Doing growth diagnostics in practice by renata.vivien


									Growth diagnostics

 Elena Ianchovichina
   March 23, 2009
                    Reform strategies
        The idea about the most binding constraint
   Targeting all distortions at once may be infeasible
    due to financial and capacity constraints, especially
    in LICs
   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
       Increases the chances of an overall positive impact
       The most binding constraint is associated with the biggest
       The second best effects are hard to estimate with accuracy
Heuristic approach to identifying the most
      binding constraint to growth
   The multipliers are typically hard to estimate
   HRV use the “Keynes-Ramsey rule”
       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
       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

            Low return to economic activity                                               High cost of finance

   Low social returns                    Low appropriability                         bad international   bad local finance

                                         government                    market
                                           failures                    failures

   poor                                                             information      coordination
                  bad infra                                         externalities:
geography         structure                                                          externalities
                                                                  “self discovery”
                              - micro risks:    macro risks:                                           low          poor
        human                 property rights,   financial,           -                              domestic      inter
        capital                 corruption,    monetary, fiscal                                       saving      mediation
                                   taxes         instability
       Source: HRV (2005)
        Growth diagnostic questions
   Is private investment low in a country? If yes:
       Is it because of high cost of capital?
           In this case the economy is considered liquidity
       Is it because of low returns to capital?
           In this case the economy is considered inefficient
     Why is the cost of capital high or
         access to capital poor?
   Limited access to external capital markets due
       Country risk
       Unattractive FDI conditions
       Vulnerabilities in the debt maturity structure
       Excessive regulations of the capital account
   Bad local finance
       Low domestic savings
       Poor domestic financial intermediation
        Why are returns to capital low?
   Low social returns due to:
       Geography
       Insufficient investment in complementary factors
       Poor natural resource management
   Low private returns to capital due to:
       Government failures affecting negatively private
           Macro-instability, high taxes, property rights issues, corruption,
            labor-capital conflicts
       Market failures affecting negatively the ability to adopt
        new technologies
           Coordination externalities
           Information externalities
                       Market failures
   Coordination failures are defined as the failure of the market
    to respond to potential investors’ demands for a diverse set of
       Allow firms to innovate, market their products successfully, and make a
       These services require simultaneous, large-scale investments in various
        sectors of the economy
       The incentive to establish these kinds of services is limited for an individual
   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
       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 and cons of HRV
   Advantages
       Country-specificity
       Selectivity via trade-offs
       Organizational framework
   Limitations
       Difficult to reject constraints as not binding
       Analysis demonstrated at the aggregate level offering
        little insight about constraints
       Emphasis is placed on private investment ignoring other
        factors determining long-run growth
    Three problems with the neoclassical models
              Solow and optimal growth

   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?
   Traditional view of capital
       Tangible, includes the economy’s stock of equipment and structures
       Return to capital is the profit received by the owners of equipment and
   A new view on capital (Mankiw, Phelps and Romer 1995)
       Capital with externalities
           If new ideas arise as capital is built and others benefit
       Human capital
           Capital is much broader concept than suggested by the national income
           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
   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
   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     ˆ         ˆ ˆ
 So that Y  K  (1   ) H  A     (A)
             ˆ ˆ ˆ          ˆ ˆ
            H  L  P  S (  S )   (B)
    Determinants of income per capita
   After rearranging (A), substituting (B) into (A), and
    representing income in per capita term we get:
                                       ˆ ˆ
        g Y  g A   .g K  g P  S (  S )  g L
            N                 H                             N
               where gx is the growth rate of variable x
   Income growth per capita is a result of:
       Growth in technology gA
       Changes in capacity which are determined by:
               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

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