistication. Uninformed citizens cannot recognize the policy implication of their ideologies. It follows that perhaps political ideology is not connected with redistributive preferences in Brazil because the level of political information is low for a significant portion of the electorate. Future research should examine this mechanism by producing direct measures of political awareness. Finally, we found a robust and significant association between race and redistributive preferences. Given the strong targeting of CCT on Afro-Brazilians, this finding should be explained by a self-interest mechanism. Recent studies also suggest the political implications of this pattern. As De Micheli (2018) illustrates, benefits mobilize Afro-Brazilians to participate in elections. Following Bueno and Dunning (2017), how the strong demand for redistribution among Afro-Brazilians relates with persistent ethnic inequalities in political representation in Brazil is an open question.

Acknowledgments This project was supported by CONICYT/FONDECYT REGULAR/1160921, CONICYT/FONDAP/15110017, and CONICYT/FONDAP/15130009.

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Appendix Table A.1:   Redistributive preferences and the control variables (proportions and means) in Brazil, 2016.  

Low or Medium Support

High Support

All

N

Household size (mean)

-3.74

 3.77

3.76

1530

Urban

86.53

87.48

87.06

1334

 7.59

 6.62

7.05

107

7.6

 6.62

7.05

107

26.3

27.44

26.94

414

Region Central-West North Northeast South

14.04

15.82

15.04

230

Southeast

44.47

43.51

43.93

674

Social trust Untrustworthy

17.23

12.88

14.85

223

Not very trustworthy

49.72

47.42

48.41

726

Somewhat trustworthy

16.07

22.13

19.44

292

Very trustworthy

16.98

17.57

17.31

260

Social mobility Downward mobility

44.5

49.21

47.16

721

Status quo

36.69

34.03

35.13

537

Upward mobility

18.81

16.76

17.71

271

Attendance at religious meetings (mean)

 0.64

 0.63

0.64

1529

A lot or some fear

57.28

62.51

60.23

922

Married

28.48

31.62

30.22

463

 26

26.61

407

858

1522

 

Conditional cash transfer Total N

27.39 664

Notes: Values include population weights. Proportions do not include missing data. High support is generated on the basis of the question “The Brazilian government should implement strong policies to reduce income inequality between the rich and the poor. To what extent do you agree or disagree with this statement?”. We transform the original seven points response scale into a categorical variable with values of one (categories 6 and 7) and 0 (categories from 1–5). The value of one means high support and 0 denotes low or medium support. Source: Own elaboration on the basis of Brazilian LAPOP 2016/2017 round.

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Redistributive Preferences in Contemporary Brazil 211 Table A.2:   Logistic regression models. Log of odds.   Income decile Educational level (ref: primary) Secondary Tertiary Employment status (ref: informal) Formal Unemployed Other

Income Cleavage

Political Cleavage

-0.00 (0.02)

0.19 (0.12) 0.47* (0.22)

0.26 (0.14) 0.41 (0.25)

-0.02 (0.15) -0.22 (0.18) -0.42** (0.15)

0.02 (0.16) -0.16 (0.19) -0.31* (0.16) 0.06 (0.13) -0.25* (0.13) 0.26 (0.14)

Right Political party identification Race (ref: white) Black or Pardo Other Female Age Squared age

AIC Null deviance Residual deviance Number of observations Household size

All Variables

-0.01 (0.02)

Political orientation (ref: left) Center

Intercept

New Cleavage

0.31 (0.18) 1500.4 2099 2079.4 1532

0.31*** (0.08) 1499.6 2099 2091.2 1532

-0.12 (0.14) -0.25 (0.15) 0.22 (0.14) 0.31** (0.12) 0.08 (0.18) -0.12 (0.10) 0.05** (0.02) -0.00** (0.00) -0.87* (0.34) 1495.4 2099 2080.8 1532

0.40** (0.13) 0.20 (0.19) -0.02 (0.12) 0.03 (0.02) 0.00 (0.00) -1.16* (0.58) 1514.6 2099 2035 1532 0.02 (0.03) (Continued )

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Income Cleavage

Political Cleavage

New Cleavage

Urban area

All Variables 0.08 (0.17)

Region (ref: north) Central-West

-0.07 (0.28) 0.22 (0.23) 0.32 (0.25) 0.12 (0.22)

Northeast South Southeast Social trust (ref: untrustworthy) Not very trustworthy

0.22 (0.16) 0.61** (0.19) 0.40* (0.20)

Somewhat trustworthy Very trustworthy Social mobility (ref: downward mobility) Status quo

AIC Null deviance Residual deviance

0.31 (0.18) 1500.4 2099 2079.4

0.31*** (0.08) 1499.6 2099 2091.2

-0.87* (0.34) 1495.4 2099 2080.8

-0.25* (0.13) -0.18 (0.16) -0.09 (0.14) 0.19 (0.11) 0.08 (0.13) -0.05 (0.14) -1.16* (0.58) 1514.6 2099 2035

Number of observations

1532

1532

1532

1532

Upward mobility Attendance at religious meetings A lot or some fear Married Conditional cash transfer Intercept

Notes: *** p < 0.001, ** p < 0.01, * p < 0.05 (two-tailed test). Standard errors in parenthesis. Dependent variable is demand for redistribution (one is high support). Source: Own elaboration on the basis of Brazilian LAPOP 2016/2017 round.

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Redistributive Preferences in Contemporary Brazil 213 Table A.3:   Logistic regression models with race and socioeconomic cleavages. Log of odds.   Income decile

Principal Interaction Principal Effects Interaction Effects Effects Income Effects Income Employment Employment 0.03 (0.02)

-0.02 (0.04)

Employment status (ref: informal) Formal

 

0.01 (0.15)

0.10 (0.27)

Unemployed

-0.23 (0.17)

-0.70 (0.36)

Other

-0.44** (0.14)

-0.10 (0.27)

0.31** (0.12) 0.09 (0.18)

(0.26) 0.57 (0.41)

Race (ref: white) Black or Pardo Other

0.34** (0.12) 0.10 (0.18)

0.21 (0.28) 0.55 (0.43)

0.40

0.03

Race: Black or Pardo*Income decile

(0.04) -0.08 (0.08)

Race: Other*Income decile

-0.04 (0.34)

Race: Black or Pardo*Formal

0.74

Race: Black or Pardo*Unemployed

(0.42) Race: Black or Pardo*Other

-0.28 (0.33)

Race: Other*Formal

-0.74 (0.55) 0.23

Race: Other*Unemployed

(0.61) -0.55 (0.51)

Race: Other*Other Intercept AIC Null deviance Residual deviance

-0.11 (0.14) 1497.6 2099 2088.6

-1.17 (0.61) 1515.6 2099 2031

0.25* (0.14) 1493.8 2099 2076.8

-1.30 (0.60) 1517.6 2099 2025

Number of observations

1532

1532

1532

1532

Notes: *** p < 0.001, ** p < 0.01, * p < 0.05 (two-tailed test). Standard errors in parenthesis. Dependent variable is demand for redistribution (one is high support). Values include population weights. Control variables were included but estimations are not shown. Source: Own elaboration on the basis of Brazilian LAPOP 2016/2017 round.

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214  L. Maldonado and M. C. Ayala Table A.4:   Logistic regression models with race and political cleavages. Log of odds.

 

Principal Effects Political Ideology

Interaction Effects Political Ideology

Principal Effects Political Party

Interaction Effects Political Party

Political orientation (ref: left) Center

-0.07 (0.13)

-0.27 (0.27)

Right

-0.23 (0.13)

-0.26 (0.23)

Political party identification

0.25 (0.14)

0.37 (0.25)

Race (ref: white) Black or Pardo

0.30* (0.12)

0.38 (0.20)

0.30** (0.12)

0.44*** (0.14)

Other

0.07 (0.18)

-0.07 (0.30)

0.07 (0.18)

0.16 (0.21)

Race: Black or Pardo*Center

0.10 (0.33)

Race: Black or Pardo*Right

-0.02 (0.30)

Race: Other*Left

0.84 (0.51)

Race: Other*Right

0.16 (0.44)

Race: Black or Pardo*Political party

-0.29 (0.32)

Race: Other*Political party

0.29 (0.52)

Intercept

0.16 (0.11)

-1.13 (0.59)

0.03 (0.10)

-1.31* (0.59)

AIC

1497.2

1520.2

1496.2

1516.4

Null deviance

2099

2099

2099

2099

Residual deviance

2087.2

2030.8

2088.4

2032.4

Number of observations

1532

1532

1532

1532

Notes: *** p < 0.001, ** p < 0.01, * p < 0.05 (two-tailed test). Standard errors in parenthesis. Dependent variable is demand for redistribution (one is high support). Values include population weights. Control variables were included but estimations are not shown. Source: Own elaboration on the basis of Brazilian LAPOP 2016/2017 round.

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Korpi, W. (2006). “Power resources and employer-centered approaches in explanations of welfare states and varieties of capitalism: Protagonists, consenters, and antagonists,” World Politics, 58(02): 167–206. Kuziemko, I., M. I. Norton, E. Saez and S. Stantcheva (2015). “How elastic are preferences for redistribution? Evidence from randomized survey experiments,” American Economic Review, 105(4): 1478–1508. https://doi.org/10.1257/aer.20130360. Lipset, S. M. and S. Rokkan (1967). “Cleavage structures, party systems, and voter alignments”, Party Systems and Voter Alignments: Cross-National Perspectives. New York: The Free Press, pp. 1–64. Loayza, N. V. and J. Rigolini (2011). “Informal employment: Safety net or growth engine?” World Development, 39(9): 1503–1515. Lohmann, H. and H. Zagel (2016). “Family policy in comparative perspective: The concepts and measurement of familization and defamilization”, Journal of European Social Policy, 26(1): 48–65. https://doi.org/10.1177/0958928715621712. Mainwaring, S. (1999). Rethinking Party Systems in the Third Wave of Democratization: The Case of Brazil. Stanford University Press. Meltzer, A. H. and S. F. Richard (1981). “A rational theory of the size of government”, Journal of Political Economy, 89(5): 914–927. Mesa-Lago, C. (1978). Social Security in Latin America: Pressure Groups, Stratification, and Inequality. University of Pittsburgh Press. Morgan, J. (2007). “Partisanship during the Collapse of Venezuela’s party system”, Latin American Research Review, 42(1): 78–98. Naumann, E. (2014). “Increasing conflict in times of retrenchment? Attitudes towards healthcare provision in Europe between 1996 and 2002”, International Journal of Social Welfare, 23(3): 276–286. Pederson, J. and K. R. Shekha (2016). “Attitudes toward public pensions in Chile, Uruguay, and Venezuela: Testing self-interest and political ideology theories in Latin American countries,” International Social Work, 0020872815617991. Perry, G., O. Arias, W. Maloney, P. Fajnzylber, A. D. Mason and J. Saavedrea-Chanduvi (2007). Informality. Exit and Exclusion. The World Bank. Pierson, P. (1996). “The new politics of the welfare state,” World Politics, 48(2): 143–179. Pribble, J. (2014). Welfare and Party Politics in Latin America. New York: Cambridge University Press. Rehm, P. (2016). Risk Inequality and Welfare States: Social Policy Preferences, Development, and Dynamics. Cambridge University Press. Rueda, D. (2006). “Social democracy and active labour-market policies: Insiders, outsiders and the politics of employment promotion”, British Journal of Political Science, 36(3): 385–406. Samuels, D. and C. Zucco (2014). “The power of partisanship in Brazil: Evidence from survey experiments”, American Journal of Political Science, 58(1): 212–225. Schmidt-Catran, A. W. and D. C. Spies (2016). “Immigration and welfare support in Germany”, American Sociological Review, 81(2): 242–261. https://doi.org/10.1177/ 0003122416633140.

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Schneider, B. R. (2013). Hierarchical Capitalism in Latin America: Business, Labor, and the Challenges of Equitable Development. New York: Cambridge University Press. Telles, E. E. (2004). Race in Another America: The Significance of Skin Color in Brazil. Princeton University Press. Van Buuren, S. and K. Groothuis-Oudshoorn (2011). Mice: Multivariate imputation by chained equations, R. Journal of Statistical Software, 45(3).

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CHAPTER 9

Understanding Informality in China: Institutional Causes and Subsequent Measurement Issues Yujeong Yang* and Wei-Ting Yen† Department of Political Science, State University of New York College at Cortland, NY 13045, USA † Department of Government, Franklin and Marshall College, Lancaster, PA 17603, USA *

Introduction Since the market reform of the late 1980s, the Chinese labor market structure has experienced major changes. One of the most important changes is the rapid growth of labor informality. In the socialist era, most Chinese urban workers participated in the formal labor market as the majority of them were employed in state-owned enterprises, provided with life-long employment security and a wide range of employment benefits. The labor market today is totally different from that of the pre-1980s. The Chinese labor market is now fragmented and stratified with the emergence of workers with different employment positions. Labor informality has grown consistently and rapidly and has become the main mode of employment (Cooke, 2008). Properly measuring the size of labor informality in China and understanding its sources have become more important than ever. However, measuring the size of labor informality in China is not an easy task. For one thing, the concept of labor informality is in and of itself opaque. There 219

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is a lack of agreement among researchers as to what defines labor informality. Consequently, researchers conceptualize labor informality differently depending on the research questions asked. For another, the concept of labor informality originally emerges as a residual term defining the labor force left out of the formal sector, or more specifically, out of the wage–employment relationship (Hart, 1973). Therefore, we rely on national labor market contexts to define what is formal to understand what is informal, leaving the concept of labor informality highly contingent upon national contexts. Studies of labor informality based on other parts of the world might not explain China’s labor informality well enough due to every country’s distinctive nature of labor informality. Put differently, the proxies used in Latin America might not be useful in Asia because labor informality is defined differently. The abovementioned reasons complicate the measurement processes of labor informality in China. As such, pinning down what labor informality is in China and how we should approach the concept are challenging tasks. One factor contributing to conceptual opaqueness is the various institutional causes of labor informality from region to region (if not country to country). In this chapter, we explore the institutional origin of labor informality in China and to compare it with other parts of the world. Labor informality is a combination of both voluntary members and involuntary members (Maloney, 2001; Perry et al., 2007). By focusing on the institutional causes, this chapter explains why workers are in the informal sector involuntarily. We show that the conceptualization of labor informality has its political root in China and, hence, leads to distinctive measurement challenges. To illustrate how China’s labor informality has its unique characteristics, we compare China to Latin America, specifically to Brazil. The chapter argues that, compared to Latin America, China’s labor informality is the result of (1) the emphasis on labor contracts under its socialist doctrine, and (2) the trajectory of the welfare state development. The first factor leads to the possibility of overlooking a subgroup of informal sector workers who hold labor contracts but still suffer from employment insecurity; the second factor leads to the suggestion that the ‘social insurance access’ is not a suitable criterion to measure the size of labor informality in China. The second factor also distinguishes China from Brazil regarding their labor informality composition. While the possession of labor contract and participation in social insurance programs are important aspects of formal employment in Brazil, identifying informal employment using the same criteria may yield inaccurate estimates of informal employment in China. Regarding the measurement issues, established scholarship had reached ­consensus that the self-employed workers are part of labor informality (International Labour Organization, 2002). Following the distinctive origin of labor informality in China, the chapter also identifies three other precarious employment types in the formal sector that should be considered as informal jobs. These job types include

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(a) those without labor contracts; (b) part-time workers with labor contracts; and (c) dispatched workers with labor contracts. We use our conceptualization of labor informality to measure labor informality in China, and the existing survey data show that the size of labor informality in China has increased from 17.38% in 2012 to 25.06% in 2014. The increase in China’s labor informality is attributed not only to the growth of the self-employed but also to the expansion of formal sector precarious employment. The growth of informal employment in the formal sector contrasts with Brazil where the size of the formal sector informal employment has decreased from 58.5% in the 1990s to 47.2% in the 2000s (Charmes, 2009: p.36). This chapter starts by providing an overview of the terms currently used by the international community to study labor informality. It is a useful exercise to fix what these terms refer to as researchers sometimes use these terms to mean different ideas in different studies. Next, we review the historical development of labor informality in Latin America, specifically in Brazil, which is ensued by a detailed discussion on the causes of labor informality in China. We then discuss and propose the ways in which labor informality should be measured in China, and use existing survey data to provide an overview of China’s labor market informality. The chapter measures the size of labor informality using two rounds of nationally representative labor survey data of 2012 and 2014, and ends with the political and policy implications for studying informal economy in China.

