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Global Economic Policies and Developing
Countries
NiGEM Scenarios for the Post-2015 Agenda
Tatiana Fic
National Institute of Economic
and Social Research
May 2014
Contents
Summary ................................................................................................................................................. 3
Introduction ............................................................................................................................................ 5
Section 1: The global macroeconomic environment for development – a modelling approach ........... 7
Section 2: Summary of Scenarios.......................................................................................................... 10
Scenario 1: Quantitative easing – effects of changes to bond yields reflecting withdrawal from
unconventional monetary policy .......................................................................................................... 10
Scenario 2: Basel III – effects of changes to bank capital and liquidity ratios ...................................... 15
Scenario 3: Tackling tax evasion – effects of changes to transfer pricing ............................................ 19
Section 3: Conclusions .......................................................................................................................... 21
Bibliography .......................................................................................................................................... 22
Summary
This paper analyses the macroeconomic impacts of global economic policies on developing
and developed countries in relation to three global scenarios: withdrawal from quantitative
easing (QE), introduction of higher capital and liquidity requirements (Basel III) and tackling
tax evasion. Our key findings suggest that:

The withdrawal of QE has been accompanied by a substantial rise in bond
yields, both in developed and developing countries. Increases in long-term interest
rates can be expected to be up to several times higher in developing than in
developed countries. Reasons for this include the greater volatility of developing
countries’ financial markets. Our calculations show that the 2013 announcement of
a withdrawal of QE in the USA led to a rise in bond yields by about 80 basis points
in the USA and 100–300 basis points in emerging markets.

Our simulations show that the macroeconomic impacts of the withdrawal from
unconventional monetary policy are greater in developed than in developing
countries. The macroeconomic impact on developing countries is more muted
(approximately half of the developed countries’ response), with the exception of
Latin America, and in particular Brazil. This results from the fact that the Brazilian
financial markets are very sensitive to monetary actions taken by the major central
banks, and in particular those of the US Federal Reserve (US FED). Although the
impacts on developing regions are smaller on average, the greatest impacts are seen
in sub-Saharan Africa (SSA). The more restrictive monetary policy pursued by the
US FED may result in a 0.8% fall in GDP in SSA countries. In Latin America and
the Commonwealth of Independent States (CIS), GDP may decline by about 0.25%.
The smallest effects are likely to be seen in the Middle East and North Africa
(MENA) and the Far East. (The regional groupings are based on the International
Monetary Fund (IMF) categories. Please see Table 1 for the countries included in
each region.) Overall, the higher bond yields result in a decrease of about 1% in the
US GDP and of about 0.5% in developing countries. The introduction of Basel III
– higher capital and liquidity requirements – brings both costs and benefits.
Basel III, intended to prevent a repeat of the crisis that started in 2007, introduced
new capital standards concerning both the quantity and quality of capital held by
banks, as well as new liquidity benchmarks. The tighter regulation brings costs in
terms of reduced output since it leads to an increase in borrowing costs, but it also
limits the likelihood of future financial crises.

Our calculations show that in GDP terms the costs of introducing tighter rules are
several times less than the benefits of higher capital and liquidity requirements –
crises are very costly and it pays to insure against them. The costs of the
insurance measured in GDP terms are similar across the largest developed and
developing countries at around 0.25%. In smaller developing countries, there would
be fewer capital and liquidity effects, which would lead to a small decline in GDP,
for example up to 0.1% in SSA. The benefits of tighter regulation may vary
depending on the structure of the economy, and amount to up to several percentage
points. Overall, the costs are much smaller than the benefits of avoiding financial
crises by establishing more stable banking rules. In SSA, the impacts of a crisis may
be up to 10 times greater than the introduction of tighter capital requirements.

There is a growing awareness among developing countries, and globally, of the
risks posed by the abuse of transfer pricing. About 60–80% of trade takes place
within multinational companies (MNCs). Incorrect pricing, such as lowering export
prices and export revenues, can lead to a reduction in the earnings and reported
profits in locations with high tax rates, while boosting profits in low-cost tax
jurisdictions. This leads to tax evasion. Tax evasion results in significant losses
of tax revenues that could be spent on improving health care, education systems
and infrastructure in developing countries.

Our stylised simulations show that if there were policies designed to tackle tax
evasion and transfer pricing, output in the developing countries would rise. For
example, assuming that export prices increase by 10% in SSA, accompanied by a
rise in profits and hence taxes, GDP in SSA could increase by up to 0.35%. Global
policies that encourage more appropriate pricing strategies can boost GDP in
developing regions.
To summarise, global economic policies – quantitative easing, new financial regulations, and
tackling tax evasion – may have a significant impact on the prospects of developing countries.
