Growth Diagnostics

O'Brien, T., Nedelkoska, L. & Frasheri, E., 2017. What is the Binding Constraint to Growth in Albania?, Center for International Development at Harvard University.Abstract

About four years ago, at the onset of CID’s engagement in Albania, the country faced two issues that were threatening its macro-fiscal stability: a skyrocketing public debt and an insolvent, publicly-owned electricity distribution system that was plagued by theft and technical inefficiency. These two interlinked issues constrained both short-term economic growth and the ability of the country to develop new drivers of long-term growth. Over the subsequent years, the government was able to successfully respond to these constraints through a now-concluded IMF program and through a series of reforms in the electricity sector. With these constraints now relaxed, CID saw the need for a new analysis of the current and emerging constraints to growth in Albania. This analysis will guide future research and inform the government and non-government actors on emerging economic issues for prioritization.

While growth has accelerated over the last several years, to over 3% in 2016, this is not a pace that will allow for a rapid convergence of incomes and well-being in Albania with that of developed countries in Europe and elsewhere. This growth diagnostic attempts to identify the binding constraint to sustainably higher economic growth in Albania.

Recognizing that economic growth requires a number of complementary inputs, from roads to human capital to access to finance and many more, this report compares across eight potentially binding constraints using the growth diagnostic methodology to identify which constraint is most binding. This research was conducted throughout 2016, building on prior research conducted by CID and other organizations in Albania. Each constraint discussed in this report is cited by analysts within or outside the country as the biggest problem for growth in Albania. Through the growth diagnostic framework, we are able to evaluate the evidence and show that some constraints are more binding than others.

Despite serious issues in many other areas, we find that the binding constraint to stronger growth in Albania is a lack of productive knowhow. By “knowhow,” we mean the knowledge and skills needed to produce complex goods and services. Albania faces a unique knowhow constraint that is deeply rooted in its closed-off past, and the limited diversification that has taken place in the private sector can, in nearly all cases, be linked to distinct inflows of knowhow. The strongest sources of knowhow inflows into Albania have been through foreign direct investment and immigration, especially returning members of the diaspora who start new businesses or upgrade the productivity of existing businesses.

The evidence also points to particular failings in rule of law in Albania that play an important role in keeping Albania in a low-knowhow equilibrium. Weaknesses in Albania’s rule of law institutions, including frequent policy reversals and corruption in the bureaucracy and judiciary, increase the risk of investments and transaction costs of business. While it is difficult to separate perceptions from reality in this area, both perceptions of weak rule of law and actual rule of law failings appear to play critical roles in constraining more diversified investment in Albania. We find that while existing firms in Albania successfully navigate the rule of law weaknesses, and in some cases benefit from the system, potential new investors are acutely sensitive to rule of law issues.



Panama has been one of the fastest growing economies in the world over the previous decade. In that short but vibrant time span, the country managed to double its income per capita. Growth has been spearheaded by the development of a modern service sector on the activities surrounding the Canal, and non-residential construction. Large public infrastructure projects and the private provision for infrastructure demanded by the service sector, have fueled growth and expanded job opportunities for non-skilled workers.

Hausmann, R., Espinoza, L. & Santos, M.A., 2016. Shifting Gears: A Growth Diagnostic of Panama.Abstract

Panama has been one of the fastest growing economies in the world over the previous decade. Growth has been spearheaded by the development of a modern service sector on the activities surrounding the Canal, and non-residential construction. Large public infrastructure projects and the private provision for infrastructure demanded by the service sector, have fueled growth and created a vibrant labor market for non-skilled workers.

Two warning signals hover over Panama´s stellar performance. The construction sector has been growing for a decade at a rate that is equivalent to doubling its stock of structures every four years. The demand for non-residential construction cannot grow indefinitely at a higher rate than the rest of the economy. This feeds into the second signal: Income inequality. In spite of the minor improvements registered over the accelerated-growth spell, Panama remains amongst the world´s top five most unequal countries.

Both warning signals point out to the need of further diversifying the Panamanian economy, and promoting economic activity in the provinces so as to deconcentrate growth and make it more inclusive.

We deployed our Growth Diagnostic methodology in order to identify potential binding constraints to that process. Skilled labor, necessary to gradually diversify into more complex and high value-added activities, is relatively scarce. This scarcity manifests into large wage-premiums to foreigners across all occupations, which are particular large within more complex industries.