Definition of Labor Informality Though the concept of labor informality is evolving and remains controversial, it is still useful to provide an overview of the terminology currently used by the international community. At the theoretical level, the definition of labor informality “is concerned with the characteristics of jobs, rather than the economic units to which they belong” (Charmes, 2009: 28). The defining characteristics of labor informality are jobs that “have no written contract and lacks social protection” (Charmes, 2009: 28). Researchers may refer to this phenomenon as informal employment or the informal sector. In this chapter, labor informality and the informal employment are interchangeable terms we use to refer to all jobs falling under the category of labor informality. Under this definition, labor informality/informal employment is comprised of two parts: informal self-employment (i.e. informal employment in the informal sector) and informal wage–employment (i.e. informal employment in the formal sector). Informal self-employment consists of own-account workers, who are selfemployed people with no employees; employers, who are self-employed people with paid employees; unpaid contributing family workers; and members of producer’s cooperatives (wherever these exist) (Chen, 2008). Another term we use to refer to

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informal self-employment is the informal sector. On the other hand, informal wage– employment consists of people who work in a wage–employment r­ elationship but who are without adequate (or any) legal and social protection. Groups that belong to this category include: (a) informal employees, who are unprotected employees with known employers (regardless of enterprise sizes)1; (b) casual workers, who exchange their labor for income on daily/seasonal basis that have no fixed employers; and (c) subcontracted workers who produce for piece-rate from small workshops (Chen, 2008). According to Chen (2008), across the developing world, informal self-employment is composed of more share of labor informality than informal wage–employment. As we show in the following sections, the prevalence of informal self-employment was indeed the case in most Latin American countries, including Brazil. Yet, we will show that informal self-employment was never a meaningful category in China until the 1980s. Labor Informality in Latin America Before we jump to the discussion of labor informality in China, we first discuss the phenomenon in Latin America. This section serves as the reference point to which we compare China’s labor informality later in the chapter. In Latin America, the institutional origin of labor informality is associated with the continent’s welfare state type. Latin America’s welfare state is a Bismarckian welfare state, which is characterized by insurance-based social policies. Such insurance-based security regime is not a coincidence, but a deliberate policy choice along with the production regime choice across countries in Latin America (Haggard, 2008; Wibbels and Ahlquist, 2011). The social insurance model directly contributes to the rise of labor informality in Latin America. This section details the reasons behind Latin America’s prevalent labor informality phenomenon and its trend overtime; we will pay special attention to the Brazil case.

 Another labor market classification that might be confusing is that the existing literature defines enterprises with fewer than five workers as informal enterprises, and enterprises with more than five workers are formal enterprises. Some researchers would classify all the employers and their paid employees working in micro-enterprises with fewer than five workers as part of the labor informality (e.g. Charmes, 2009). However, we find this way of classification confusing as it mixes both informal self-employment and informal wage– employment. From the employee perspectives, as long as they are not protected with legal contract and social protection, they are considered informal employees. It does not matter how big the firm is. 1

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The Cause: Development Strategy and Social Insurance To trace how the Bismarckian welfare state is related to labor informality, it is ­important to first understand why social insurance was the common social policy type in Latin America. In a nutshell, the social insurance model emerged as a companion policy along with the development strategy in early years for many Latin American countries. The dominating development model was the import– substitution–industrialization (ISI) strategy, which reached its peak as the policy choice in the 1950s and 1960s. The ISI strategy involves two parts. On the one hand, government subsidizes the chosen industrial sectors to begin the process of industrialization. The chosen industries usually produce commodities that were supposed to be imported from overseas. On the other hand, the government helps eliminate the international competitors by either setting higher trade barriers or manipulating the exchange rate (or both).2 What accompanies the ISI strategy is the social insurance-based welfare state. This is a strategic combination that happened not just in Latin America, but also in other ISI-oriented economies. Wibbels and Ahlquist (2011) argue that to promote and to implement the ISI strategies successfully, governments need to cultivate the labor force suitable for the ISI class structure. As a result, countries adopting the ISI model are also inclined to adopt the social insurance model, which can easily have a narrow range of beneficiaries and would help maximize the beneficiaries’ wage over time. Due to the contributory nature of social insurance policies, such policy model tends to protect only the better-off of the formal sector and strengthen the existing social hierarchy, especially in the developing world (van Ginneken, 2003). These are usually workers associated with the ISI-related industries. Together, these policies create the privileged working and middle classes that serve both as the central labor force and the core consumers of the products they produce. Brazil followed the ISI plus social insurance path described in Wibbels’ and Ahlquist’s argument. Among all the Latin American countries, Brazil was one of the first countries to adopt the ISI model. In the 1930s, Brazil joined Chile, Argentina, Uruguay, and Mexico and became the first batch of the ISI strategy followers. The protectionism strategy emerged against the backdrop that the world just came out of the 1929 Great Recession, and the Keynesian ideology of big government started to gain its popularity (Haggard, 2008). The ISI model was promoted strongly by the then populist leader Getúlio Vargas, who was the president of Brazil from 1930–1945  To learn more about the ISI strategy and its evaluation, see Bruton (1998). To learn more about why some countries are more likely to adopt the ISI strategy, see Wibbels and Ahlquist (2011). 2

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to 1951–1954. His successor, Juscelino Kubitschek de Oliveira (1956–1961), d ­ eepened the ISI industrialization furthermore. During that time, Brazil successfully established automobile and steel industries. The ISI strategy has also created a strong and organized labor force in Brazil. Between the 1970s and the 1980s, the unionization rate in Brazil was more than 35%. Even though the rates decreased to 24.8% in the 1990s after the debt crisis, the strength of the unionized labor in Brazil was still stronger than other countries in the region. For instance, around the same time, the unionization rate was 4.4% in Guatemala (Inter-American Development Bank, 2003). When Getúlio Vargas became the leader of Brazil, he not only focused on fostering the economy through a series of tariff and quotas, he also passed several legislative bills to provide pension and health insurance to a number of occupational groups. According to Malloy (1979: 19), the passage of social insurance programs was a top-down effort to link the “potentially powerful groups into dependency relationship” with the state, and to stratify the society internally into competing groups all of which have to rely on the state. The Consequence: Measures and Trends of Labor Informality in Latin America The direct impact of the insurance-based social protection regime is that it defines what labor informality is (or is not) in Latin America. In Latin America, the most prominent conceptualization of labor informality follows the “legalistic/social protection” criteria (e.g. Perry et al., 2007; Baker and Velasco-Guachalla, 2018). That is, labor informality is when workers are in an employment relationship that is “not subject to standard labor legislation, taxation, social protection, or entitlement to certain employment benefits” (International Labour Organization, 2002). Even though the legal criterion (i.e. whether one is employed with a labor contract) and the social protection criterion (i.e. whether one enrolls in the public-run social benefit programs) are distinct, Baker and Velasco-Guachalla (2018: 173) argue that the two criteria overlap to a great deal in the Latin American context, precisely because a social insurance-based welfare state means that “a formal employment contract brings with it enrollment in the state-run social security system”. In other words, the early development of social insurance policies leads to the fact that a labor contract usually includes the publicly mandated social benefit. When an employer avoids providing a legally binding labor contract, they are usually trying to avoid the social benefit an employer is obligated to pay for. As such, it is the social protection programs that divide Latin America’s labor market into the formal and informal employment (Levy, 2008; Levy and Schady, 2013).

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Under the Bismarckian welfare state, as mentioned above, workers are considered employed informally when they are not registered under any social insurance programs (e.g. public pension and health insurance, etc.). Hence, one usual proxy used in survey data to approach a worker’s formal/informal status is related to whether they enroll in public-run social insurance policies or not. For instance, Baker and Velasco-Guachalla (2018) used related survey items in the Latin America Public Opinion Project (LAPOP) to identify whether a worker is in an informal wage–employment relationship or not. The survey item they use asks whether respondents have social security (in the 2006 and the 2008 wave) or health insurance (in the 2008 wave) thorough their employers (Baker and VelascoGuachalla, 2018). On the size of labor informality, the average share of the non-agricultural informal employment in Latin America is 54.2% before 2000. While Brazil had the share of labor informality dropped from 60% point to 51% point within 10 years, countries, such as Argentina and Bolivia, experienced an increase of labor informality during the same period (Charmes, 2009: 34). Because the social security regime is highly connected to the labor market regime, the major form of labor informality in Latin America is informal self-employment. In the 1990s, informal self-employment constituted 61% of the non-agricultural informal employment while informal wage–employment made up the other 39%. The pattern is almost identical across Latin American countries. Brazil has a more balanced composition of labor informality in the region as informal self-employment only leads informal wage–employment by 6% points at the 53% versus 47% difference in the 2000s (Charmes, 2009: 36). Such a balanced composition is also a reflection of a relatively higher social insurance coverage rate in Brazil. Compared to other countries in the region, 55.8% of the employed workers aged above 20 are covered in contributory social insurance programs in Brazil, ranking Brazil as the fourth most covered country (Levy and Schady, 2013: 201). Overall, because the social insurance coverage directly links to the size of labor informality, there is a strong and negative correlation between the two in Latin America (see Figure 1). When the social insurance coverage is larger, labor informality is smaller, and vice versa. The solid black dot is where Brazil stands relative to other countries in the region. To sum up, this section briefly discussed the institutional cause of labor informality in Latin America. Due to the early development of the social insurance models in the region, the size of labor informality in Latin America is directly related to employers trying to avoid paying for the state-run social insurance benefit. As such, three characteristics can best summarize the informal employment in Latin America. First, informal self-employment constitutes the most part of the

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Coverage of Social Insurance Policy

90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 0%

10%

20%

30%

40%

50%

60%

70%

80%

The Share of Labor Informality Figure 1:   The relationship between labor informality and social insurance coverage. Source: Charmes (2009) and Levy and Schady (2013).

informal employment. Second, the higher the social insurance coverage, the lower the ­informal employment size. Third, enrollment in any state, run social insurance programs or not is a good proxy for labor informality.

Chinese Labor Informality in Historical Perspective In this section, we turn our focus to China. We trace the rise of labor informality in China through the historical perspective. We show that China’s small informal employment in early years was attributed to its communist ideology, and how the phenomenon of labor informality has grown rapidly after China began its market reform after 1978. Moreover, because social benefit in China is tied closely to the household registration system, labor informality in China, then, is related to firms hiring rural migrant workers who are not entitled to social benefits in urban cities under the household registration system. We trace in detail the various types of labor informality arising in China over the last three decades. Labor Informality in the Early Market Reform Era (~1990s): The Growth of the Informal Sector Compared to other developing countries, China has relatively small informal employment. The underdevelopment of the informal employment is attributable

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to its socialist legacy. While labor informality has existed in China even under the socialist economic system, it was not recognized as a fully developed concept (Chen and Hamori, 2013). Before the economic openness and reform started in the late 1980s, most urban workers were employed in state-owned enterprises (SOEs) and were provided with generous employment-based welfare benefits, such as housing, education, pension benefits, health care. Hence, there was little room for the informal employment to emerge in the urban labor market. Under the socialist economic system, the informal employment could not squeeze in the rural labor market as well because individual rural workers were affiliated with collective lands and the products were managed by the communes. The informal employment emerged and started to develop with the market reform in the late 1980s. The informal employment began to grow from the Chinese rural areas. Rural economic activities started to be arranged on the basis of c­ ontracts. Individual rural workers provided a contracted number of products to the township government and sold the surplus products at the informal urban market. Rural decollectivization also played a role in facilitating the growth of the informal employment by releasing a large number of workers who previously engaged only in agriculture and not in other forms of economic activities. An increasing number of rural workers participated in economic activities in the informal sector — unregulated and under-monitored economic sector — by selling small food or fruits or by repairing shoes, bicycles, or keys (Cook, 2008). The economic activities of these self-employed workers are unregulated and under-monitored by the state. While the size of the informal sector has grown rapidly since marketization, the divide between formal and informal labor was not fully developed as a concept that stratifies the labor market. Until then, the rural–urban dichotomy was more decisive than the emerging divide between formal and informal labor (Cooke, 2008). The divide between formal and informal labor reinforced the divide between urban and rural labor markets, rather than cross-cutting the divide between urban and rural labor market, as the informal employment rises mostly from the rural areas whereas the urban formal labor market remains insulated from the shock of marketization. The dichotomy between the formal and informal employment has gained importance as the informal employment penetrated the urban market. The informal employment has emerged in the urban market in the form of informal private enterprises since the early 1990s. These informal private enterprises are composed of less than seven employees or are usually owned and managed by an individual or by a family. These enterprises are regulated and monitored not as strictly as formal enterprises, such as the SOEs, collective enterprises, or foreign enterprises. The growth of these informal enterprises in the urban labor market has been rapid and has contributed a lot to the urban employment (Huang, 2009).

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Labor Informality in the Market Reform Era (mid-1990s to early 2000s): Labor Informality’s Contagion to Formal Sector In its early stage of the market reform, the size of labor informality grew due to the emergence of the informal self-employment. Starting from the late 1990s, however, labor informality has permeated into the urban formal sector. The urban economy previously predominated by the SOEs has become diversified with the rise of private enterprises and foreign enterprises and the restructuring of the SOEs. The newly emerging formal sector — foreign and private enterprises — has become a large consumer of informal employees. Most foreign enterprises and emerging private enterprises were focused on export-oriented and labor-intensive industries. In order to attract these firms’ investments to their own localities, local governments have strived to secure a stable supply of cheap and low-skilled labor. Hiring urban workers, however, was not a cost-efficient deal for many foreign firms. Under the Chinese household registration system (i.e. the hukou system), urban workers were entitled to various welfare benefits provided by their employers. Hiring urban workers was inevitably accompanied by an increase in labor costs. In this context, Chinese local governments loosened their restriction on rural-to-urban migration and encouraged rural workers to migrate to urban areas and to work in foreign and private enterprises. Profit-motivated foreign and private firms could thus reduce labor costs by employing these migrant workers as they were exempt from the obligation to provide employment-based welfare benefits to these workers (Knight et al., 1999). These migrant workers received lower wages than urban workers, were exposed to various forms of labor exploitation and experienced a high level of employment insecurity. These migrant workers often lacked written labor contracts, were compensated with lower wages, and experienced a high level of employment insecurity. They could not claim employment-based welfare benefits their formal counterparts could claim. While the concept of employment relationship built on labor contract was introduced in the Labor Law of 1994, many workers entering the emerging foreign and private firms did not establish a formal relationship with their employers due to their lack of knowledge. Employers in the emerging economic sector took advantage of the nascent and incomplete institutional arrangements and the lack of migrant workers’ legal knowledge and successfully hired them with lower wages. Firms did not inform workers about the existence or the role of labor contract or even discouraged workers from signing the labor contracts for employer’s fear of increasing labor costs. These worker–employment relationships could not be monitored, managed, or regulated properly by relevant authorities or local governments as their employment relations

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with the firms were not built on labor contracts. Nor were there proper regulations to protect the informal employed workers from various forms of labor abuse. The restructuring of SOEs in the late 1990s has further facilitated labor informalization in the formal sector. Many laid-off workers generated by the SOE reform engaged in short-term, part-time, non-standard jobs created in the formal sector. It was then that the Chinese authority officially recognized the existence of labor informality. In 1996, the Shanghai labor authority introduced the concept of “non-standard flexible employment” to indicate various forms of labor informality characterized by temporary, fixed-term, casual workers in the formal sector and the self-employed (Wang et al., 2016). Chinese government has deliberately avoided describing these non-standard workers as informal and adopted the term of ­“flexible” worker instead in order to dilute the negative connotation and to reduce the delegitimizing effect that the term “informal” may bring to the society. This new group of informal workers, who are employed in the wage — ­employment relationship but without written labor contracts, are similar to the self-employed or employees in small-scale private business in that they are all in informal wage–employment that has a high level of employment insecurity. Yet, this new group of informal workers is different from informal self-employment in that they are employed in formal sector enterprises that are subject to government regulation. It makes an important difference between informal wage–employment workers and informal self-employed workers. A research comparing these two groups under labor informality found important differences between the two. In China, informal wage-employed workers lacking labor contracts earn lesser money and have lower level of subjective well-being than informal self-employed workers. Yet, they work shorter hours and are provided with better social protection than informal self-employed workers (Liang et al., 2016). These differences come from the fact that the formal sector is regulated more intensively by the state regulation and is affected more directly by labor regulations and laws. The differences between the two groups loom larger with the implementation of the Labor Contract Law of 2008, which I am turning to now. Labor Informality in the 2010s: The Emergence of Dispatch Workers The Chinese labor market in the 2010s has experienced major changes with the implementation of the Labor Contract Law (LCL) of 2008. While the concept of labor relationship built on labor contracts has been introduced since the 1994 Labor Law, it was not until the enactment of the 2008 LCL that employment contract requirement has fully been implemented. The 2008 LCL was enacted in response to the growing level of social instability caused by the poor treatment against migrant