The scale of the impact on individual countries depends on their structural features and the
strength of real and financial linkages with developed economies.
Introduction
Financing development beyond 2015 will require a stable global environment, international
co-operation, domestic resource mobilisation (DRM), assistance to developing countries and
innovative sources of finance. Developed and developing countries are becoming more
interconnected, offering opportunities for new partnerships, but also generating space for
policy spillovers and the cross-border transmission of shocks, both positive and negative.
The 2007–2008 global financial crisis led to an economic slowdown in many countries, and
turmoil on the global financial market. As a result, the growth prospects for a number of
countries have been reviewed and the post-crisis macroeconomic policy landscape has changed
in several dimensions.
First, in the face of the severity of the crisis and inadequate conventional monetary measures,
with interest rates reaching the zero bound, central banks turned to unconventional monetary
policies and started making major purchases of assets, both government bonds and asset
securities. This has significantly affected bond and equity markets, and the wider economy, not
only in developed countries but also in the developing countries that have experienced
increased volatility in capital flows, making macroeconomic management difficult.
Second, after the banking meltdown, it became evident that the global financial architecture
required fundamental changes. Left to their own devices, banks did not hold the capital and
liquidity that was commensurate with the level of risks they were taking. The crisis released
the systemic risks embedded in the global banking sector, with wide-ranging repercussions
both for the financial sector and the real economy, in the light of which a set of new regulatory
rules, Basel III, has been introduced.
Third, the feedback loop between the banks and the sovereigns resulted in a worsening of the
recession-ravaged fiscal situation in many countries. The fiscal crisis was particularly salient
in the Eurozone. This has affected the speed of convergence of individual economies towards
a post-crisis equilibrium. The crisis put the spotlight on the lack of public resources to deal
with the recession as well as difficulties in the banking sector. This is predominantly
attributable to the crisis itself, but, especially in the case of developing countries, it was also
exacerbated by tax evasion.
The ability to finance a post-2015 development agenda will depend on many factors, of which
the post-crisis policy landscape is one. This paper does not explore the possibilities of global
development co-operation but looks at the macroeconomic environment that may significantly
shape the scale of the financial gap in developing countries and of financial capacities in
developed countries. All countries confront the task of generating growth, and this paper
attempts to quantify the effects of policies that will shape the global macroeconomic landscape
in the medium term.
The paper examines the impact of three types of global policies on the prospects for developing
countries. We simulate the impacts of three global scenarios that may affect both the scale of
the financing needs in developing countries and the financial capacities in developed countries
and analyse the impacts of the following policy shocks:

Changes to bond yields resulting from a withdrawal from unconventional monetary
policies

Changes to capital adequacy and liquidity ratios – reflecting the new Basel III rules

Potential changes to transfer pricing resulting from actions aimed at tackling tax
evasion
The simulations use the global economic model, NiGEM, developed by the National Institute
for Economic and Social Research (NIESR). The model covers the global economy, with most
countries modelled separately and others modelled by region. In particular, regions such as
SSA, MENA, LAC, the CIS and the Far East are modelled separately. (Further details on the
NiGEM model are available at: http://nimodel.niesr.ac.uk/ and the regional groupings are given
in Table 1).
The paper is structured as follows. Section 1 highlights the role of global developments for
official development assistance (ODA) and briefly describes the methodological approach.
Section 2 presents the results of simulations and discusses their implications. Section 3
concludes.
Section 1: The global macroeconomic environment for development –
a modelling approach
The global financial crisis placed economic and financial pressures on all countries. Developed
countries have experienced a major drop in incomes, unmatched by any recession since the
1930s. This has been accompanied by rising unemployment and debt levels, and an
unprecedented plunge in global trade. The crisis has also revealed that the global financial and
fiscal architectures require stronger regulation, and the design and implementation of new
policies to prevent future financial crises.
The direct effects of the crisis were manifested in reduced private financial flows and official
development assistance (ODA) to developing countries (in terms of the volume of ODA and
aid programmes (te Velde and Massa, 2009)), as well as a decline in remittances from migrant
workers and falling prices for export goods (Das and Dutta, 2012). Although 2013 saw a record
level of ODA, more volatile ODA flows pose a severe macroeconomic management problem
for aid-receiving countries. They lack the resources to smooth crisis-related shocks by adopting
fiscal stimulus packages as developed countries did, and are therefore forced to rely more on
ODA. Crisis-driven cuts in ODA disbursements are likely to aggravate the problems already
imposed by the crisis and delay the development process.
