Deep roots or current policies – what drives sustained prosperity differences across locations?

Mercedes Delgado, Christian Ketels, Michael Porter, Scott Stern

There is a consensus among economists that ‘deep roots’ – geography, natural endowments, and institutions – are important determinants of prosperity differences across countries. This column argues that deep roots matter, but they are neither the whole story nor an excuse for political inaction today. Current policies are important – especially the broad range of policies that shape the business environment and the sophistication of companies – and they are affected but not determined by the past.

What explains the dramatic differences in prosperity levels across locations? A large segment of the research-oriented literature points towards ‘deep roots’, i.e. legacy factors that have been set long ago (Spolaore and Wacziarg 2012). The debate rages on as to whether geographic location and natural endowments (e.g. McCord and Sachs 2013, Sachs et al. 2001) or institutional legacies – themselves influenced by geography and natural conditions (e.g. Acemoglu et al. 2001, Acemoglu and Robinson 2012) – are key. The more policy-oriented literature has instead focused predominantly on studying the impact of current policies on prosperity differences over the short to medium term, with different efforts integrating this large literature to generate policy blueprints (e.g. OECD 1995) or country rankings (e.g. Sala-i-Martin and Artadi 2004).

Both lines of research have provided important insights for theory and practice. But how do their findings relate to each other? More specifically, does the ‘deep roots’ literature imply that current policy choices are essentially endogenous to the underlying factors that have been shown to be important in the long run? If the answer is yes, policies need to focus on the long term and squarely address these underlying factors to have a sustained impact on prosperity. If the answer is no, even countries with problematic legacies have policy room for action.

Long- and short-term drivers of prosperity: The concept of foundational competitiveness

The analysis of a large country sample covering factors driven both by short- to medium-term policy choices and by long-term underlying factors has allowed us to empirically examine the respective roles of these different drivers of prosperity differences (Delgado et al. 2012). Our approach starts by defining foundational competitiveness as the expected level of output per working-age individual that can be supported by the overall quality of a country as a place to do business. The focus on output per potential worker – a broader measure of national productivity than output per current worker – reflects the dual role of output per worker and workforce participation in determining a nation’s standard of living. Drawing on the literature, we identify three broad drivers of expected output per potential worker that are the outcome of policy choices:

Social infrastructure and political institutions (SIPI) (a terminology that draws on Hall and Jones 1999);

Monetary and fiscal policy; and

The microeconomic environment.

Endowments – geographic conditions and natural resources – are included as a control for natural conditions beyond political control.

We estimate this framework using numerous established data sets covering a sample of more than 130 countries over the period 2001–2008. Our results establish a positive and distinct relation between each of these broad areas and country-level differences in output per potential worker. We find both institutional factors (SIPI) and microeconomic factors to be important and of comparable relevance in their relation to economic outcomes. Monetary and fiscal policies are significant as well, but appear less powerful than institutional and microeconomic factors.1

How do these findings relate to the literature on ‘deep roots’, whether focused on the impact of geographic and other endowments (Sachs et al. 2001) or the institutional legacy of a specific colonial past (Acemoglu et al. 2001)? Natural conditions are included as controls in our analysis; they are significant but do not eliminate or reduce the relationship between any of the three broad dimensions of foundational competitiveness and output per worker (or prosperity). Legacy conditions are included as another independent variable and turn out to play a different role – once they are introduced in the analysis, the current quality of institutions and monetary and fiscal policies lose significance in explaining cross-country differences in output per potential worker. This is consistent with the view that historical legacy has a significant impact on current conditions in these areas. Microeconomic circumstances, however, have a positive relationship with output per potential worker even after controlling for these historical factors. This is consistent with the view that current policies in areas such as physical infrastructure, skills, innovation, and entrepreneurship are important for output per potential worker and are not determined by a location’s legacy.

Deep roots, then, do matter for prosperity, whether they are driven by geography or historical legacies. But the outcomes of current policies – especially on microeconomic conditions – are as important, and are not endogenous to a country’s deep roots. Poor legacy conditions are a burden on prosperity but are not an excuse for poor policies that entrench weak economic outcomes.

The role of deep roots vs. competitiveness in practice: The case of Botswana

A good illustration of how these findings are manifested in a particular country is Botswana. The country has been hailed as one of the most successful development stories of the last 40 years, and has become a frequently cited case in the ‘deep roots’ literature – the country had a legacy of ‘inclusive’ institutions that enabled the creation rather than the extraction of wealth (Robinson et al. 2003). Seen as a poor outpost with little potential, Botswana experienced a relatively mild form of colonisation that left its traditional institutions largely intact. And while it had to deal with the challenges of being land-locked, it had access to significant natural resource wealth in the form of diamonds (McCord and Sachs 2013).

