2018

PANEL DATA ECONOMETRICS:

INSTITUTIONAL QUALITY, ECONOMIC
ACTIVITY AND RECESSIONS

BRUNO RODRIGUES CANDEA

Database and Stata Files published at 23, February 2018. Available

at: http://dx.doi.org/10.17632/yxpn6pgy2r.1

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Summary

1. Introduction ............................................................................................................................................................................................... 2
2. Literature Review ..................................................................................................................................................................................... 2
3. Metodology ............................................................................................................................................................................................... 3
3.1 Data ....................................................................................................................................................................................................... 3
Recession Dummy .............................................................................................................................................................................. 3
Control of Corruption ....................................................................................................................................................................... 3
Voice and Accountability ................................................................................................................................................................. 3
Rule of Law ............................................................................................................................................................................................ 3
Vulnerable Jobs in % of Workforce ............................................................................................................................................. 3
Gross Capital Formation in % of GDP ......................................................................................................................................... 3
Foreign Direct Investments Inflows in % of GDP ................................................................................................................... 4
3.2 Models.................................................................................................................................................................................................. 4
Unbalanced Panel Data .................................................................................................................................................................... 4
Logistic Regression ............................................................................................................................................................................ 4
Instrumental Variables – Two Stage Least Squares............................................................................................................... 5
4. Results ......................................................................................................................................................................................................... 5
5. Conclusions ............................................................................................................................................................................................... 7
6. Bibliography .............................................................................................................................................................................................. 7
6.1 Data ....................................................................................................................................................................................................... 7
6.2 Papers ................................................................................................................................................................................................... 7

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1. INTRODUCTION incorporating the general equilibrium effects, i.e., the
analysis of all price and quantity interactions, in addition
to other macro considerations, and the fiscal, monetary
and security policies that raises on the disaster context
Economic Resilience, basically, can be understood as (ROSE, 2015).
the capacity of an economy to recover from shocks, also
focusing on efficiency, constancy, absorption and other The Dynamic Economic Resilience is defined as the
systemic characteristics of adapting to new conditions and efficient use of resources, for repair and reconstruction.
recovering from shocks, but from an economic point of This time-related aspect of the economic resilience focus
view. In this sense, can be defined as “the capacity of an on enhancing the capacity of an economy, dealing with
economy to reduce vulnerabilities, to resist to shocks and hastening the speed of recovery from the shocks or
to recover quickly” (CALDERA-SÁNCHEZ et al., 2016) and, disturbances (ROSE and KRAUSMANN, 2013).
moreover, as “the policy-induced ability of an economy to
withstand or recover from the effects of such shocks”
(BRIGUGLIO et al., 2009).
2. LITERATURE REVIEW
In this sense, to shed some light to the discussion, we
introduce the terminology of Economic Vulnerability,
defined as “the exposure of an economy to exogenous Although major crisis of global level are rare,
shocks, arising out of economic openness” (BRIGUGLIO et severe recessions have been frequently observed over the
al., 2009). Sewing the thoughts of the aforementioned last decades, being intensified by the deregulation of
researchers, Economic Resilience, then, can be financial system in USA (BENTLEY, 2015). Studies shows
summarized as the capacity of an economy to reduce the that another movement, the liberalization of the Credit
exposure of these same economies to exogenous shocks, Markets at least captures some of the unobserved risk in
arising out of economic openness, or other economic or the literature that treats the role of Market Opening over
social infrastructural characteristics, in order to improve the risk increase that leads to some of these recessions
the capabilities of this system to recover from the effects (GIANNONE, LENZA and REICHLIN, 2010), evidencing the
of exogenous shocks. importance of the development and observation of
The economic variables are generally categorized in measures that can be taken to minimize the negative
three levels: microeconomic, the role of Economic Sciences impacts of these risks, that can be a relevant variable to
that deals with individual businesses, companies, firms or shocks (OECD, 2016). The table 1 below shows some
households; mesoeconomic, the role that studies examples of economic crisis registered in the post-1970
individual industries, markets; and macroeconomic, a period, just to illustrate how recurrent economic shocks
combination of economic entities (ROSE and and recession has been in the global economic history.
KRAUSMANN, 2013). Furthermore, the economic
resilience can be firstly defined in two fields: Static
Economic Resilience, and Dynamic Economic Resilience. Table 1 – Post-1970 Economic Recessions
The Static Economic Resilience is defined as the
capability of a system to maintain a certain level of Economic Crisis Starting Main Cause /
functioning after a shock (ROSE and KRAUSMANN, op. Year Nature
cit.). In disaster conditions, commonly observed after these
East Asia 1997 Exchange
shocks, the agents generally face resource scarcity, and
this field of study deals with the efficient use of these Mexico 1994 Exchange
scarce resources at a given point of time (ROSE, 2015). This
field, nonetheless, can be distinct in two operational European Exchange Rate 1992 Exchange
Mechanism
metrics, the Direct Static Economic Resilience – DSER, and
the Total Static Economic Resilience – TSER. The first one, Japanese Asset 1986 Banking
Direct Static Economic Resilience – DSER, refers to the
Argentine Great Depression 1989 Debt
partial equilibrium analysis, i.e., the equilibrium analysis
that consider only a part of a market, ceteris paribus, based Black Monday 1987 Stock Market
on a restricted range of data, in order to study an Crash
individual firm or industry (micro and mesoeconomic
Israeli Stock Crisis 1983 Asset Bubble
levels), whilst Total Static Economic Resilience – TSER,
refers to the macroeconomic level of the economy,