This paper examines the macroeconomic impacts of global developments that could potentially
affect the economic prospects of developing countries. To assess the impacts of global
developments on growth in developed and developing countries – which determines the scale
of the financial gap in the aid-receiving countries and the degree of financial capacity in donor
countries – we conducted a series of macroeconomic simulations.
The analysis was based on NiGEM, a large-scale quarterly macroeconomic model of the world
economy developed by the NIESR. Most OECD countries are modelled separately, and other
countries are modelled at the regional level. By incorporating the models for individual
countries into the global context the aim is to ensure that the impacts of global policy changes
are, via links between countries, detected for all analysed economies. All country and regional
models in NiGEM contain the determinants of domestic demand, a supply side, export and
import volumes, prices, current accounts and net foreign assets. Output is determined in the
long run by factor inputs and technical progress interacting through production functions, but
is driven by demand in the short to medium term. Economies are linked through trade,
competitiveness and financial markets and are fully simultaneous. Table 1 shows the list of
countries and regions in NiGEM.
Table 1. NiGEM country and regional coverage
NiGEM countries and regions
Countries
Australia, Austria, Belgium, Brazil, Bulgaria, Canada, China,
Czech Republic, Denmark, Estonia, Finland, France, Germany,
Greece, Hong Kong, Hungary, India, Indonesia, Ireland, Italy,
Japan, Latvia, Lithuania, Mexico, Netherlands, New Zealand,
Norway, Poland, Portugal, Romania, Russia, Slovakia, Slovenia,
South Africa, South Korea, Spain, Sweden, Switzerland, Taiwan,
UK, USA and Vietnam
Regions (based on IMF categories)
Sub-Saharan Africa (SSA) (IMF’s ‘Africa’ category): Angola,
Benin, Botswana, Burkina Faso, Burundi, Cameroon, Cape
Verde, Central African Republic, Chad, Comoros, Democratic
Republic of Congo, Republic of Congo, Côte d’Ivoire, Equatorial
Guinea, Eritrea, Ethiopia, Gabon, Gambia, Ghana, Guinea,
Guinea-Bissau, Kenya, Lesotho, Liberia, Madagascar, Malawi,
Mali, Mauritius, Mozambique, Namibia, Niger, Nigeria,
Rwanda, São Tomé and Príncipe, Senegal, Seychelles, Sierra
Leone, Swaziland, Tanzania, Togo, Uganda, Zambia and
Zimbabwe.
Far East (IMF’s ‘Developing Asia’ category) (excluding China,
India, Indonesia and Vietnam, which are modelled separately):
Republic
of
Afghanistan,
Bangladesh,
Bhutan,
Brunei
Darussalam, Cambodia, Fiji, Kiribati, Lao People’s Democratic
Republic, Malaysia, Maldives, Myanmar, Nepal, Pakistan, Papua
New Guinea, Philippines, Samoa, Solomon Islands, Sri Lanka,
Thailand, Democratic Republic of Timor-Leste, Tonga and
Vanuatu.
Middle East (IMF’s category of the ‘Middle East and North
Africa’ (MENA) plus advanced economies in the region that are
not modelled separately (i.e. Israel)): Algeria, Bahrain, Djibouti,
Egypt, Islamic Republic of Iran, Iraq, Israel, Jordan, Kuwait,
Lebanon, Libya, Mauritania, Morocco, Oman, Qatar, Saudi
Arabia, Sudan, Syria, Syrian Arab Republic, Tunisia, United
Arab Emirates and Republic of Yemen.
Latin America and the Caribbean (LAC) (IMF’s ‘Western
Hemisphere’ category (excluding Brazil and Mexico, which are
modelled separately)): Antigua and Barbuda, Argentina,
Bahamas, Barbados, Belize, Bolivia, Chile, Colombia, Costa
Rica, Dominica, Dominican Republic, Ecuador, El Salvador,
Grenada, Guatemala, Guyana, Haiti, Honduras, Jamaica,
Nicaragua, Panama, Paraguay, Peru, St. Kitts and Nevis, St.
Lucia, St. Vincent and the Grenadines, Suriname, Trinidad and
Tobago, Uruguay and Venezuela.
Commonwealth of Independent States (CIS) (excluding
Russia, which is modelled separately): Armenia, Azerbaijan,
Belarus, Georgia, Kazakhstan, Kyrgyz Republic, Moldova,
Mongolia, Tajikistan, Turkmenistan, Ukraine and Uzbekistan.
The simulations in NiGEM are undertaken with reference to a baseline scenario. A set of shocks
makes it possible to quantify the effects of three global developments – withdrawal from
quantitative easing, implementing Basel III requirements and tackling tax evasion – and then
compare the baseline and alternative scenarios.