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workers. For the Hu Jintao-Wen Jiabao administration that rose in power with the catchphrase of “harmonious society”, maintaining social stability and reducing labor discontents have become important issues. By enacting a more enforceable and protective labor law, the Chinese government tried to improve workers’ working environment and to reduce social instability (Meng, 2017; Gallagher et al., 2014; Li and Freeman, 2015). With the implementation of the LCL of 2008, the Chinese government has made it mandatory for workers to sign labor contracts with their employers. Employers were punished when they failed to sign labor contracts with their employees within a month from the commencement of employment relations. The implementation of the LCL enabled workers to possess a higher sense of employment security and claim various labor rights. Whether the Labor Contract Law of 2008 reduced the size of informal labor, however, is subject to debate. The passage of the LCL has certainly increased the proportion of workers with labor contracts (Gallagher et al., 2014). The proportion of contracted worker has increased not only within the urban worker group but also in the migrant worker group. With the implementation of the law, workers gained power to file labor disputes, to claim their social rights, and to protect themselves from rampant labor abuse. The strict enforcement of labor regulations, however, ironically incentivized employers to hire workers indirectly or through non-standard ways so that they can reduce the higher labor cost associated with stable employment positions. This creative implementation of the LCL and business’s exploitation of the LCL created a large number of non-standard workers whose employment positions are not necessarily in violation of the labor contract law but remain still precarious, the so-called “precarious employment” (Cook, 2008; Swider, 2015). Dispatch worker is the most common form of these precarious jobs.3 Employment precariousness has transmitted not only to vulnerable industries or private enterprises susceptible to higher labor cost but also to the well-protected sectors such as state-owned manufacturing enterprises (Park and Cai, 2011b). In the worst case, dispatch workers compose more than two-third of full time employees at SOEs (CLB, 2013). The state has overlooked, if not facilitated, the growth of this new type of precarious employment to boost labor market flexibility (Wang et al., 2016). Nevertheless, whether to see these precarious workers as informal sector workers or not remains a controversial issue. Some argue that precarious workers should be classified as formal workers in that precarious workers establish formalistic labor relations with their employers, at least in paper (Gallagher et al., 2014). Others, on the other hand, see precarious workers as informal workers (Ren and Peng,  Different terms are used to indicate this group of workers — dispatch workers, subcontracted workers, agency workers.

3

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2007; Park and Cai, 2011a; Wang et al., 2016). Precarious workers are paid less or irregularly and experience a higher level of job insecurity. They also receive less welfare benefits than formal sector workers. Some labor agency firms have bargained with the local labor bureau and social insurance companies so that they can allow these labor agency firms to provide only limited social benefits to the agency workers (Wang et al., 2016). They are hardly monitored by labor authorities due to the complexity of the employment relationship they have with the firms they are working for. In this regard, some even evaluate that the LCL has unintentionally contributed to an increase of informal wage–employment in the formal sector, rather than eradicating it. The increase in the number of precarious workers (i.e. informal wage-employed workers with labor contracts) is a new phenomenon that has received relatively fewer attention from the previous literature on Chinese labor informality. This chapter considers the size of the precarious workforce in measuring the size of labor informality in China. Labor Informality and the Revision of the Labor Contract Law in 2013 The over-expansion of precarious workers, especially explosion in the number of dispatch workers, has worried the Chinese government about its ramification on its economic development and social stability. The Chinese government’s turn to domestic-consumption-oriented model also played a role in motivating the state to revise the LCL in a way that prevents employers from taking advantage of the loopholes of the law and hire workers informally without being caught by the labor contract law. The revised labor contract law of 2013 restricts the use of dispatch workers, stipulates the 6-month limit on using temporary workers and sets the maximum percentage of dispatch workers in a firm’s total employees. Yet, many observers cast doubt on the effectiveness of the revised law in reducing the abuse of non-standard employment and are suspicious that employers will find a way to circumvent the new law.

Measuring the Size of Labor Informality in China Following the discussion on the rise of labor informality in China, this section focuses on the ways in which we can measure China’s labor informality. It has been a challenge to measure labor informality accurately in China, partly due to the government’s neglect on purpose. Therefore, we provide various ways of measuring China’s labor informality and discuss the job categories that should be included under labor informality.

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The Difficulty of Measuring Chinese Labor Informality Measuring the size of labor informality in China is challenging. Despite the ­substantial increase in the size of labor informality, the Chinese government has shown little enthusiasm in understanding the size and source of its informal labor (Park et al., 2012). While the Chinese official statistics provides a remote estimate of labor informality, they are far from being consistent (Zhou, 2013). The Chinese government’s lack of effort to understand its labor market informality is in sharp contrast to other large uneven developing countries, such as India, where the government intervenes proactively in measuring the size of informal employment. Even in reports produced by the International Labour Organization (ILO), where the size of informal employment of various countries is reported, the size of Chinese labor informality is either not reported or is represented by the size of informal employment of four large cities in China. The Chinese government’s lack of enthusiasm in understanding the nature of its labor informality is also evidenced by the term it uses to describe the informal economy. The term “informal employment” as a concept was first introduced by the Shanghai authority in 1996. Yet, the Chinese government has deliberately avoided using the term “informal (非正规, feizhenggui)”. Instead, the Chinese government adopted a term “flexible (灵活, linghuo)” employment in order to dilute the negative connotation that the term “informal” may bring to the society (Cook, 2008). The Chinese government’s denial of “informal” economy has delayed the attempt to systematically examine the extent and characteristics of the Chinese labor informality, not to mention enactment of relevant policies and regulations regarding informal employees (Liang et al., 2016). While burgeoning literature on Chinese labor informality approximates the size of the informal sector by using various survey data, this lack of official statistics or publicly available firm-level surveys complicates deep understanding of the Chinese labor informality. Measuring the size of labor informality in China is also challenging because the sources of labor informality have been changing and have become diversified over the past few decades. Labor informality comes both from wage–employment and self-employment. Two key characteristics distinguish the two categories (Hart, 1985). First, wage–employment is monitored and regulated by the state and the relationship between employers and most employment relationships are built on explicit labor contracts. It is possible, however, for employers to hire workers informally by not establishing their relationship based on labor contracts. Economic globalization and price competition have facilitated the informal employment in the wage relationship. Self-employment, on the other hand, is not subject to state’s regulations. The employment relationship is not built on a written contract. Most workers outside of

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wage–employment are either self-employed or employees in small enterprises not regulated by the state. Their employment relationships are characterized by high flexibility and instability. Estimates from Official Statistics Using the Residual Methods There have been important and meaningful academic attempts to measure the size of the Chinese labor informality. One of the major approaches is to estimate the size of informal economy at the macro level by using national-level official statistics and the other is to use various survey data. Most researches using official statistics adopt the residual approach in which the size of labor informality is measured by the gap between the total urban labor force and the number of formal employees (Park and Cai, 2011b; Cook, 2008; Huang, 2009; Hu and Zhao, 2006; Zhang et al., 2015). The number of total urban labor force comes from the annual sample surveys of the entire population conducted by the National Bureau of Statistics (NBS). The number of formal employees is estimated as the number of workers counted and reported by urban firms of different ownerships (Park and Cai, 2011a).The Chinese official statistics further breaks down the number of reported workers by four different ownerships; (1) state-owned enterprises; (2) collective enterprises; (3) other enterprises; and (4) private enterprises and self-employed. There is a debate regarding which workers are supposed to be considered as “formal (sector) workers”. Some works treat the entire number of reported workers as the size of formal sector workers. In calculating the size of labor informality, these works subtract the number of reported workers from the number of total urban labor force (Park and Cai, 2011a; Zhang et al., 2015). The gap between the number of total labor force and of registered workers implies that there are uncounted urban labor forces. These uncounted workers, by definition, are informal in a sense that their employment status is not counted by the formal system. It is likely that these workers’ employment stability or security cannot be monitored and managed very effectively. Other works share the point that “uncounted” workers reflect the size of informal workers but they are different in that they treat workers in private enterprises and self-employed as “informal sector” workers (Huang, 2009; Hu and Zhao, 2006). These works subtract the sum of formal sector workers — the number of employees in state-owned enterprises, collective enterprises, and other enterprises — from the number of total employment. This approach provides a larger estimate of the size of labor informality as it treats not only “uncounted” workers but also private enterprise- and self-employed workers as informal workers.

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While this approach is widely used, this residual approach may provide a limited and potentially flawed description of the size and characteristics of Chinese labor informality. First, it is not clear who constitute the “uncounted” worker group. Some argue that the number of uncounted workers is likely to capture the number of informal employees in formal sectors (Hu and Zhao, 2006). Others, on the other hand, interpret this number as the number of workers in informal sectors such as unregistered private and self-employed sectors (Park and Cai, 2011a). This unclarity and limited information on uncounted worker group makes it hard to understand the changing nature of Chinese informality and diverse sources from which labor informality is created. Moreover, the post mid-2000s estimate of labor informality measured by the residual approach is suspected to be systematically biased and is not likely to capture the changes in Chinese labor informality. Until the mid-2000s, the size of labor informality measured by the residual approach was approximately equal to other estimates of labor informality in urban China (Chen and Hamori, 2013). Hence, the residual estimate was broadly used to grasp the chances in Chinese labor informality. Since the mid-2000s, however, the estimate from the residual method has started to show bigger mismatch with estimates from other surveys and reports. The residual estimate shows a decreasing trend of the size of uncounted workers (see Figure 2). Some might interpret this as decrease of informal wage-employed workers after the strict enforcement of the LCL. Yet, various survey data and reports witness an increase, not decrease, in both informal wage–employment and informal self-employment after the implementation of the LCL (Liang et al., 2016). Estimates from individual-level surveys (see the following section) also show that the size of informal wage–employment has grown and occupied the largest portion of labor informality in China. The decreasing number of uncounted workers since the late2000s from the residual approach is not likely due to actual downsizing of labor informality in wage–employment relationships but is more likely due to the changes in the reporting system. For most research projects that adopted the residual method, this potential systematic bias was less of a problem because they stopped measuring the size of the informal sector using the residual method before 2008 — the year the LCL was implemented. For a more recent update of the size of labor informality, the residual estimate is likely to suffer from this potential systematic bias. Not only does the residual approach provide a flawed estimate of the number of informal wage-employed workers, it also risks an underestimation of the size of labor informality in wage–employment relationship by treating all workers in formally registered firms as formal workers. As discussed, labor informality exists even in formally registered sectors and with different forms — those who are without labor contract and various forms of precarious workers with labor contract. The residual

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of informal employment (1996)

50

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Shanghai labor authority

Non-countable Workers (%)

19 8 19 9 9 19 0 9 19 1 9 19 2 9 19 3 9 19 4 9 19 5 9 19 6 9 19 7 9 19 8 9 20 9 0 20 0 0 20 1 0 20 2 03 20 0 20 4 0 20 5 0 20 6 0 20 7 08 20 0 20 9 1 20 0 20 11 1 20 2 1 20 3 1 20 4 15

0

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20

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Private Sector Workers & Self-employed (%)

year

Figure 2:   Changes in the Chinese labor market and labor informality using the residual method.

estimate of labor informality will collapse these worker groups and obfuscate the understanding of the changing nature of Chinese labor informality and various sources from which labor sector workers are generated. Estimates from Survey Data To supplement the limitation coming from the residual approach, many resort to individual-level survey data. Survey estimates of labor informality may not provide information on longitudinal changes in Chinese labor informality as the residual estimates do. Yet, they provide a more nuanced information on Chinese labor informality as they provide detailed information on differences in employment sectors, employment positions, and social economic characteristics of workers who constitute different informal sector worker groups. Most survey estimates of labor informality, for example, provide a breakdown of informal self-employment and informal wage–employment. Most researches identify the self-employed workers as informal sector workers (Cook, 2008; Park and Cai, 2011a). For labor informality in wage–employment relationship, the possession of labor contract is adopted as the core criterion in deciding a worker’s employment position (Liang et al., 2016; Park et al., 2012;

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Chen and Hamori, 2013). Another variant of this approach is to examine not only a worker’s possession of labor contracts but also his/her social insurance (pension, health insurance, unemployment insurance) participation status (Park et al., 2012). While the possession of labor contract and participation in the social insurance program are important aspects of formal employment, identifying labor informality by focusing only on the possession of labor contract and participation in social insurance program may yield an inaccurate estimate of the size of labor informality. While the possession of labor contract is a necessary condition for formal employment, it is not a sufficient condition for formal employment. Cooke (2008), for example, criticizes that defining labor informality in terms of the lack of a labor contract and social insurance coverage may risk tautology and fail to capture precarious employment — such as formal sector workers who are contracted as temporary workers or workers who are employed indirectly by labor dispatch agencies. These “precarious” workers have a higher level of employment insecurity even when they signed labor contracts (Cook, 2008; Swider, 2015). This chapter tries to capture the size of this precarious employment in addition to the size of labor informality captured by the number of employees lacking labor contracts. We define precarious employment as wage workers with labor contracts who are employed indirectly by labor dispatch agencies, are paid on non-regular basis, and are employed as a part-time worker and estimate the size of this worker group. A Snapshot of Chinese Labor Informality in the 2010s This section describes the recent changes in Chinese labor market and composition of labor informality using two nationally representative survey datasets. As discussed, survey data are limited in providing a longitudinal description of development of Chinese labor informality. It is because there are only a few survey projects that were conducted over years with consistency. The China General Social Survey is a widely used survey that was conducted over various years, starting from 2003. The most recent round of survey was conducted in 2013. Figure 3 describes longitudinal changes in the composition of non-agricultural employment in China that the CGSS captures. The dark grey area and medium dark grey area show the size of employees in the formal sector, while the medium dark grey area captures the size of precarious workers in the formal sector, defined by workers who do not have fixed employers or are hired indirectly by labor dispatch agencies. Many of them are likely to lack labor contract. The dark grey area captures the size of the formal sector employees who are hired directly by fixed employer. Although both workers are in the formal sector, workers hired by

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80

Informal Sector Workers (%)

40

60

Formal Sector Precarious Workers (%)

0

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Formal Sector Employees(%)

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2008

Year

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Figure 3:   Labor employment by sectors.

fixed employers have higher levels of job security. Yet, this does not mean that all formal sector employees are formal. There can be workers without labor contracts or are employed temporarily. The light grey area captures the size of the informal sector employees and includes employees in petty enterprises (getihu), employees who work for family business, or self-employed. The size of informal sector (light grey area) is growing while the size of formal employment (dark grey area) is shrinking. The increase of labor informality in China is attributable not only to the growth of the informal sector but also to the expansion of precarious employment formal sector in the (in medium dark grey area). The growth of formal sector labor informality is in contrast to Brazil, where the size of formal sector informal employment has decreased from 58.5% in the 1990s to 47.2% in the 2000s (Charmes, 2009). Two rounds of a most recent nationally-representative survey, China Labor Dynamic Surveys of 2012 and 2014, show a similar trend with more detailed breakdown of labor informality (see Figures 4 and 5). According to the survey, the size of informal self-employment has increased from 17.38% in 2012 to 25.06% in 2014. Formal sector employees with labor contract occupy 41.05% and 36.23% of the entire non-agricultural workforce in 2012 and 2014, respectively. Yet, 20.69% and 21.9% of these contracted workers are either employed indirectly by labor dispatch agencies, paid weekly or daily wages, or are employed as part-time workers.

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Figure 4:   2012 Chinese workers’ employment composition.

Figure 5:   2014 Chinese workers’ employment composition.

In 2012, slightly more than a half (50.32%) of formal sector employees lacked labor contracts, taking 41.57% of entire non-agricultural workforce in China. The proportion of formal sector employees lacking labor contracts increased in 2014 to 51.2% of the formal sector employees. Overall, both macro-level statistics and micro-level survey data evidence the growth of labor informality in China. A further breakdown of employment status and job characteristics show that the growth of Chinese labor informality is attributable both to the growth of informal sector and the growth of informality within the formal sector.