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 Latin American Sovereign Debt
1982 Debt
1970s Energy Crisis 1973 / Increase of Oil
1979 Prices
Source of Historical Data: (BABECKY, 2012). Elaborated by the author.
If we consider only the United States financial system
as another object for illustration of the relevance of
recessions for the economy, crisis as the 1857, 1893, 1907
and 1929-1933, with all of that presenting many
similarities with the 2007-2008 events (BORDO, 2008).
These are some examples that highlights the seriousness
of economic crisis and recessions, not only for the country
itself but for the entire world (RAMSKOGLER, 2015). In the
case of the global economic crisis that began in 2007 and
spread its effects over the 2008-2009 economic turmoil,
the negative effects were massive in many aspects.
Contrary than the common perceptions of part of the
literature on the financial crisis, the emerging economies
suffered negative impacts as much as the advanced
economies (DIDIER, HEVIA and SCHMUKLER, 2012).
In fact, there are estimates that more than 20 million
jobs disappeared because the global financial crisis,
accordingly the statistics from the International Labour
Organization. The unemployment raised from 5.5% of the
labour force in 2007 to 5.7% in 2008 and 6.2% in 2009. The
unemployment in high-income countries raised from 5.6%
in 2007 to 5.9% in 2008, 8% in 2009 and 8.3% in 2010, while
in the low-income countries, the unemployment rate
remained near the 5.6% level (ILOSTAT, 2017).
Figure 5 – GDP Growth – 1970 to 2015
Elaborated by author based on data from World Bank (updated Oct 2017)
The figure 5 above shows the World Gross Domestic
Product, measured in % annual growth rate. The data,
gathered from the World Bank World Development
Indicators (WDI) database, demonstrates how the growth
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rate has fallen after 2007, recovering its 2007 growth level
in 2010 but then falling again and remaining stable.
3. METODOLOGY
3.1 Data
Recession Dummy
Gross Domestic Product is the broadest measure of
economic activity (BEA, 2008), and generally the most used
to define recessional periods. Because of this, we
constructed a dummy variable that assumes value one (1)
if the year registered consecutive quarterly periods of
negative GDP growth and zero if not.
This allows us to have a register of recessional points
for our sample, that covers data from 2000 to 2016 for 175
countries. After the parameterization of the dummy, we
recorded about 250 recessional points, in a sample of
more than 3,000 data points.
Control of Corruption
A standardized indicator, collected at the World
Governance Indicators database from World Bank, that
captures the perception of how much the political body of
a country is “captured” by private interests.
Voice and Accountability
A standardized indicator that captures the extent to
which a citizen can participate in the process of choosing
the government, as well as her freedom of expression,
freedom of association and freedom of media.
Rule of Law
Another standardized indicator from the World Bank
Governance database, that addresses the use of military
force to enforce the rule of law, the power and freedom of
the judiciary bodies, alongside other characteristics that
defines the law enforcement capacity of a country.
Vulnerable Jobs in % of Workforce
An annual percentage of the employed population that
is considered having vulnerable jobs, accordingly a
methodology of the International Labour Organization.
Gross Capital Formation in % of GDP
Our dataset provides a large amount of data (55
variables, of many types – from institutional quality to
economic indicators), and we pre-tested all of them to
identify what would be relevant for the definition of
