One of the crucial functions of state capitalism is to mobilize resources via state-owned enterprises and government investment to overcome exogenous shocks so that the incumbent governments can survive the hard times and remain in power(Crivelli and Staal 2009). The exogenous shocks include wars, natural disasters, commodity price inflation and financial crises, etc. In this research project, I primarily focus on one type of exogenous shock: global financial crises. In an era of financial liberalization, economic crisis can spread from one country to another in a short period of time, posing enormous threat to the economic and political stability of countries. During a period of economic turmoil, private firms have less incentive to increase their investment, largely because they are concerned that the future revenue stream may not cover their investment costs. By contrast, government enterprises and investment can play a vital role in driving fixed asset investment and stimulating domestic demand during economic crises(Boubakri et al. 2011, Pepinsky 2009). Such ability to mitigate the impact of financial shocks is important for the political survival of weakly institutionalized regimes.
The late 2000’s global financial crisis posed a great threat to the economic stability of developing and emerging market countries. By exploiting this global financial crisis as an exogenous shock, I intend to conduct a time series cross-national analysis of developing and emerging market countries to test whether countries in which the state was heavily involved in the economy prior to and during the crisis suffered less in this global economic downturn.
The sample consists of 90 countries, from the year 2005 to 2013. The global financial crisis during 2008 and 2009 originated in the United States and spread quickly to other developed countries such as the United Kingdom, Germany, and France. To some extent, this global financial crisis can be seen as an exogenous shock to the developing world and thus offers an opportunity to evaluate the effects of a global financial crisis on developing and emerging market countries and isolate the factors that may help mitigate vulnerability to financial crises. Therefore, the sample does not include developed countries. In addition, the sample also excludes countries without measurement of key variables.
The key outcome variable is a country’s “annual GDP growth rate” from the World Development Indicators (WDI) dataset. The key independent variable is the level of state engagement in economy, captured by the indicator “government enterprises and investment as a share of gross investment” from the Economic Freedom of the World (EFW) dataset. The original indicator ranges from 0 to 10 and lower ratings are assigned to countries with higher levels of government enterprises and government investment. I recoded this indicator and divided 0-10 into three categories (0-low, 1-medium, 2-high) such that higher values indicate greater state involvement in the economy.
A country’s vulnerability to global financial crisis may stem from the exposure to the international market and openness of capital account. Therefore, I control for the level of trade openness and capital account openness, captured by the indicator “capital controls”(ranging from 0 to 10) and the indicator “freedom to trade internationally”(ranging from 0 to 10). These two variables are also derived from the EFW dataset. I recoded these two variables so that 0 represents low, 1 represents medium and 2 represents high. I also control for economic size, measured as the logarithm of lagged GDP.
I use fixed effects models to test the impact of state engagement in economy on growth during financial crisis. Specifically, to provide empirical evidence whether economic growth is less volatile during economic crisis for countries where the state was heavily involved in the economy. As my data showed that countries change their level of intervention in economy as a response to economic shocks, I add interaction term to estimate the impact of state engagement in economy conditional on crisis. The fixed effects regression model is specified as follows: \[{Y_{it}} = \beta X_{it}Z_{t} + \lambda LnGDP_{t-1}+\theta x_{it}Z_{t}+\gamma_{i} + \delta_{t} + \epsilon_{it}\]
where \(Y_{it}\) is the outcome of interest – economic growth rate for country \(i\) in year \(t\), \(X_{it}\) is the level of government enterprises and investment for country \(i\) in year \(t\)(0 - Low, 1 - Medium, 2 - High), \(Z_{t}\) is an indicator variable for the financial crisis that equals 1 for the years 2008, 2009 and 2010, \(LnGDP_{t-1}\) is the logarithm of lagged GDP, \(x_{it}\) is a vector of other country-level control variables (“freedom to trade” and “capital controls”), \(\gamma_{i}\) and \(\delta_{t}\) are country fixed effects and year fixed effects, \(\epsilon_{it}\) is idiosyncratic error term.
In this analysis, I am interested in \(\beta\), the coefficient of the interaction term between the state engagement in economy and the crisis indicator variable. It captures the impact of level of government enterprises and investment during the global financial crisis (2008-2010).
Table 2 reports the results of fixed effects regressions. Column (1) shows that without any control variables, the interaction term between the state’s engagement in the economy and the financial crisis indicator has a positive effect on the annual GDP growth rate. The magnitude of the coefficient is 0.400, indicating that during the global financial crisis, the annual economic growth rate of the country with high level state engagement in the economy would be 4.0 percent higher than its counterfactual with medium level of state engagement in the economy, the growth rate of the medium level would be 4.0 percent higher than the low level, but this effect is not statistically significant. Without interaction, state engagement in economy has a negative effect, but not significant. Crisis has a negative and significant effect on the growth rate. In column (2), I control for lagged GDP (logged), degree of freedom to trade and capital account openness in the model specification. When control for these covariates, the effect of crisis is not significant, while lagged GDP has a negative and significant effect on economic growth.
##
## Table 1: Summary statistics
## ==================================================
## Statistic N Mean St. Dev. Min Max
## --------------------------------------------------
## GrowthRate 752 4.942 4.244 -17.669 34.500
## StateEngagement 752 0.761 0.820 0 2
## Crisis 752 0.328 0.470 0 1
## CapitalControl 752 1.507 0.726 0 2
## FreeTrade 752 1.206 0.436 0 2
## laggedGDP 752 23.989 1.804 20.353 29.606
## --------------------------------------------------##
## Table 2: Fixed effects models
## ======================================================================
## Dependent variable:
## -----------------------------------------------
## GrowthRate
## (1) (2)
## ----------------------------------------------------------------------
## StateEngagement -0.366 -0.298
## (0.353) (0.340)
##
## Crisis -1.900*** 0.199
## (0.404) (1.508)
##
## laggedGDP -8.046***
## (0.946)
##
## CapitalControl -0.083
## (0.504)
##
## FreeTrade 0.858
## (0.679)
##
## StateEngagement:Crisis 0.400 0.230
## (0.361) (0.359)
##
## Crisis:CapitalControl -0.065
## (0.447)
##
## Crisis:FreeTrade -1.450*
## (0.784)
##
## ----------------------------------------------------------------------
## Observations 752 752
## R2 0.048 0.149
## Adjusted R2 -0.085 0.023
## F Statistic 11.094*** (df = 3; 659) 14.353*** (df = 8; 654)
## ======================================================================
## Note: *p<0.1; **p<0.05; ***p<0.01According the estimation results, I find no significant effect of state engagement in economy on economic growth during the period of global financial crisis. The regression results show that before and after the crisis, state engagement in economy has a negative effect on economic performance while during the times of economic shocks, the effect is positive. However, none of these effects are statistically significant. Thus in this analysis, I did not find empirical support for the claim that developing and emerging market countries can use government enterprises and investment to alleviate the negative effects of financial shocks during the economic hard times.
Crivelli, Ernesto, and Klaas Staal (2009), “Nationalizations and efficiency”, SFB/TR 15 Discussion Paper No. 268.
Boubakri, Narjess, Jean-Claude Cosset, Omrane Guedhami and Walid Saffar (2011), “The Political Economy of Residual State Ownership in Privatized Firms: Evidence from Emerging Markets”,Journal of Corporate Finance, 17(2), 244?258.
Pepinsky, Thomas (2009), Economic Crises and the Breakdown of Authoritarian Regimes :Indonesia and Malaysia in Comparative Perspective. New York, NY: Cambridge University Press.