Major investments in education have improved indicators of schooling quantitatively, but quality remains a major concern. We find that Panama’s immigration policies are preventing skills from spilling over from their special economic zones into the rest of the economy. On top of that, the list of professions restricted to Panamanians and other constraints on skilled labor flows, are constraining even further the pool of skills. As we document here, these efforts are not helping the Panamanian workers, quite the contrary.

We also find that corruption, and to a lesser extent, red tape, are other important factors that shall be addressed in order to allow Panama to shift the gears of growth, tackle inequality and continue growing at a fast pace.

Originally published October 2016. Revised January 2017.

Sustainable Development in Sri Lanka

Sri Lanka's path to middle income status has been remarkable in several ways, with consistently high GDP growth rates and enviable performance in education, health and poverty reduction. The end of Sri Lanka's 26-year conflict led to a further acceleration of economic growth, with real annual growth rates in GDP per capita exceeding 7 percent from 2010 to 2012. But growth collapsed thereafter and has remained at or below 4 percent for the last four years, slowing the rate of Sri Lanka's overall development and leaving many parts of the country left behind.

Hausmann, R., Espinoza, L. & Santos, M.A., 2015. Diagnostico de Crecimiento de Chiapas: La Trampa de la Baja Productividad.Abstract

Chiapas no sólo es la entidad de menor ingreso per cápita de México, sino también la que menos creció durante la última década. En consecuencia, la brecha que lo separa del resto del país ha venido ampliándose significativamente. Este desempeño contrasta con el entorno de relativa estabilidad macroeconómica e institucional que ha prevalecido durante este período.

El bajo nivel de ingreso de Chiapas es consistente con la incapacidad que exhibe el estado para producir cosas que pueda vender más allá de sus límites. Sus exportaciones per cápita son de las más bajas de México, y están concentradas en una serie de productos primarios agrícolas, que se transan en mercados altamente competitivos de muy bajos márgenes.

¿Cuáles son las razones detrás del pobre desempeño económico de Chiapas? Este documento sigue la metodología de diagnóstico de crecimiento desarrollada por Hausmann, Rodrik y Velasco (2005), adaptándola a un contexto sub-nacional. Nuestro objetivo sigue siendo el mismo: identificar las principales restricciones al crecimiento económico de Chiapas.

De acuerdo con los resultados de nuestro análisis, las principales restricciones al crecimiento del estado no se encuentran en ninguno de los sospechosos habituales. Los bajos niveles de educación en alguna medida están asociados al atraso de Chiapas, pero apenas alcanzan para explicar una pequeña parte de la brecha. La orografía y el clima de Chiapas representan un reto para el levantamiento y mantenimiento de su infraestructura, pero esta última no aparece como la principal restricción al desarrollo de su tejido productivo. Tampoco hay evidencia de fallas en los mercados de crédito. Los bajos niveles de crédito privado en Chiapas están más asociados a la baja productividad de las actividades económicas que allí se realizan, que a cuellos de botella o insuficiencias en la oferta de financiamiento.

Nuestra conclusión es que Chiapas se encuentra en una trampa de (baja) productividad. Su principal problema es que tiene una economía de muy baja complejidad o sofisticación, que refleja sus pocas capacidades productivas. Los sistemas de producción modernos requieren de un número de insumos complementarios que están ausentes en Chiapas. En ese contexto, la diversidad productiva y la inversión privada son bajas, porque los retornos a la inversión son también muy bajos. Dado que la demanda derivada de inversión privada es baja, inhibe el surgimiento de una oferta de insumos complementarios, dando lugar a un problema de coordinación similar al del huevo y la gallina. Resolver este problema de coordinación requiere de la intervención del estado. Algunos de los pocos casos de exportaciones de manufacturas que existen en Chiapas han resultado de intervenciones exitosas del estado para coordinar la existencia de los insumos necesarios para la producción con la demanda por ellos. Esta característica provee el sustento argumental que justifica la creación de las Zonas Económicas Especiales.

En Chiapas, esta situación se ve además agravada por la conjunción de tres factores: (1) altas transferencias gubernamentales, (2) carencia de transporte público y (3) bajo nivel educativo.