When the country gained independence in 1966, it was very poor. Its impressive subsequent growth has in the literature been explained by its institutional strength that enabled the productive investment of its natural resource wealth. But the country’s path to higher prosperity is getting more challenging; recent analyses reveal how Botswana is finding it increasingly difficult to make effective policy choices at the higher levels of prosperity it has now achieved (World Bank 2012). The dependence on diamonds remains as high as ever, and the numerous attempts at economic diversification (e.g. Government of Botswana 2008), the attraction of foreign companies, and the development of a strong domestic private sector have so far achieved only muted success.

Our framework allows for a detailed assessment of Botswana’s competitiveness profile underlying these outcomes – on social infrastructure and political institutions (SIPI), the country ranked 44th in our sample of 144 countries assessed in 2013 (31st in a sample of 74 countries tracked since 2002). On microeconomic competitiveness, however, it ranked only 92nd (63rd in stable sample), with particularly weak rankings (108th; 69th in stable sample) for the sophistication of company operations and strategies. The trends over the last decade we examined indicate that the gap between SIPI and microeconomic fundamentals has even increased – while macroeconomic competitiveness has remained stable, microeconomic competitiveness has eroded.

Table 1. Botswana’s foundational competitiveness, 2002 vs. 2013

Note: Stable sample of 74 countries; raw data drawn from the World Economic Forum’s Global Executive Opinion Survey, multiple years.

The central policy challenge in Botswana, then, is heavily microeconomic – systematically upgrading firms and the microeconomic business environment. For institutional development and monetary and fiscal policies there is a fair amount of consensus on what constitutes best practices that countries should adopt. The number of individual policy areas in this field is manageable, and they are mainly influenced by government. Microeconomic upgrading is often more difficult given the sheer complexity in the number of interacting policy areas and in the need to involve multiple stakeholders. Policymakers in Botswana face complex choices on where to start and how to ensure implementation. Good basic institutions make it easier to face these choices. But as the country is learning, they do not ensure that the right decisions will be made or that execution will follow.

Deep roots and current policies: The need for an integrated perspective

Our cross-country analysis and the case of Botswana point towards the need for integrating the different perspectives on drivers of cross-country prosperity differences that are often positioned as alternatives in the literature. Deep roots matter but they are neither the whole story nor an excuse for political inaction today. Current policies are important – especially the broad range of policies that shape the business environment and the sophistication of companies – and they are affected but not determined by the past. Effective policy advice needs to understand both the current policies and the deep roots that influence the way these policies emerge and translate into sustained prosperity gains. Researchers and policymakers looking to provide country-specific advice for prosperity upgrading are well advised to take a close look at the full range of factors that drive foundational competitiveness rather than focus on identifying one generic overarching factor.

References

Acemoglu, D, S Johnson, and J A Robinson (2001), “The Colonial Origins of Comparative Development: An Empirical Investigation”, American Economic Review, 91(5): 1369–1401.

Acemoglu, D and S Johnson (2012), Why Nations Fail: The Origins of Power, Prosperity, and Poverty, New York: Random House.

Delgado, M, C Ketels, M Porter, and S Stern (2012), “The Determinants of National Competitiveness”, NBER Working Paper 18249.

Government of Botswana (2008), Botswana Excellence: A Strategy for Economic Diversification and Sustainable Growth, Gaborone: Government of Botswana.

Hall, R E and C I Jones (1999), “Why Do Some Countries Produce So Much More Output per Worker than Others?”, Quarterly Journal of Economics, 114(1): 83–116.

McCord, G C and J Sachs (2013), “Development, Structure, and Transformation: Some evidence on comparative economic growth”, NBER Working Paper 19512.

OECD (2005), Economic Policy Reforms: Going for Growth, Paris: OECD.

Robinson, J A, D Acemoglu, and S Johnson (2003), “An African Success Story: Botswana”, in D Rodrik (ed.), In Search of Prosperity: Analytic Narratives on Economic Growth, Princeton: Princeton University Press: 80–119.

Sachs, J D, A D Mellinger, and J L Gallup (2001), “The Geography of Poverty and Wealth”, Scientific American, March: 71–74.

Sala-i-Martin, X and E V Artadi (2004), “The Global Competitiveness Index”, in The Global Competitiveness Report 2004–2005, Hampshire: Palgrave Macmillan.

Spolaore, E and R Wacziarg (2012), “How Deep Are the Roots of Economic Development?”, NBER Working Paper 18130.

World Bank (2012), “Botswana Development Policy Review: An Agenda for Competitiveness and Diversification”, Unpublished discussion document.

Footnote

1 For details, see Delgado et al. (2012), Table 2.