Section 2: Summary of Scenarios
Scenario 1: Quantitative easing – effects of changes to bond yields
reflecting withdrawal from unconventional monetary policy
We analyse the macroeconomic effects of international movements of capital that may be
attributed to withdrawing unconventional monetary policy measures. In particular, we look at
changes to bond premiums in developed and developing countries that have materialised in
response to the US FED’s tapering of quantitative easing (QE).
Following the US FED announcement concerning withdrawal of unconventional monetary
policies, government bond yields have gone up not only in the USA but also worldwide. Long
rates have increased in developed countries as well as in countries such as Brazil, China, India,
Russia and South Africa (the so-called BRICS). Figure 1 shows 10-year government bond
yields for four of the developed countries with the largest economies – France, Germany, the
UK and the USA – and for four of the largest developing economies – Brazil, China, India and
Russia.
Figure 1. Government bond yields in four developed and developing countries
Government bond yields in four developed countries
FED's tapering announcement
6
5
4
3
2
1
France
Germany
US
UK
01/01/2014
01/09/2013
01/05/2013
01/01/2013
01/09/2012
01/05/2012
01/01/2012
01/09/2011
01/05/2011
01/01/2011
01/09/2010
01/05/2010
01/01/2010
01/09/2009
01/05/2009
01/01/2009
01/09/2008
01/05/2008
01/01/2008
01/09/2007
01/05/2007
01/01/2007
0
Government bond yields in four developing countries
India
Russia
01/01/2014
01/09/2013
01/05/2013
01/01/2013
01/09/2012
01/05/2012
01/09/2011
01/05/2011
01/01/2011
01/09/2010
01/05/2010
01/01/2010
01/09/2009
01/05/2009
01/01/2009
01/09/2008
01/05/2008
01/01/2008
01/09/2007
01/05/2007
01/01/2007
China
01/01/2012
FED's tapering announcement
20
18
16
14
12
10
8
6
4
2
0
Brazil
Source: DATASTREAM
The increases in government bond yields have been much stronger in developed than in
developing countries. Between May 2013 and February 2014 the long rates increased by about
80 basis points in the USA, 90 in the UK, 50 in France and 30 in Germany. Among the
developing countries, the long rates increased most strongly in Brazil – by about 300 basis
points, by 150 in India and Russia, and about 100 in China. While it is important to note that
the increases in government bond yields are not solely the effect of the US FED’s tapering
announcement (they may also reflect a plethora of other factors, including an improved global
macroeconomic situation), it seems that financial markets in countries such as Brazil, China,
India and Russia have reacted more strongly to the announcement of withdrawal from the bondbuying programme, for which several factors are likely to be responsible.
First, capital outflows from developing countries generate more volatility in the financial
markets, with the result that their currencies depreciate. The international portfolio rebalancing
leads to a decline in equity prices and a rise in government bond yields.
Second, the cyclical position of developing countries is currently less advantageous than that
of the developed countries. While the economies of developed countries have been gradually
gaining momentum, the larger developing economies have been slowing down. The exit from
QE can thus be more painful and generate more volatility in the latter since capital outflows
deepen their output gaps.
Third, developing countries can be more affected by the volatility in the financial markets
resulting from the tapering of QE if they have large external imbalances and corporate and
household debt. Sizeable current accounts and high debt levels can thus pose a risk factor for
some developing countries.
Below we quantify the macroeconomic impacts of the higher bond yields in developed and
developing countries. We apply stylised shocks to term premium in the USA, Brazil, China,
India, Russia and South Africa. The size of the shocks is shown in Table 2. We assume that the
shocks are close to permanent.1 We also assume that US monetary policy is switched off for
the first year to reflect the central bank strategy of withdrawing unconventional monetary
policy instruments first, before switching to the conventional measures (it also conforms to
market expectations concerning increased interest rates by the US FED (as of February 2014)).
Table 2. Stylised bond yield shocks
Country
USA
Brazil
China
India
Russia
South Africa
Shock to bond
80 bp
300 bp
100 bp
150 bp
150 bp
100 bp
yields
Note: The shocks reflect changes in yields between May 2013 and February 2014. These changes result from the
FED’s tapering announcement and other factors, and the shocks should be interpreted as stylised rather than as
responding exclusively to tapering.
Figure 2 and Table 3 show the results of the simulation. The higher bond yields translate into
a modest weakening of growth prospects both in developed and in developing countries. The
impact on the real economy in developing countries is relatively small, with the strongest
response in Brazil. The sensitivity of the Brazilian economy to global portfolio shifts is higher
since the Brazilian financial markets respond more to global financial shocks than is the case
in other countries.
