Analyzing barriers to growth Miller UA323 1 2Hausmann, Rodrik and Velasco: Identifying barriers to growth Not covered in text (too old). Required reading: Hausmann, Rodrik and Velasco (2008) Introduced an analytical tool for policy reform that has been implemented for many countries Large focus of discussion for international organizations such as the World Bank and the Inter-American Development Bank 3Second Best Start with the Theory of the Second Best Theory of the second best originally explicated by Richard Lipsey and Kelvin Lancaster (1956) Informally, the basic result is: if two things in an economy are screwed up, fixing one may not be an improvement 4HRV’s second best presentation Start with the Theory of the Second Best where the ” represent “wedges” or distortions on different economic activities Effectively, HRV define the wedges as the difference between the social value of an activity and its private value τ = (τ1,τ 2,…,τ k ) 5HRV’s second best presentation (II) where the ” are the net marginal social and private values of the activities Can think of this as a version of the private sector’s first order condition The distortion in any activity depends on the distortion in all other activities μi s (τ ,!) μip(τ ,!) = τ i 6HRV’s second best presentation (III) where u is utility of a typical individual (or could be a social welfare function) and the lambdas are Lagrange multipliers Here we are thinking of the wedges as constraints on the utility maximization problem 7HRV’s second best presentation (IV) The first term means there is a direct gain from reducing the i’th distortion But the sum in the second term could be positive or negative (or zero if no other activities are distorted) 8HRV’s analysis of possible reform strategies Fix everything at once: well great, but usually impossible As much as you can fix: fails to consider the economic logic of the second best Go at the equation above directly: really hard to estimate the summation term Concertina method (go by tau): requires listing all the constraints – and the most distorted activities may not be important for growth 9HRV’s recommendation: fix the “most binding constraints” What they mean is go for the big Lagrange multiplier That is, try to first fix the stuff where the direct benefit of fixing it is big So how do we identify targets First goal is growth Identify 3 categories of problems n Returns to accumulation n Private appropriability of returns n Financing cost of accumulation 10 Insights from endogenous growth They illustrate with a version of the Romer model, but with distortions. This has a growth path with: 11 Insights from endogenous growth (II) r = r(a,θ, x) a: indicator of total factor productivity: index of externality x: availability of complementary factors of production 12 The HRV Tree 13 HRV’s example: Brazil and El Salvador versus DR 14 Brazil, El Salvador and DR Brazil and El Salvador engaged in much bigger reforms than DR, but got less payoff in terms of growth Going through the tree, HRV identify the most important constraint being lack of domestic savings For El Salvador, identify the problem as lack of domestic investment opportunities Growth in DR resulted from targeted reforms to exploit opportunities in tourism and “maquila” 15 Differential diagnosis From: Hausmann, Klinger and Wagner (2008)
