Development and stability : institutional development and economic stability in Liberia 2004-2015

Development and Stability

Institutional Development and Economic Stability in

Liberia 2004-2015

Carmen Hendriks 11002077 Carmenhendriks@hotmail.com Thesis Peacebuilding and International Relations Political Science First Reader: Dr. J. Krause Second Reader: Dr. N. Vanderkerckhove 19 June 2018 Words: 8.191

Inhoudsopgave

Development of the Central Bank ... - 13 -

Access to finance ... - 16 -

Financial Sector Regulation ... - 20 -

Conclusion ... - 26 -

-Introduction

On the 30th of March 2018, the 15-year long peacebuilding mission in Liberia came to an end. This mission has been hailed as succesful by the United Nations, in the sense that the mandate has been implemented (Berbatovci 2018). This mandate contained the rebuilding of justice and security institutions, which according to the Special Representative in Liberia, Farid Zarif, would pave the way for economic growth through the peace rebuild by the UN peacekeeping mission (United Nations n.d.-b; United Nations News 2017). Economic development has often been

connected to sustainable peace, for example by the deputy-Secretary General of the United Nations (Berbatovci 2018) and the director of the IMF (Strauss-Kahn 2009). The rebuilding of financial organizations, in order to facilitate economic growth, has been mostly implemented by international financial organizations like the IMF and the World Bank.

However, does this economic growth generated by the rebuilding of the financial institutions contribute to economic stability and development and thus sustainable peace? This causal relationship is often assumed when reconstructing financial institutions and in the literature. This thesis will examine whether this causality is plausible. The research question is thus: did the rebuilding of financial institutions in Liberia contribute to economic stability?

It is relevant to examine this possible causal relationship since it can provide the international community with more knowledge of how sustainable peace can be achieved. It is also relevant since there seems to be a gap in the literature on the relationship between economic growth and economic stability.

This thesis also takes into account how everyday economic circumstances, such as (youth) unemployment, income inequality and poverty have changed over the course of the peacebuilding mission and their possible implications for the political stability in Liberia.

The argument that this thesis makes, is that international organizations like the IMF and the World Bank have focused their attention on generating high economic growth in Liberia. In doing this, they have not taken into account that this high economic growth might not automatically lead to economic stability, whilst this stability is an important component of sustainable peace. Economic stability is not the same as

economic growth, since it takes the volatility of the economy into account. A country can thus have high economic growth, but when this growth (or inflation or current account balances) is very volatile, for example after a shock to the economy, the economy is not stable. Thus, when circumstances in Liberia change, the economy shrinks and becomes more volatile and the country becomes unstable, the

sustainable peace which is desired is undermined and conflict may arise again. The thesis is build up as follows: first, the state of the literature on economic stability will be reviewed. Second, a short historical background of the case will be given and the methodology of the thesis will be explained. Third, the analysis will be done in order to answer the research question. Last, a conclusion and further

recommendations will be made.

Literature Review

The impact of UN peacekeeping missions on economic performances in host

countries has been extensively researched. Carnahan, Durch and Gilmore (2006: 8) show that GDP per capita in Liberia has slightly increased since the start of the peacekeeping mission in 2003. Furthermore, inflation has decreased since the start of the mission (idem: 12). The economy in Liberia expanded steadily up until around 5 years ago, when prices of iron ore and rubber, two of Liberia’s largest exports, fell and the Ebola crisis severely weakened the economy (Poquie 2016).

The economic recovery of the country can, at least partly, be explained by the rebuilding of financial institutions. As Addison et al. (2005) show, the financial system is one of the crucial components that need to be rebuild in order to achieve recovery from war. In particular, Addison et al. (idem: 715) focus on both reconstruction and reform of the financial sector, including currency reform, central bank construction and regulation. The reconstruction of the financial sector can then, similar to

economies in Europe after the Industrial Revolution, lead to economic development, as Schumpeter (1911) argues.

This relationship has been studied by King and Levine (1993) in a cross-country study, in which a significant and robust relationship between financial development and economic growth has been found, which reinforces the argument as developed by Schumpeter. King and Levine indicate four elements of financial development (idem: 718): size of the intermediary financial system as indicated by

the ratio of liquid liabilities to GDP, the importance of domestic banks compared to the central bank, the distribution of credit to private firms compared to total credit and credit issued to private firms as a fraction of GDP. The relationship found by King and Levine has been reinforced by recent articles examining low-income countries

(Hassan, Sanchez and Yu 2011; Akinlo and Egbetunde 2010; Khadraoui and Smida 2012)

Economic growth in developing nations is, according to Otani and Villanueva (1989: 42), determined by exports, savings rates and investments in human capital. Financial institutions which increase access to capital and facilitate trade are thus essential to economic development. One of the key roles for international

organizations is then to assist in the creation and reconstruction of these financial institutions, like a Central Bank, investment banks and commercial banks.