1
We apply the shocks over the period of 10 years (to avoid problems with model convergence in the long run).
Results are reported for the next eight years.
Figure 2. GDP effects of changes in bond yields – the impacts on the US and largest
developing economies
GDP change (% deviation from baseline)
1
2
3
4
5
6
7
8
years
9
0
-0.2
-0.4
-0.6
-0.8
-1
-1.2
-1.4
-1.6
Brazil
China
India
Russia
South Africa
US
Table 3. GDP effects of changes in bond yields – the impacts on the US and largest
developing economies (percentage deviation from baseline)
Year
1
2
3
4
5
6
7
8
9
Brazil
-0.40
-0.94
-0.95
-0.87
-0.81
-0.79
-0.78
-0.76
-0.66
China
-0.16
-0.28
-0.35
-0.39
-0.43
-0.47
-0.54
-0.60
-0.65
India
-0.13
-0.34
-0.41
-0.45
-0.51
-0.60
-0.71
-0.82
-0.89
Russia
-0.35
-0.48
-0.45
-0.49
-0.56
-0.63
-0.71
-0.78
-0.80
South
Africa
-0.12
-0.32
-0.42
-0.49
-0.56
-0.61
-0.65
-0.68
-0.69
USA
-0.38
-0.97
-1.06
-1.07
-1.13
-1.21
-1.29
-1.31
-1.22
Next, we look at the impacts of US FED’s tapering on the least developed regions: SSA, LAC,
MENA, CIS and the Far East. Since the financial markets in the least developed countries
(LDCs) are shallow, the effects of the taper will materialise mainly in trade channels. Figure 3
and Table 4 show the results.
The largest effects are seen in SSA – the US FED’s taper may shave off up to 0.8% of GDP in
these countries. In LAC and the CIS the more restrictive monetary policy announced by the
US FED may have spillovers representing up 0.25% of their GDP. The smallest effects are
likely to be in MENA and the Far East. The relatively larger impacts in SSA result from the
greater estimated elasticity of African domestic demand with regard to external shocks.
Figure 3. GDP effects of changes in bond yields – the impacts on the least developed
regions: SSA, LAC, MENA, CIS and the Far East
GDP change (% deviation from
baseline)
1
2
3
4
5
6
7
years
8
9
0.2
0
-0.2
-0.4
-0.6
-0.8
-1
Sub-Saharan Africa
Far East
Latin America
Middle East
CIS
Table 4. GDP effects of changes in bond yields – the impacts on the least developed
regions: SSA, LAC, MENA, CIS and the Far East (percentage deviation from baseline)
Years
1
2
3
4
5
6
7
8
9
SSA
0.02
-0.12
-0.39
-0.62
-0.75
-0.78
-0.75
-0.69
-0.60
Far East
0.04
0.06
0.04
0.01
-0.01
-0.03
-0.04
-0.07
-0.08
LAC
0.05
-0.07
-0.17
-0.17
-0.19
-0.22
-0.24
-0.26
-0.26
MENA
-0.02
-0.04
0.00
0.02
-0.01
-0.05
-0.08
-0.10
-0.10
CIS
0.01
0.01
0.03
-0.01
-0.07
-0.12
-0.17
-0.21
-0.23
To recap, the slightly weaker prospects for both developed and developing countries resulting
from a withdrawal from QE may affect both the scale of financing capacities in advanced
economies and of financing needs in emerging economies. Higher bond yields alone result in
a decrease in the US GDP by about 1% and by about 0.5% in developing countries. The impacts
on the least developed regions are probably slightly smaller than those in the developed and
the largest developing economies. Their financial markets are shallower and the propagation
of shocks is experienced mainly in trade channels (in SSA the impacts are slightly larger than
in the other developing regions because of the region’s greater elasticity of domestic demand
to external trade shocks).
Scenario 2: Basel III – effects of changes to bank capital and liquidity
ratios
Our second scenario analyses the impact on growth of Basel III – the new regulatory capital
and liquidity requirements. In 2011 the Basel Committee introduced a set of new rules for
banks aimed at strengthening their resilience to crises. Capital standards concerning both the
quantity and the quality of capital were redefined and new liquidity benchmarks were
introduced. Table 5 shows changes to capital requirements that banks must adopt by 2019.
Such a relatively long timespan is expected to give banks the chance to use retained profits
earned during boom periods, which should minimise the adverse impact of higher capital
requirements on the economy. The Basel III requirements apply to banks worldwide.
According to the new rules, core equity – the highest quality capital – increased to 4.5% of
risk-weighted assets. Along with a capital-conversation buffer of 2.5% above this, the common
equity requirement increased to 7%. The high quality Tier 1 capital was set at 6% with the
overall minimum capital ratio at 8%. Basel III also introduced a counter-cyclical buffer of up
to 2.5% – it is designed to be monitored nationally and increased if bank risks increase – in
particular during periods of excessive economic growth or property price bubbles.
