Variables for Sustained Growth- 2015 Index
Economic theory tells us that countries’ performance, in terms of GDP growth, is driven primarily by three factors: growth in employment (Labour), growth in capital stock, and improvements to Total Factor Productivity (TFP). Productivity therefore has a major role to play in determining the level of wealth that countries will attain.
Numerous factors are likely to influence productivity in each country, but for public policy makers and investors it is important to understand how some of the major elements evolve over time and how each country’s performance compares to its peers, in order to gain better understanding of the economic growth potential of their country and how its future course could be improved.
The Variables for Sustained Growth (VSG) Index was developed in order to compare the productivity potential of different countries across a broad range of areas. It forms part of a set of models that are used to assess countries’ long term economic growth.
The VSG Index comprises 21 series, which were selected based on academic studies and business survey results to assess countries’ productivity performance. The importance of each category in the index, as captured by the weights used for each series, was determined by econometric analysis, as well as by primary research.1
There is substantial amount of correlation between the individual series making up the index. This is consistent with a balanced development path, where progress across economic infrastructure goes hand-in hand with improvements in the institutional framework.
The VSG Index is divided into five pillars:
- Macroeconomic stability
- Openness to catch up in best practice
- Infrastructure quality
- Human capital
- Strength of public institutions
Nigeria: Stronger public institutions
President Buhari’s election victory on the back of popular demand to reduce corruption and strengthen some of Nigeria’s public institutions highlights the burden lack of developed public institutions represents for the economy.
Even though the country has achieved above-average GDP growth in recent years, economic performance was still below the potential, while recent lower oil prices have put further pressure on the government to deliver public services and investment with fewer resources.
In order to estimate how far the Nigerian economy is held back by its weak public institutions, we looked at the difference in economic growth a rise in this part of the VSG Index could generate. To do so, we raised Nigeria’s current score of 3.4 in the VSG category for institutions’ strength to 9.1, which is equivalent to the VSG value of Finland, the highest performer.
Chart 3 below outlines the growth path for Nigeria under the two scenarios. Average annual GDP growth is expected to be 1.4% higher in 2020-25 in a scenario of stronger public institutions, with the difference in annual GDP growth gradually narrowing to just over 0.4% by 2045-50.
Conclusion and how the VSGs can be used
Performance in the 2015 VSG Index ranged from 8.4 in Luxembourg to only 1.8 in the Central African Republic. Such a wide range represents the challenges and opportunities faced by many countries to up their game and provide better prospects for their people.
While developed economies fared relatively well in our 2015 index, some developing countries, such as Malaysia and Chile, were not far behind, illustrating how economies with lower levels of wealth could reach relatively high productivity potential.
There are numerous areas that influence countries’ productivity performance. The VSG Index aims to capture the major parts, and offers policy makers and investors an insight into countries’ performance and how it compares to peers and those best in class in each category.
Performance in the VSG Index, together with changes to the future labour and capital stocks, is also used to ascertain countries’ long-term growth prospects. Improvements in areas covered by the VSGs, including transport infrastructure, technology readiness, and the strength of public institutions can have significant impact on future economic growth and wealth, as illustrated in this report.
How the VSG Index can be used
It is important for policy makers to understand how different policy options would impact economic performance. The VSG Index is used in conjunction with our long term growth model to translate different policy options into alternative economic scenarios.
Alternative policy scenarios are created through:
- benchmarking analysis – the selection of a benchmark country whose performance a government wishes to emulate in one area; and
- policy change simulation – the estimation of the impact on the VSG Index from a specific policy option.
Investors can use the same methodology to demonstrate how improvements in areas such as infrastructure, health, or education originated by their investment would impact economic growth in the countries where they plan to invest.