To establish how international organizations have contributed to financial

development, I will focus on the way the International Monetary Fund (IMF) has provided Liberia with technical assistance in order to develop their financial system (IMF 2018). The IMF has indicated the importance of institutional rebuilding and links this reconstruction to economic growth and lasting peace (IMF 2004: 9-11). Similarly, the World Bank provides support for institutional development, focusing on

supervision and credit assessment. According to the World Bank, post-conflict reconstruction has a positive impact on lasting peace, with the reconstruction of the domestic economy and access to resources being seen as key components of

economic recovery (International Bank for Reconstruction and Development 1998: 4). The program developed by the World Bank and the IMF to assist in financial sector development, the Financial Sector Assessment Program, has not yet been requested in Liberia, although the Central Bank has recommended this to the government (Central Bank of Liberia 2016: ii). In the meantime, there is a Financial Sector Development Implementation Plan, which developed in coordination with the FIRST initiative and the World Bank. This plan involves a series of objectives in order to reform the financial sector in Liberia (idem: 1-2). These objectives include a

regulatory framework, a sound and competitive financial market, supportive financial institutions and deep financial inclusion (ibid.).

For the analysis in this thesis, the effects of three key developments on the stability of the economy will be examined. These three key developments are:

increased independence of the Central Bank, increased access to finance and increased regulation of the financial sector.

Besides the IMF and the World Bank, the UN also promotes economic

development through facilitating access to credit and financial resources, on both the regional and national level (Bureau for Crisis Prevention and Recovery 2008: 48-95). Financial development is thus one of the key prerequisites for economic growth. This development, as outlined above, has been supported by the IMF and the World Bank and is a crucial component of the recovery of post-conflict states. Economic growth however does not necessarily lead to sustainable peace. It is generally recognized that economic stability does facilitate lasting peace. This is recognized by the managing director of the IMF, who states that “economic stability and a prosperity which is broadly shared – both within and among countries – can foster peace” (Strauss-Kahn 2009).

Economic stability, in this thesis, will be conceptualized as “avoiding economic and fiscal crises, large swings in economic activity, high inflation, and excessive volatility in foreign exchange and financial markets” (IMF 2018). Economic stability is generally measured by analyzing “behavior of macroeconomic outcome variables including the growth of real output, the rate of inflation, and the current account deficit” (World Bank 2005: 9). The relationship between this economic stability and peace has been researched by several authors.

Mobarak (2005: 351) shows that countries with large drops in growth, which indicates unstable economies, are countries which do not have strong institutions for conflict management. This can then give rise to domestic and international conflict. This argument is further developed by Bluhm, De Crombrugghe and Szirmai (2014), who find a significant relationship between development of institutions and economic slumps, which are then connected to weaker conflict management and increased chances of social conflict.

Similarly, Rodrik (1999) shows that shocks to trade, which can result in unstable economies, can result in conflict. Rodrik’s argument is similar to that of Mobarak, however his analysis mainly focuses on trade, rather than on growth. The relationship between trade volatility and conflict, along with the relationship between growth volatility and conflict which Mobarak finds, further indicates that economic instability, which takes both trade and growth into account, can give rise to domestic

conflict, which is recognized by the IMF (Strauss-Kahn 2009) and Bluhm, De Crombrugghe and Szirmai (2014), as stated above.

Furthermore, there appears to be a negative relationship between democracy and volatility (Quinn and Woolley 2001; Anbarci, Hill and Kiramanoglu 2011). This decrease in volatility occurs when a country becomes democratic, since it works through preferences of voters for lower output volatility. Thus, when international organizations assist in the democratization process after conflict, the volatility of the economy decreases. This then, as Rodrik, Mobarak and Bluhm, De Crombrugghe and Szirmai show, can reduce the recurrence of conflict.

There is a gap in the literature however. Most of the projects by international

organizations in post-conflict societies focus on creating and reconstructing financial organizations in order to facilitate economic growth to create sustainable peace. Furthermore, economic stability, as in low economic volatility, is seen as reducing conflict recurrence. It is then the assumption of these international organizations that the economic growth which results from the rebuilding of financial institutions will lead to economic stability, which then leads to sustainable peace.

There is no consensus on this relationship however. It has been recognized that low economic volatility can increase economic growth (Ramey and Ramey 1995). It has been established however, that low economic volatility can also decrease economic growth in the sector of finance, where risk can increase

investments, known as Simpson’s fallacy (Ramey and Ramey 1995; Imbs 2007; Imbs 2002).

The other way around, the causality between economic growth and economic volatility is even more contested. Antonakakis and Badinger (2012) have illustrated how the scholarly community has analyzed the causality between growth and volatility (specifically output volatility). They identify that Stiglitz (1993) has first recognized the possible relationship between growth of the economy and output volatility. This causality has been analyzed by Fountas and Karanasos (2006) found a significant positive relationship in Germany and the United States. On the other hand, Lee (2010) does not find a significant relationship in the G7 between 1965 and 2007 (Antonakakis and Badinger 2012: 2).

These scholars mainly focus on output volatility. As established above however, economic stability also concerns inflation volatility and account deficits,

which includes trade volatility. The causality between economic growth and these variables is even less researched by the scholarly community, which indicates the gap in the literature previously identified.

In order to analyze the ways in which Liberia has achieved economic growth and economic stability, it is necessary to operationalize these concepts in order to analyze the economic situation.

To begin with, economic growth is defined and operationalized as the percentage increase in real GDP per capita (Barro 1991).

