Final Recommendations of the International Panel on ASGISA (South Africa)

As part of the Accelerated and Shared Growth Initiative (ASGI-SA), the National Treasury of the Republic of South Africa convened an international panel of economists through Harvard’s Center for International Development. This panel spent two years analyzing the South African economy and its growth prospects, and composed 20 papers spanning all aspects of economic policy. The present paper synthesizes this body of work. We summarize the panel’s assessment of the binding constraints to growth in South Africa and provide specific policy recommendations to help achieve the goal of accelerated and shared growth.

Examining Beneficiation

Beneficiation, moving downstream, and promoting greater value added in natural resources are very common policy initiatives to stimulate new export sectors in developing countries, largely based on the premise that this is a natural and logical path for structural transformation. But upon closer examination, we find that very few countries that export raw materials also export their processed forms, or transition to greater processing. The quantitative analysis finds that broad factor intensities do a much better job of identifying patterns of production and structural transformation than forward linkages, which have an insignificant impact despite the fact that our data is biased against finding significant effects of factor intensities and towards finding significant effects of forward linkages. Moreover, the explanatory power of forward linkages is even smaller in sectors with high transport costs, and in sectors classified as primary products or raw materials, which are the most common targets of such policies. Finally, the results are the same even when only considering developed countries, meaning that colonial legacy inhibiting transitions to natural resource processing are not to blame. These results suggest that policies to promote greater downstream processing as an export promotion policy are misguided. Structural transformation favors sectors with similar technological requirements, factor intensities, and other requisite capabilities, not products connected in production chains. There is no reason for countries like South Africa to focus attention on beneficiation at the expense of policies that would allow other export sectors to emerge. This makes no sense conceptually, and is completely inconsistent with international experience. Quite simply, beneficiation is a bad policy paradigm.

Achieving Export-Led Growth in Colombia

The purpose of this paper is to analyze Colombia’s experiences with and opportunities for export led growth. We first review Colombia’s growth and export performance over the past 30 years and find that the country is indeed facing an export challenge. We then go on to develop new metrics and apply them to Colombia’s export challenge. First, we consider the opportunities for upgrading quality within existing exports, and find that Colombia has very little opportunity for growth in this dimension. Second, we consider the level of sophistication of the current export basket, and find that it is low and commensurate with the lack of export dynamism. Although not a significant drag on growth, the current export basket will not be sufficient to fuel future output growth. Finally, we develop the concept distances between products, open forest, and the option value of exports to examine the possibility that Colombia’s current structure of production is itself a barrier to future structural transformation. While improvements in the export package have been slow in the past, this evidence suggests that Colombia does now enjoy more options for future structural transformation. As there are attractive options for structural transformation nearby, a parsimonious approach to industrial strategy, rather than a risky strategic bet to move to a new part of the product space, seems appropriate. In order to inform such a strategy, we use the metrics developed in the diagnostic to evaluate new export activities in terms of their proximity to current activities, their sophistication, and their strategic value. We identify the sectors representing the best tradeoffs between these aims for Colombia as a whole, as well as its regions. We also devote separate attention to the topic of Agricultural exports, and to exports of services. Finally, we use these metrics to analyze the list of ‘high-potential’ sectors in the United States, developed by another firm, as well as the sectors prioritized in Colombia’s Agenda Interna. These external lists of high-potential sectors are found to be sensible, but could be further rationalized using these metrics. This identification of nearby, high-potential, and strategically valuable sectors is not meant to be a definitive list for targeted subsidies and ‘picking winners’. Rather, it provides a robust data-driven approach to inform the next steps in achieving export-led growth in Colombia: which private sector actors should be consulted first? What sector-specific reforms should be stressed? How should public spending on infrastructure and training, which are also sector-specific, be prioritized? What foreign firms should be targeted by FDI promotion agencies? These decisions can be informed by our analysis and the accompanying data.

The Structure of the Product Space and the Evolution of Comparative Advantage

This paper establishes a robust stylized fact: changes in the revealed comparative advantage of nations are governed by the pattern of relatedness of products at the global level. As countries change their export mix, there is a strong tendency to move towards related goods rather than to goods that are farther away. The pattern of relatedness of products is only very partially explained by similarity in broad factor or technological intensities, suggesting that the relevant determinants are much more product-specific. Moreover, the pattern of relatedness of products exhibits very strong heterogeneity: there are parts of this ‘product space’ that are dense while others are sparse. This implies that countries that are specialized in a dense part of the product space have an easier time at changing their revealed comparative advantage than countries that are specialized in more disconnected products.

Growth Diagnostic: Belize

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.

Structural Transformation and Patterns of Comparative Advantage in the Product Space

In this paper we examine the product space and its consequences for the process of structural transformation. We argue that the assets and capabilities needed to produce one good are imperfect substitutes for those needed to produce other goods, but the degree of asset specificity varies widely. Given this, the speed of structural transformation will depend on the density of the product space near the area where each country has developed its comparative advantage. While this space is traditionally assumed to be smooth and continuous, we find that in fact it is very heterogeneous, with some areas being very dense and others quite sparse. We develop a measure of revealed proximity between products using comparative advantage in order to map this space, and then show that its heterogeneity is not without consequence. The speed at which countries can transform their productive structure and upgrade their exports depends on having a path to nearby goods that are increasingly of higher value.