Table 5. Basel III
Basel III capital requirements (in percentages)
Common
Tier 1 capital
equity (after
deductions)
Minimum
4.5
6.0
Conservation
2.5
buffer
Minimum
+ 7.0
8.5
conservation
buffer
Countercyclical
0-2.5
buffer range
Source: BIS, 20102
Total capital
8.0
10.5
The tighter regulation brings costs in terms of reduced output, and benefits in terms of reduced
bank risk-taking and less likelihood of banking crises. We attempt to quantify the impacts of
Basel III rules and look at both the macroeconomic costs and benefits.
2
BIS (2010) Annex 1 to Group of Governors and Heads of Supervision announces higher global minimum
capital standards, press release.
We assume that Basel III implies a small but permanent increase in borrowing costs. In the
model we approximate it by a small, permanent increase in investment premium, which results
in an increase in the cost of capital for the user. This approach is based on Barrell et al. (2009)
who simulate the impact of higher capital ratios and liquidity standards on bank borrowing
costs and the user cost of capital.
Next, we compare this scenario with a crisis scenario – where financing conditions tighten
abruptly and very significantly in all countries. This is approximated by a temporary, but very
significant, rise in risk premium.
Under the costs scenario, the higher costs of borrowing for households and enterprises stifle
domestic demand, and hence GDP. In response to a 0.5% increase in investment premium,
reflecting tighter regulation in the area of bank capital and liquidity, 3 GDP in all analysed
countries would be lower by up to 0.25 basis points (see Figure 4 and Table 6). The
responsiveness of the USA and the UK is slightly less than that of the other countries, which
may result from smaller role of the banking sector in business financing in those countries
(businesses finance themselves via the stock market rather than the banking sector).
Under the benefits scenario we simulate the effects of a significant, but temporary, increase in
risk premium. We assume that the risk premium increases by 4% and remains at the higher
level over a period of two years – which corresponds to a financial crisis. This results in an
significant instantaneous drop of GDP for about three years. It should be mentioned that our
crisis scenario does not envisage a permanent change of the risk premium (since risk was
underpriced before the crisis), which would imply a permanent scar on output in the long run,
and augment the costs of crises.
The size of the shock was calibrated on the basis of studies analysis the impacts of Basel III on GDP – see
Barrell et al. (2009) and BIS (2010).
3
Figure 4. GDP effects of Basel III and GDP effects of a financial crisis – the impacts on
the largest developed and developing economies (percentage deviation from baseline)
Crisis-driven change in risk premium effects
1.00
0.50
0.00
-0.50
1
2
3
4
5
6
7
8
years
-1.00
-1.50
-2.00
-2.50
-3.00
Brazil
Germany
South Africa
China
India
UK
France
Russia
US
GDP change (% deviation from baseline)
GDP change (% deviation from baseline)
Higher capital and liquidity effects
1.00
0.50
0.00
-0.50
1
2
3
4
5
6
7
8
years
-1.00
-1.50
-2.00
-2.50
-3.00
Brazil
Germany
South Africa
China
India
UK
France
Russia
US
Table 6. GDP effects of Basel III and GDP effects of a financial crisis – the impacts on
the largest developed and developing economies (percentage deviation from baseline)
Higher capital and liquidity effects
Years
1
2
3
4
5
6
7
8
Brazil
-0.11
-0.14
-0.11
-0.09
-0.09
-0.10
-0.10
-0.12
China
-0.07
-0.15
-0.18
-0.21
-0.23
-0.25
-0.27
-0.29
France
-0.07
-0.18
-0.21
-0.22
-0.23
-0.24
-0.25
-0.26
Germany
-0.09
-0.17
-0.17
-0.17
-0.18
-0.20
-0.22
-0.25
India
-0.05
-0.14
-0.17
-0.19
-0.20
-0.21
-0.24
-0.27
Russia
-0.11
-0.20
-0.21
-0.21
-0.22
-0.24
-0.26
-0.30
South
Africa
-0.05
-0.16
-0.21
-0.23
-0.23
-0.23
-0.24
-0.25
UK
-0.04
-0.06
-0.04
-0.03
-0.04
-0.06
-0.08
-0.10
USA