As stated above, economic stability is associated with low output volatility, low inflation and low account deficit volatility (which concerns the difference between import and export). Volatility is generally measured by calculating the standard deviation (Badinger 2010: 15). Low volatility is then a standard deviation of less than 1 from the average of the sample (idem: 17), which in this case runs from the start of the mission in 2003 until the end of the mission in 2018. Low inflation is seen as price stability. Liberia is part of the West African Monetary Zone (WAMZ), which has set its inflation target at an annual inflation below 10% (Qureshi and Tsangarides 2008: 214). The volatility of inflation is also taken into account, since a large volatility in growth is negatively associated with economic growth and thus possibly economic stability (Judson and Orphanides 1999; Fatás and Mihov 2013).

It is necessary to develop the ways in which the reconstruction of financial institutions has contributed to economic stability, rather than solely the contribution to economic growth. Should it be found that economic stability is not achieved through

reconstructing financial institutions, then the development strategies by international organizations to create sustainable peace should be adjusted.

I expect to find that the rebuilding of institutions in Liberia has not yet resulted in economic stability. This lack of stability could potentially be explained by the fact that these new institutions have not yet been fully developed in order to achieve stability, which made them unequipped to handle the situation of both the decline in prices of iron ore and rubber, and the Ebola crisis. This would be a result of the lack of priority for economic stability in favor of pursuing high economic growth by international organizations like the IMF and the World Bank. This high economic growth did then

not automatically lead to economic stability, which undermined the Liberian economy when circumstances in exports and society changed.

Case Background

The peacebuilding mission in Liberia started in October 2003, after the warring parties in Liberia signed a peace agreement in August (Dennis 2006: 6). This peace agreement came after a civil war which began in 1999 when a rebel group emerged in the northern part of the country (idem: 5). This rebel group, the Liberians United for Reconciliation and Democracy (LURD), was supported by Guinea, a neighboring country (ibid.). Four years later, in early 2003, a second rebel group emerged in the southern part of the country, the Movement for Democracy in Liberia. This marked the beginning of the end for the government of Charles Taylor, who came into power following the first Liberian Civil War which lasted from 1989 until 1993 (idem: 4-5).

The peacebuilding mission was mainly instated with the goal of restoring law and order in the country, which had largely been undermined by the civil war. The mission was multidimensional, with components raging from military and political to gender, disarmament and child protection (idem: 6). These developments should then eventually result in a due electoral process later on. A key characteristic of the mission was the close cooperation with the Economic Community of West African States (ECOWAS) and the African Union, as well as humanitarian and development agencies (United Nations n.d.-a).

Aside from cooperation with these agencies and organizations, the mission also worked closely together with other missions in sub-Saharan Africa, in order to create a coordinated UN response to conflicts in the area. These missions include UNAMSIL in Sierra Leone, MINUCI in Cote d’Ivoire and the UN Office for West-Africa (ibid.).

The UN mission came to a close in March 2018 and has been hailed as a success by the United Nations, mainly as a result of the increased stabilization and peace, as well as the three succesful elections held during the last decade, in 2005, 2011 and 2017 (United Nations 2018). These elections not only saw the election of the first female President in Africa in Ellen Johnson-Sirleaf in 2005 and her re-election in 2011, but also the first peaceful transition of power in the country since the Civil War,

when George Weah was elected president in 2017. Notable in the evaluation of the mission is the fact that the economic situation in the country is not taken into account when determining whether or not the mission is a success, even though the country has been experiencing set-backs in their economic recovery as a result of the financial crisis, decline in prices of main export products and the Ebola outbreak a couple of years ago (Sy and Copley 2014).

This economic recovery of Liberia should result from the intervention of several other organizations which cooperate with the United Nations. These organizations include ECOWAS, the International Monetary Fund and the World Bank. One of the main focuses of the missions include rebuilding infrastructure and institutes in order to create economic growth, attract investors and supply the residents with capital (World Bank n.d.-a). Other missions included development aid and supplying the

government with loans and debt relief. Although the peacekeeping mission has ended, the presence of international financial organizations is maintained, through projects and programs which aim at developing the economy and facilitating the recovery of the economy.

Methodology

As has been said before, this thesis looks at the financial stability in Liberia as a result of the development of financial institutions. In order to determine whether or not this is the case, it is necessary to determine how financial stability is measured.

Financial stability is measured by three factors, outlined in the theoretical framework: volatility of economic growth, inflation rates and volatility of current

account deficits (World Bank 2005: 9). These three factors are measured annually by the World Bank and result in their World Development Indicators (World Bank n.d.-b). The three indicators are operationalized by the variables of GDP per capita growth in annual percentages, inflation of consumer prices in annual percentages and current account balance as percentage of GDP. The data used to create the indicators comes from internationally recognized sources, such as government data and surveys conducted in the regions or countries themselves (ibid.).

In order to then see how stable the country is, it is necessary to determine volatility of two of the indicators: current account deficits and GDP growth. This can

be done by measuring the standard deviation of these variables. This standard deviation indicates the variance in the indicator and thus how stable it is (Badinger 2010: 10). As mentioned in the theoretical framework, a standard deviation of more than one is considered a high volatility (idem: 17). For inflation, the benchmark as set by the West African Monetary Zone is inflation lower than 10% annually (Qureshi and Tsangarides 2008: 214). However, the volatility of inflation is also taken into account, since this is negatively correlated with growth and thus stability (Judson and

Orphanides 1999; Fatás and Mihov 2013), although it is not defined by the World Bank as an indicator of economic stability.

