Growth Diagnostics

Growth Diagnostics in Real Life: The Growth Lab's Project in Sri Lanka

On today's episode of The Growth Lab Podcast, CID Student Ambassador Emily Ausubel interviews Tim O’Brien and Dan Stock, Research Fellows at Harvard's Growth Lab. Tim and Dan discuss the Growth Lab project in Sri Lanka and how they are applying the Growth Diagnostics Methodology to identify the country’s binding constraints for diversification and economic growth. Read the Growth Diagnostic. Read more about Growth Diagnostics in Real Life: The Growth Lab's Project in Sri Lanka
Hausmann, R. & Klinger, B., 2007. Growth Diagnostic: Belize. Publisher's VersionAbstract

Belize’s economic history shows marked periods of growth accelerations and recessions. There have been two such expansions and collapses in the past two decades, with disturbingly similar features. While not always initiated by public spending, these booms quickly became public-investment led, until ballooning budget, trade, and current account deficits and the resulting shrinking reserves and growing debt required home-grown adjustment programs. The huge cuts in public investment and sharp increases in reserve requirements created marked recessions. In addition, the second acceleration happened after a significant collapse in private savings, and ended up creating a huge debt overhang which has eliminated public savings. As a consequence, Belize is a country with a low savings, little access to international finance, and an extremely high domestic cost of finance. Access to finance is the binding constraint to economic growth.

We show that other potential constraints are not binding. Returns to education are low, and there is little to no infrastructure congestion, suggesting that although Belize is a structurally high-cost country, lacking complementary factors of production are not holding back growth. Furthermore, tax, inflation, exchange rate stability, and law and order do not seem to restrict investment through lowering appropriability. Finally, the country is not being held back by a lack of self-discovery. Although the movement to new export goods is critical for Belize’s growth, this process is being hindered by the cost and availability of finance, both public and private.

The appropriate policy stance is therefore to institutionalize fiscal discipline and gradually reduce the cost of credit. Given that low public savings are presently the result of expensive debt service, and also that foreign debt has created barriers to foreign borrowing and a heightened tax on financial intermediation which are key contributors to the high cost of finance, fiscal sustainability is key for drawing down the cost of finance in Belize. Reforms to prevent a lack of fiscal discipline in the future, particularly surrounding political cycles, are critical to end the past two decade’s ‘stop-and-go’ growth pattern. Finally, the government must address the rapidly rising implicit tax expenditure on investment promotion, as well as the fall in the tax take.

But these reductions in the domestic cost of finance will, as best, be gradual given the size of the debt. In the meantime, there is a need for public investment in areas such as public safety, road maintenance, and rural airports that if ignored, could have deleterious effects on long-term growth. Creative ways to finance such productivity-enhancing investments, which would not increase publicly-guaranteed debt, must be pursued.

In addition, the industrial strategy of the country must adapt to the current financial constraints and focus on attracting investors who aren’t subject to the high domestic interest rate, namely foreign investors. The current industrial strategy is not consistent with Belize’s constraints to growth.

Hausmann, R., et al., 2020. Diagnóstico de Crecimiento de Loreto: Principales Restricciones al Desarrollo Sostenible.Abstract

Sembrado en el flanco oeste de la selva amazónica, Loreto se encuentra entre los departamentos más pobres y con peores indicadores sociales del Perú. El desarrollo enfrenta allí un sinfín de barreras, pero no todas son igualmente limitantes y tampoco hay recursos para atender todos los problemas a la vez. El Laboratorio de Crecimiento de la Universidad de Harvard, bajo el auspicio de la Fundación Gordon and Betty Moore, ha desarrollado un Diagnóstico de Crecimiento que buscar identificar las restricciones más limitantes, y priorizar las intervenciones de políticas públicas alrededor de un número reducido de factores con el mayor impacto. La investigación, que se fundamenta en análisis de bases de datos nacionales e internacionales, e incluye factores cuantitativos y cualitativos derivados de las visitas de campo, identifica a la conectividad de transporte, los problemas de coordinación asociados al autodescubrimiento, y la energía eléctrica, como las restricciones más vinculantes para el desarrollo de Loreto. De acuerdo con nuestras conclusiones, mejoras en la provisión de estos tres factores tendrían un mayor impacto sobre el desarrollo sostenible de la región que mejores en la educación y los niveles de capital humano, el acceso a financiamiento, y otros sospechosos habituales. Este reporte es el segundo de una investigación más amplia – Transformación estructural y restricciones limitantes a la prosperidad en Loreto, Perú – que busca aportar insumos para el desarrollo de políticas públicas a escala nacional y regional que contribuyan a promover el desarrollo productivo y la prosperidad de la región.