-0.07
-0.13
-0.11
-0.09
-0.09
-0.10
-0.13
-0.16
UK
USA
-0.54
-1.38
-0.96
0.23
0.62
0.57
0.36
0.17
-1.07
-2.46
-1.42
0.34
0.59
0.45
0.26
0.11
Crisis-driven change in risk premium
Years
Brazil
China
France
Germany
India
Russia
South
Africa
1
2
3
4
5
6
7
8
-1.14
-2.06
-0.77
0.62
0.81
0.62
0.44
0.34
-0.62
-1.71
-1.66
-0.80
-0.27
0.03
0.16
0.20
-0.85
-2.16
-1.61
-0.31
0.02
0.05
0.04
0.04
-0.96
-2.11
-1.41
-0.36
-0.16
-0.14
-0.13
-0.14
-0.46
-1.74
-1.94
-0.84
-0.13
0.19
0.28
0.26
-1.08
-2.69
-1.99
-0.24
0.28
0.38
0.35
0.27
-0.41
-1.63
-1.82
-0.60
0.23
0.45
0.32
0.13
Figure 5 and Table 7 show the impacts of Basel III on developing regions. In qualitative terms
the impacts are the same as in the largest developed and developing economies. Higher capital
and liquidity effects lead to a small decrease in the GDP, of up to 0.1%. These costs are,
however, much smaller than the benefits associated with avoiding financial crises (compare
charts in Figure 5). The biggest impacts are seen in SSA, where the impacts of a crisis are more
than 10 times greater than the introduction of tighter capital requirements. The size of the
premium shocks corresponding to tighter regulation and the crisis is the same across countries
(see above) – the differences result from structural differences between regions.
Figure 5. GDP effects of Basel III and GDP effects of a financial crisis – the impacts on
least developed regions: SSA, LAC, MENA, CIS and the Far East (percentage
deviations from baseline)
Crisis-driven change in risk premium effects
1
1
GDP change (% deviation from
baseine)
GDP change (% deviation from
baseline)
Higher capital and liquidity effects
0.5
0.5
0
1
2
3
4
5
6
7
8
-0.5
9
years
-1
0
1
2
3
4
-0.5
5
6
7
8
9
years
-1
-1.5
-1.5
-2
Sub-Saharan Africa
Far East
Middle East
-2
Sub-Saharan Africa
Far East
Middle East
CIS
Latin America
CIS
Latin America
Table 7. GDP effects of Basel III and GDP effects of a financial crisis – the impacts on
least developed regions: SSA, LAC, MENA, CIS and the Far East
Higher capital and liquidity effects
Years
1
2
3
4
5
6
7
8
SSA
-0.03
-0.08
-0.11
-0.11
-0.10
-0.09
-0.09
-0.09
CIS
-0.03
-0.05
-0.03
-0.03
-0.03
-0.03
-0.04
-0.06
Far East
-0.01
-0.01
-0.01
-0.01
-0.02
-0.02
-0.03
-0.04
LAC
-0.01
-0.03
-0.03
-0.03
-0.03
-0.03
-0.04
-0.05
MENA
-0.02
-0.03
-0.01
0.00
0.00
-0.01
-0.03
-0.04
9
-0.11
-0.07
-0.05
-0.06
-0.04
LAC
-0.19
-0.54
-0.37
0.12
0.17
0.10
0.08
0.07
0.05
MENA
-0.18
-0.47
-0.31
0.17
0.28
0.14
0.01
0.02
0.08
Crisis-driven change in risk premium
Years
1
2
3
4
5
6
7
8
9
SSA
-0.47
-1.52
-1.55
-0.37
0.43
0.83
0.90
0.75
0.49
CIS
-0.46
-0.92
-0.34
0.35
0.36
0.25
0.14
0.04
-0.05
Far East
-0.22
-0.46
-0.23
0.14
0.19
0.15
0.08
0.03
0.00
To sum up, the introduction of Basel III brings both costs and benefits. On the one hand, higher
capital and liquidity requirements imply slightly higher borrowing costs, which result in a
weakening of growth across developed and developing countries. On the other hand, more
stable and resilient banking systems are less prone to financial crises which, as the recent
experience shows, can be very costly. Our simulations show that in the case of all countries
and regions the benefits substantially outweigh the costs.
Scenario 3: Tackling tax evasion – effects of changes to transfer
pricing
Our final scenario models the effects of tax evasion. Tax evasion is a major issue in developing
countries since they lack the capacity and resources to collect tax revenues (HMRC, 2013).4
MNCs often manipulate transfer prices by changing the sale or purchase prices in order to
transfer the revenues and profits to tax havens. Our scenario investigates the potential impacts
of a reduction in tax evasion in developing countries. Assuming that transfer pricing affects
relative terms of trade, in a situation in which transfer pricing can no longer be manipulated,
export prices, profits and tax revenues in developing countries would all increase.