In order to determine how the development of financial institutions has contributed to economic stability, it is useful to compare the situation in Liberia to the rest of the region, to determine whether or not the volatility in current account deficits and

economic growth, and levels of inflation are region-wide phenomena. Thus, data shall be collected on the variables in the same time-span (2004-2015) for other countries in West Africa. These countries are: Benin, Burkina Faso, Cape Verde, Cote d’Ivoire, The Gambia, Ghana, Guinea, Guinea-Bissau, Mali, Mauritania, Niger, Nigeria,

Senegal, Sierra Leone and Togo. The levels of volatility in these variables shall then be compared to the levels in Liberia.

The timespan which is used in this thesis is 2004 until 2015. The reason that this timespan is chosen is the fact that the peacebuilding mission started in late 2003, so the first effects of the presence of the mission and the rebuilding of the institutions emerge in 2004. The peacebuilding mission ended in early 2018, however the data on the current account deficits only run until 2015. Even though the data does not run until the end of the mission, the fact that the data runs through 2015 still captures the effects of the Ebola-crisis and the decline in prices of main export products, which occurred in 2014 (Sy and Copley 2014).

Aside from the statistical portion of the analysis, a large part of the analysis is done by examining the various articles, books and reports which concern the rebuilding and restoring of the financial institutions in Liberia by the United Nations and other international financial organizations. It is then analyzed how this restoring had an effect on the stability of the economy, both in theory and in practice.

key developments in Liberia have affected the economic stability of the country. These three developments are: increased independence of the central bank, increased access to finance, as in access to loans and financial services, and increased regulation of the financial sector. These three developments all have an effect on the three measures of economic stability: inflation, volatility of the current account balance and volatility of economic growth. These relationships will be further explored in the analysis.

Through examining how these developments have affected the economic stability, it provides insights on how various unexpected shocks to the economy, mainly the decline in export prices and the Ebola crisis, have dampened the benefits of financial sector development.

Furthermore, the analysis also looks at four different indicators of the everyday economic situation for Liberians and how they may have an effect on political stability and possible resurgence of conflict and violence. These indicators are: youth

unemployment, unemployment, income inequality and poverty rates. All data on these variables is sourced from the World Development Indicators as provided by the World Bank. However, it is necessary to mention that there is a lack of data on these variables and thus should be interpreted as a possible reflection of the situation rather than definite data on the everyday economic situation.

The research question is thus answered through an analysis of the effects of the various developments in the financial sector on the various indicators of economic stability in Liberia. A comparison is made to other countries in West Africa to determine the evolution of the various variables in the rest of the region to ensure that the developments result from the projects instated by the IMF and the World Bank rather than resulting from region-wide phenomena.

Following, the development of the four indicators of economic circumstances will be examined in order to understand their effects on political stability.

Analysis

For this analysis, there will be a focus on three main aspects of the rebuilding of financial institutions: development of the Central Bank, restoring access to finance and regulating the financial sector. In the following section, each aspect will be further

examined in order to determine how, in theory, this development could lead to a stable economy and how the economy has changed in practice as a result of various shocks.

1. Development of the Central Bank

The Central Bank in Liberia was established in 1999 to replace the National Bank of Liberia (Bloomberg n.d.). During the Civil War, the Central Bank was closed for a period of almost three months, but reopened following the peace agreement signed in August 2003 (IRIN 2003). Since the end of the war, several international

organizations have assisted the Liberian government with rebuilding the Central Bank. One of these initiatives came from the FIRST initiative in collaboration with the World Bank. They developed a plan in order to develop the financial sector in the country. One of the goals of the plan was to create a regulatory framework for the Central Bank “in line with international best practices”. These practices, which mostly concern the independence of the Central Bank, all create an environment, in theory, for price stability.

The relationship between independence of the Central Bank and price stability has been extensively researched. Ever since the 1970’s, governments have created new legislation in order to make their central banks more independent, starting with New Zealand. The general idea behind central bank independence is the lack of time-inconsistency problems. Time-inconsistency problems, meaning short-term practices that are not in line with long-term goals, result from the relationship between unexpected inflation and output growth. When the central bank

unexpectedly creates inflation, output will temporarily be higher and unemployment will be lower. This is convenient for politicians before an election, since lower unemployment is generally seen to be positive in the eyes of the public, thus

increasing the chance that the responsible politician will be re-elected. However, this unexpected increase in inflation has higher inflation on the long term as a

consequence. This higher inflation in the long run does not create higher output or lower unemployment and is inconsistent with the wishes of the Central Bank.

If a Central Bank is thus independent from politicians, through rules or term length for officials which run longer than the election cycles, this time-inconsistency problem is thus solved and thus has lower inflation in the long run as a consequence.

It is thus important for a country to create a central bank which can conduct monetary policy independently from politics in order to achieve price stability. In Liberia, the central bank independence weighted score, as measured by Garriga (2016), has been consistent at around 0.53 from 1999 until 2012. This means that, even though the Central Bank in Liberia has developed, it has not become more independent since the start of the peacebuilding mission in 2003. This lack of change in score is explained by the fact that Garriga has not identified a change in the structure of the central bank since 1999, when the new central bank was instated (ibid.).

