Why we learn nothing from regressing economic growth on policies by Dani Rodrik Presented by Olexiy Polkovnikov Wisdom Ejebugha Warsaw University 05 November 2007

Outline Introduction Economic policies in cross national regressions Origins of problems Other Limitations Conceptual insight Rodrik’s simple model Results of reasoning Technical constituent Conclusion

Introduction Cross-country regressions An approach to asses policy effectiveness and its influence on growth

Economic policies in cross national regressions Fiscal policy Government consumption Inflation Black market premia on foreign exchange Overvaluation of the exchange rate Financial liberalization Trade policy State ownership in industry or banking Industrial policy

Origins of problems Parameter heterogeneity Outliers Omitted variables Model uncertainty Measurement errors Endogeneity

Other Limitations Doubtful statistical basis upon which inferences are drawn from cross-country regressions Partial correlations not behavioral relations The growth process is universal

Conceptual insight Limitations of existing analysis To overcome the oversimplification Mathematics as the tool for desegregation Reviving cross-country regressions

Rodrik’s simple model Policy distribution Increase the social welfare Creation and distribution of rents Parameters Honesty Extent of market imperfections Ability

Rodrik’s simple model cotd The solution comes from the politician maximization problem, and it is suboptimal due to diversion factor. Sensitivity analysis yields us the range of channels of influence of policy on growth

Results of reasoning An increase in policy is rarely accompanied by a rise in growth Politician may be a social-welfare maximizer Cross-national relationship between policy and growth is always negative resulting from variations in honesty and need for intervention across countries

Technical constituent Level of income to be regressed on productivity and not growth rate Maximization without constraints

Technical constituent cotd Overstatement of policy endogeneity Proper formulation and definition of theoretical model

Conclusion Full specification is needed Correlation is not causality Higher level of desegregation is desirable

Thank you

Further reading 1 Brunetti Aymo (1997): ‘Political Variables in Cross-country Growth Analysis’: The measures of most political variables are unsuccessful while others are successful as explanatory variables in cross-country growth regressions

Further reading 2 Ross Levine and Sara J. Zervos (1993): Vol. 83 American Economic Review ‘What we have learned about Policy and Growth from Cross-country Regressions?’ There is always fragile relationship between policy variables with short-run impacts when regressed on cross-country data over a long period of time

Further reading 3 Mattew McCartney (2006); ‘Can a Heterodox Economist use Cross-country Growth Regressions’ Explores rationale that cross-country regressions are an intrinsically poor method to isolate the link between changes in policy and changes in economic growth rates