Las transferencias gubernamentales traen efectos similares a los que se identifican en la literatura económica de la enfermedad holandesa: encarecer los costos relativos de los bienes transables, inclinando la actividad económica hacia los sectores no-transables. La ausencia de un sistema de transporte público reduce de manera directa el beneficio neto de trabajar en la ciudad si se vive en el campo. Así, se ha establecido un equilibrio dual con diferencias significativas entre remuneraciones a través de todo el rango de profesiones y ocupaciones entre las ciudades y sus comunidades rurales más próximas. Por último, aunque Chiapas ha venido cerrando gradualmente la brecha educativa que lo separa del resto del país, aún existen diferencias significativas. En nuestra opinión, esa brecha se debe a que la decisión de acumular años de escolaridad es en parte endógena a los retornos que se obtienen de la educación. Visto así, las brechas de educación vendrían a ser un espejo de las diferencias en términos de los métodos de producción que predominan en Chiapas, en contraste con el resto del país. Por esa razón observamos que si bien los retornos a la educación son mayores en Chiapas, para cada nivel educativo es más rentable emigrar (a un lugar donde existan otros insumos complementarios que hagan posible una productividad mayor y un mayor salario) que quedarse a trabajar en la entidad. Los emigrantes chiapanecos, aunque son pocos, perciben ingresos similares a los trabajadores con igual nivel de educación en el lugar de destino.

Las implicaciones en términos de política de este diagnóstico apuntan hacia la necesidad de aprovechar el conocimiento que ya existe en los mayores centros poblados de Chiapas y en el resto de México, para promover la diversificación hacia otras actividades más complejas que puedan construir sobre las capacidades ya existentes en la zona. La creación de un sistema de transporte público que vincule a las comunidades rurales que rodean la ciudad podría resolver la restricción de la escasez de mano de obra, a la vez que abre mayores oportunidades de trabajo urbano para los habitantes de comunidades rurales vecinas. Este es un ejemplo típico de la dinámica del huevo y la gallina que predomina en Chiapas, toda vez que se requiere de una escala mínima de operación para la creación de un sistema eficiente de transporte público, que a su vez no será posible en tanto no exista suficiente demanda de transporte.

Nuestra prescripción sugiere que llevemos la montaña a Mahoma, dado que Mahoma no ha ido a la montaña. Es decir, procurar resolver los problemas de coordinación a través de una intervención que acerque las oportunidades de trabajo a donde están los trabajadores, dado que bajo las condiciones actuales a estos últimos no les resulta rentable acercarse a donde están las oportunidades de trabajo. Hay zonas rurales con bajas tasas de participación y altas tasas de pobreza en la vecindad de San Cristóbal de las Casas. Esta también es una región donde existe mucha incertidumbre para la actividad económica privada, toda vez que predomina allí la existencia de territorios ejidales de propiedad comunitaria. Una implicación de nuestro análisis podría ser crear un Parque Industrial  alrededor de San Cristóbal, que resuelva la carencia de bienes públicos que ha mantenido alejada la actividad económica privada (inseguridad jurídica, dificultad para conseguir terrenos, conflictividad social), y a la vez acerque a las empresas a donde se encuentra la mano de obra disponible. La experiencia dentro de Chiapas de empresas como Arnecom-Yazaki indica que con períodos cortos de entrenamiento, los trabajadores podrían integrarse a sistemas relativamente modernos y ocuparse de forma productiva.

Esta solución es un escalón sobre el cual se puede entrar en una dinámica sostenida de desarrollo, a través de mejoras sucesivas en la productividad derivada de la transformación productiva y de la adopción progresiva de sistemas de producción más modernos. Para crecer, Chiapas debe empezar por aprender a hacer cosas que ya se producen en el resto de México y pueda vender fuera del estado. A partir de allí, se empezará a crear el tejido económico y el conocimiento asociado a métodos más modernos de producción, y de allí gradualmente se podría desarrollar la capacidad exportadora y pasar a actividades más complejas. Ese proceso requiere de una coordinación entre los diferentes actores, gobierno (nacional y regional), sector privado, y academia, con el objetivo de buscar proactivamente actividades adyacentes, así como identificar y resolver los respectivos cuellos de botella de forma dinámica.