recessional periods, as well as the GDP growth.
Surprisingly, one of the variables that had a strong
significance in both our models was the gross capital
formation, in % of GDP. The relationship of this indicator
with economic activity is, however, clear, as that the
macroeconomic theory already considers this as a relevant
factor.
Foreign Direct Investments Inflows in % of GDP
The amount of foreign investments received by the
country, measured in % of GDP, collected from the World
Development Indicators database at World Bank.
3.2 Models
Unbalanced Panel Data
Following the definition found in the recent work of
Hauser (2017), in structures of panel data, we generally
assume that:
Xit , i = 1, . . . , N, t = 1, . . . , T
Where T is usually a small amount of data. We also have
differences between balanced panels (where all data is
observed for all individual), and unbalanced ones (where
some data is not observed due to missing values).
The standard static model with i = 1,…, N, t = 1,..., T is:
Yit = β0 + X’itβ + uit where:
Xit is a K-dimensional vector of explanatory variables,
without a constant term;
β0, the intercept, is independent of i and t
β, a (K × 1) vector, the slopes, is independent of i and t;
uit is the error term, that varies over i and t. Individual
characteristics (which do not vary over time), zi , may be
included:
Yit = β0 + X’it β1 + Z’i β2 + uit
Assuming iid errors and applying OLS we get consistent
estimates, if E(uit) = 0 and E(Xituit) = 0, if the Xit are
weakly exogenous.
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This is the model we used to model the GDP growth, by
an ordinary regression constructed over the observed data
for five variables.
The final model, defined after a proofmarked battery of
tests, is the one that uses:
- Ln(GDP): Annual GDP growth, as the dependent variable;
And as the independent variables:
- VCA: Voice and Accountability;
- LAW: Rule of Law;
- SIZ: Size Of Government;
- Ln(GCF): Gross Capital Formation;
- Ln(FDII): Foreign Direct Investments Inflows
Logistic Regression
Accordingly Bartolucci (2009), the logistic regression
model, also known as Logit, is used when we want to
model binary variables [0,1]. The logit approaches the
probability of a binary outcome to happens through a link
function defined as:
This link function is followed by its inverse function:
What draws some basic assumptions that
independence between the response variables given the
covariates (static models); and the heterogeneity between
subjects is only explained on the basis of observable
covariates and then unobserved heterogeneity is ruled out
(homogeneous models).
This model was chosen for modeling the second
variable of interest, the recession dummy we created. The
model we finally defined as the best fitted uses:
- REC: Recession dummy, as the dependent variable;
And as the independent:
- CPT: Control of Corruption;
- VCA: Voice and Accountability;
- ln(VUL): Vulnerable Jobs;
- ln(GCF): Gross Capital Formation.
Instrumental Variables – Two Stage Least Squares
Following Wooldridge (2013) definition, since the use
of IV will necessarily inflate the variances of the estimators,
and weaken our ability to make inferences from our
estimates, we might be concerned about the need to apply
IV (or 2SLS) in a particular equation. One form of a test for
endogeneity can be readily performed in this context.
By the equation below:
difference between both indicates that H0 is unlikely to
hold. H0 is the Random Effects model yit = β0 + x 0 itβ +
αi + uit
HA is the Fixed Effects model yit = αi + x 0 itβ + uit I βˆ
RE is consistent (and efficient), under H0, not under HA,
and βˆ FE is consistent, under H0 and HA. We consider the
difference of both estimators. If this difference is large, we
reject the null hypothesis:

Y1 = β0 + β1Y2 + β2z1 + β3z2 + u1

Since is efficient under H0, it holds:
where Y2 is the single endogenous explanatory variable,
and the z’s are included exogenous variables, we have a
situation where this equation can be overidentified for the
IV. In this case, we use at least one instrument (and in the
The Hausman statistic under H0 is:
case of the equation above we have two, z1 ad z2), that
can be used to estimate this in two stages. The first one
uses the reduced form:

Y2 = π0 + π1z1 + π2z2 + π3z3 + π4z4 + v

If is not positive definite in a finite
To calculate the OLS residuals of the regression. This sample, testing is performed only for a subset of β.
residuals are then used to estimate the true value of the
OLS residuals, which are, in their turn, incorporated in the The results for the Hausmann test performed over the
second stage: 2SLS regression model presents evidences of the null
hypothesis, of exogeneity:
Y1 = β0 + β1y2 + β2z1 + β3z2 + δˆv + ω
What can solve the problem of overidentification,
allowing us to apply a more simple approach through OLS.
The two instruments we used in this model were:
- ln(BDM): Broad Money in % of GDP; Additional tests shows that the instrument is strong:
- ln(TRA): Trade in % of GDP

4. RESULTS

Endogeneity is one common problem of econometrics.

Basically, it happens because of an interaction between the
independent variable and the error term, what cancels one
the most basic identities of econometrics:

X′ϵ=0
The Hausman test, therefore, verifies if the H0 that xit
and αi are uncorrelated. We compare two estimators: one,
that is consistent under both hypotheses, and one that is
consistent (and efficient) only under the null. A significant

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 Otherwise, the two-instruments model for the
previously tested variable FDII presents some problems.
One can notice that the signals of VCA and LAW
coefficients may not carry practical sense. As well, the
significance of the instrumental variable in the best model
we verified is not statistically relevant (only at a 10%
confidence interval). Other problem is that the tests has
shown that there is some kind of overidentification in the
model:
At the end of the analysis, we noticed that the most
accurate model is the one that worked with OLS estimation
applied for unbalanced panel data:
Here, we also have negative coefficients for Voice and
Accountability, and Rule of Law. We did not found
theoretical fundaments for this results, but all coefficients
were statistically significant. Perhaps the amount of
investments to enhance and/or construct the institutional
quality can cause negative impacts over the GDP growth,
but this a theme for a future study itself.
We therefore built a third model, using a logistic
regression, what is presented below:
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The logit model that presented the best results was the
one described above, and we notice that the control of
corruption, control of the job vulnerability and gross
capital formation can reduce the probability of a recession
to happen. Otherwise, Voice and Accountability also had a
unexpected behavior in the model, as in the case of the
2SLS and the OLS regression models.
The recessional phenomena was correctly classified in
almost 90% of the cases, as shown below:
The marginal effects carries some interesting
information: one point in the Control of Corruption index
can reduce the probability of a recession in about 4%, very
likely the job vulnerability. The greatest marginal results
was at the gross capital formation, almost 26% of impact
in reducing the probability of a recessional period.

5. CONCLUSIONS
Recessional periods are very complex to address, and
remains as an important discussion in economics. We
verified the difficulties of study this question, because the
lack of data for many variables, the paradoxical findings of
most part of the literature found in recessions and even
the difficulties of defining what a recession in fact is.
We found positive relationships between the
investments in gross capital formation and gross domestic
product, what was expected, and because this
expectations we ran tests about endogeneity,
autocorrelation and other pre-modeling tests.
The results has shown us the better specification in the
case of the OLS estimation, because some structural
problems of the 2 Stage Least Squares estimation. The
problems found in 2SLS can probably come from the fact
we used an unbalanced panel data.
The third model, ran by a logistic regression (logit), had
good results in determining a few interesting variables that
were not explored by the current literature until now.
Actually, none of the works we found explores the
indicators and variables we used in this modelling.
Nonetheless, this paper raises some research questions
about recessions that we want to explore in future works.
Most detailed tests and the use of dynamic panel data can
also be useful tools for this future research, as well as the
collection of more data, non-standardized data for some
variables, or other definitions for recession periods.
6. BIBLIOGRAPHY
6.1 Data
[1] THE MADDISON-PROJECT, 2013 version. Accessed in
23, December 2017. Available at:
http://www.ggdc.net/maddison/maddison-
project/home.htm
[2] WORLD GOVERNACE INDICATORS, 2017 version.
Accessed in 03, January 2018. Available at:
https://datacatalog.worldbank.org/dataset/worldwide-
governance-indicators
[3] WORLD DEVELOPMENT INDICATORS, 2017 version.
Accessed in 01, February 2018. Available at:
https://datacatalog.worldbank.org/dataset/worldwide-
governance-indicators
[4] WORLD BANK JOBS, 2017 version. Accessed in 01,
February 2018. Available at:
http://databank.worldbank.org/data/reports.aspx?source
=Jobs
6.2 Papers
[5] ROSE, A. Measuring Economic Resilience: Recent
Advances and Future Priorities. Center for Risk and
Economic Analysis of Terrorism Events (CREATE).
University of Southern California, Sep. 2015.
[6] HOLLING, C. Engineering Resilience versus Ecological
Resilience. In: SCHULZE, P. (Org.). Engineering within
Ecological Constraints. The National Academy of
Sciences, 1996. p.33-34.
[7] CALDERA-SÁNCHEZ, A.; SERRES, A.; GORI, F.;
HERMANSEN M.; ROHN, O. Strenghtening Economic
Resilience: Insights from the Post-1970 Record of Severe
Recessions and Financial Crises. OECD Publishing, 2016.
[8] BRIGUGLIO, L.; CORDINA, G.; FARRUGIA, N.; VELLA, S.
Economic Vulnerability and Resilience: Concepts and
Measurements. Oxford Development Studies, Vol. 37,
No. 3, Sep. 2009.
[9] ROSE, A.; KRAUSMANN, E. An Economic Framework
for the Development of a Resilience Index for Business
Recovery. International Journal of Disaster Risk
Reduction, Vol. 5, 2013. p. 73-83.