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Conclusion and Implications The goal of this chapter is to introduce the institutional causes of informality in China and the subsequent measurement issue. To better illustrate how China’s informality has a distinctive origin from other BRIC countries, we use Brazil as the representative case of Latin America for comparison. The major takeaways are as follows. First, compared to Brazil, and other Latin American countries, where labor informality largely takes the form of informal self-employment, the Chinese labor market has started with a relatively small segment of informal self-employment. The small size of the informal self-employment is directly attributed to China’s ­socialist legacy. In China, the market reform of the late 1980s has increased the size of the informal sector, creating a large number of informal sector employees (Park et al., 2012). Yet, as marketization deepens, labor informality has spread to wage–­employment relationship. The increased demand for cheap and low-skilled labor from the growing number of foreign and private enterprises has facilitated the labor market dualization, increasing both the size of informal self-employment and informal wage–employment. Second, due to the household registration system in China, social benefit is tied closely to an individual’s birth place. As such, even though the “legal/social ­protection” criterion can be combined and viewed as the same thing in Brazil, it should be used separately in China. In China, a labor contract is not associated with state-run social insurance benefit. In Brazil, employers would purposely avoid signing the labor contract to alleviate paying for the social benefit costs. In China, employers can sign labor contracts without paying a lot of (if any) social benefit. This is why we observe a rise of informal employment in the formal sector in China. Dispatched worker is a classic example. By law, dispatched workers have labor contracts, but with a third party, not with the firm they work in. For employers, the purpose of having a third party, which is usually a firm that is solely responsible for sending dispatched workers, signing the labor contract is to help alleviate the labor costs and to lessen the benefit package employers must pay out. In this regard, dispatched workers are also subject to high job insecurity and low (to zero) social benefit, which makes their circumstance almost the same as other informal workers, even though dispatched workers have labor contracts. To sum up, having a labor contract or not does not really define labor formality/informality in China. Third, the size and composition of labor informality are highly affected by government policies. Brazil’s Bismarck style welfare state incentivizes employers and excludes workers from the formal sector (or more precisely, the wage–­ employment relationship). The social insurance-based welfare state results in

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informal self-employment-based labor informality in Brazil. In China, there has been an increase of informal wage–employment jobs due to the implementation of the Labor Contract Law of 2008. While the law has increased the proportion of workers with labor contracts, it has also created many precarious workers, such as part-time workers or dispatch workers. Some implications can be derived from the conclusion. At the theoretical level, the diverging paths and sources of labor informality have made Chinese informal workers highly heterogenous. They have been treated differently in the labor market and received different types of benefits from their employers or from the state. Such heterogeneity also distinguishes China’s labor informality from other BRIC countries’ labor informality. Hence, in order to better grasp the size and nature of the Chinese labor informality, it is essential to understand various paths from which labor informality is generated. If we only define labor informality with the “no labor contract and no social benefit” criterion, like how we did in Brazil, we may fail to capture precarious employment, workers with labor contracts but without enough social benefit and job security, as a form of informal employment in China. In this chapter, we take the initial step and discuss how we should measure informality in China given the various sources of labor informality. A related issue is that it begs further theoretical debate on whether the current conceptualization of labor informality can travel across countries. We are in need of better dataset that can produce more internationally comparable data on labor informality. Due to the data availability issue, many of the studies out there only use “self-employment” as the proxy for labor informality (e.g. Berens, 2015). The “self-employment” proxy is not only not comprehensive but also not really useful for cross-national comparison. How to create better proxies for labor informality for cross-national analysis is an important question to be explored as the next step.

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CLB (2013). China curbs its enthusiasm for the new Labour Contract Law. Cook, S. (2008). “The challenge of informality: Perspectives on China’s changing labour market,” IDS Bulletin Volume, 39: 48–56. Cooke, F. L. (2008). “Labour market regulations and informal employment in China: To what extent are workers protected?” Third China Task Force Annual Meeting. Gallagher, M., J. Giles and A. Park et al. (2014). “China’s 2008 labor contract law: Implementation and implications for China’s workers,” Human Relations, 0018726713509418. Ginneken, W. Van (2003). Extending Social Security: Policies for Developing Countries. Social Security Policy and Development Branch, ILO. Haggard, S. and R. R. Kaufman (2008). Development, Democracy, and Welfare States. Princeton, NJ: Princeton University Press. Hart, K. (1973). “Informal income opportunities and urban employment in Ghana,” Journal of Modern African Studies, (11): 61–89. Hart, K. (1985). “The informal economy,” Cambridge Anthropology, pp. 54–58. Hu, A. and L. Zhao (2006) “Informal employment and informal economy in the economic transformation in the process of urbanization in China (1990–2004),” Journal of Tsinghua University, 21: 111–119 (in Chinese). Huang, P. (2009) “China’s neglected informal economy: Reality and theory”, Modern China, 35: 405–438. Knight, J., L. Song and J. Huaibin (1999). “Chinese rural migrants in urban enterprises: Three perspectives”, Journal of Development Studies, 35: 73–104. Li, X. and R. B. Freeman (2015). “How does China’s new labour contract law affect floating workers?” British Journal of Industrial Relations, 53: 711–735. Liang, Z., S. Appleton and L. Song (2016). “Informal Employment in China: Trends, Patterns, and Determinants of Entry”, Discussion Paper, pp. 1–33. Inter-American Development Bank (2004). Good Jobs Wanted: Labor Markets in Latin America. Washington, DC: Inter-American Development Bank. International Labour Conference (2002). Decent Work and the Informal Economy. Retrieved from http://www.econstor.eu/handle/10419/52876. Access Date: 2014/10/01. Levy, S. (2008). Good Intentions, Bad Outcomes: Social Policy, Informality, and Economic Growth in Mexico. Washington, DC: The Brookings Institution. Levy, S. and N. Schady (2013). “Latin America social policy challenge: Education, social insurance, redistribution”, Journal of Economic Perspectives, 27(2), 193–218. Malloy, J. (1979). The Politics of Social Security in Brazil. University of Pittsburgh Press. Meng, X. (2017). “The labor contract law,” macro conditions, self-selection, and labor market outcomes for migrants in China.” Asian Economic Policy Review, 12: 45–65. Park, A. and F. Cai (2011a). “The informalization of the Chinese labor market”, In S. Kuruvilla, Lee C. K. and M. E. Gallagher (eds.), From Iron Rice Bowl to Informalization: Markets, Workers, and the State in a Changing China, Chapter 2. Ithaca, NY: ILR Press, vi, 233 p. Park, A. and F. Cai (2011b). “The informalization of the Chinese labor market”, In S. Kuruvilla, C. K. Lee and M. Gallagher (eds.), From Iron Rice Bowl to Informalization: Markets, Workers, and the State in a Changing China. Ithaca, NY: Cornell University Press.

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Park, A., Y. Wu and Y. Du (2012). “Informal employment in urban China: Measurement and Implications”, World Bank Working Paper 77737. Perry, G., W. Maloney, O. Arias, P. Fajnzylber, A. Mason and J. Saavedra-Chanduvi (2007). Informality: Exit and Exclusion. Washington, DC: International Bank for Reconstruction and Development/The World Bank. Ren, Y. and X. Peng (2007). “The 2006 Report on the Development of Informal Employment in China: A Review of the Labor Market. Chongqing, China. Swider, S. (2015). “Building China: Precarious employment among migrant construction workers”, Work, Employment and Society, 29: 41–59. Wang, J., F.L. Cooke and Z. Lin (2016). “Informal employment in China: Recent development and human resource implications”, Asia Pacific Journal of Human Resources, 54: 292–311. Wibbels, E. and J. S. Ahlquist (2011). “Development, trade, and social insurance”, International Studies Quarterly, 55(1): 125–149. Zhang, Y., Q. Chen and B. Qin (2015). “The effect of Urban informal employment on e­ conomic growth”, Exploration on Economic Issue, 3 (in Chinese). Zhou, Y. (2013). “The state of precarious work in China”, American Behavioral Scientist, 57: 354–372.

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CHAPTER 10

Insiders, Outsiders, and the Politics of Employment Protection: Insights from the Brazilian Case Santiago López-Cariboni Department of Social and Political Science, Universidad Católica del Uruguay, Uruguay

Introduction Why do informal workers remain unprotected by the state in developing countries despite prolonged periods of sustained economic growth and political democracy? For many observers, at the heart of this problem are the employment protection rules that increase employer cost to fire and hire workers. These rules determine the level of individual job security for those holding a formal job. Moreover, in combination with contributory social security and unemployment schemes, compliance with labor market regulations also determines access to social insurance. Advocates of deregulation argue that the consequence of strict rules in the labor market is that only a small share of formal labor is protected while households that depend on informal jobs perceive lower incomes and remain vulnerable to the ups and downs of the economy. This controversial position is partially based on the insider–outsider theory of the labor market (Saint-Paul, 2000; Lindbeck and Snower, 1988). Prominent theoretical accounts of insider–outsider theory suggest that only insider workers benefit from employment protection legislation (EPL) at the expense of outsiders. In developed nations, the insider–outsider model of the labor market 243

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has been extended to a political model in which conflicting labor market policy preferences shape partisan strategies with respect to labor market policies (Rueda, 2005, 2007). A central aspect of this model is that rational workers must have consistent preferences for employment protection (as well as other passive and active labor market policies). Research in developed countries gives support to these predictions: labor market outsiders tend to have more preferences for deregulation and active labor market policies that enable them to become insiders. In developing countries, the dramatic division between formal and informal workers is often seen as the equivalent process of labor market segmentation between insiders and outsiders. Yet, recent research suggests that understanding the politics of employment protection in developing countries may be more complex than simply applying the insider–outsider model to the problem of labor informality. Some recent works on formal–informal workers’ political preferences show that labor market groups vary too little and do not show the expected level of polarization given the existing large differences in employment vulnerability, wages and access to social protection. Unexpected political similarity between insiders and outsiders in developing countries may be rationalized by considering existing criticisms to this theory in the context of developed economies. One important challenge emerges from the strong political and academic debate on whether EPL is detrimental for outsiders or it is in the interest of those with vulnerable jobs. Other scholars point out the heterogeneity of labor market outsiders as well as the need for moving beyond conceptualizing labor market groups by the current job category instead of more suitable risk-based conceptualizations of “insiderness” and “outsiderness”. These challenges are not only important in the context of developed nations but also informative of the potential reasons for why the insider–outsider model may not find strong empirical support in developing countries. Moreover, the existing literature in developing countries also provides important reasons why the insider–outsider theory may fail to account for workers’ labor market preferences. The more cited reasons are, among others, the level of integration between formal and informal sectors (i.e. workers’ transitions), the consequences of low enforcement, and the formation of broad labor coalitions facilitated by multi-dimensional policy preferences. This chapter shows the extent to which the insider–outsider model helps to describe the politics of employment protection in one of the BRIC countries: Brazil. Existing evidence on differences between Brazilian formal and informal workers with respect to their policy and political preferences provide only marginal support to the insider–outsider model. This is puzzling given that Brazil has strict labor regulations, though imperfectly enforced, and a large informal sector covering two-third of business, 40% of GDP, and 35% of employees (Ulyssea, 2018).

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This chapter first reviews the insider–outsider theory of the labor market and its implications for workers’ preferences about employment protection legislation. Second, a discussion on some theoretical and empirical challenges to the insider– outsider model is provided. Third, it follows a review of evidence on formal–informal workers’ preferences for both employment protection and political preferences in Brazil. Finally, the chapter closes with a discussion on the adaptability of the insider– outsider model to understand labor market preferences in developing countries.

Employment Protection Rules, Dualization, and Labor Market Preferences Dualization in Developed Nations EPL constrains the ability of firms to dismiss workers as they would do in the absence of regulation. While, in principle, this type of protection should benefit labor against the interest of capital, many have argued that labor market institutions protecting employment only benefit a group of privileged workers rather than the entire working class (Saint-Paul et al., 1996; Saint-Paul, 2000). The argument says that employment protection benefits the employed because these workers can create artificial monopoly power and bid up wages (Lindbeck and Snower, 2001; Saint-Paul, 2000). The introduction of EPL increases the employment tenure of many low-productivity jobs which would be destroyed otherwise. In turn, such benefits for the employed workers translate into costs for the unemployed ones because regulation reduces the number of available jobs offered by risk-averse employers. The argument has been then generalized to broad categories of “insiders” and “outsiders”. As a result, the existing research not only considers the unemployed as labor market outsiders, but it also includes other non-standard workers such as those with temporary employment contracts (Rueda, 2005). The intuition is that outsiders are all workers for whom EPL represents a barrier that increases the cost of entry into good quality, protected insider jobs. The growing process of segmentation between secure and unstable jobs is known as “dualization” of the labor market (Palier and Thelen, 2010; Rueda, 2005, 2007; Saint-Paul, 2002). Crucially, the insider–outsider model helps to derive neat predictions about policy and political preferences. The immediate implication for EPL preferences is that labor market outsiders should demand lower employment protection because this would increase labor mobility and chances of exit from unemployment and precarious employment (Rueda, 2005: 64). To the contrary, insiders (i.e. the permanently employed) should prefer maintaining the rules that grant market power to them and increase their salaries and job tenures above the competitive benchmark.

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An important number of studies have analyzed insider–outsider differences in preferences for different types of labor market policies in advanced democracies (Rueda, 2005, 2007; Emmenegger, 2009a). Others have focused on insider-outsider differences in party preferences (Lindvall and Rueda, 2014) and preferences for different social policies (Burgoon and Dekker, 2010). In the empirical literature, workers who are in stable employment are often considered as insiders, while all the unemployed, involuntary fixed-term employed, and involuntary part-time employed workers are coded as outsiders (Rueda, 2007; Emmenegger, 2009a; Lindbeck and Snower, 1988, 2001; Saint-Paul, 1998, 2002). While the insider–outsider model has direct implications regarding preferences for employment protection, the literature has focused on preferences for different types of policies that either protect the unemployed with transfers (passive labor market policy) or actively help the unemployed to find new jobs (active labor market policy). Surprisingly, research that analyzes explicit preferences for employment protection legislation (instead of broad proxies) is scarce and confined to the world of developed nations (Guillaud and Marx, 2014). Labor Informality in Developing Countries While research on insider–outsider preferences often looks at developed countries, in the developing world labor markets are divided and show a stark difference between formal and informal workers. As the literature often equates “outsiderness” to labor informality, the central question is whether there is a formal–informal divide in workers’ preferences for labor protection and political attitudes. One plausible intuition is that insider–outsider differences in developing countries should be easier to observe because dualization is far more dramatic than in developed nations. In developing countries, such as Brazil, the main expression of dualization is the division between workers being protected by often rigid labor market regulations and not being protected at all by any mandatory rule (i.e. informality). A widely accepted definition of labor informality is the “legalistic” or “social protection” conceptualization (Perry et al., 2007). Workers are informal ‘‘if their employment relationship is not subject to standard labor legislation, taxation, social protection, or entitlement to certain employment benefits” (International Labour Organization [ILO] and International Labour Office, 2002). In practice, two main groups of informal workers exist: informal self-employed workers and informal wage earners (Perry et al., 2007). Small enterprises like bars, restaurants, or haircutters make up the vast majority of the total number of enterprises and they usually engage in underground activity operating outside of state regulations and taxation (Gërxhani and Gerxhani, 2004; Johnson et al., 1997; Schneider, 2005).

