Guest blog written by Manuela Fulga
The pandemic threatens to erase years of progress made by developing and emerging economies towards sustainable development. The World Bank estimates that between 71 and 100 million people could be pushed into extreme poverty in 2020, increasing the global extreme poverty rate for the first time in more than 40 years.
This realization convinced me to apply to the “Leading Economic Growth” course at Harvard Kennedy School. My objective was to explore and learn practical strategies that countries can adopt in the current context, particularly with limited resources and tight fiscal spaces, in order to protect their population without forgetting the important investments necessary to achieve the Sustainable Development Goals (SDGs) by 2030.
The 10-week online course allowed me to take the key concepts from the lectures and readings and apply them to a specific country, developing a plan for the recovery. It truly felt like a journey, and more specifically like a climbing expedition: professors Hausmann and Andrews were the expert guides, leading the way and setting the trail for us; the video lectures and readings were the manuals we read before starting to climb; the weekly assignments – deep-dives to help us develop our own country strategy – represented key milestones, or the most difficult trails where we had to reflect on the learnings and apply them to our strategy; the feedback of the teaching assistants was our anchor and rope, setting us on the right path to success.
This course opened my eyes to new ways of thinking about economic growth and particularly to innovative approaches that can support governments in identifying game-changing policies. These are the four key takeaways that have forever changed my view on development and economics, and that have the potential to help countries build back better from COVID-19 towards a more resilient future.
Focusing on problems rather than solutions
The dominant theory of change in development is that great governments emerge when a savvy leader takes the opportunity of a crisis to implement the right policies and holds power long enough to drive implementation. In reality, the story is far from simple: it is not about one solution applicable for all, forced down the system by a powerful individual. Development is a complex matter, where many social and economic factors are correlated and interact with each other, causing at times unexpected consequences, and requiring multiple iterations to achieve true impact.
This is why “problem-driven iterative adaptation” (PDIA) is a more hopeful concept than “solution- and leader-driven change” (SLDC): countries do not have to wait for a brilliant leader to change their faith, but can adopt a new approach by engaging distributed groups of agents in a gradual and iterative search for the best policy to drive economic growth. PDIA materializes when governmental agents interact and exchange information in new ways, yielding locally determined responses to economic challenges by constructing and deconstructing bottlenecks preventing growth. This enables governments to transform tangled and complex problems into manageable issues, by revealing the root causes and addressing them step by step, identifying quick wins.
A visual representation of the problem deconstruction process can be developed through the fishbone diagram, which allows to identify the sub-causes generating a bigger bottleneck to economic growth. This is the example of Saint Lucia I developed: a deconstruction of the lack of diversification in the island, where tourism accounts for more than 50% of GDP.
Growth diagnostic and the binding constraint
Many development institutions support the reforms included in the Washington Consensus, a set of free-market economic policies promoted for developing countries to drive economic growth. They represent a manual with a list of solutions deemed to be the answer to stimulate economies. Harvard research demonstrated that only 14.5% of major liberalizations were followed by growth accelerations, and that only 18.2% of growth accelerations were preceded by major economic liberalization: in essence, the Washington Consensus reforms are not achieving their expected impact.
That was the case in El Salvador around the beginning of the millennium. The country was a reformer, but not a performer: it had adopted a number of “good” market reforms that should have stimulated growth by the book, but the economy was actually stagnating. Why? In practice, economies face multiple distortions and sometimes eliminating one worsens another, significantly reducing the desired impact.
Generating economic growth through production requires multiple inputs – physical materials, human capital, technology, public goods, etc. – and many inputs are complements rather than substitutes: any country needs more of all of those complements at the same time to be able to increase production. As a consequence, the input that is in shortest supply represents the binding constraint preventing economic growth, or the strongest impediment for the country to stimulate development. Following the basic rule of supply and demand, the binding constraint can be identified by analyzing the price of the various production inputs, applied to all inputs: human capital, education, finance, infrastructure and others.
Combining PDIA to the growth diagnostic allows countries to address the strongest constraint to growth, and explore solutions that are true game-changers for their development. For Saint Lucia I have identified the cost of electricity as the country’s binding constraint. In fact, the Caribbean region has one of the highest average electricity tariffs in the world, three times the cost of electricity in the US, and increased by almost 80% over 2002-2014. The prohibitively high costs pushed out of business many manufacturing firms and weigh on the island’s ability to diversify away from tourism.
Technology, knowhow and economic complexity
The adoption of technology is key to accelerate development, and is a significant opportunity for developing and emerging countries to boost their economies. Technology manifests in three forms: 1) Embedded knowledge through tools; 2) Codified knowledge through codes, manuals, formulas; 3) Tacit knowledge in the form of knowhow. While embedded and codified knowledge can easily be transferred across countries and people, knowhow, or the ability to perform a specific task, is only acquired through experience. Given that transferring knowhow is a difficult process, developing countries are limited in their ability to leverage technology to drive growth. In fact, professor Hausmann argued that the biggest difference between rich and poor countries is the amount of knowhow that is diffused in societies, as it determines the amount of complex products that the country is able to produce.
For a country to increase its economic complexity and diversify, each individual in society should have a different knowhow than other individuals, and all should be able to combine knowhow in various ways to generate innovation and new products. Research proves that an increase in economic complexity leads to economic growth: the graph shows the high correlation between diversification and the level of wealth across countries.
So, what can developing and emerging countries concretely do? The data seems to suggest that countries shouldn’t specialize, but rather diversify and look for policies that can increase economic complexity. The process starts with specialization at an individual level, but governments should be focused on increasing the diversification of the economy as a whole. To pursue this strategy, governments should analyze their position in the product space: this gives an indication of the collective knowhow present in their economy and allows to predict opportunities for diversification into similar products that could be developed with the existing skill set. Tools such as the Atlas of Economic Complexity can inform the diversification journey.
Networks, connectivity and development
Harvard research on Chiapas, the poorest state in Mexico, provided an in-depth analysis of the root causes of limited economic growth in the region. It revealed that the binding constraint was not bad finance, or lack of infrastructure, or human capital: it was related to urban transportation. The cost of going to work for the population in the outskirts represented such a high percentage of their salary that it did not pay off to undertake it.
The problem was a lack of connectivity, limiting the poorest part of the population from accessing jobs and deterring companies from opening their industries, causing a severe impediment to economic growth. Diversification into new businesses is only possible if individuals with a certain skill set are able to interact and collaborate with individuals with other capabilities, and that connection increases the productivity of the entire system by generating growth. Development is therefore directly linked to the ability of skilled individuals to connect within a network and share their knowhow with others, so that the system truly adds more value than the sum of its parts. Countries must strategically plan the use of limited resources during the pandemic, and if their objective is economic growth, the critical role that connectivity plays should not be forgotten.
This is a blog series written by the alumni of the Leading Economic Growth Executive Education Program at the Harvard Kennedy School. Participants successfully completed this 10-week online course in July 2020. These are their learning journey stories.