Download Doing growth diagnostics in practice

Growth diagnostics
Elena Ianchovichina
PRMED, World Bank
Joint Vienna Institute
June, 2009
Analytics of reform
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Welfare may decline if reforms tackling some distortions
are implemented as long as other distortions remain
In formal terms,
du / d i   i    j  (  sj   jp ) /  i
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j
u is welfare; τi is a distortion in activity i
Distortions drive a wedge between social and private valuation of
activities
 is represents
the net marginal valuations of activity i by society
p
s, and  i by private agents
λi is the Lagrange multiplier corresponding to the constraint
associated with the distortion in activity i and is the direct effect
of removing the distortion
the distortion associated with the biggest multiplier effect is the
binding constraint
The direct effect is always welfare improving, but the indirect
effect may not be, implying that welfare may decline if the
indirect effect is negative and larger than the direct effect
Reform strategies
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The idea about the most binding constraint
Targeting all distortions at once raises welfare but
may be infeasible due to:
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financial and capacity constraints, especially in LICs
limited political capital to engage in wholesale reform
Targeting the biggest distortion or a number of large
distortions may not lead to welfare improvement due
to large second best effects
Targeting the most binding constraint
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Increases the chances of an overall positive impact
The most binding constraint is associated with the biggest
multiplier
The second best effects are hard to estimate with accuracy
Heuristic approach to identifying the most
binding constraint to growth
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The multipliers are typically hard to estimate
HRV use the “Keynes-Ramsey rule”
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It captures the most important factors affecting economic
growth in the short run
HRV construct a framework that guides the growth
analysis at the aggregate level
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Helps identify a bundle of major constraints
In practice, it is very difficult to identify the most binding
constraint to growth with the heuristic approach
Growth diagnostics
Problem: Low levels of private investment and entrepreneurship
High cost of finance
Low return to economic activity
Low appropriability
Low social returns
government
failures
poor
geography
low
human
capital
bad international
finance
market
failures
information
externalities:
“self discovery”
bad infra
structure
- micro risks:
macro risks:
property rights,
financial,
corruption,
monetary, fiscal
taxes
instability
bad local finance
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coordination
externalities
low
domestic
saving
poor
inter
mediation
-
Source: HRV (2005)
Growth diagnostic questions
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Is private investment low in a country? If yes:
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Is it because of high cost of capital?
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In this case the economy is considered liquidityconstrained
Is it because of low returns to capital?
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In this case the economy is considered inefficient
Why is the cost of capital high or
access to capital poor?
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Limited access to external capital markets due
to:
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Country risk
Unattractive FDI conditions
Vulnerabilities in the debt maturity structure
Excessive regulations of the capital account
Bad local finance
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Low domestic savings
Poor domestic financial intermediation
Why are returns to capital low?
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Low social returns due to:
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Geography
Insufficient investment in complementary factors
Poor natural resource management
Low private returns to capital due to:
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Government failures affecting negatively private
appropriability
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Macro-instability, high taxes, property rights issues, corruption,
labor-capital conflicts
Market failures affecting negatively the ability to adopt
new technologies
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Coordination externalities
Information externalities
Coordination failures
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Coordination failures are defined as the failure of the market
to respond to potential investors’ demands for a diverse set of
services:
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That allow firms to innovate, market their products successfully, and
make a profit
These services require public investments in various sectors of the
economy and can benefit all economic agents at a limited marginal
cost of an extra user
In this situation, there are positive externalities where the social
returns are higher than the private returns to investment
Consequently, the incentives to establish these kinds of services is
limited for an individual firm, and if left to the private sector, these
public goods and services will be underprovided
Role of government and public
investment
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Education, some types of infrastructure, health and security are
some areas where government have to play a key role
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A study by Moreno-Dodson (2008) shows the positive relationship between
public spending and growth, particularly when the allocation of spending
focuses on the provision of public goods rather than on subsidizing or
providing private goods and inputs
Recognition that smart industrial policy can play an important role:
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Strategic support for certain activities including provision of infrastructure
and services:
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That benefit firms in a specific geographic location (special economic zones)
That benefit firms in a specific industry but have positive spillover effects on other economic
activities
Access to technology to comply with international sanitary and health standards;
Marketing information, e.g. knowledge about international consumer preferences, trends,
fairs
Special training to update skills of local experts
Regional and international agreements that govern trade in good, services and immigration
policies
Information failures
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Information failures are defined as the failure of firms to
“discover” which products they can produce at low enough
cost to be profitable and competitive
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Focus is on the private sector since when it comes to development of
“new” products the private sector is more effective than the
governments at generating the kind of innovation and productivity
growth needed for sustained growth rates
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Private firms are profit driven, whereas governments have a much broader set of
objectives that may lead to an inefficient management of government-owned
enterprises
Public investment can crowd out private investment since businesses may fear
unfair competition from SOEs.
Firms must experiment with new product lines, adapt new technologies from
abroad to local conditions
Diversification of the productive structure requires “discovery” of an
economy’s cost structure
Pros of HRV
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Country-specificity
Selectivity via trade-offs
Organizational framework
Adaptability to analysis at the national or
sub-national levels
Limitations of HRV
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Difficult to reject constraints as not binding
Important to acknowledge information gaps to avoid
drawing wrong conclusions
Analysis demonstrated at the aggregate level offering little
insight about the distributional impacts of growth across
economic agents
Focus is on the short-run, rather than on determinants of
long-run growth
Human capital is viewed as a complementary factor,
although skills are a key determinant of exclusion from the
labor market
Three problems with the neoclassical models
Solow and optimal growth
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Do not predict the large differences in income
observed in the data
Predict conditional convergence but at a much
more rapid speed than estimated empirically
Predict greater rate of return differentials
between rich and poor countries than is
empirically plausible
How can one reconcile Solow with the data?
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Traditional view of capital
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Tangible, includes the economy’s stock of equipment and structures
Return to capital is the profit received by the owners of equipment and
structures
A new view on capital (Mankiw, Phelps and Romer 1995)
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Capital with externalities
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If new ideas arise as capital is built and others benefit
Human capital
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Capital is much broader concept than suggested by the national income
accounts
People accumulate capital whenever they forgo consumption today in order
to produce more income tomorrow
Schooling and on-the-job training is also investment
Endogenous growth models
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Romer (1986): growth is an outcome of
externalities in capital accumulation
Lucas (1988): growth is an outcome of
externalities in human capital accumulation
Romer (1990): growth is an outcome of
knowledge accumulation
Growth accounting with
human-capital-adjusted labor input
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Modified production function to capture the
contribution of education (“brains”) and the size
of the labor force (“brawn”)
Y  AK  H (1 )
H  LPeS
S is the years of schooling
 P is participation rate
 ω is returns to education
ˆ
 So that Yˆ  Kˆ  (1   ) Hˆ  A
Hˆ  Lˆ  Pˆ  S (ˆ  Sˆ )
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(A)
(B)
Determinants of income per capita
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After rearranging (A), substituting (B) into (A), and
representing income in per capita term we get:
g Y  g A   .g K  g P  S (ˆ  Sˆ )  g L
N
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H
N
where gx is the growth rate of variable x
Income growth per capita is a result of:
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Growth in technology gA
Changes in capacity which are determined by:
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Growth in the capital stock per unit of labor adjusted for skills
Growth in the labor participation rate
Growth in returns to education and years of schooling
Demographic changes leading to changes in the dependency ratio