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The causes of labor informality have been long debated. One account conceptualizes informality as the result of a process of exclusion (Harris and Todaro, 1970). This view is closely linked to the insider–outsider model described before insofar as informal workers are excluded because of the legal barriers that protect formal jobholders. It is because of this reason that EPL has been accused of creating a rigid environment comprising wage rigidities as well as regulations, such as high labor taxes or firing restrictions.1 Standard theory of dual labor markets sustains that markets are segmented by wage setting in the formal sector. Workers unable to enter the formal sector due to labor market rigidities enter the disadvantaged (less well-paid, less protected) sector to avoid unemployment (Harris and Todaro, 1970). Informal workers are thus self-employed in marginal economic activities or employed in small firms with low productivity levels (Hart, 1973; Sethuraman, 1976; Tokman, 1978; Fields, 2009). This perspective is consistent with the idea that the size of informal sector is significantly affected by the institutional settings and regulations, such as the “­ regulation of entry” and costs of start-up business (Auriol and Warlters, 2005; Djankov et al., 2002; Hibbs and Piculescu, 2010; Ulyssea, 2010). Seminal work by Djankov et al. (2002) shows that firms face significant “entry costs”, such as registration and license fees, to be able to operate formally. These authors find that stricter entry regulation is associated to a greater relative size of the unofficial economy and larger employment in the informal sector. Indeed, a large literature sustains that lowering entry costs should decrease informality (Ulyssea, 2010; Djankov et al., 2002; Auriol and Warlters, 2005). Job security rules have clear impacts on labor market dynamics. Empirical research confirms theoretical expectations that rules discouraging dismissals and temporary contracts lengthen durations in different labor market states (employment, unemployment, not in the labor force) and, accordingly, reduce flows between these states (Betcherman, 2015). Cross-country studies show that EPL explains a significant variation in job and worker flows (Caballero et al., 2013; Micco and Pagés, 2006; Haltiwanger et al., 2008). Case studies in Latin America have also linked reductions in EPL with lower job tenure and higher turnover (Saavedra and Torero, 2004; Hopenhayn, 2004). To the extent that rigid labor employment protection rules create exclusion in the labor market, the insider–outsider model would predict that informal workers should oppose these rules and formal, protected workers should be the main supporters of employment protection. Moreover, if from the point of view  Whether driven by segmentation (presence of wage rigidities) or distortions more ­generally, the (reductive) effect of regulations on the number of vacancies that open in the formal sector is similar (Perry et al., 2007: 106). 1

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of the insider–outsider model workers have consistent preferences for labor market rules, they should also exhibit distinct political preferences and political attitudes. Therefore, what is the empirical support for the insider–outsider model of labor market preferences? To what extent are informal and formal workers politically distinct?

Empirical Evidence for Insider–Outsider Models of Politics Preferences for Labor Market Policies Analyzing labor market preferences is important to understand the political economy of labor market policies. For instance, the outsider group size may be correlated with policy change, but this would only provide for indirect evidence of causal mechanisms: i.e. Spain deregulated employment protection in times when outsiders outnumbered insiders (Dolado et al., 2002; Bentolila et al., 2012). Supplyside arguments of labor market policies need to rest on solid assumptions about the distribution of workers’ preferences. The seminal work of David Rueda (2005, 2006) argues that social democracy and trade unions only represent the interests of labor market insiders: that is, insiders benefit from minimizing labor turnover which requires strict job security regulations. Hence, labor market insiders support EPL, while outsiders (e.g. unemployed or part-time workers) and capitalists oppose them. The political consequence is that insiders disproportionally vote for Social Democratic (left) parties, which, together with trade unions, are the main actors pushing for labor market regulations. The macro-level relationship between partisanship and EPL has found empirical support in several studies (Botero et al., 2004; Rueda, 2005; Saint-Paul, 1996, 2002). Yet, EPL is not the only labor market policy that governments may implement. Labor market outsiders can benefit from active (i.e. job creation) and passive labor market policies (i.e. unemployment benefits). Labor market insiders, on the other hand, do not benefit from these LMPs and have to finance them ultimately via taxes (Rueda, 2006). According to this argument, labor market outsiders should be more supportive of active and passive LMPs than insiders. Rueda uses Eurobarometer to analyze a dependent variable that measures an individual’s willingness to pay taxes to create new jobs: level of agreement with the statement I would be ready to pay more tax if I were sure that it would be devoted to creating new jobs. The results indicate that the probability of agreeing goes up by 7.5% if an individual is an outsider rather than an insider and by 11.2% if an individual is an outsider rather than a member of the upscale group. Schwander and Haüsermann (2013), in turn, offer a conceptualization and measurement of labor market insiders and outsiders based on their respective risk

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of being atypically employed or unemployed. In an analysis of 18 advanced nations, they confirm the impact of labor market vulnerability, indicating a potential for politicization of the insider–outsider conflict. The main findings are as follows: Being an outsider increases the likelihood of agreeing that the government is (definitely or probably) responsible for providing a job for everyone by about 6% points when a welfare regime-specific, dichotomous operationalization is used. If a country-specific continuous measure of “outsiderness” is used, a change from the highest to the lowest value of “outsiderness” has an effect of 15% points (from 78.5% to 63.4%) on the likelihood that a respondent agrees that the government should provide a job for everyone. More importantly, passive labor market policy preferences also show insider–outsider differences. Schwander and Haüsermann find that outsiders have somewhat stronger preferences for passive labor market policies insofar as outsiders are more likely to agree with the statement that the government should spend more on unemployment benefits. The difference between insider and outsider preferences is 4.2% points when considering their welfare regime-specific, dichotomous measure. For a change from the maximum to the minimum level of their continuous measure of outsiderness, the change in support for unemployment is between 13.1 and 14.4  points. Setting aside the important debate of how to conceptualize and measure insiders and outsiders, the existing evidence shows that factors that increase the insiders’ vulnerability to unemployment can align their interests with those of outsiders. These factors could be, for example, a decrease in the level of employment protection and an increase in the instability of the unemployment rate. Indeed, insiders increase their support for active labor market policies by 10% if they feel insecure about their jobs (Rueda, 2006). Therefore, parties that want to represent the interests of labor as a whole face a strong political dilemma between catering to a small core constituency of powerful insiders and providing entry options to a large number of unorganized labor market outsiders (Rueda, 2005, 2014). This dilemma is, however, lessened in situations where a larger group of insiders is at risk. As a consequence, left parties may be more inclined to support pro-outsider policies that constituencies of vulnerable insiders may demand. As left parties make stronger emphasis on active and passive labor market policies, outsiders are likely to become supportive of left parties, which they otherwise tend to oppose. The prediction that some of the insider–outsider policy preferences can converge with higher insider vulnerability finds support in both developed nations (Rueda, 2005) and developing countries (Carnes and Mares, 2014; López-Cariboni and Menéndez, 2018). Carnes and Mares (2014) attribute the expansion of noncontributory pensions in the developing world to the effects of deindustrialization on employment vulnerability. They argue that deindustrialization raises the demand

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for transfers to the informal sector by (a) increasing the aggregate share of “vulnerable” or informal employment and (b) threatening the employment security of formal wage earners. Their argument of preference formation explains the reasons for a broad coalition of formal and informal workers in support for protection for outsiders. From a related angle, Garay (2016) stresses that outsiders mobilize successfully when they are able to coalesce with insider organizations (unions) in favor of non-contributory policies that provide protection for informal workers. In turn, left-wing governments would channel this increased demand for pro-outsider passive labor market policy.2 Note, however, that this line of argumentation is not about preferences for employment protection rules. In that sense, the argument is similar to that of Rueda (2005, 2007) in which left governments can implement alternative, active or passive labor market policies without changing the status quo in EPL. Research on preferences for employment protection legislation in developing countries is dramatically scarce, and direct tests of workers’ preferences for EPL are inexistent. One line of argumentation goes back to the origins of dualism in developing nations. Developing projects based on import–substitution–­industrialization (ISI) have been characteristic for creating high levels of labor market segmentation, where a group of powerful labor market insiders is able to protect ex ante employment protection even long after the exhaustion of the development project (Rueda et al., 2015). First, workers in the import-substituting sector were economically and politically privileged. As a result, import-substituting countries produced uncontested labor markets (Murillo, 2000; Mesa-Lago, 1997; Haggard, 1990) in which insiders earn above competitive wages, and firms in imperfectly competitive product markets also charge more than the competitive prices (Lindbeck and Snower, 2002). The labor market power of industrial labor results from their condition of being both a scarce production input and as a key domestic consumer of the manufactured output (Mallet, 1970). These increased wage differentials and promoted government policies limited the arbitrage between urban and rural wages. As a consequence, the risks of not being employed in a protected industrial job exacerbated (Iversen and Soskice, 2001) and so did the demands for restrictive labor market rules and generous social insurance programs (Rueda et al., 2015; Wibbels and Ahlquist, 2011). After the implementation of the ISI model, rigid labor markets, such as Brazil, were characterized by employment guarantees, high severance pay requirements,  Recent research has started to analyze the effects of dualization on politics and policies in developing countries (Carnes and Mares, 2013, 2014, 2015, 2016; Carnes, 2014a, 2014b; Baker and Velasco-Guachalla, 2018; Holland and Schneider, 2017; Berens, 2015a, 2015b). Accounts on social protection in developing countries build on the insider–outsider model to explain the effect of informal employment on the provision of non-contributory social policy (Carnes and Mares, 2013, 2014). 2

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high minimum wages, and long-term contracts (Heckman et al., 2000; Botero et al., 2004). Tight rules in dual labor markets implied ex ante employment protection and transfer benefits targeted to formal workers employed in strategic inward-oriented industries (McGuire, 1999; Huber et al., 2006). From this perspective, and consistently with the insider–outsider model, the persistence of large informal sectors in developing countries seems to be a consequence of differences in the level of protection against unemployment (Rueda et al., 2015). More importantly, this type of analysis suggests that formal workers should be the main labor market group backing up EPL. Because of the centrality of EPL for the very survival of insiders, unionized formal workers spent important resources blocking labor deregulation even when being forced to accept other undesirable macroeconomic reforms, such as trade liberalization and privation of state-owned enterprises (Murillo and Schrank, 2005; Murillo, 2001). However, this topic remains largely under-studied in the empirical literature analyzing individual-level preferences for employment protection. One important account of the evolution of EPL in Latin America sustains that union density exerts its influence on the laws that govern the collective action of workers, while skill levels impact the laws that govern individual employment relations (Carnes, 2014b). While the argument of Carnes is strongly based on the relationship between workers’ skills and social policies — emphasized in the literatures on “varieties of capitalism” (Hall and Soskice, 2001) — as well as in power resources approaches (Esping-Andersen, 1985; Huber and Stephens, 2001), it is still consistent with the insider–outsider model insofar as more skilled workers are more likely to be formal and therefore prefer stronger EPL. The most direct evidence regarding preferences for labor regulation in developing countries probably comes from a recent study by Berens and Kemmerling (2016). The authors analyze survey data form 18 Latin American countries (Latinobarometer, 2005) that contain the following question: How much protected do you feel [under] the labor law in (country)?: (1) very protected, (2) fairly protected, (3) a little protected or (4) not at all protected. However, the wording in Spanish/ Portuguese refers to the perception of worker protection and not one’s own feeling of protection: Cuán protegido por la ley laboral cree Ud. que se sienten en (país) los trabajadores?. The authors argue that the variable is weakly correlated with individual perceptions of job-security and therefore it measures people’ assessment about the capacity of the labor law to protect workers in general. Berens and Kemmerling (2016) find that formal workers are significantly more likely to think that workers are protected by the employment rules than informal workers.3  They also show evidence about that contextual data, such as the level of collective labor rights matters. Informal workers are skeptical of labor regulations when collective labor protection — as measured by Mosley (Mosley 2010) — is relatively high. 3

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Insider–Outsider Political Behavior The existing literature has documented that insiders and outsiders are politically different in advanced democracies. For example, the unemployed participate less in politics (Lorenzini and Giugni, 2012; Marx and Picot, 2013), have lower trust in political institutions (Sani and Magistro, 2016), feel less politically efficacious (Marx and Nguyen, 2016), and are more supportive of “leftist” political parties (Emmenegger, 2009b; Marx and Picot, 2013) and policies, such as redistribution (Cusack et al., 2006). Lindvall and Rueda (2014) sustain that when major left parties cater to insiders’ demands, outsiders will be forced to either abstain from voting or consider alternative options, which may range from radical left support (as in Sweden in 1998) to extreme right parties that receive voter support of the unemployed (as in France, Finland and other European countries). These findings are often hard to compare as the operationalization of the insider–outsider divide may vary from one study to another. Rovny and Rovny (2017) consider four different operationalizations of insiders and outsiders and find two main systematic results: (a) outsiders are less likely to vote for the major right than insiders, and (b) outsiders are more likely to abstain from voting. Another important difference between labor market outsiders and insiders is the fact that workers with vulnerable employment tend to behave like pure economic voters. That is, those who have lower employment protection rely more on the general success of the economy, and therefore their evaluations about government performance are sensible to the evolution of the economy. Singer (2013) analyzes survey data from Latin America and Eastern Europe and provides evidence that workers who feel higher risks of unemployment place significantly greater weight on sociotropic evaluations of the government than do those with more secure employment situations. Consistent with this finding, Singer (2016) sustains informal workers who are excluded from employment law and welfare safety nets, have their fortunes tied to economic fluctuations and therefore have strong incentives to focus its evaluations of the incumbent on his or her perceived economic competencies. His analysis of the Argentinean electoral data finds support for this claim. Using comparative international data from the Comparative Study of Electoral Systems (CSES), Singer (2011a) also finds that the political salience of economic performance rises with individual status of unemployment and economic vulnerability. Moreover, in a different study on the American state legislative elections, Singer (2011b) shows evidence suggesting that economic safety‐nets that reduce vulnerability to poverty, such as unemployment insurance programs, lower the salience of the economy and provide electoral cover for incumbent politicians during economic slowdowns. In a similar vein, Marx (2014) shows evidence that compared to permanent workers,

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temporary workers (or outsiders) were more likely to hold the government responsible for their poor economic situation and vote against it in the 2009 German election. In sum, there is evidence suggesting that insiders and outsiders have different policy preferences that may translate into political behavior. However, the most basic claim of the insider–outsider model regarding a conflict around employment protection legislation does not remain unchallenged. The existing debate opens the possibility that observed political differences between insiders and outsiders may not be necessarily originated in a struggle around labor market regulations. Challenges to the Insider–Outsider Model Insider–outsider theory has been criticized from different viewpoints and approaches. This section revises only some of the empirical and theoretical challenges, which are relevant to the extent to which labor market preferences are translated into politics. A strong intuition in the insider–outsider model of labor market preferences is that outsiders are negatively affected by rules that reduce their chances to access to good, secure jobs. One counterargument presented by Tsakalotos (2004) suggests that deregulation, even when benefitting outsiders at the expense of insiders, also changes the power balance towards employers. When insiders lose the power that underpins their privileges, they are weakened not only with respect to the outsiders but also with respect to state and private sector employers. This increases the risk of triggering a process of regulatory change that, in the long term, may be damaging to all workers and not just the current insiders. If deregulation reduces the power of insiders against capital, there is room for an unstable political situation. The net effect of such deregulating context potentially harms today’s outsiders to a larger extent than the costs they pay for the status quo, i.e. rigid labor market rules governed by the insider worker preferences. In this context, outsiders may have little incentive to support liberal reforms and therefore their opposition to deregulation is not irrational. In turn, the work by Emmenegger (Emmenegger, 2009a) raises alternative criticisms to the insider–outsider model of labor market preferences and politics. A first claim is that the insider–outsider theory of employment and unemployment makes strong assumptions about workers’ rationality and may therefore overestimate labor market polarization of policy preferences. Second, the insider–outsider theory is criticized because it may ignore the role of policy packages offered by parties. In a policy bundle, job security regulations cannot be separated from other issues, and as a result, outsiders may have no other choice than voting for left (Social Democratic) parties, even when they would not approve parts of the offered policy package such as over-regulation of the labor market. Finally, the insider–outsider theory may also

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disregard reasons why outsiders could support job security regulations as much as labor market insiders do. In line with previous arguments (Tsakalotos, 2004), these reasons are long-term expectations, the power balance between capital and labor, and intra-household relationships. In an analysis of survey data from the International Social Survey Programme (ISSP), Emmenegger finds conflicting evidence with the insider–outsider model in a sample of 14 developed countries. In the wave of 1996, respondents were asked whether they supported governmental action for declining industries to protect jobs. In the 1997 wave, respondents were asked how important do you personally think each item is in a job: job security?. It should be noted that the two dependent variables are only proxies for labor regulation and none of them directly captures preferences for reform in labor market rules. The findings suggest that the self-employed are the group most critical of job security given the negative effects in both dependent variables. Part-time, temporarily employed, and non-employed respondents have similar preferences for job security, being less supportive of labor market regulations than insiders. However, unemployed respondents are significantly more supportive of job security regulations. In sum, labor market insiders and unemployed people are very supportive of job security regulations. The remaining labor market o ­ utsiders, that is, the temporarily, part-time employed, and non-employed people, are more critical while “upscales” and self-employed people are rather hostile towards job security regulations. The finding that unemployed and insider workers have similar attitudes toward labor market regulations is at odds of the insider–outsider model. Emmenegger speculates that future expectations of the unemployed may be a reason why they support labor regulations. The unemployed, he argues, are currently looking for new jobs and hope to get full-time, permanent jobs in the near future. Yet, the empirical literature often faces strong limitations to offer credible tests of insider–outsider preferences for labor regulation itself. In an insightful study, Guillaud and Marx (2014) use the French Electoral Study 2012 to analyze the support for employment protection among different labor market groups. They make use of a question on the single employment contract: Would you be in favor of or against the establishment of a single employment contract replacing temporary and permanent contracts? It would be easier to fire someone than with a permanent contract but severance payments would increase with seniority. The survey was conducted when a salient policy proposal regarding the implementation of a single type of employment contract was being debated in France. Therefore, the authors use information about respondents’ attitudes towards real alternatives of policy reform. Moreover, France is known for its segmented labor market (Palier and Thelen, 2010) and strict labor market regulation on dismissals (Venn, 2009). Hence, the main preconditions for insider–outsider arguments seem to apply.