The Binding Constraints to Growth in Morocco
Hausmann, R. & Rodrik, D., 2006. The Binding Constraints to Growth in Morocco. In Fostering High Growth and Employment in the Kingdom of Morocco. Washington, DC. Washington, DC: The World Bank, pp. 15-49. Abstract

This book identifies the binding constraints to growth of Morocco. It applies an innovative procedure known as 'growth diagnostic' and has a central finding. The Moroccan economy suffers from a too slow process of structural transformation for achieving higher growth, especially for its exports that face unfavorable external shocks arising from competitor countries in the main markets for Moroccan exports. This process of so-called 'productive diversification' requires that Morocco enhance its competitiveness. Four government failures are identified as the binding constraints to growth in Morocco: a rigid labor market; a taxation regime that represents a heavy burden for firms and an obstacle to hiring skilled human capital; a fixed exchange rate regime that has allowed regaining price stability, but, given existing rigidites in the labor market, does not favor international competitiveness; and an anti-export bias, featuring a still high level of trade protectionism despite recent progress in tariff reductions and the signing of several Free Trade Agreements. In parallel, three market failures affect competitiveness and innovation: information failures, coordination failures between the public and private sector, and training failures that rank the country among those with the lowest level of training offered by businesses.

Rodrik, D. & Hausmann, R., 2005. Self-Discovery in a Development Strategy for El Salvador. Economia , 6 (N1).Abstract

El Salvador is a star reformer. After the civil war of the 1980s, the country was able to adopt important political and institutional reforms. These included the incorporation of all political groups into the electoral process, the adoption of a new constitution, the elimination of the military police, the creation of a civilian police with members from both sides of the war, and the adoption of rules to strengthen the independence of the judiciary. On the economic front, the country consolidated its fiscal position, modernized its tax system, liberalized trade and banking, improved the regulation and supervision of its financial system, privatized most state productive assets including energy and telecommunications, and reformed its social security system in line with the Chilean model. It also expanded and granted local autonomy to the school system through the Community-Managed Schools Program (EDUCO). Finally, El Salvador dollarized its financial system in November 2000. Given the investment-grade rating earned by the country, domestic money market rates have converged to U.S. levels.

Unfortunately, El Salvador is not a star performer. Standard theory would predict that such an improvement in the institutional and regulatory environment should be followed by convergence to a higher income level. Instead, after an initial period of recovery that lasted until 1997, real gross national income per capita stagnated at levels comparable to those achieved by the country in the late 1970s. Its income relative to the United States has not recovered from the fall associated with the civil war and is just over half the ratio achieved in the late 1970s.

El Salvador is not alone in finding that reform efforts have had smaller-thanexpected
growth effects. With the exception of Chile, the effects of reform ongrowth throughout Latin America have been smaller than the initial estimates carried out in the mid-1990s.In this context, El Salvador is an interesting case, since it has been particularly effective in applying wide-ranging reforms.

This paper explores why these reforms have failed to produce more growth and what can be done about it.2 We begin by placing the economic choices faced by the incoming Salvadoran administration in a regional and historical perspective. The late 1980s and early 1990s in Latin America were preceded by a decade of stagnation, but coincided with a time of unusual confidence in the future. The collapse of communism, the failure of many interventionist policies in Latin America in the 1980s, and Chile’s success gave governments a clear idea of the road they wanted to leave and the road they wanted to take. Inadequate past performance and consensus on the road ahead led to a forceful policy agenda.

Export Diversification in Algeria
Hausmann, R., Klinger, B. & López-Cálix, J.R., 2010. Export Diversification in Algeria. In Trade Competitiveness of the Middle East and North Africa. Washington, DC. Washington, DC: The World Bank, pp. 63-101.Abstract

This chapter applies new methodologies to examine the history of and future opportunities for export diversification in Algeria. The first section examines Algeria’s productive structure, which is highly concentrated in the hydrocarbons sector. It shows that this pattern of specialization is inconsistent with the country’s endowment of hydrocarbon resources. The lack of export diversification is suggestive of an inefficient distortion, reversal of which should be a clear policy priority.

The second section reviews some of the traditional explanations for a lack of export diversification in an oil-exporting country and shows that these explanations do not seem to hold for Algeria. It offers an alternative explanation, based not on macroeconomic volatility or real exchange rate appreciation but on the specificity of productive capabilities in the oil sector and their substitutability to other activities. This explanation underlies the notion of a “product space,” in which structural transformation occurs.

The third section introduces a new methodology to export diversification in Algeria, which is shown to be specialized in a highly peripheral part of the product space. Even activities that compose the non-oil export basket are highly peripheral in the product space, which helps explain the severe lack of export diversification.