Compared to other countries in West Africa, the score on the Central Bank Independence Index is quite low (ibid.). These scores are visualized in Table 1.

Table 1. Weighted Central Bank Independence Scores in Liberia and West Africa 2012

This low degree of central bank independence would in theory lead to a higher rate of inflation, as well as a higher degree of volatility in inflation. This relationship is

reflected in Figure 1, where inflation rates in Liberia are compared to average inflation rates in West Africa.

Country Weighted Central Bank Independence Score 2012 Country Weighted Central Bank Independence Score 2012 Liberia 0,533125 Guinea-Bissau 0,8015 Benin 0,8015 Mali 0,8015 Burkina Faso 0,8015 Mauritania 0,636

Cape Verde 0,518 Niger 0,8015

Cote d'Ivoire 0,8015 Nigeria 0,62625

The Gambia 0,549395 Senegal 0,8015

Ghana 0,560667 Sierra Leone 0,72475

0 2 4 6 8 10 12 14 16 18 20 20 04 20 05 20 06 20 07 20 08 20 09 20 10 20 11 20 12 20 13 20 14 20 15 Liberia Inflation, consumer prices (annual %)

West Africa Inflation, consumer prices (annual %)

Figure 1. Inflation rates in Liberia and West Africa 2004-2015

As reflected in the figure, the inflation rates in Liberia are consistently higher than those in the rest of West Africa during the period of 2004 to 2015. Similarly, the volatility in inflation is also larger in Liberia, 3.007 compared to 1.63. The inflation rates have been lower than 10%, which is the target, since 2009, but only barely so during the last 5 years. In the rest of West Africa however, inflation rates have not exceeded 6 percent in the last decade, which indicates more price stability than in Liberia.

The figure shows the increase in inflation during the financial crisis in 2008-2010, the decline in prices of exports in 2014-2015 and the Ebola crisis in the same period. These peaks, which do not appear in the same degree for the other countries, show that the Central Bank was not equipped to handle the change in circumstances.

The peak in 2011 was a result of a more global instance of inflation, partly fueled by an overheating of the Chinese economy and rising oil and commodity prices (Barboza 2011).

Thus, a more independent central bank has been able to keep inflation below 10% for the last 5 years, however the increased independence of the central bank has not lead to a less volatile inflation rate. Thus, this development has only partly

2. Access to finance

The second important feature of the rebuilding of financial institutions in Liberia is restoring the access to finance. Increased access to finance allows businesses and households to invest in education, equipment or financial instruments, such as bonds. Research shows that improved access to finance, such as access to loans, services and bank accounts, increases investments made by households and small businesses (Ellis, Lemma and Rud 2010). For example, loans could enable a household to pay for education or equipment in order to make a business more productive. Ellis, Lemma and Rud then show that this increase in access to finance also generates more economic growth (ibid.).

This increase in investments through an increase in access to finance can then be linked to a decrease in volatility of current accounts. Chinn and Ito (2007) show that the volatility in current account balances in developing economies can be explained by a decrease in investments. Thus, an increase in access to finance and investments should decrease the volatility of current accounts and thus increase the stability of the economy.

As mentioned above, the access to finance is a key feature of the development of the financial sector in Liberia. Several projects in the country, such as a collateral registry system, are established in order to advance access to finance. The collateral registry allows small and medium enterprises (SMEs) to use equipment, such as agricultural machines and vehicles, as collateral in order to qualify for loans (Central Bank of Liberia 2016: vii). Similarly, projects are in place in order to improve financial

infrastructure tools. These tools include credit guarantee schemes which reduce risks of lending and training for SMEs to improve financing proposals which increase their chances to obtain a loan (ibid.).

It can thus be expected that the improved access to finance in Liberia has led to an increase in investments, represented by gross capital formation as a percentage of GDP. This data, compared to that of other countries in West Africa, is visualized in Figure 2.

0 5 10 15 20 25 30 20 04 20 05 20 06 20 07 20 08 20 09 20 10 20 11 20 12 20 13 20 14 20 15

Liberia, gross capital formation (% of GDP) West Africa, gross capital formation (% of GDP)

Figure 2. Investments in Liberia and West Africa 2004-2015

As can be seen from Figure 2, investments as a percentage of GDP has virtually not increased nor decreased in the period of 2006 to 2014. It is only in 2015 that

investments have slightly increased. This indicates that the improved access to finance has not been reflected in investments, however, the decrease in prices of exports and the Ebola crisis have not had an impact on investments either. This could be a result of the Central Bank adjusting interest rates in order to compensate for a potential loss of GDP as a result of the decrease in export prices and the Ebola crisis, which would keep investment rates relatively constant, especially if investors have not become more uncertain or investments have become more risky.

The real interest rates percentages, which indicate interest rates adjusted for inflation, in Liberia compared to the rest of West Africa in the period 2004-2015 are visualized in Figure 3.

