Do this or do that? A model to prioritize reforms

This paper aims to fill the methodological gap in development economics that until now there exists no quantitative tool that allows to prioritize reforms in a systematic nor optimal way. Following the recent debate on the issues Randomized Control Trials (RCTs) have with establishing external validity and general equilibrium effects, this paper proposes a micro-founded Growth Diagnostics framework to consider general equilibrium effects and prioritize policy prescriptions. Building conceptually on Hausmann et al. (2005), we set up two continuous-time Overlapping Generations (OLG) models to obtain the private and social net-marginal valuations of economic activities as measured by their shadow values. With these in hand, we define the wedges in the net-marginal private and social valuations to set up a new planner problem (the super policy maker problem), where the planner minimizes an aggregate function of disagreement as measured by the wedges. We illustrate our frame-work with an application to the literature on structural change. Worth noting, the final wrapping optimization problem allows to prioritize optimally economic reforms in a second-best framework, thus, to put it in the words of Rodrik (2010), to first diagnose before one prescribes the remedy.