Income Benchmark Applied Inclusive Growth Analytics Course June 29, 2009 Leonardo Garrido

Presentation plan  Establish a rationale for benchmarking  Define benchmark guidelines  Identify elements of an income benchmark  Identify elements of a potential growth benchmark  Show practical issues on Income Benchmarking  Tool demo 2

3 Benchmarking, why?  Countries always looking up at peers / role models Theoretical foundations: Subjective well-being theory (Happiness Economics)  Satisfaction from material and non material goods  Interdependent utility functions  For better assessment of a country growth performance and potential As an anchor. Is the country catching up?  (income benchmark tool example) Will it be able to achieve a given target?  To help identify shadow prices in a Growth Diagnostic exercise  Because, despite heterogeneity and idiosyncratic elements, empirical regularities have been found in cross country analysis Predictions from neoclassical growth models : Conditional Convergence  Growth forecasting tool

4  The choice of relevant benchmark countries depends on the question one would like to be answered Are we interested in expected effect of proposed policies?  Look up at “similar” countries  Ideally, one should aspire to a “natural experiment” where the selected benchmark is a replica in all but one respect to the country under study Is it about potential or expected growth outcomes?  Look up at similar countries and initial conditions Is it about achieving long run targets?  Role models Is it about linkages?  Correlate countries on variables of interest Is it about outcomes?  Empirical identification of relevant groups Benchmark guidelines (I)

5 Benchmark guidelines (II)  Similar countries to compare with “Similarity”: Attribute that is thought to primarily determine a given outcome Candidates for similarities include: Initial conditions, income per capita, geographic characteristics, productive structure, export patterns… Collier & O’Connell, Opportunities and Choices: Collier & O’Connell, Opportunities and Choices:  Role models Countries which performance or welfare indicator wants to be attained.  Correlate countries Those affecting /affected by analyzed countries by means of some transmission mechanism.  Outcomes Growth Commission, “13 Success Stories” Growth Accelerations, Hausmann et al (2004) Growth Patterns, Pritchett (2000) Sustained Growth in Africa, Johnson et al. (2007)

6 Elements of an Income Benchmark (I)  Basically, one aims to answer some of the following questions: How long would it take to analyzed country to reach benchmark’s current income level at a given (hypothetical) growth rate? How long would it take to analyzed country to catch up with benchmark country at hypothetical growth rate? How long would it take to attain a given income level category? What growth rate would it be necessary to catch up / reach current income level of benchmark country or reach threshold of next income level category? What income level will it be obtained growing at hypothetical growth rate during specified period of time?  Notice that our questions refer to Income Levels. We are ignoring issues regarding the growth rate, poverty and income distribution. Growth potential to be addressed in next session (Growth Decomposition) Poverty-growth links addressed tomorrow (Kenneth Simler)  Also ignores the relationship between the cycle and the trend

7 Elements of an Income Benchmark: A reality check  Is the hypothetical / desired income level feasible? Feasibility: Country is (and will not be) resource constrained  Input availability / Dynamic input formation compatible with income target Observe we are touching upon the growth rate Observe we are touching upon the growth rate Compare desired with historical trends Compare desired with historical trends Scenarios for TFP: Linked to: Reform, Composition and level of government expenditures… Scenarios for TFP: Linked to: Reform, Composition and level of government expenditures…  External – Internal Balance: Are Saving, Investment and Current Account Balances path compatibles with a given income target / growth rate?  Political economy issues: Will the country be able to do what it takes to accelerate growth / move to a higher income level?  What are the long term growth implications of short term fluctuations? (shocks)

8 Potential growth benchmark  Normally interested in “accelerating” and “sustaining” “high” growth rates These are empirical definitions. See references above (p.5)  Potential growth: Growth rate a country can achieve and sustain at country’s natural rate of unemployment of productive factors (natural rate of output growth). More on this in next session  From benchmarking point of view, it is reasonable to compare “initial conditions” in analyzed countries vis a vis initial conditions present benchmark countries when growth began to accelerate. (Johnson et al, 2007)

9 Income Benchmark Tool Nuts and Bolts (I) Measuring GDP growth  2 ways of calculating annual growth rate of GDP for period T>2: From initial vs final period GDP From OLS regression using all data Methods yields slightly different results, but are highly correlated  Excel example

10 Income Benchmark Tool Nuts and Bolts (II) Formulas  Basic formula How long would it take to analyzed country to reach benchmark’s income level, at analyzed country’s hypothetical growth rate (g)? How long would it take to analyzed country to reach benchmark’s income level, at analyzed country’s hypothetical growth rate (g)? –Y 0 is income level of analyzed country –Y t is income level of benchmark country –Solve for unknown t Time to catch up if analyzed country grows at (g a ) and benchmark country grows at g b ? Time to catch up if analyzed country grows at (g a ) and benchmark country grows at g b ? –Y 0 is income level of analyzed country –Y t is income level of benchmark country –Solve for unknown t –How to interpret negative result? Solve for “g” instead of “t” to answer questions regarding the growth rate Solve for “g” instead of “t” to answer questions regarding the growth rate

11 Income Benchmark Tool Nuts and Bolts (III) Excel formulas  Excel commands to calculate historical growth rates:

12 Income Benchmark Tool Nuts and Bolts (IV). GDP units  Real Prices vs Current Prices  Local Currency Units vs Foreign Currency Units  Parity Purchasing Power  Alternative Methods: World Bank Atlas

GDP comparisons 13 Bottom poorest countries, in per capita GNI (Current US$ vs Current US$ at PPP) 2005

14 Income Benchmark Tool Demo  Some definitions Income choice Atlas Method GDP for allocating countries by income groups  Navigating the file: Picking a country and benchmarks Assumptions Interpretation