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
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The HRV Tree
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HRV’s example: Brazil and El
Salvador versus DR
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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)