18 December 2007

Testing the Growth Diagnostics approach

Bolivia is the poorest country in South America - its income per capita is not much above Ghana. A revolution, radical land reform, decades of foreign aid and structural adjustment have not changed this basic fact. The only dynamic parts of the economy are the natural gas and soy beans produced in the eastern plains, far from where most Bolivians live.

Bolivia is therefore a prime candidate for a Growth Diagnostic as proposed by Ricardo Hausmann, Dani Rodrik and Andres Velasco. Growth Diagnostics are appealing to policymakers for two reasons. One, they are empirically grounded, without sacrificing theoretical rigour. Two, they combine hard data with case studies - which makes life more interesting for the grad students as well!

I joined David Elmaleh, Naomi Krieger and Molly Kinder to read dozens of reports, run regressions and crank out charts. We soon became dissatisfied with the standard explanations for Bolivia's poor growth. If low foreign investment was the problem, why didn't Bolivia boom in the 1990s? If the people of the highlands were poor because they were excluded from power, why didn't the Bolivian revolution of 1952 or the election of President Evo Morales change that? If the IMF and World Bank were the problem, why didn't the massive debt cancellation of 2002-03 help?

The key to Growth Diagnostics is that you can't do everything at once. The key is to identify the binding constraint to growth - the market or government failure that is the most important cause of the many problems you observe. Our very tentative conclusion, based on the best data we could find, was that Bolivia is stuck in an informality trap. Small businesses can't get credit to grow or increase their productivity, because they are in the informal sector. But when they try to join the formal sector, they find the taxes, regulations and red tape they have to endure put them at a competitive disadvantage.

Meanwhile, gas and agricultural exports are booming, but those sectors don't employ many people and the profits are captured by multinationals and large landowners. The government of President Morales is trying to tax them to fund welfare and pensions, but the (relatively) productive eastern provinces have responded by declaring autonomy and threatening to dissolve the state.

In this tense environment, what could the Bolivian government do to promote growth and poverty reduction? Nothing, say the eastern provinces - we know what to do, let us get on with it! We humbly suggest another approach: by tackling bank monopolies, cutting red tape and reducing the legal burden on small businesses, the government will be helping its core constituency, the indigenous people of the highlands, to break out of poverty. Neighbouring countries like Chile, Peru and Brazil have realized that being pro-poor doesn't mean you have to be anti-business.

We hope that the government and provinces will be able to resolve the constitutional crisis and give growth a chance. The prospects are good: after all, everyone from Argentina to Venezuela wants to help Bolivia. Why not get the World Bank to build roads and Hugo Chavez supply free heating oil to the (freezing) altiplano?

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