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Department of Economics- FEA/USP Crime and Economic Growth: A Case Study of Manaus, Brazil Pedro Drugowick Paula Pereda WORKING PAPER SERIES Nº 2019-19 DEPARTMENT OF ECONOMICS, FEA-USP WORKING PAPER Nº 2019-19 Crime and Economic Growth: A Case Study of Manaus, Brazil Pedro Drugowick ([email protected]) Paula Pereda ([email protected]) Abstract: Due to economic and social advances since the 1990s, Brazil became the 7th largest economy in the world in 2012. However, crime rates have not stopped rising since the beginning of the last decade, with Brazil having the 11th largest homicide rate on the planet in that year (UN). In this paper we estimate how much crime harms economic activity from a case study of the city of Manaus, where in 2007 the organized crime group known as “Família do Norte” was created. We analyzed the effects on Manaus’ GDP per capita using the synthetic control method. The comparison between Manaus and its synthetic control in the period after the creation of the criminal group showed that the presence of the criminal faction diminished the city’s GDP by 3% per year. Robustness checks confirmed this result, showing how organized crime can disrupt the country’s economic advances. Keywords: Crime and economic activity; Organized crime; Synthetic control method. JEL Codes: K32; O47; Z18. Crime and Economic Growth: A Case Study of Manaus, Brazil ABSTRACT Due to economic and social advances since the 1990s, Brazil became the 7th largest economy in the world in 2012. However, crime rates have not stopped rising since the beginning of the last decade, with Brazil having the 11th largest homicide rate on the planet in that year1. In this paper we estimate how much crime harms economic activity from a case study of the city of Manaus, where in 2007 the organized crime group known as "Família do Norte" was created. We analyzed the effects on Manaus’ GDP per capita using the synthetic control method. The comparison between Manaus and its synthetic control in the period after the creation of the criminal group showed that the presence of the criminal faction diminished the city’s GDP by 3% per year. Robustness checks confirmed this result, showing how organized crime can disrupt the country's economic advances. 1. INTRODUCTION “Any government is better than the absence of government. Despotism, however bad, is preferable to the greater evil of anarchy, widespread civil violence, and the permanent fear of violent death.” Almost four hundred years after this remark by Hobbes (1968), the problems of despotism has been resolved, but the absence of government still remain, although in the latter case the problem is less one of anarchy and more one of weakened institutions that fail to secure the right to property of citizens - who are at the mercy of civil violence. In the last five years, Syria - despite its current war-torn status - recorded fewer murders than Brazil2 (280,000 Brazilian deaths vs. 256,000 war deaths)3. The United Nations has estimated that in 2012 Brazil was responsible for 13% of all the murders in the world, putting the country in first place in absolute number of violent deaths. Not by chance, in this same study Brazil was in 11th place as the most violent country, having 11 of the 30 most dangerous cities in the world (Remigio, 2014). As a consequence, three out of four Brazilians are afraid of being murdered (Madeiro, 2016), and this figure is even higher for women (83%). Concerning the right to private property in Brazil, robbery and theft statistics show similar trajectories to those for homicides: in 2010, around 12 million people were victims 1 United Nations 2 Brazilian Yearbook of Public Security (n.d.) 3 Although the damages (psychological, human and economic) caused by the fighting in Syria to the survivors are immeasurable, Brazilian numbers of murders are still impressive. of robbery or theft (7.3% of the Brazilian population)4. When first measured in 1988, this statistic was 3.9% of the population. According to the Organization for Economic Cooperation and Development (OECD), the rate of assaults5 in Brazil in 2012 was 7.9%, twice the world average. Another statistic that draws attention is cargo thefts in the country, which directly affects the private sector. The number of these thefts in Brazil jumped from 12,000 in 2002 to 17,500 in 2014 (NTC & Logistics, 2017). Brazil also occupies the sixth position in the ranking of places with greatest risk to freight transportation, tied with Iraq and Somalia (Bretas, 2016), and second place in the world ranking of shoplifting (Fellet, 2010). Paradoxically, in recent years, and especially in the last decade, Brazil underwent a major transformation6. Backed by the commodity boom of the 2000s, economic growth was among the best in the world (Brainard & Martinez-Diaz, 2009). During this period, several socioeconomic indicators