Hausmann, R., et al., 2020. La Riqueza Escondida de Loreto: Análisis de Complejidad Económica y Oportunidades de Diversificación Productiva.Abstract

El Laboratorio de Crecimiento de la Universidad de Harvard, bajo el auspicio de la Fundación Gordon and Betty Moore, ha desarrollado esta investigación para identificar las capacidades productivas existentes en Loreto y las actividades económicas con potencial para liderar la transformación estructural de su economía. Este reporte forma parte de una investigación más amplia – Transformación estructural y restricciones limitantes a la prosperidad en Loreto, Perú – que busca aportar insumos para el desarrollo de políticas públicas a escala nacional y regional que contribuyan a promover el desarrollo productivo y la prosperidad de la región, tomando en cuenta sus características particulares.

Hausmann, R., et al., 2020. Emerging Cities as Independent Engines of Growth: The Case of Buenos Aires.Abstract

What does it take for a sub-national unit to become an autonomous engine of growth? This issue is particularly relevant to large cities, as they tend to display larger and more complex know-how agglomerations and may have access to a broader set of policy tools. To approximate an answer to this question, specific to the case of Buenos Aires, Harvard’s Growth Lab engaged in a research project from December 2018 to June 2019, collaborating with the Center for Evidence-based Evaluation of Policies (CEPE) of Universidad Torcuato di Tella, and the Development Unit of the Secretary of Finance of the City of Buenos Aires. Together, we have developed research agenda that seeks to provide inputs for a policy plan aimed at decoupling Buenos Aires’s growth trajectory from the rest of Argentina’s.

Listen to the Growth Lab Podcast interview with the authors. 

Hausmann, R. & Klinger, B., 2007. Growth Diagnostic: Paraguay.Abstract

Paraguay’s growth history is characterized by prolonged periods of stagnation, interrupted by a few small recessions and growth accelerations. These dynamics reveal that growth in Paraguay has been dependent on latching on to particular export goods enjoying favorable external conditions, rather than driven by macroeconomic or political cycles. Moreover, the country currently has significant room for further export growth in existing products, as well as many new export products that are nearby and have high potential. But these available channels to generate sustained growth have all gone unexploited. Our growth diagnostic indicates that the underlying obstacles that have prevented the country from developing many of the available opportunities are related to two constraints: the provision of infrastructure and a lack of appropriability due to corruption and a poor regulatory environment. The current environment is one where the only activities that can survive have to be un-intensive in infrastructure, and either unintensive in transactions requiring an efficient business environment or at least at a scale where informality and corruption is a viable alternative to institutional blockages. We provide policy recommendations that will help alleviate these problems, focusing on not only on institutional and infrastructure reforms in the abstract, but outlining a process of learning from the relevant private sector actors what sector-specific needs in the areas of regulations and infrastructure are the most important for achieving accelerated growth in Paraguay.

Macroeconomic Stability & Long-Term Growth in Jordan

This project deployed research guided by Growth Diagnostic and Economic Complexity methodologies, first to understand constraints to growth and key opportunities and later to guide problem-specific research.

Pan, C.I., 2019. Tax Avoidance in Buenos Aires: The Case of Ingresos Brutos.Abstract
This study presents evidence of tax avoidance in Buenos Aires, Argentina. I exploit a break in the tax scheme of the most controversial tax, Ingresos Brutos (gross income), between the city and the greater area, which are otherwise identical law and regulation-wise for the studied population. When possible, workers would rather travel longer distances to their jobs than face the tax burden. Given that this type of avoidance is costly, results suggest that Ingresos Brutos might be acting as a binding constraint to growth for businesses.
Hausmann, R., et al., 2019. Jordan: The Elements of a Growth Strategy.Abstract

In the decade 1999-2009, Jordan experienced an impressive growth acceleration, tripling its exports and increasing income per capita by 38%. Since then, a number of external shocks that include the Global Financial Crisis (2008-2009), the Arab Spring (2011), the Syrian Civil War (2011), and the emergence of the Islamic State (2014) have affected Jordan in significant ways and thrown its economy out of balance. Jordan’s debt-to-GDP ratio has ballooned from 55% (2009) to 94% (2018). The economy has continued to grow amidst massive fiscal adjustment and balance of payments constraints, but the large increase in population – by 50% between 2008 and 2017 – driven by massive waves of refugees has resulted in a 12% cumulative loss in income per capita (2010-2017). Moving forward, debt sustainability will require not only continued fiscal consolidation but also faster growth and international support to keep interest payments on the debt contained. We have developed an innovative framework to align Jordan’s growth strategy with its changing factor endowments. The framework incorporates service industries into an Economic Complexity analysis, utilizing the Dun and Bradstreet database, together with an evaluation of the evolution of Jordan’s comparative advantages over time. Combining several tools to identify critical constraints faced by sectors with the greatest potential, we have produced a roadmap with key elements of a strategy for Jordan to return to faster, more sustainable and more inclusive growth that is consistent with its emerging comparative advantages.

