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.

The Challenge of Fiscal Adjustment in a Democracy: The Case of India

India’s fiscal problem has deep roots in its federal fiscal system, where multiple players find it difficult to coordinate adjustment. The size and closed nature of the Indian economy, aided by its deep domestic capital market and large captive pool of domestic savings, has disguised the cost of fiscal laxity and complicated the building of a consensus on reform. The new fiscal responsibility act establishes a new rules-based system to overcome this coordination failure. To strengthen the framework, we recommend an autonomous scorekeeper and the extension of similar rules to the state governments as part of a comprehensive reform of the federal system.

Economic Development as Self-Discovery

In the presence of uncertainty about what a country can be good at producing, there can be great social value to discovering costs of domestic activities because such discoveries can be easily imitated. We develop a general-equilibrium framework for a small open economy to clarify the analytical and normative issues. We highlight two failures of the laissez-faire outcome: there is too little investment and entrepreneurship ex ante, and too much production diversification ex post. Optimal policy consists of counteracting these distortions: to encourage investments in the modern sector ex ante, but to rationalize production ex post. We provide some informal evidence on the building blocks of our model.