-15 -10 -5 0 5 10 15 20 20 04 20 05 20 06 20 07 20 08 20 09 20 10 20 11 20 12 20 13 20 14 20 15

Liberia Real Interest Rate (%)

West Africa Real Interest Rate (%) Figure 3. Real interest rates in Liberia and West Africa 2004-2015

As can be seen from Figure 3, the interest rates in Liberia have been rather volatile, with a standard deviation of 6.57 compared to 3.73 in the rest of West Africa. The large decrease in real interest rate in the period of 2008-2009 can be attributed to the large inflation rates as a result of the financial crisis. The decrease in interest rates in 2011 can be attributed to both a slight increase in inflation, as well as a decrease in interest rates. This decrease in real interest rates lowers the cost of capital, which increases investments. The same decrease cannot be seen in 2014 as a result of the Ebola crisis, instead, a small increase in real interest rates can be seen. This

indicates that interest rates are higher than inflation, which would increase the cost of capital. This would then result in a decrease in investments, however this cannot be seen in Figure 2.

A different aspect of investments should then be considered. Foreign Direct Investments (FDIs) inflows are investments made in a country by non-resident

investors. These investors can include both private investors as well as states. Since FDIs play a large role in developing economies, volatility in FDIs could result in volatility in current account balances. In Figure 4, data on FDIs as a percentage of GDP is visualized for Liberia and West Africa in the period 2004-2015.

0 10 20 30 40 50 60 70 80 90 20 04 20 05 20 06 20 07 20 08 20 09 20 10 20 11 20 12 20 13 20 14 20 15

Liberia, FDI net inflows (% of GDP) West Africa, FDI net inflows (% of GDP)

Figure 4. Foreign Direct Investment net inflows in Liberia and West Africa 2004-2015

Figure 4 shows a consistently higher level of FDIs in Liberia compared to the rest of West Africa. This could be a result of projects instated by the IMF and the World Bank in order to develop Liberia. For example, the IMF granted Liberia more than 35 million dollars and a loan of more than 46 million dollars in 2015 (International

Monetary Fund 2015), whilst the World Bank granted Liberia 20 million dollars in 2018 (World Bank 2018). However, the FDI inflows have been volatile, with a standard deviation of 19.69 compared to 1.46 for the rest of West Africa. This high volatility of FDI inflows could have contributed to a more volatile current account balance.

The current account balances as a percentage of GDP in Liberia and West Africa in the period of 2004-2015 are shown in Figure 5.

-90 -80 -70 -60 -50 -40 -30 -20 -10 0 20 04 20 05 20 06 20 07 20 08 20 09 20 10 20 11 20 12 20 13 20 14 20 15 Liberia Current account balance (% of GDP)

West Africa Current Account Balance (% of GDP)

Figure 5. Current Account Balances in Liberia and West Africa 2004-2015

Figure 5 shows a large volatility in current account balances in Liberia with a standard deviation of 15.23 compared to that of West Africa, which has a standard deviation of 2.61. Furthermore, the levels of the current account deficit have been larger in Liberia, which has consistently run a deficit since 2004, with large increases in deficit corresponding with the financial crisis in 2008, the global inflation in 2011, the decrease in prices of export and the Ebola crisis in 2014.

This data shows that, although access to finance has increased, current account volatility is persistent. The volatility in the current account balance mostly results from the continuous dependence on foreign aid and other forms of Foreign Direct Investments. Thus, this development has not contributed to a more stable economy in Liberia.

3.

Financial Sector Regulation

The last section of the analysis focuses on the effects of financial sector regulation. Regulation, for example regulation of banks concerning risk-taking or laws designed in order to ensure financial system-wide resilience, can increase economic

performance. The relationship between quality of regulation and economic performance in emerging economies has been studied by several authors. For example, Jalilian, Kirkpatrick and Parker (2007) show that there is a strong causal

linkage between quality and efficiency of regulation and economic performance. These results build upon a larger academic debate, regulation theory. Regulation theory states that economic performance can be hampered as a result of a lack in regulation (idem: 88). It argues that a lack of regulation could result in market failure, imperfect information and distortions in distribution of income and wealth. These factors then dampen economic growth and performance (ibid.).

Similarly, a lack of regulation, or insufficient regulation, is also said to be one of the causes for the global financial crisis (Lall 2012: 625). In particular, Basel II, the global regulatory framework for banks, received the most damning verdict after the crisis. Several of its features, including minimal regulation for trade in financial assets, relief for large banks and a reliance on risk models compiled by the banks themselves, are said to have contributed to the crisis (ibid.). Other criticisms of Basel II included a critique of the estimation of risk. Basel II is seen as having

underestimated the risk in the financial system as well as having overestimated how banks would be able to deal with these risks (De Larosière et al. 2009: 16).

Similarly, Agénor and Pereira da Silva (2016) show that macroprudential regulation, like reserve requirements, result in lower financial as well as overall economic volatility. This is a result of the reduction of unsustainable credit booms as well as a reduction of asset price bubbles (idem: 32). In general, macroprudential regulation seems to smooth pro-cyclicality in the financial sector, which results in lower volatility, as well as strengthen the financial system as a whole, which reduces systemic risk (ibid.).

In Liberia, more regulation in the financial sector has been an important feature of the efforts to rebuild the financial sector. The Financial Sector Development

Implementation Plan (Central Bank of Liberia 2016: iii), which was launched in 2016 but has been in place in other forms since the beginning of the peacebuilding

mission, has put several recommendations forward in order to advance

macroprudential regulation. These include creating legislation in key areas such as insolvency as well as updating legislation on financial institutions and the Central Bank, setting up surveillance of the sector in order to reduce risk and prevent crises, regulation for the insurance sector and improve further regulations that are not in line with international practices (ibid.).