Barrios, D., et al., 2018. Tabasco: Diagnóstico de Crecimiento.Abstract

Since 2003, the GDP per capita of Tabasco has consistently figured among the 4 largest in the country. However, this level of economic activity has not translated into an equally favorable performance in other social welfare metrics. According to CONEVAL, the Tabasco poverty rate in 2016 was 50.9%, seven percentage points higher than the national rate (43.6%). On the other hand, the average monthly income of the workers of the state is in the 40th percentile of all the states.

This discrepancy can be explained because the mining activity, despite accumulating only 3% of jobs, represents more than 50% of the state's GDP. If we only consider non-oil GDP, we have that the GDP per capita of the state has tended to be located around the country's median, and for 2016 it was in the 30th percentile nationwide.

Barrios, D., et al., 2018. Campeche: Diagnóstico de Crecimiento.Abstract

Campeche cuenta con el PIB per cápita más alto de todo México. Si bien buena parte de este desempeño se debe a la actividad petrolera (la cual representa 80% de la actividad económica del estado), incluso si se considera únicamente el PIB no petrolero per cápita el estado se ubicaba por encima del 80% de las entidades federativas del país. En 2016 el PIB per cápita de la entidad –a pesar de ser el más alto de todo México – era 45% de su valor en 2003, lo que equivale a una caída anual promedio de aproximadamente 6%. Si bien esta caída ha sido sostenida, las razones que la subyacen parecen haber variado en el tiempo.

En el período 2003-2009 se evidenció una divergencia entre el comportamiento de la actividad petrolera y la no petrolera. Por un lado, todos los sectores de la economía no petrolera, con la excepción de servicios de apoyo a los negocios, reflejaron tasas de crecimiento positivas. Por el contrario, la actividad petrolera cayó abruptamente, debido a que a pesar de que hubo aumentos en la cantidad de pozos de desarrollo perforados y en la cantidad de equipos de perforación activos, la producción petrolera cayó 26%, alcanzado con ello niveles que no se habían observado desde 1997.

Barrios, D., et al., 2018. Baja California: Diagnóstico de Crecimiento.Abstract

Baja California se ha ubicado consistentemente entre los estados más prósperos de México, pero también entre los de crecimiento más volátil. De hecho, el desempeño económico reciente del estado estuvo marcado por una fuerte fase de desaceleración (como consecuencia de la crisis financiera en Estados Unidos), y una de recuperación, en la que si bien la entidad logró alcanzar sus niveles de crecimiento pre-crisis, solo ha podido hacerlo de manera parcial en términos de productividad, ingresos laborales, y empleo.

Esta trayectoria de colapso y recuperación parcial invita a una reflexión sobre los dilemas que enfrenta la entidad, particularmente en torno a sus fuentes de vulnerabilidad. Como se vio, una parte importante de la caída del producto durante el periodo de desaceleración viene explicada por la contracción de la demanda en los Estados Unidos. Sin embargo, factores más específicos al estado, tales como su integración multidimensional con California (incluyendo la del mercado inmobiliario), jugaron un papel amplificador de los efectos de la crisis. Adicionalmente, el hecho de que la entidad no haya sido capaz de mitigar los efectos de la transición tecnológica de su principal producto de exportación o de re-desplegar estos conocimientos productivos en actividades que permitieran recuperar plenamente los ingresos medianos, el empleo y la productividad laboral, puede ser indicio que existen características, propias de su naturaleza productiva, que abonan bien sea a aumentar la vulnerabilidad o a reducir la capacidad de recuperación.

Sánchez, R.R., Hinojosa, A.S. & Wright, S.S., 2018. Growth Diagnostic for the State of Oaxaca.Abstract

Oaxaca is the second-poorest state in Mexico. It is also growing more slowly than the national average, leading to regional divergence. This paper seeks to diagnose the binding constraints that keep GDP growth in Oaxaca low.

There is significant variation in average monthly incomes within Oaxaca, with a 12x gap between the municipality with the highest salary and that with the lowest. Oaxaca has 570 municipalities, whereas given its population and the national average for people per municipality it should have 66. And it is very indigenous: 58% of the population speaks an indigenous language, compared to a national average of 15%. Oaxaca’s product space, a measure of how many kinds of industries provide employment in the state, is very low and has seen very limited change since 2004. The state shares some similarities with other states in southern Mexico, such as Chiapas and Guerrero. All three share a limited manufacturing base which, even after signing NAFTA, remained flat as a proportion of state GDP. They also have a poverty rate nearly 3 times the national average. 

Oaxaca is a large state with a rugged natural landscape. Its population is highly dispersed, relative to other states in Mexico. This makes infrastructure critical. However, widespread road construction between 2004 and 2014 does not seem to have made a difference to either growth rates or economic complexity at the municipality level, suggesting the infrastructure constraint is not binding. We believe, however, that mobility might be. Transportation costs as a proportion of wages are very high, and are further increased by costly road blockages. This limits the flexibility of the labor force and the aggregation of talent.

