Ricardo Hausmann - Growth Diagnostics

Growth Diagnostics

Growth Diagnostics is a methodology developed by Ricardo Hausmann, Dani Rodrik and Andrés Velasco to determine the underlying reasons why some developing economies are not growing as fast as might be expected. The underlying assumption is that different countries experience slow growth for different reasons (compare to the Anna Karenina principle). In the handbook "Doing Growth Diagnostics in Practice", the origin of the term is explained:

The growth diagnostic approach is based on the idea that there may be many reasons why an economy does not grow, but each reason generates a distinctive set of symptoms. These symptoms can become the basis of a differential diagnostic in which the analyst tries to distinguish among potential explanations for the observed growth rate of the economy.

Thus the Growth Diagnostics methodology departs from the "symptoms" of low growth that are visible in a country's economy—for example, low investment. Using a decision tree, all possible causes of these symptoms are inspected and if possible, eliminated. Next, the causes of these causes are scrutinized. This goes on until the most binding constraint to growth in a country is found. This is the constraint that economic policy in the country will need to address to accelerate growth. The authors argue that applying the wrong cure for the wrong disease, i.e. implementing the wrong economic reform in the wrong circumstances, can be both economically unproductive and politically dangerous.

One of the first applications of the Growth Diagnostics methodology was a case study of El Salvador, described in the paper "Growth Diagnostics", co-authored by Dani Rodrik and Andrès Velasco. At the time, the country had good macroeconomic indicators, decent institutions, low interest rates and returns to education. However, it was investing little. According to the authors, the Growth Diagnostics methodology revealed that in the end, the low investment in El Salvador could be brought back to a problem of self-discovery: the country was losing its traditional industries and it was unclear what it should invest in next. This lack of innovative investment ideas, then, was El Salvador's most binding constraint on growth. Since the publication of this paper, the Growth Diagnostics strategy has been adopted by a number of international institutions including the World Bank, the Inter-American Development Bank, the Asian Development Bank, the UK’s Department for International Development and the Millennium Challenge Corporation. The PREM network currently collects country case studies that use the Growth Diagnostics methodology.