The Use of Decomposition Methods to Understand the Economic Growth Gap between Latin America and East Asia

Abstract

Understanding how growth factors contribute to explaining the large differences in growth rates across countries remains an important research agenda. The common approach to exploring this issue is based on the use of multiple linear regression analyses. This work contributes to growth literature by applying a new perspective based on the use of variance decomposition procedures: Shapley–Owen–Shorrocks and Oaxaca–Blinder. These methodologies have four main advantages with respect to traditional methodologies: they make possible the quantification of the relative contribution of each factor to economic growth, they allow us to estimate the efficiency in the use of the endowments of each factor, they can be used with any functional form and they can be used with estimation methods that are robust regarding endogeneity issues. We illustrate these advantages by analyzing the causes of the economic growth gap between Latin America and East Asia over the period 1980–2014. We find that the economic growth divergence between the two regions can be primarily explained by the differences in institutions and physical capital. In addition, the results indicate that the higher East Asian performance is not only due to its higher levels of endowments in these factors, but also to the higher efficiency in its use. We connect our results with the 2030 Agenda for Sustainable Development.