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As in other studies aiming at testing insider–outsider preferences for labor regulations, the key explanatory variable in Guillaud and Marx (2014) is individuals’ employment status. They label permanent workers as insiders, and distinguish two outsider groups: temporary contracts and the unemployed. Interestingly, the authors find that temporary workers do not differ significantly from permanent workers (insiders) regarding preferences for employment protection. Contrary to the findings by Emmenegger (2009), these authors only confirm the insider–outsider argument for the unemployed, who show greater support for deregulation. They interpret the fact that temporary workers do not differ significantly from permanent workers (regarding preferences for employment protection) as an indication that future expectations play an important role in shaping labor market preferences. The intuition here is that the prospect of obtaining a permanent employment contract is more remote for the unemployed than for the temporary workers. An important implication for insider– outsider theory is that this model may overemphasize the relevance of employment protection for temporary workers, often considered as labor market outsiders. The authors advice against treating distinct labor market groups as a composite outsider category and call for group-specific theoretical arguments that provide a rationale for the effect of unemployment and temporary work on policy preferences. However, it should be emphasized that the evidence from Guillaud and Marx (2014) is not entirely against the insider–outsider model. They do find important differences between wage-earners on the one hand and the self-employed and unemployed on the other. The self-employed and unemployed support the single employment contract more significantly than wage-earners, which can be interpreted as a preference for deregulating the protection of permanent, insider workers. In a developed country, the self-employed often employ workers themselves, therefore it is more likely that they are reacting as employers than as labor market outsiders. More importantly, the significant result for the unemployed in Guillaud and Marx (2014), indicates that the insider–outsider argument is relevant for this group. However, this evidence is not robust to alternative measures of the dependent ­variable. Even so, the substantive effect shows that the unemployed are about 11% points more likely to support the single employment contract (i.e. deregulation) than permanent workers. Another challenge to the insider–outsider model of labor market preferences refers to the causal link between labor market status and preferences for employment protection. Recent research shows that the socioeconomic background simultaneously determines both the risk of getting unemployed and political socialization experiences from early childhood onwards (Wehl, 2018). This argument builds on previous fi ­ ndings suggesting social status of parents is positively related to both labor market success (Gregg and Machin, 2001) and egalitarian or leftist orientations

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(Rekker et al., 2015) of the offspring. Wehl (2018) argues that social immobility together with stability in individuals’ political pre-dispositions are strong enough forces to create a non-causal relationship between unemployment and labor market attitudes. Analysis of data from the fourth wave of the European Social Survey (ESS 2008) includes 31 countries. The main dependent variable is a 11-point scale of how much responsibility the government should have in (a) ensuring a reasonable standard of living for the unemployed and (b) in creating new jobs for everyone, who wants one. The evidence supports the claim of no causality between unemployment and policy attitudes, while such evidence is less strong for passive labor market policy attitudes. Her study analyzes. The evidence suggests that individuals’ preferences may reflect those of insiders and outsiders not because of current changes in job status but due to early socialization and inherited political beliefs and socioeconomic status from their parents. Even when the consequences of written labor regulations may be potentially large, they are also dependent on another key policy, which is the level of enforcement. An existing important literature analyzes the causes and consequences of EPL enforcement. For instance, Almeida and Ronconi (2016) observe that the targeting of labor inspections is at odds with the assumption that agencies exclusively focus on reducing violations. Instead, they find that labor inspections are biased toward large firms, operating in industries with lower tax evasion, and with a smaller share of low-skilled workers. If, in essence, governments target firms that are more likely to comply after being inspected, the evidence could suggest that inspection agencies are concerned about both avoiding job destruction and collecting revenues rather than reducing violations (Almeida and Ronconi, 2016). As long as workers are embedded in an environment with strong EPL but low compliance, they may not observe the “dualizing” consequences of EPL because the labor market may look relatively more integrated than segmented. Indeed, cross-country analyses by Caballero et al. (2013) and Micco and Pagés (2006) find that the effect of EPL on job and worker flows is very important where the rule of law is strong and may largely disappear where the rule of law is weak. Similarly, Almeida and Pool (2017) find that the extent to which trade affects labor market outcomes depends on the de facto stringency of the labor regulations faced by plants. The authors exploit data from Brazilian industries and show plants facing stricter enforcement of the labor laws increase employment by less than plants facing fewer inspections.4 Their results confirm that EPL limits job  Interestingly, recent research shows that governments may use enforcement of EPL regulation as a compensatory policy against negative shocks form liberalization. There is evidence suggesting that, had enforcement of labor regulations been stricter in Brazil, the effect of import competition on trade-displaced workers’ employment outcomes could have been

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creation if de jure regulations are more stringent.5 The implication of this literature for the insider–outsider model is that preferences for EPL may depend on the level of enforcement. Research in labor economics in developing countries shows that much of the entry into informality is voluntary in nature (Levy, 2010; Maloney, 2004; Perry et al., 2007; Bosch and Esteban-Pretel, 2012). One argument is that informal workers choose to stay in the informal sector because they have a “comparative advantage” such that they would not necessarily be better off in the formal sector (Maloney, 2004; Günther and Launov, 2012). For example, for many workers in micro-firms with relatively low levels of human capital, accumulating experience in the informal sector often enables them to get a formal job later. Other longstanding views in development economics emphasize the role of informal markets in providing outside options to smooth consumption (Morduch, 1995; Rosenzweig, 1988). Households can smooth consumption by borrowing and saving, accumulating non-financial assets, adjusting labor supply and relying on formal and informal (family networks) insurance arrangements. These mechanisms generally help workers to protect consumption patterns from income shocks (Morduch, 1995: 104). In practice, important contributions find support for the exclusion view of informality (Loayza, 2011), while others suggest that both types of informalities coexist (Perry et al., 2007; Gunther and Launov, 2012; Fields, 2005; Radchenko, 2014). This is an important challenge to the insider–outsider model because the model assumes a segmented labor market where those in the informal sector are excluded from the good quality jobs. When informality is voluntary, predictions about preferences for EPL and other social policies cannot be directly derived from the standard insider–outsider model. Another challenge to the application of the insider–outsider account in developing countries comes from the fact that EPL may protect workers without creating labor market rigidities. That is, EPL in dualistic labor markets, in which the share of permanent workers is shrinking, may not affect firms’ decisions regarding employment adjustment. Sofi and Kunroo (2017) exploit EPL variation across Indian states and find EPL does not hinder employment reallocation while reducing the labor turnover. This suggests that the efficiency in the labor market is not negatively affected by EPL, and at the same time, employment protection rules are beneficial for enterprises and workers. The empirical literature testing individual preferences is quite scarce in developing countries. For instance, Berens (2015a) analyzes preferences for redistribution and social policies based on pooled survey data from the Latin American Public Opinion much more adverse than it actually was (Dix-Carneiro and Kovak, 2017; Ponczek and Ulyssea, 2017). 5  See also Almeida and Carneiro (2005) and Kanbur and Ronconi (2018).

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Project (LAPOP) 2008 and 2010. While informal workers are significantly more likely to be at economic risk than their formal counterparts, they are, however, not more supportive in social policy and redistribution. Moreover, this is also the case in insecure environments reflected by higher unemployment rates. One interpretation is that the findings provide no support for the insider–outsider model probably because the labor market is not so segmented. A similar conclusion is reached by Baker and Velasco-Guachalla (2018) who analyze political and policy preferences of Latin American workers. I pay more attention to this study in the following section dedicated to the case of Brazil.

Labor Market Preferences and Insider–Outsider Politics in Brazil Individual Employment Protection Legislation in Brazil and Labor Market Outcomes Until the recent labor overhaul of the labor law,6 Brazil has on paper one of the least flexible labor markets in the world. All employees must have a work permit where the employment history of the worker is registered (carteira de trabalho). Permit holders are entitled to several benefits, such as retirement pension, unemployment insurance, and severance payments. The labor code in Brazil is also difficult to change because it is largely written into the Brazilian constitution. The 1988 constitution strongly increased the degree of worker’s protection (Barros and Corseuil, 2004). The protections involve a maximum working period of 44 hours a week, a maximum period for continuous shift work of 6 hours, a minimum overtime pay of 1.5 times the normal hourly wage, paid leave of at least four-third of the normal wage, and a paid maternity leave of 120 days. Moreover, employers must contribute to the social security system and to a job security fund (FGTS). The FGTS is basically a severance pay individual account, which accumulates as long as a worker remains employed with the firm. Since 2001, employers make monthly contributions (equivalent to the 10% of the employee’s wage). For an employer, firing a worker with a wage of R$100 involves a disbursement of approximately R$165 (Cardoso and Lage 2007), which makes Brazil an example of rigid labor regulations. Except for the firing index,  Brazil implemented a labor reform in 2017 which introduces flexible working hours, facilitates part-time work, relaxes workers’ holidays and cuts the statutory lunch hour to 30 minutes. Importantly, the reform also scraps dues that all employees must pay to their company’s designated union, regardless of membership. Also, collective agreements between employers and workers will overrule many of the labor code’s provisions.

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Firing Index

Payroll Taxes

Mean (155 countries)

36.7

35.9

16.3

1st quartile

11.0

20.0

8.0

2nd quartile

33.0

40.0

14.7

3rd quartile

61.0

50.0

23.8

Maximum

100.0

100.0

55.0

Brazil

67.0

20.0

26.8

Latin America

40.5

29.5

15.9

OECD: high income

30.1

27.4

20.7

Source: Ulyssea (2010) based on the Doing Business database (World Bank).

Brazilian firms face labor costs that are well above the Latin American average, being located at the top quartile of the distribution in 155 countries (see Table 1).7 In practice, employment protection legislation in Brazil makes firing formal workers comparatively more costly than in other countries from Latin America (Almeida and Carneiro, 2012). For instance, mandated advance notice before dismissal to workers is combined with the obligation that employers, in the interim period, should grant workers 2 hours a day to search for a job. This interim period is at least 1 month long. Moreover, employers cannot change the worker’s wage within this period. As a consequence, about 25% of paid hours are not worked, without considering the intrinsic drop in motivation before dismissal which may involve a 25% decline in production (Barros and Corseuil, 2004). Whenever a worker is fired without cause, he/she has the right to receive a compensation from the employer on top of what was accumulated in the worker’s job security fund (the penalty equals to a 40% of the accumulated fund during the worker’s tenure with the firm).8 Because dismissal costs increase with the duration of the work contract, employment protection legislation in Brazil makes the status of “insiderness” an increasing function of job tenure. From the expected effects of employment protection legislation, Brazil exhibits large insider–outsider differences in labor market outcomes. Since the constitutional reform in 1988, the size of the informal sector increased in Brazil (see Figure 1).  Doing Business database, available at www.doingbusiness.org.  Some authors have found that regulations of severance payment in Brazil may induce ­several workers to force their dismissal. This has the potential to increase turnover rates and increase firm’s costs even more (Neri, 2002). 7 8

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260  S. López-Cariboni Labor informality and share of informal salaried workers as percentage of informal labor (secondary y-axis)

Controlled formal–informal wage gap and unemployment

Figure 1:   Labor informality and formal–informal wage gap in Brazil (before and after the ­constitutional reform of 1988). Source: Ulyssea (2010) based on Monthly Employment Survey (PME).

Substantial increases in the fixed costs of hiring formally were seen as responsible for this trend in informality in the Brazilian labor market (Ulyssea, 2010). Interestingly, existing research downplays the impact of other liberalizing reforms, such as trade liberalization during the 1990s, on informal employment’s growth, while changes in

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labor market regulation seemed to have played a major role (Goldberg and Pavcnik, 2003; Bosch et al., 2012). Moreover, the rise in labor informality was accompanied by a larger share of informal salaried workers in the total informal employment. Before the constitutional reform, the share of informal wage earners was suffering a significant drop, but then increased up to 50% of informal labor in the early 2000s. This is important because as opposed to the informal self-employed, informal salaried workers are those who correspond more closely to the standard queuing view of the segmented labor market (Bosch and Maloney, 2010). Together with the increase in informality, both the unemployment rate and the wage gap between formal and informal workers (controlled by standard covariates in Mincerian regression) also increased. In sum, the evidence suggests a clear division between labor market insiders and outsiders, which, in turn, should provoke political differences between labor market groups. Labor Market Preferences and Workers’ Political Polarization Survey data on preferences for labor market regulations are scarce and often not directly asking about labor regulations per se. Potentially relevant information is the insider–outsider difference in the perception of feeling protected by the labor code. The Latinbarometer has collected this data in 1997, 2000, 2001, and 2005. The question is worded as follows: How protected do you feel by the labor law in Brazil? Here, I take the percentage of respondents who report feeling “very protected” or “fairly protected” as the outcome of interest. Informal workers are those who declare to be “self-employed”, “farmer/fisherman”, or “informal” worker. Formal workers are those who fall in any the of the following categories: “salaried employee in a public company”, independent or salaried “Professional (doctor, lawyer, accountant)”, “salaried senior management”, “salaried middle management”. Figure 2 shows the evolution of insider–outsider differences in the perception of feeling protected by the labor law for each type of workers. In general, evidence suggests that informal workers feel less protected by the labor law than formal workers. However, the differences between formal and informal workers in perceptions about EPL are only moderate and vanish in 2001 and 2005. Only in 1997 and 2000, these differences are statistically significant in the formal worker category at 7 and 9% points, respectively, who are more likely to feel protected by EPL than informal workers. The main change observed in 2001 is the fall in perceptions of protection among formal workers. In 2005, both formal and informal workers reach their highest level of perception that EPL protects workers in Brazil, and therefore, there is no significant difference. This descriptive evidence provides only weak ­support to the insider–outsider model of labor market preferences.

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Figure 2:   Proportion of formal and informal workers who feel protected by the labor law. Note: The spikes denote a 95% confidence interval.