South Africa’s Export Predicament

This paper explores export performance in South Africa over the past 50 years, and concludes that a lagging process of structural transformation is part of the explanation for stagnant exports per capita. Slow structural transformation in South Africa is found to be a consequence of the peripheral nature of South Africa’s productive capabilities. We apply new tools to evaluate South Africa’s future prospects for structural transformation, as well as to explore the sectoral priorities of the DTI’s draft industrial strategy. We then discuss policy conclusions, advocating an ‘open-architecture’ industrial policy where the methods applied herein are but one tool to screen private sector requests for sector-specific coordination and public goods.

This paper is part of the South Africa Growth Initiative.

China and the Global Economy: Medium-term Issues and Options – A Synthesis Report

China’s economic and social achievements since the beginning of reform and opening are unprecedented in global history. Managing the growth process in this continuously changing environment has required great skill and the use of unconventional economic policy. Now China has entered a new era in its development process with a set of challenges largely different from those of the recent past. Some problems – such as growing internal and external structural imbalances, increasing income and regional inequality – have arisen from, or been exacerbated by, the very pattern and success of high growth since reforms began. Others are newly posed by rapid changes in the global economy. These challenges can best be tackled in an integrated and coordinated fashion. This report, supported by the China Economic Research and Advisory Programme (CERAP), identifies the primary challenges facing China today and presents options for meeting them.

The Implications of Dark Matter for Assessing the US External Imbalance

This paper clarifies how dark matter changes our assessment of the US external imbalance. Dark matter assets are defined as the capitalized value of the return privilege obtained by US assets. Because this return privilege has been steady over recent decades, it is likely to persist in the future or even to increase, as it becomes leveraged by an increasingly globalized world. Once this is included in future projections of US current accounts, the US external position looks much more balanced than depicted in official statistics.

Growth Diagnostics

Most well-trained economists would agree that the standard policy reforms included in the Washington Consensus have the potential to be growth-promoting.

What the experience of the last 15 years has shown, however, is that the impact of these reforms is heavily dependent on circumstances. Policies that work wonders in some places may have weak, unintended, or negative effects in others.

We argue in this paper that this calls for an approach to reform that is much more contingent on the economic environment, but one that also avoids an anything goes attitude of nihilism. We show it is possible to develop a unified framework for analyzing and formulating growth strategies that is both operational and based on solid economic reasoning. The key step is to develop a better understanding of how the binding constraints on economic activity differ from setting to setting. This understanding can then be used to derive policy priorities, in a way that uses efficiently the scarce political capital of reformers.

Our approach is motivated by three considerations. First, while development is a broad concept entailing the raising of human capabilities in general,we believe increasing economic growth rates is the central challenge that developing nations face. Higher levels of living standards are the most direct route to achieving improvements in social and human indicators. Reform strategies should be principally targeted at raising rates of growth that is, they should be growth strategies.

Second, trying to come up with an identical growth strategy for all countries, regardless of their circumstances, is unlikely to prove productive. Growth strategies are likely to differ according to domestic opportunities and constraints.

There are of course some general, abstract principles such as property rights, the rule of law, market-oriented incentives, sound money, and sustainable public finances which are desirable everywhere. But turning these general principles into operational policies requires considerable knowledge of local specific cities.

Third, it is seldom helpful to provide governments with a long list of reforms, many of which may not be targeted at the most binding constraints on economic growth. Governments face administrative and political limitations, and their policy-making capital is better deployed in alleviating binding constraints than in going after too many targets all at once. So growth strategies require a sense of priorities. What we propose to do in this paper is to develop a framework for growth diagnostics that is, a strategy for figuring out the policy priorities. The strategy is aimed at identifying the most binding constraints on economic activity, and hence the set of policies that, once targeted on these constraints at any point in time, is likely to provide the biggest bang for the reform buck.

The methodology that we propose for this can be conceptualized as a decision tree (see Figure 1, discussed below). We start by asking what keeps growth low. Is it inadequate returns to investment, inadequate private appropriability of the returns, or inadequate access to finance? If it is a case of low returns, is that due to insufficient investment in complementary factors of production (such as human capital or infrastructure)? Or is it due to poor access to imported technologies? If it is a case of poor appropriability, is it due to high taxation, poor property rights and contract enforcement, labor-capital conflicts, or learning and coordination externalities? If it is a case of poor finance, are the problems with domestic financial markets or external ones? And so on.

Then we discuss the kind of evidence that would help answer these question one way or another. We also illustrate the practical implications of this approach by drawing on examples from specific countries.

Aside from providing a useful manual for policymakers, our approach has the advantage that it is broad enough to embed all existing development strategies as special cases. It can therefore unify the literature and help settle prevailing controversies. For example, our framework will clarify that doctrinal differences on development policy between proponents of the Washington Consensus and of state-led strategies, or between pro-globalizers and cautious globalizers are grounded in divergent evaluations about the nature of the binding constraints on growth. Making these differences explicit, and clarifying the nature of the evidence that can resolve them, can move us forward to a more productive policy agenda.

The outline of the paper is as follows. We first lay out the conceptual framework, linking our terminology of binding constraints to standard economic models. In particular, we relate our framework to theories of second-best and partial reform and of endogenous growth. We next cast the framework in the form of a decision tree, and discuss the nature of the evidence that is required to move along the nodes of the tree. In the final section we carry out an analysis of several “archetypal” cases, each representing a different syndrome or combination of binding constraints.