-3 -2 -1 0 1 2 3 4 5 6 7 20 04 20 05 20 06 20 07 20 08 20 09 20 10 20 11 20 12 20 13 20 14 20 15 Liberia GDP per capita growth (annual %)

West Africa GDP per capita growth (annual %)

lower incentives for the public to remove their money from banks in economic downturns (ibid.; Boyle et al. 2015). These withdrawals, or bank-runs, can result in banks going into default, which can pose the risk of systemic failure, especially in interconnected banking networks. Deposit insurance gives citizens the guarantee that they will receive their deposits, usually up to a certain amount, which thus reduces economic growth volatility through decrease in systemic risk.

The economic growth volatility, measured as volatility in GDP growth per capita in percentages, in Liberia and the rest of West Africa in the period 2004-2015 is visualized in Figure 6.

Figure 6. Economic Growth in Liberia and West Africa 2004-2015

As can be seen in Figure 6, economic growth in Liberia has been higher than in the rest of West Africa up until the outbreak of the Ebola crisis and the decline in prices of key export produces in late 2013 and early 2014. The economic growth does show larger volatility than in the rest of West Africa, as can be seen during the financial crisis, where economic growth reduced by more than 4 percentage points between 2007 and 2009, whilst economic growth in the rest of the region reduced by 2.4 percentage points. The volatility is also reflected in the difference in standard deviation. For Liberia this is 2.75, whilst the standard deviation in the rest of West Africa is 1.13.

volatile growth of GDP per capita in general, and compared to the rest of West Africa. Thus, this development has not contributed to a more stable economy in Liberia. The analysis shows that the various projects instated in order to develop the financial sector in Liberia, including a more independent central bank, increased access to finance and more regulation of the financial sector, have thus not resulted in a more stable economy, as measured by inflation, volatility in current account deficit and volatility in economic growth. This is mostly caused by the inability of the financial sector to lessen the shocks to the economy resulting from the financial crisis, a decrease in prices of key exports and the Ebola crisis. Rather, the projects have mostly focused on creating economic growth, which has been successful after the financial crisis up until 2013, when prices of iron ore and rubber decreased and the Ebola crisis wreaked havoc upon the economy, resulting in a more volatile economy.

Thus, the developments in the financial sector have not, or only slightly in the case of an increase in independence for the central bank, contributed to a more stable economy in Liberia.

In addition to the movements of inflation, current account balance and economic growth, it is also worth taking a look at various other indicators which reflect the economic situation for the broader population. These indicators are: poverty rates, youth unemployment rates and income inequality. The levels and/or volatility in these indicators reflect not only development, but also possible sources of armed conflict. For example, Azeng and Yogo (2013) find that youth unemployment and income inequality have significant effects on political instability. Higher rates of youth unemployment and higher levels of income inequality increase chances of internal conflict (ibid.). Furthermore, there is also a link between poverty and political instability. According to Rice (2007), poverty can increase chances of conflict.

Unfortunately, the is little to no (recent) data on poverty and income inequality in Liberia and the rest of West Africa. There is however data on youth unemployment, which, as mentioned above, has a significant effect on potential conflict. The variable of youth unemployment measures total youth unemployment as the percentage of the labour force between the ages of 15 and 24 which is unemployed. This data is sourced from an estimate by the International Labour Organization (Rafei 2014). This is done since there is virtually no recent data on youth unemployment from

unemployment may differ from actual unemployment. Data on youth unemployment in Liberia and West Africa is visualized in Figure 7.

Figure 7. Youth Unemployment in Liberia and West Africa 2004-2015

As can be seen from Figure 7, youth unemployment rates in Liberia have been lower than in the rest of West Africa in the period 2004-2015. The rates declined in the period of the financial crisis and have been steady at a rate of around 3.2% of the population. The standard deviation of youth unemployment rates in Liberia is 0.69 whilst it is 0.30 in West Africa. The volatility of youth unemployment is thus lower for West Africa, although the levels of youth unemployment are higher.

Similar trends can also be observed in the rates of unemployment for all of the labour force. Like the data on youth unemployment, this variable measures

unemployment as a percentage of the population and is sourced from estimates by the International Labour Organization and thus may not be entirely accurate. The unemployment rates in Liberia and West Africa are visualized in Figure 8.

0 1 2 3 4 5 6 7 8 9 10 20 04 20 05 20 06 20 07 20 08 20 09 20 10 20 11 20 12 20 13 20 14 20 15 Liberia, youth unemployment (% of population)

West Africa, youth unemployment (% of population)

Figure 8. Unemployment in Liberia and West Africa 2004-2015

As can be seen from Figure 8, the unemployment rates in Liberia have decreased in the period following the global financial crisis and have been steady since. This could be a result of the increase in economic growth in this period. However, since these are estimates, the effects of the Ebola crisis and the decrease in prices of key exports may not be reflected in these figures. However, a steady and relatively low rate of (youth) unemployment could increase the political stability in Liberia and ensure sustainable peace.

As mentioned above, the data on income inequality (i.e. the GINI index) and poverty rates are sparse. The last data on these indicators are from 2014.