Now, I turn to the revision of existing evidence regarding political polarization between formal and informal workers in Brazil. In an important recent study, Baker and Velasco-Guachalla (2018) analyze the extent to which labor market groups vary in terms of political behavior and policy preferences. Their work aims at testing some political implications of the insider–outsider model in Latin American countries. In particular, they analyze three claims grounded in the “dualist” conception of labor markets: (a) that informal workers are less politically engaged than formal-sector workers, (b) that informal workers are more right-leaning in vote choice and issue attitudes, and (c) that informal workers are more favorable toward non-contributory social policies. First, the “undermobilization hypothesis” suggests that informal workers are less likely to be collectively organized and to participate in politics. Lack of mobilization would reflect social atomization and absence of visible common interests among informal workers, which ultimately prevents informal workers to overcome collective action problems. Second, the “right-leaning hypothesis” states that informal workers are less supportive of the political left than formal workers. Because of lower mobilization and unionization rates, informal workers have weaker ties with left parties. Informal workers are also less receptive of ideological discourses

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and class-based politics. Closely linked to this idea is the fact that informal workers are more prone to enter into clientelistic exchanges (Roberts, 2002; Levitsky, 2003; Huber and Stephens, 2012).9 Third, it has been said that informal workers also have stronger preferences for non-contributory policies that can protect outsiders from income risk and poverty. Hence, they should prefer means-tested and universalistic social assistance, such as cash transfers and minimum pension programs, that have been increasingly implemented in many developing countries (Garay, 2016; Carnes and Mares, 2014, 2016). Using data from the Latin American Public Opinion Project (LAPOP) in 18 countries, Baker and Velasco-Guachalla (2018) provide country-bycountry evidence for these hypotheses. The authors find little support for the three hypotheses. Here, I concentrate on their results for Brazil. We have already seen that segmentation in the Brazilian labor market is only weakly related to preferences for employment protection rules (see Figure 2). The insider–outsider model would also predict that informal workers should demand passive or active labor market policies that protect outsiders. Baker and Velasco-Guachalla find no support for informal workers being more supportive of the Bolsa Familia program that targets conditional cash transfers to the informal poor. The Brazilian Electoral Panel Study 2014 (BEPS 2014) includes the f­ ollowing question: Now let’s talk about social policies. Some types of programs, like Bolsa Família, use resources from taxes paid by everybody to benefit some people of low income. Other types of programs, like the INSS, use resources from taxes paid by those with a signed workers booklet and benefit only those who pay. Which type of policy do you prefer? (1) Policies that benefits some with taxes paid by everyone, like the Bolsa Familia. (2) Policies that benefit those who pay, like the INSS. (3) Both or indifference or neither [Not read]. The authors also create a means-test index as a dependent variable, which is an index from five binary questions asking for approval/disapproval of different anti-poverty social policies. The results indicate that informality has a significant effect on the support for the means-test index, though the effect size is only one-fifth of a standard deviation of the dependent variable. Also, informal workers do not show significantly more support for the Bolsa Familia than formal workers. This evidence is consistent with the idea of broad coalitions of formal and informal labor supporting non-contributory policy in developing countries (Carnes and Mares, 2014; Garay, 2016; Holland and Schneider, 2017; López-Cariboni and Menéndez, 2018). Regarding political mobilization, Baker and Velasco-Guachalla find that, in contradiction with the undermobilization hypothesis, Brazilian informal workers  For instance, recent studies in India find informal workers to be more clientelistic and promarket than formal workers (Milner and Rudra, 2017; Wibbels, 2017). 9

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are more likely to participate in politics (protesting, campaigning, etc.) than formal workers, and they participate in elections as much as formal workers do. The authors show that there is no significant difference between formal and informal workers in their patterns of vote stability and partisan attachments. Finally, Brazilian informal workers are not more likely to support right-leaning policies than formal workers. Taken together, Brazilian formal and informal workers only have mild differences with respect to preferences for EPL and non-contributory policy. These differences, precisely because they are not large enough, are not observed to have a clear correlate with the political behavior of insiders and outsiders. In sum, the evidence fails to provide an unambiguous support for the insider–outsider model of politics in Brazil. Discussion There are several possible reasons why formal and informal workers do not show substantial polarization in preferences for employment protection legislation, and consequentially, their political preferences do not either diverge. One debate in labor economics is whether developing countries have segmented labor markets. A large empirical literature has shown evidence against the segmented market view. This stream of research in Brazil finds significant job mobility across sectors or workers reporting being better, off by taking up an informal job (Curi and Menezes-Filho, 2006; Barros et al., 1990). When interpreting the null findings for the insider–outsider model, Baker and Velasco-Guachalla say the following: “The reason, we think, lies in the insights of the revisionist model, which has found the formal and informal sectors to be more integrated than was long thought” (2018: 177). Indeed, a key assumption of the insider–outsider model is that labor market regulations impose rigidities in the labor market. Despite high costs and rigidities imposed by regulation in Brazil, they may not generate large enough barriers to workers’ mobility between formal and informal sectors (Ulyssea, 2010). Table 2 presents the mobility pattern of Brazilian workers from 2003 to 2005. The transition Table 2:   Transition matrix in the Brazilian labor market (January 2003–2005). Formal Salaried

Informal Salaried

Unemployed

Self Employed

Formal salaried

84.9

7.2

4.7

3.2

Informal salaried

24.3

53.6

8.4

13.7

Unemployed

23.5

25.3

38.7

12.6

Self employed

7.1

13.2

4.0

75.7

Source: Ulyssea (2010) based on Monthly Employment Survey (PME).

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matrix displays the probability of moving from employment and unemployment status, where the rows indicate the original status and the columns the worker’s destination after a 12-month period. Therefore, the level of stability for every job status is captured by the diagonal’s elements of the matrix. While the formal sector presents a significantly lower exit probability than the informal one, the transition rate from the formal to the informal sector is much lower than in the opposite direction. Ulyssea (2010) interprets this fact as evidence that workers’ mobility is higher to what the dualistic model of the labor market would predict. If Brazilian workers can enter into the formal sector, prospects of upward mobility may lead outsiders to anticipate and adopt insider preferences (Tsakalotos, 2004). Future expectations of upward mobility (Benabou and Ok, 2001; Guillaud, 2013) may partly explain the lack of significant differences between preferences and attitudes of formal and informal workers. This effect may be more significant if there is a context of formalization in the labor market. Indeed, higher entry rates from informality to formal labor in Table 2 are consistent with the decreasing trend of informality since the early 2000s shown in Figure 3. The aforementioned evidence opens the important discussion of the nature of informality in Brazil. Despite Brazil being more segmented than other Latin American countries, such as Mexico, many informal workers are able to offer reasons why they would not take a formal job. In 1990, in Brazil, two-third of informal self-employed would not leave their current jobs for jobs with signed work contracts, while one-third of informal salaried workers would not change their work for a formal one (Perry et al., 2007). While this supports the idea that much of the informal employment is voluntary rather than involuntary, it also shows that the composition of informality between salaried informal workers and self-employed informal workers matters. As the self-employed workers increase relative to the informal wage earners, voluntary informality may be also higher. As explained by Berg (2011), the rise in formality rates in Brazil was driven by an increase in the percentage of wage earner workers with signed labor cards. This group made up 34.5% of the total employed in 2008. More importantly, between 1999 and 2008, this category grew at an average annual rate of 6.6%, while the growth rate between 1992 and 1999 was only 0.7%. In turn, the job growth of non-contributing selfemployed workers declined from an annual rate of 3.9% in 1992–1999 to 1.3% in 1999–2008. Hence, the observed blurring in differences regarding preferences for EPL in 2005 (see Figure 2) may be potentially due to a larger share of voluntary relative to involuntary informality in Brazil since 1999 onwards. The first main implication is that the insider–outsider model may not accurately predict workers’ preferences because the assumption that EPL segments the labor market may be too strong for the case under analysis. Yet, it is important to see that

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Figure 3:   Share of informal employment in Brazil (1992–2008). Note: ILO definition of informality: Informal workers are private sector and domestic workers who do not have a signed labor card, self-employed workers and employers who do not contribute to the social security system, unremunerated workers, and workers who produce and build for their own use. Formal workers are private salaried workers and domestic workers with a signed labor card (carteira assinada), government workers and military, as well as employers and self-employed workers who contribute to the Brazilian social security scheme (Previdência). Workers aged 16 years and older. Rural areas of the Northern states not considered. Missing data for 1994 and 2000. Source: Calculations based on Berg (2011) using the Brazilian national household survey IBGE/PNAD.

this does not invalidate the insights from the insider–outsider model. Instead, it opens the room for finer grained hypotheses. Precisely, the second implication is that the insider–outsider model (i.e. the effect of “outsiderness” on preferences for EPL) may be conditional on other variables that affect the extent to which EPL segments the labor market. These variables are likely to be alternative explanations of the size and composition of labor informality. Indeed, there are multiple reasons for the rise in formal employment in Brazil during the 2000s. Economic growth and real exchange rate depreciation fostering the export boom may have improved the conditions in the Brazilian labor market (Baltar et al., 2006). More importantly, the costs of entry were reduced since the introduction of the SIMPLES law that facilitated registration and lowered the rate of taxation for small businesses. The government also increased the enforcement of the labor law through more inspections and jurisprudence. For instance, between

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1996 and 2008, the number of workers registered as a result of inspection increased from 268,000 to 669,000 (Berg, 2011). Other policies affecting the structure of public spending, access to domestic credit, and the export profile may have also affected the process of formalization (Cardoso Jr, 2007). Interestingly, enforcement of the labor law may have negative consequences for the level of employment, therefore the government has positive incentives to implement deliberate non-enforcement. Political models of enforcement, as in Holland (2015) and Feierherd (2017), argue that non-enforcement of law is an available tool for politicians to purse political goals to build support among different voter groups: enforcing the labor law among firms where compliance tends to be higher and not enforcing it in firms that are likely to remain informal. Despite the general trend of increasing enforcement, there is large variation across different Brazilian regions. For instance, recent research shows that Brazilian governments may have used enforcement of EPL regulation as a compensatory policy against negative shocks form liberalization. Lower enforcement of labor regulations in Brazil reduced the effect of import competition on trade-displaced workers’ employment outcomes (Dix-Carneiro and Kovak, 2017; Ponczek and Ulyssea, 2017). Enforcement policy may affect the consequences of EPL and therefore insider–outsider preferences. However, this line of research has not been sufficiently explored in the literature. Baker and Velasco-Guachalla (2018) discuss other potential explanations for the high degree of convergence in political preferences between insiders and outsiders. One of them is the fact that left-wing governments in Latin America have implemented policies that benefit both insiders and outsiders with the aim of building political support (López-Cariboni and Menéndez, 2018). For instance, the left in Brazil has maintained high levels of EPL together with the implementation of cash-transfer programs targeted at outsiders (e.g. Bolsa Familia). These policies may help increase the outsider support for parties that are traditionally backed up by labor market insiders. Suggestive evidence comes from the realignment of Lula’s electoral support before and after the implementation of cash transfers for the poor informal sector. Figure 4 shows this important change: The x-axis represents the mean Human Development Index per district (which is a variable that captures well the targeting of the Bolsa Familia program) and the y-axis represents the change in the Lula’s vote share between the presidential elections of 2002 and 2006. As it can be observed, Lula increased its basis of political support among the poorest districts, where most households are recipients of the cash-transfer program. Conversely, in most developed areas, Lula even lost some electoral support. However, these effects did not occur for the Workers’ Party in Brazil, which may have failed to claim the credit for the implementation of pro-outsider policy (Handlin, 2013).

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Figure 4:   Change of Lula’s electoral support between 2002 and 2006 across levels of Human Development Index. Source: Based on data from Zucco (2008).

Concluding Remarks This chapter has revised the literature on insider–outsider models and its potential implications for political preferences among different types of workers. Those who are covered by job security rules have longer job tenure and lower turnover rates. The insider–outsider model predicts that EPL may potentially have a negative effect on those outside its protective umbrella. However, this argument has been contested on the grounds that it is unclear whether deregulation of the labor market brings the expected benefits for labor market outsiders. An important empirical question is whether formal and informal workers in developing countries show policy and political preferences that reflect the dualization of the labor market. The analysis of Brazilian data shows that labor market preferences are not ­substantially different between formal and informal workers. Understanding why this is the case is politically and economically important. One possibility is that the labor market in Brazil is not being substantially segmented by the labor law, and instead, EPL only benefits workers without harming the efficiency of the labor ­market. Moreover, informal workers may be supportive of labor regulations if they have the expectation of becoming formal workers in the future in the context of

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steady increase of formalization. The small differences between insiders and outsiders with respect to political preferences, such as voting for the left, may also be the result of policies implemented by programmatic governments aimed at building political support of both insiders and outsiders. In sum, the Brazilian experience shows that even when EPL may be strict and potentially divisive, it does not translate into a clear political cleavage in terms of policy preferences. This is by no means the reason to disregard some of the insights from the insider–outsider model. Instead, the model is useful to guide future research and finer grained analysis of the labor market. There exist several potential reasons for the absence of clear formal–informal differences in workers’ preferences. This chapter has emphasized problems of measurement and identification of insiders and outsiders, the existence of heterogeneous outsiders and voluntary informality, the consequences of different active and passive labor market policies other than EPL, and the degree of enforcement of labor laws. Yet, future research should also consider other alternatives that may explain the convergence of insider–outsider preferences. For instance, workers may form their preferences at the household level, and therefore combinations of formal informal workers within a single household may blur differences in individual preferences. Also, the so-called “lighthouse effect”, whereby some EPL norms, such as the minimum wage, impose a benchmark for unskilled labor throughout the economy including the informal sector where it is not binding. Finally, the politics of EPL may be more about class-based politics than insider–outsider divisions. If this was the case, workers may have markedly different preferences from capital, whereas the insider–outsider model could only explain differences at the margin between formal and informal workers.

References Almeida, R. and P. Carneiro (2005). “Enforcement of labor regulation, informal labor, and firm performance.” https://doi.org/10.1596/1813-9450-3756. Almeida, R. and P. Carneiro (2012). “Enforcement of labor regulation and informality,” American Economic Journal: Applied Economics, 4(3): 64–89. https://doi.org/10.1257/ app.4.3.64. Almeida, R. K. and J. P. Poole (2017). “Trade and labor reallocation with heterogeneous enforcement of labor regulations,” Journal of Development Economics 126 (February). Elsevier: 154–66. https://doi.org/10.1016/j.jdeveco.2017.01.004. Almeida, R. and L. Ronconi (2016). “Labor inspections in the developing world: Stylized facts from the enterprise survey,” Industrial Relations, 55(3): 468–489. https://doi. org/10.1111/irel.12146. Auriol, E. and M. Warlters (2005). “Taxation base in developing countries,” Journal of Public Economics, 89(4): 625–646.

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CHAPTER 11

Conclusions Santiago López-Cariboni Department of Social and Political Science, Universidad Católica del Uruguay, Uruguay

Informality has different negative consequences for living conditions in developing countries. At the individual level, having an informal job or being the owner of a hidden firm increases risks and uncertainty, curbs future productivity, and lowers expected income. At the aggregate level, informality may also be negative for collective social outcomes, such as eroding the fiscal contract and decreasing the sense of citizenship. Part I has analyzed the challenge of tax revenue in BRICs within the context of opening world markets. Globalization challenged governments to find alternative sources of revenue, while at the same time, more developed societies demanded increasing public goods and services. Income growth enabled the BRICs to shift from trade and corporate taxes to more efficient and viable sources such as indirect consumption taxes (e.g. VAT). However, consumption taxes are not necessarily an adequate tool to fight informality. To the contrary, consumption taxes contribute to income inequality and can perfectly coexist with high levels of informal labor. BRIC governments have been changing their revenue sources in a similar direction but at very different velocities. As explained in Chapter 2, income growth can help governments to increase tax collection without necessarily introducing profound reforms to the tax system and reducing informality. Revenue mobilization needs a strong administrative capacity to shrink the informal economy. But citizens should also believe that paying taxes is fair. In both respects, BRIC countries have a lot more to improve. The general conclusion arising from Chapter 2 is that BRIC 277

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countries have increased their tax revenue in the context of moderate changes in revenue sources, but they still show important signs of weak administrative capacity and potential erosion of the fiscal contract. Indeed, consolidating a fiscal contract is a major challenge for countries with large informal sectors such as the BRICs. Chapter 3 discusses the links between informal employment and tax compliance, two related but theoretically distinct phenomena. The theoretical discussion in this chapter suggests that area-specific non-compliance (i.e. informal labor) is contagious and may affect other areas (i.e. tax evasion). For example, informal workers who are unprotected by existing regulations may become more prone to violate norms in other areas. Yet, understanding the links between informality and compliance probably demands considering heterogeneous informal workers and their motivations to enter into or opt out of informal employment. The chapter makes a political argument, by which voluntarily self-employed workers may be less likely to engage in tax evasion and more likely to vote relative to excluded, informal salaried workers. The broader implication for BRIC nations is that labor market informality may be quite problematic for the general fiscal contract and the sense of citizen responsibility where informal labor results from a logic of exclusion. More importantly, policy makers and actors interested in broadening the tax base should consider tax evasion not in isolation but linked to labor market dynamics and politics. An interesting example is tax aid in BRICs. We have learned form Chapter 4 that tax aid is correlated with higher overall tax revenue and with reforms that increase income tax revenue, which is mostly paid by the rich. These policies have several advantages in terms of equity concerns, especially where consumption taxes are the biggest revenue source for all BRICs today. Also, tax aid may be counterbalancing the aid curse because general aid is known to decrease income tax revenue relative to consumption tax revenue. However, tax aid has a positive effect on the shadow economy and may not be broadening the tax base, that is, tax aid in BRICs seems to increase revenue by taxing already formalized taxpayers more, not by bringing in new taxpayers. An implication of the chapter is that governments are not using their increased extractive capacity to provide incentives that make firms and workers enter into the formal sector. Part II brings important insights on the political economy aspects of informal settlements and basic service provision. Chapter 5 provided a theoretical argument and detailed empirical evidence about the role of social capital for the ability of slum dwellers to demand local public goods. In particular, slum dwellers become more effective in attracting goods and services as their level of social trust and connectedness increases. Moreover, the mechanism is that social capital allows for electoral coordination among slum members which, in turn, increases the chances of being rewarded with public investment. The major contribution of the chapter is that, in