The fourth section applies product space data to Algeria’s industrial strategy, using the methodology to identify high-potential export sectors. This data-driven approach has the benefit of systematically scanning the entire set of potential export goods using an empirically validated methodology. It complements other more qualitative and contextual approaches. This section uses the same methodology to review the sectors already identified by the Algerian government in the new industrial policy.

The last section discusses the policy implications of this analysis. A wide variety of methodologies can be used to generate lists of high potential export sectors; more difficult is determining what to do with such lists. The section offers a few specific policy recommendations and discusses some best practices. But the fact that most required public goods and constraints to investment are sector specific means that recommendations cannot be made at the macro level.

Diagnosing the Binding Constraints on Economic Growth (Belize)
Hausmann, R. & Klinger, B., 2010. Diagnosing the Binding Constraints on Economic Growth (Belize). In Towards a Sustainable and Efficient State: The Development Agenda of Belize. Washington, DC. Washington, DC: Inter-American Development Bank, pp. 11-35. Publisher's VersionAbstract

Belize’s long-term growth performance has been comparatively good. It is not clear what comparator group is relevant, given Belize’s status as both a Caribbean and a Central American country. Compared with its Central American counterparts, Belize has been a growth star. In 1960, it was the second-poorest country in the region; now it is among the “top tier” countries, with gross domestic product (GDP) per capita (Figure 1.1) near that of Costa Rica and Panama. Moreover, much of this growth was achieved after independence. Among its Caribbean peers, however, Belize’s performance has been average, and it has not been able to close the gap with the better-performing economies in the region. And since 2004, economic growth has been sluggish, barely above the rate of population growth, implying that reactivating economic growth is a central development challenge for the country.

Hausmann, R., Austin, E.L. & Mia, I., 2009. The Mexico Competitiveness Report 2009, World Economic Forum.Abstract

The past 20 years have been a period of important reforms in Mexico. Since the late 1980s, the country has undergone an impressive process of liberalization, opening of the economy, and macroeconomic stabilization. Extreme vulnerability to external shocks, double-digit inflation, and current account and fiscal deficits seem to have been overcome. However, a number of weaknesses continue to drag the country’s productivity and hence its potential for sustained economic growth and the well-being of its citizens. In spite of a very benign external environment in the period 2003–07, Mexico’s growth rates have been disappointing, and the challenges facing the country have become even greater in the context of the current major economic and financial crisis — one of the most serious in decades — affecting the United States and the rest of the world. The Mexico Competitiveness Report 2009 aims at providing Mexico’s policymakers, business leaders, and all relevant stakeholders with a unique tool that identifies the country’s main competitiveness flaws and strengths, together with an in-depth analysis of areas that are key to the country’s potential for long-term growth. In doing so, the Report aims to support the country’s reform process and contribute to the definition of a national competitiveness agenda of the priority issues that need to be tackled for Mexico to boost its competitiveness in the face of the present daunting economic outlook. The Report is organized into three thematic parts. Part 1 assesses the current state of Mexico’s competitiveness and its potential for sustained growth using the broad methodological framework offered by the Global Competitiveness Index (GCI) 2008–2009. Part 2 features contributions from a number of experts providing additional insights and diagnostics related to particular aspects of the competitiveness challenges faced by the country. Part 3 includes detailed profiles for Mexico and 10 selected countries and offers a comprehensive competitiveness snapshot for each of these countries.

Rodrik, D., 2010. Diagnostics before Prescription. Journal of Economic Perspectives , 24 (3) , pp. 33-44.Abstract
Development economists should stop acting as categorical advocates (or detractors) for specific approaches to development. They should instead be diagnosticians, helping decisionmakers choose the right model (and remedy) for their specific realities, among many contending models (and remedies). In this spirit, Ricardo Hausmann, Andres Velasco, and I have developed a "growth diagnostics" framework that sketches a systematic process for identifying binding constraints and prioritizing policy reforms in multilateral agencies and bilateral donors. Growth diagnostics is based on the idea that not all constraints bind equally and that a sensible and practical strategy consists of identifying the most serious constraint(s) at work. The practitioner works with a decision tree to do this. The second step in growth diagnostics is to identify remedies for relaxing the constraint that are appropriate to the context and take cognizance of potential second-best complications. Successful countries are those that have implemented these two steps in an ongoing manner: identify sequentially the most binding constraints and remove them with locally suited remedies. Diagnostics requires pragmatism and eclecticism, in the use of both theory and evidence. It has no room for dogmatism, imported blueprints, or empirical purism.