In 2014, Liberia scored 33.2 on the GINI index on a scale from 0 to 100 with 0 representing perfect equality and 100 perfect inequality. In comparison, Burkina Faso, Mauritania and Niger scored 35.3, 32.6 and 34.3 respectively. There is no data on other countries during this time. Liberia thus has, on average, lower income

inequality than these other three countries. Similarly, incomes have also become more equal since 2007, when Liberia scored 36.5 on the GINI index. This might be a region-wide phenomenon however, since the GINI-coefficient for Niger has also decreased from 37.3 in 2007. For the other two countries, data in 2007 is not available.

In 2014, the percentage of the population living below the national poverty line at 2 dollars per day in Liberia was 54.1 percent. This is quite high compared to other

0 1 2 3 4 5 6 7 20 04 20 05 20 06 20 07 20 08 20 09 20 10 20 11 20 12 20 13 20 14 20 15 Liberia, unemployment (% of population) West Africa, unemployment (% of population)

countries in the same year in West Africa. Percentages of the population living below the national poverty line in Burkina Faso, Mauritania and Niger were 40.1, 31 and 44.5 percent respectively. Poverty rates have reduced in the period 2007-2014 however. For example the poverty rate in Liberia in 2007 was 63.8 percent, 46.7 percent in Burkina Faso in 2009, 42 percent in Mauritania in 2008 and 48.9 percent in Niger in 2011. The reduction in poverty rates might thus be a region-wide

phenomenon. The poverty rates are rather high though compared to the remainder of the region which could increase political instability.

The reduction in the GINI-coefficient and poverty rates in Liberia might thus

contribute to increased political stability. Similarly, the rates of (youth) unemployment have also decreased in the period of 2004 to 2015 which contributes to political stability.

It however remains to be seen how the Ebola crisis and the decrease in prices in key exports will have an effect on poverty rates and the GINI-coefficient in Liberia. The admittedly sparse data on (youth) unemployment and income inequality does not seem to reflect the economic instability in the country as of this moment. However, the economic instability could possible fuel political instability should the inequality and (youth) unemployment rates suddenly experience a shock as a result of this economic instability. Furthermore, the high poverty rates could also increase political instability in Liberia.

Thus, creating a stable economy in Liberia remains a priority in order to ensure that rates of poverty, income inequality and (youth) unemployment do not result in political instability which could lead to a resurgence in conflict and violence.

Conclusion

In this thesis, the relationship between development of institutions in the financial sector in Liberia and the stability of the economy has been analyzed. The analysis shows that, although several developments are instated in the country, the economy has not been stabilized over the period 2004-2015. Although the inflation is below the benchmark of 10%, the rates are still volatile. Similarly, there is also a large volatility in the current account balances and the economic growth. Furthermore, the volatility in these variables is also larger than the volatility in other countries in West Africa.

The results from this analysis show that the economy has been volatile and has been destabilized as a result of both the global financial crisis and two prominent shocks to the economy, the decline in prices of key exports and the Ebola crisis, which started in 2013-2014. The fact that the economy has destabilized in such a manner shows that the financial sector in the country has not been able to provide measures to lessen the effects of the shocks and create stability.

The destabilization of the economy even after the development of the financial sector could have been a result of developments mostly focusing on generating economic growth rather than creating economic stability. As a result, several of these developments, which in theory should result in more stability, have not been able to ensure economic stability as the economy has not been able to react to unforeseen circumstances such as the decline in prices of exports and the Ebola crisis.

Furthermore, the rates of income inequality, (youth) unemployment and

poverty, although decreased, remain high and could possibly be vulnerable to shocks as a result of the instability of the economy. This could lead to political instability and a resurgence in conflict and violence.

The research question for this essay was: did the rebuilding of financial institutions in Liberia contribute to economic stability? The answer to this question is thus no, the rebuilding of financial institutions through increasing independence of the central bank, increasing access to finance and strengthening regulation of the financial sector has only partly contributed to the stability of the economy in the case of inflation levels, and has not contributed to stability in the case of inflation, economic growth and current account balance volatility.

This research shows that the current approach of international financial organizations and the UN to economic recovery after war do not result in economic stability. Since this could result in political instability, it is necessary for these organization to re-evaluate the rebuilding of financial institutions to reflect a goal of economic stability rather than the highest possible economic growth. This could prove to be a valuable source in creating sustainable peace in Liberia.

Further research is necessary into the exact developments of the financial sector in Liberia. This can be done through process tracing of the various development. Process tracing allows the researcher to uncover various causal mechanisms in

detail in order to determine the relationship between certain variables.

Similarly, research like this thesis can be done for other countries which have experienced peacebuilding missions which contained an element of financial sector development. Should a similar conclusions be made then it is necessary for the IMF and the World Bank, as well as other international financial institutions, to rethink their strategies for the rebuilding of financial institutions.

Furthermore, the relationship between financial development and sustainable peace needs to be researched in order to fully grasp determinants of sustainable peace. For example, research like done in this thesis can be done for countries in which the peacebuilding mission has come to an end longer ago, in order to see the effects of financial development on peace. This is not yet possible for Liberia since the mission has only come to an end a few months ago at time of writing. This

research has developed a small portion of this relationship by researching the effects of financial development on economic stability. Further research which analyzes the relationship between economic stability and sustainable peace in countries which have experienced a peacebuilding mission can thus be a next step.

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