Low human capital can reduce the social returns to investment. Even though education is contentious in the state’s politics, Oaxaca’s education gap has been falling over time relative to the national average and its neighbors. This relative increase in years of education, however, has not been translated into economic development. We find that returns to education in the state are very similar to the returns to education in the rest of Mexico and higher than returns to education in Chiapas. We also note that the proportion of schooling undertaken in private institutions is in line with that in other states with higher quality of education. Finally, a Oaxaca-Blinder decomposition suggests that education does not explain wage differentials between Oaxaca and other states. All this evidence suggests that education is not a binding constraint to growth in Oaxaca.

Governance challenges increase the risk of investing in Oaxaca. For instance, over 75% of the municipalities in Oaxaca are governed through Usos y Costumbres. Only 153 of the 570 municipalities use a government-run election to determine their leader, and out of those, four did not elect a municipal president in the June 2016 election due to internal conflicts. 146 municipalities lack a police service. While Usos y Costumbres is a key part of the local social contract, it creates problems, such as in contract enforceability. It also limits migration in and out of the state. We also observe a negative correlation between Usos y Costumbres and local wages that is not explained by factors like indigenous origin.

We also explore access to finance as a constraint to GDP growth. While enterprise surveys confirm that high interest rates, and distance to banks are a problem, Oaxaca’s microenterprises bypass these problems by borrowing from cajas de ahorro or local credit unions. However, most borrowing is destined for consumption rather than investment. We also observe that FDI flows into Oaxaca are very scarce. For these reasons, we believe the binding constraint in Oaxaca is not access to finance, but rather low returns to investment.

It is helpful to think whether there is an underlying syndrome that might explain the two binding constraints we identified: transportation costs and governance. One possible hypothesis is the isolation of people into very small communities that have very strong bonds within the community and very weak bonds outside of it. Oaxaca shows high variety in ethnic groups, languages, and government systems. On average, each municipality has 6,670 people, but there are 110 municipalities with less than 1,000 people. Elsewhere in Mexico, dispersed rural populations gradually converged into urban clusters around job opportunities. In Oaxaca, the process is not yet afoot because of a “productivity trap”, in which low productivity means urban salaries do not cover the costs of transportation or permanent moves, and dispersion keeps productivity low by failing to concentrate employees. Cultural diversity has a side effect of encouraging spatial dispersion and isolation, and of having hundreds of different sets of “rules of the game” covering the state’s population. Increasing the complexity of this economy requires breaking the trap by finding new business models (i.e., encouraging discovery) and coordinating economic activities.  

Economic complexity analysis can point us to new industries that are feasible given Oaxaca’s productive capabilities and the existing constraints we discussed. While Oaxaca’s municipalities have among the least complex economies in the country, some industries stand out from our complexity analysis as potentially promising for Oaxaca. The end of the report singles out some industries for further analysis.

Hausmann, R., 2016. Constraints to Sustained and Inclusive Growth in Sri Lanka, Growth Lab at Harvard's Center for International Development.Abstract
In late 2015, CID was requested to conduct an initial analysis of constraints to sustained and inclusive economic growth in Sri Lanka. The findings of this analysis were presented at the Sri Lanka Economic Forum in Colombo in January 2016. This presentation outlined the initial findings and offered a series of questions that were then discussed at length with policymakers and academics during the two-day forum. The initial analysis found that recent growth and the sustainability of growth moving forward are constrained by weakness in Sri Lanka’s balance of payments, where a trade imbalance combined with low levels of foreign direct investment effectively puts a speed limit on economic growth. While monetary and exchange rate policy could be used to soften this constraint, solving the underlying problem requires structural transformation, which has proven difficult in Sri Lanka. At the same time, the analysis identified the government’s inability to raise revenues as a major risk that threatens to be more binding moving forward. Finally, the analysis identified the primary dimensions of inequality in the country as between regions and between cities and rural areas.
Hausmann, R., 2018. Accessing Knowhow for Development, Growth Lab at Harvard's Center for International Development.Abstract

Economies grow by adding new products and services to their production portfolio, not by producing more of the same kinds of products. The key to such diversification is access to know-how, but know-how often has to come from abroad. This is because it is often easier to move brains to new countries than to move new know-how into brains. In the experience of Singapore, India, Vietnam and most other dynamic economies, three channels of know-how transfer stand out: FDI, immigration and diaspora networks.

In this lecture, Professor Hausmann explores the relationship between economic development and the accumulation of know-how. In particular, he discusses how to tackle Sri Lanka’s limited export diversification.

Video - Accessing Know-how for Growth in Sri Lanka

Video - Full Q&A on Sri Lanka's export diversification

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