also improved – unemployment dropped, the minimum wage rose in real terms, and the creation of social programs such as the conditional income-transfer program Bolsa Família reduced socioeconomic inequality as measured by the Gini Index. Latin America in general experienced considerable economic growth during the period, but this was accompanied by an increase in crime indicators (Alvarado, 2015). Among the potential explanations for this conundrum are the poor quality of institutions and the presence of organized crime related to drug trafficking. The latter explanation certainly fits Brazil, where violence has increased in the last few years, particularly in the North and Northeast regions7 of the country, where the homicide rate has doubled since the beginning of the last decade, vis-à-vis stagnation in the rest of the country8. These two regions are also the weakest economically in the country9, and both have witnessed a spread of organized crime in the past decade. The first organized crime factions created in Brazil came from the Southeast region. More precisely, the first major criminal faction was created in Rio de Janeiro in 4 National Household Survey (PNAD). 5 "Assault" means physical attack on another person's body, resulting in serious bodily injury, excluding sexual assault. 6 All data presented in the above paragraphs predate the recent economic crisis of 2015-2017. Also, the true numbers are certainly higher due to underreporting (although this is also true of other countries and is difficult to estimate). 7 Brazil is divided officially into five regions: North, Northeast, Midwest, Southeast and South. 8 Atlas of Violence - Ipea (s.d) 9 Some articles show a high correlation between institutions and economic development (Acemoglu et al., 2001) the 1970s, called Comando Vermelho (Red Command – CV) (Martín, 2017). Some years later, in the 1990s, the other large Brazilian criminal group was created in the state of São Paulo: Primeiro Comando da Capital (First Command of the Capital – PCC). At first, these two factions were rivals and focused their actions in their respective states, but throughout the 2000s, organized crime gradually migrated from the Southeast to the Northeast (Zaverucha and Junior, 2010). In a context of the spread of organized crime groups to the North and Northeast, we see the emergence of a new criminal organization in 2007, called Família do Norte (Northern Family - FDN). Since then, the homicide rate per thousand inhabitants of the city of Manaus (capital of Amazonas state), for example, rose by 55% in less than 10 years (from 35.6 in 2006 to 54.9 in 2015). As a result, Manaus was ranked 23rd on the list of the world's most violent cities in 2016 (Barbosa, 2017). Data from 2014 on Brazilian states points to a negative relationship between crime and economic growth, as shown in Figure 1. Figure 1: Homicide rate vs. GDP per capita (2014) Source: IPEA In this paper we intend to explore the causality between these two variables, i.e., does violence, identified by the level of criminal activity in a place, influence economic activity? We discuss some channels by which we believe there is such an effect. In terms of identifying this effect, the literature already indicates that regions with high crime rates tend to have worse economic development, and that economic decay leads to an increasing rate of violence, thus the direction of causality is not obvious. Therefore, the strategy to identify the effect of crime on economic growth used here is examine the sudden creation of a new criminal group in the city of Manaus using the synthetic control method to evaluate its effect on economic activity. 2. CRIME AND ECONOMIC ACTIVITY The potential output of an economy comes from its production function and criminal activity negatively affects the main production factors in this function. First, there is a disincentive for companies to invest in regions where legal security and physical safety are poor. Danielli and Marani (2008) show a negative relationship between foreign direct investment in Italy and organized crime. According to the authors, more unsafe places are unlikely to have good teaching centers or to attract skilled labor, hampering the accumulation of human capital. For the number of effective workers, there also appears to be a reflection of the homicide rate on the labor force (economically active population). By comparison, in 2014 in Brazil, more than 30 thousand young people (between 15 and 29 years old) were murdered. That means a potential workforce that could have contributed to Brazilian GDP growth over the next 20-30 years ended up being wasted – and this is only for 2014. In addition, total factor productivity is typically undermined by increasing violence. Pinotti (2012) showed that the entry of the Italian mafia in the regions of Apulia and Basilicata contributed to the drop in labor productivity in those regions.