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the context of electoral competition and democratic politics, social capital among the urban poor is vital for reducing the allocation of clientelistic goods relative to programmatic goods and services. This is good news because it shows that building social networks among the poor helps to improve their capacity to independently elevate political demands. However, the bad news is that opportunistic governments have no incentive in promoting social capital within the urban poor because their electoral strategies will become costlier. It is for this reason that the author makes the interesting policy implication that other non-governmental actors such as NGO or Development Agencies should be in charge of implementing grassroots activities. Relatedly, Chapter 6 analyzed the provision of informal basic services. In ­particular, the chapter finds that electricity losses — which over time variation is mostly due to irregular consumption — move counter-cyclically in democracies but not in autocracies. This suggests that deliberate non-enforcement of the law increases when politicians have incentives to protect dislocated and poor voters during negative income shocks. The implication is that democratization increases the informal provision of insurance for the lower class. Country-specific evidence for the BRICs is consistent with the same patterns. Democratic cases such as Brazil and India show counter-cyclical electricity losses, while non-democratic (or fully democratic) cases such as Russia and China present no significant cyclicality. Deliberate non-enforcement is a policy that governments implement in various different areas, such as the labor market, tax collection, street vending, etc. The chapter expanded the existing knowledge, showing that informal service provision may be used to cushion income shocks by redistributing income from electricity bill payers to non-payers. This suggests that governments may not always have a clear incentive to formalize access to basic services because they would lose a cheap and potentially effective policy tool to compensate the discontent among the poor during bad economic times. Part III has analyzed different aspects of labor informality, political mobilization, and preferences. Chapter 7 shows that informal and formal workers in Brazil are different in their political networks and linkages. The chapter is novel in the sense that it establishes a clear connection between different types of work and political mobilization. It brings a new perspective by describing how individual and local level of informality variates with political communication, networks, and politician linkages. Informal workers are assumed to be relatively harder to identify, coordinate, and monitor than their formal counterparts. As a consequence, the chapter shows that politicians target less clientelistic offers to informal workers. Moreover, the local labor market context increases these differences. As local informality rises, formal workers gain relatively more clientelistic offers. These findings are important because they reveal key political differences between insiders and outsiders. Moreover, these findings suggest the broad implication that where informality is high, politicians may

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become more programmatic to deal with informal workers (i.e. targeting conditional cash transfers) and more clientelistic to deal with formal ones. Despite differences in political linkages and networks, Chapter 8 shows that Brazilian formal and informal workers show no significant differences in redistributive preferences. The study combines a qualitative analysis of the Brazilian institutional context with an original analysis of survey data from the Latin American Public Opinion Project (LAPOP) for the period of 2008–2017. The authors interpret weak associations between policy beliefs and occupations at the light of high level of fluidity in labor market transitions between the formal and the informal sectors. Instead, the evidence suggests that education and race are associated with support for redistribution. Hence, the insider–outsider labor market division seem to be a non-significant cleavage in the redistributive politics of Brazil. Importantly, labor market informality is tremendously heterogeneous among BRICs. This requires paying attention to measurement issues, and also to the history and causes of informality in diverse countries such as the BRICs. Chapter 9 analyzes the transformation of the Chinese labor market documenting the rise of labor informality. The chapter revises the debate of measuring informality in China and explains why the proxies used in Latin America might not be useful in the context of Asia. Labor informality and its political roots in China lead to distinctive measurement challenges. The chapter develops a thorough analysis of the institutional origin of labor informality in China, offering comparisons with other areas in the world. China’s labor informality is the result of labor contracts under its socialist doctrine and a particular history of welfare state development. A subgroup of informal sector workers who hold labor contracts but are still highly exposed to insecurity should be better understood as outsiders. Hence, “social insurance access” is not a suitable criterion to measure the size of labor informality in China. This calls for further theoretical debate whether current conceptualizations of labor informality can travel across countries. Finally, Chapter 10 abstracts form important measurement issues and revisit the question of preferences for employment protection legislation. The chapter shows that the predictions of the insider–outsider model are only weakly supported with descriptive Brazilian survey data. This is puzzling given that Brazil has strict labor regulations, though imperfectly enforced, and a large informal sector. Moreover, many political economy models of labor market policies are often based on the insider–outsider model and applied to the problem of informality in developing countries. If workers do not differ substantially in their preferences, then more research is needed to explain, both theoretically and empirically, when the distribution of preferences for employment protection predicted by the insider–outsider model may or may not hold.

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Index

A ability to tax, 33 administrative capacity, 33 administrative procedures, 60 Afrobarometer, 62 age, 194, 196–197, 201–202, 204–205, 211 aid curse, 92, 95 All-China Federation of Trade Unions, 15 Argentina, 70–71 Argentine Panel Election Study (APES), 62 authoritarian country, 3 autocracy, 142, 144–145, 147, 149

C CAF, 67 chain reactions, 66 China, 57–58 China General Social Survey, 236 China Labor Dynamic Surveys, 237 Chinese government, 15 choose informality, 63 citizenship responsibilities, 55 civic activities, 68 civic duty, 66, 70 civic engagement, 55 clientelism, 46, 158–159, 161, 169, 172–174, 177, 180, 182 collective actions, 72 communism, 37 compliance, 53–56, 60–61, 63–64, 66, 72–74, 256, 278 compliance with civic responsibilities, 54, 66 compliance with labor market regulations, 54 conditional cash transfer, 198, 202, 210, 212 conditional cooperation, 65–66 conservative, 197 conservative profile, 196 consumption-smoothing, 142 consumption tax, 56, 89, 92, 95

B barriers to trade, 34 basic services, 142, 278–279 benefits definition, 61–62 Bismarckian welfare state, 222–223, 225 Bolsa Família, 169, 267 Brazil, 57, 59, 62, 246, 258–260, 263, 265, 279–280 Brazilian Electoral Panel Study (BEPS), 62 Brazilian Electoral Panel Surveys, 168 Brazilian formal and informal workers, 264 Brazilian labor market, 260 Brazilian tax revenue, 57 bureaucracy, 13

281

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282  Index

contributions to social security, 59 corporate income taxes, 33 corporate tax, 89, 277 corruption, 46, 64 cost–benefit calculation, 54, 64, 66 cost of punishment, 66 cost of the fine, 64 counter-cyclical, 142–144, 147, 149 counter-cyclical evolution of transmission and distribution losses, 148 counter-cyclical in democratic countries, 149 counter-cyclical informal transfers, 145 counter-cyclical social spending, 140 credible commitments, 64 D deindustrialization, 158 deliberate non-enforcement, 15–16 demand for irregular access to electricity, 145 democracy, 3, 139–140, 142, 144–149 democratic governments, 140 democratic leaders, 140 democratic political competition, 145 democratic political institutions, 3 democratization, 142, 144, 158, 279 deterrence, 63–64, 66, 73 development, 11 disenchantment, 71 dispatched workers, 221, 229–231, 239–240 donor, 83, 85, 87–88, 91–92, 96 dualistic approach, 5 dualistic labor markets, 257 dualization, 245 dynamic effects, 73 E economic development, 45 economic growth, 3, 41 economic liberalization, 158 economic voting, 71

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economic vulnerability, 61 efficiency, 43 electoral coordination, 103–105, 108–110, 115, 119–120, 122, 124–127, 131 electricity theft, 140 Employment and Unemployment Survey in India, 61 employment protection legislation (EPL), 13, 245–246, 248, 251, 256, 280 employment protection rules, 243 employment-related benefits, 72 enforcement, 54, 143, 257, 266 enforcement agencies, 71 enforcement of EPL, 267 enforcement of the labor law, 267 entry, 68 entry barriers, 60 entry into informality, 68 evasion, 63 exclusion, 67–68 exit view, 68 experienced formal and informal, 63 exposure to risk, 196 F fairness, 65–66, 70 fear of punishment, 63 field experiment, 64–65 fiscal contract, 32, 47, 54–55, 64, 66 flexibility, 69 forbearance, 16, 140 foreign aid, 92 formal and informal employees, 204 formal and informal workers, 8, 193, 197, 199, 207 formal employment, 70 formalization, 158, 165, 180 formal sector, 142 G gender, 166, 177, 182 general taxes on consumption, 33

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Index 283

geography, 164, 167 Germany, 65 globalization, 33, 38, 277 globalized world, 61 government, 198, 200–201, 203, 205 government competence, 65 H health coverage, 63 health insurance (referring to seguro de salud/seguro social), 62 heterogeneity among informal workers, 67 horizontal relationships, 65 household registration system, 226, 228, 239 hukou status, 13 I IMF, 39, 87–90 inclusive government institutions, 45 income cleavage, 197 income inequality, 193, 204–205, 210 income tax, 54, 83, 85, 89, 91–95 India, 57 India Human Development Survey, 61 indirect consumption taxes, 277 individual income taxation, 41 inequality, 81, 86 inequity aversion, 65 informal basic services, 279 informal employment, 55, 73 informality, 31, 54–55, 57, 61, 66–67, 73–74, 280 informal labor, 56, 59, 68 informal provision of insurance, 140 informal salaried workers, 69–70, 261 informal sector, 5, 7, 55, 57–58, 157, 196, 199 informal self-employed, 261 informal settlements, 278 informal workers, 53–54, 58, 63, 73, 202, 243–244, 252

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in-group members, 72 insider–outsider model, 243–246, 253–255, 257, 261 insider–outsider policy preferences, 249, 254–255 insiders, 243 institutional causes, 219–220, 225, 239 institutional context, 64, 71 institutional weaknesses, 64 institutions, 13 instrinsic motivation to pay taxes, 65 insurance, 142 International Labor Organization (ILO), 54–56, 61 international organizations, 33, 87 international tax assistance, 84 involuntary, 68, 70 involuntary informal employment, 71 involuntary informality, 71–72 involuntary informal labor, 60 involuntary informal workers, 67, 72 irregular access to basic services, 140, 142–143, 149 irregular access to electricity, 142, 149 irregular access to energy, 143 irregular electricity consumption, 142–143 irregular transfers, 148 ISI, 223–224 Israelis, 71 L laboratory experiment, 64 labor contract law, 229–231, 240 labor contracts, 220–221, 228–232, 236–240 labor informality, 11, 15, 54, 246, 280 labor inspections, 256 labor law in Brazil, 261 labor law protection, 72 labor market dualization, 61 labor market exclusion, 55 labor market institutions, 59, 72

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284  Index

labor market preferences, 255 labor market regulations, 66 labor regulation, 71, 73, 254, 256 Latin America, 64, 69, 251 Latin America and the Caribbean, the Afrobarometer, 61–62 Latin American countries, 56, 251 Latin American Public Opinion Project (LAPOP), 61–62 Latin American workers, 258 leader, 104, 109, 111, 114–115, 117–118, 120–122, 124, 128 left–right ideology, 195 left-wing governments, 267 legalist account, 7 legalist, definition, 62 legalistic definition of informality, 61 legally enforce compliance, 71 local public goods, 103, 106, 108–109, 112–114, 121, 127–128 logistic regression analyses, 203 logistic regression models, 211, 213–214 logit regression coefficients, 205 low state-capacity, 64 low tax morale, 58 M market reform, 219, 226–228, 239 material interests, 195, 200–201, 207 measure of informality, 58, 280 migrants, 13 migrant workers, 226, 228 mobility from informal to formal sectors, 69 modern taxes, 37 multinational corporations, 34 N National Bureau of Statistics, 233 natural resources, 36 new cleavages, 193–194, 197, 200, 202, 204, 207

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new informal or formal workers, 63 non-compliance, 59, 72–73 non-enforcement of the law, 279 non-governmental actors, 279 non-technical losses, 143 O official development assistance, 88 old cleavages, 193, 195, 201 out-group member, 72 outsiderness, 72 outsiders, 158, 243 over-compliance, 64 own-account workers, 55 P payment of taxes, 64, 277 payroll taxes, 59–60 perception of feeling protected by the labor law, 261 policy preferences, 15, 159, 161, 194–195, 197 political cleavages, 208 political ideologies, 193–194, 197, 200, 202–204, 209, 214 political mobilization, 158–160, 182, 279 political networks, 159–162, 168–169, 177, 182 political participation, 160 political polarization between formal and informal workers, 262 political preferences, 158 political socialization, 158–159 political variables, 207 post-communist countries, 38 poverty, 8, 44, 81, 86, 89 precarious employment, 220–221, 230, 236–237, 240 preferences, 248, 279 preferences for employment protection legislation, 250

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productive view, 61 programmatic politics, 161 progressive taxation, 64 property taxes, 69–70 prosocial behavior, 65 provision of (or willingness to provide) services, 65 psychological responses, 72 public goods, 64–65, 70, 83, 89, 96, 278 public pension scheme, 60 public services, 105 public social spending, 198 punishment, 63 Q quasi-voluntary compliance, 39, 64–65 R race, 194, 197, 200, 202, 205, 207–209, 211, 213–214 reciprocity, 65–67 redistribution, 32 redistributive capacity, 34 redistributive politics, 193 redistributive preferences, 194, 196–197, 199–200, 203–205, 207–210 regulation of entry, 13, 247 regulatory costs, 59 relevant tax authorities, 62 residual approach, 233–235 responsibility attribution, 71–72 revenue bargaining, 38 revenue capacity, 35 revenue generation, 32 revenue maximizers, 45 revenue mobilization, 277 rewards for tax compliance, 64 rich, 64 risk of audit, 64 risk of being caught, 63, 66 rural workers, 227–228

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Russia, 57 Russia Longitudinal Monitoring Survey of HSE, 61 Russian Federation, 61 S segmentation hypothesis, 61 segmented labor market, 257 self-employed workers, 55, 57, 62, 69, 196, 202, 246 self-employment, 57–58, 60, 69, 221–222, 225, 228–229, 232, 234–235, 237, 239–240 self-interest, 70 shadow economy, 10, 32, 278 signed booklet (carteira assinada), 62 size of the informal sector, 59 slum, 8, 10, 278 slum dwellers, 103, 105–108, 110, 118–121, 128–129, 278 social capital, 103–106, 108–111, 113, 115–117, 119–120, 122, 124–130, 278–279 social exclusion, 72 social insurance-based welfare state, 223–224, 239 social insurance programs, 220, 224–226 socialist legacy, 227, 239 social norms, 54, 65 social policy attitudes, 193 social policy beliefs, 195 social protection, 61, 162 social security benefits, 8 social security contributions, 55, 60, 67–68 social security (seguro social), 62, 142 socioeconomic impact, 198 socioeconomic situation, 203 spouse, 63 state capacity, 15, 33 state-owned enterprises (SOEs), 13, 219, 227, 233 state-run enterprises, 36

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286  Index

street vendors, 60 structuralist approach, 7 survey, 58, 62, 66–67 survey data, 57, 67 survey instruments, 62 switches between formal and informal sectors, 69 T tariffs, 34 tax administration, 42, 85–86, 89, 92–93 tax aid, 84–85, 87–92, 94–96, 278 taxation, 70, 162 taxation–representation, 83–84, 95 tax base, 85, 278 tax collection, 83–84, 89–90 tax competition, 34 tax compliance, 54, 63, 65–67 tax enforcement, 83 taxes, 70 tax evasion, 31, 34, 54, 59, 65, 69, 84–86, 89–90, 92 tax intake, 42 tax mix, 35, 42 tax morale, 39, 57–58, 65 taxpayers, 45 tax rates, 59 tax revenue, 31, 83–85, 87–96, 278 tax state, 31 tax structure, 65 tax threshold, 84, 89–90 transit from formal to informal, 63 transition matrix, 264 transmission and distribution losses (TDL), 140–141, 148 trust in public institutions, 64

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U Udaipur, 103–105, 107, 109, 118, 120–121, 127, 131 uncounted workers, 233–234 undermobilization hypothesis, 159 unemployed workers, 71 unemployment, 72 unfair, 65 United Nation’s Sustainable Development Goals, 61 United States, 71 unofficial economic activity, 3 unofficial economy, 10 unpaid worker, 62 upward mobility, 265 urban workers, 219, 227–228 V value-added taxes (VAT), 34, 39, 59–69, 70, 85, 95 VAT collection, 60 VAT gap, 35 vertical relationships, 65 voluntarily exit, 69 voluntary, 60, 67–68, 70 voluntary informality, 257 voting, 67, 70, 72 W welfare systems, 198, 208 withholding consumption taxes, 67 workers, 69 Workers’ Party in Brazil, 267 World Bank, 87–91 World Values Survey (WVS), 57–59, 61–62

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