Saturday, October 18, 2008

I just noticed I might have wasted a few months of my life...

I just came across a really interesting paper by Ricardo Hausmann and company on growth diagnostics. They illustrate the problem of identifying binding constraints in an economy with the following example from the animal kingdom (Ricardo is great at coming up with such short stories for motivating his work):

"Suppose you were asking: what is the binding constraint to animals thriving in the Sahara desert? This is not unlike the question of what limits economic growth in a country. However, in the Sahara, it is instructive to note that of those few animals that do thrive in that environment, a very large proportion are camels and a very small proportion are hippopotamus. The fact that the animals most intensive in the use of water, hippopotamus, are scarce while the animals least intensive in the use of water, camels, are thriving suggests that the supply of water may be a binding constraint to the spread of animals in the Sahara.

In general, the idea is that looking at the nature of the most successful parts of the economy can be informative of the constraints that affect others. We would expect to observe that those who are either structurally less intensive in the constrained factor, or at least more able to bypass it, will be doing comparatively well. Conversely, those sectors most intensive in the constraint will be doing relatively poorly."

The idea is that surveys/interviews with firms to identify binding constraints, usually conducted with the relatively more successful companies, can take you in the useful direction because these firms are successful precisely because they have been able to surmount these constraints one way or another. For example, if such firms are reporting that customs is not a binding constraint, it may be that they bribe the officials to get their goods across, while corruption continues to be a major impediment.

At my previous life in Ankara, I spent a few months net working on the Turkey Investment Climate Assessement. In fact, we were using the TOBB database of firms, which covers all the registered enterprises rather than a limited (and therefore biased) databases such as from TUSIAD (for an extreme case of this problem, see McKinsey 2003, which used the largest firms to make inferences on whole sectors). However, by taking our sample from registered firms, we were totally ignoring unregistered firms, i.e. the informal sector (we even had a section on informality in the survey).

What is the solution? The "waste of life" in the subject was a bit of an exaggeration; the Worldbank ICA surveys have definitely been useful, at least for Turkey. But to identify the real bottlenecks in the economy, it could have been identified with the De Soto way, i.e. taking the informal sector into the picture.

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