As an example, we simulate a scenario where we raise export prices in two developing regions
– SSA and LAC. Our stylised scenarios assume a 10% increase in export prices in developing
countries. This is calibrated on the basis of Bernard et al. (2006), who find that the wedge
between the arm’s-length price and the related party price is about 40%. Product characteristics
4
The recent decision of the G20 concerning an automatic exchange of fiscal information does not affect
developing countries.
are influential in determining this gap – while the wedge for commodities (undifferentiated
goods) is about 10%, the gap for differentiated goods amounts to about 70%. Given that most
developing countries export commodities,5 we use the lower band estimated by Bernard et al.
(2006) and shock the export price of commodities by about 10%. Next, we assume that profits
in SSA and LAC increase in proportion to the value of their exports (the increase in profits
amounts to the additional value of exports resulting from higher export prices). Finally, we
assume that all the additional profits are taxed6 and the money raised through taxes is spent on
boosting growth in the two regions. Figure 6 and Table 8 show the results.
Figure 6. GDP effects of tackling tax evasion – the impacts on SSA and LAC
0.18
GDP change (% deviation from
baseline)
GDP change (% deviation from
baseline)
0.35
0.3
0.25
0.2
0.15
0.1
0.05
0
0.16
0.14
0.12
0.1
0.08
0.06
0.04
0.02
0
1
2
3
4
5
6
7
8 9
years
1
Sub-Saharan Africa
2
3
4
5
6
7
Latin America
Table 8. GDP effects of tackling tax evasion – the impacts on SSA and LAC
Year
1
2
3
4
5
6
7
8
9
5
SSA
0.330
0.296
0.271
0.250
0.231
0.219
0.211
0.207
0.204
Year
1
2
3
4
5
6
7
8
9
LAC
0.159
0.124
0.109
0.107
0.105
0.103
0.102
0.102
0.102
We assume that the share of commodities in exports from SSA and LAC corresponds to 70% and 50%
respectively.
6
We assume that the tax rate is 50%.
8 9
years
Policies aimed at reducing the abuse of transfer pricing have the potential to improve growth
prospects in developing countries. In our stylised scenario, a 10% increase in export prices in
the countries of SSA and LAC, accompanied by a proportional increase in profits and hence
taxes can lead to 0.35% increase in GDP in SSA. The responsiveness of small developing
countries in LAC is slightly smaller – GDP improves by up to 0.15%. The regional differences
result from different price elasticities of exports and imports. In SSA these elasticities are
slightly higher, which implies that tackling the abuse of transfer pricing would be particularly
beneficial for this region. While the quantitative impacts may be surrounded by uncertainty, in
terms of the qualitative results, our simulations suggest that policies encouraging pricing of
exports and imports at an arm’s-length rather than related party price may have macroeconomic
benefits for developing countries.
Section 3: Conclusions
The global financial crisis, and its severe economic consequences – a significant slowdown in
global economic activity, a collapse in global trade, and debt- and unemployment-related
problems many developed economies – have led to a re-evaluation of global prospects and also
prompted a re-design of the global regulatory and economic policy frameworks. First, the major
central banks started using unconventional monetary policy instruments, such as major
purchases of assets. This has had implications for the financial markets and the real economy
in developed countries, and has also had spillovers affecting developing countries. An exit from
QE will not only have a local impact, but through international financial and trade channels
will spread to developing countries. Second, after the banking meltdown, international
regulators have strengthened banking regulations, introducing a set of new capital and liquidity
requirements, Basel III. Basel III brings costs and benefits for all countries. Third, in the light
of the international debate on tax evasion, it has been acknowledged that in order to sustain
prosperity it must be shared more equally worldwide. The LDCs still lose billions of dollars in
taxes that could be used to tackle poverty and boost their economies.
This paper has sought to quantify the macroeconomic effects of these three types of policies.
We looked at the impacts of a withdrawal from QE that induced a rise in bond yields in
developed and developing countries. Our simulations show that an increase in bond premium
results in a moderate weakening of GDP – in the USA by about 1% and in the largest
developing economies by up to 0.5%; in the least developed regions, since their financial
markets are shallower, the impacts are likely to be smaller. All banks must introduce higher
capital and liquidity requirements and Basel III by 2019, and these measures bring costs and
benefits. Our analysis shows that the benefits should significantly outweigh the costs – in terms
of output across all countries the benefits are at least several times greater than the costs.
Finally, tackling tax evasion would be particularly beneficial for the LDCs. Our stylised
simulations show that while introducing new tax rules would have a minor negative impact on
countries where tax evasion is high, they would have a significant positive impact on the LDCs,
enabling them to tackle poverty and boost their economies.
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