Absorptive capacities and economic growth in low and middle income economies

TL;DR

This study extends the concept of absorptive capacity to the national level, identifying key capacities that influence economic growth in low and middle-income countries and providing policy recommendations.

Contribution

It develops a comprehensive framework of six national capacities using factor analysis and links these capacities to economic growth with empirical evidence.

Findings

Enhancing infrastructure, financial, and public policy capacities promotes growth.

Improving human capital with specialized skills positively impacts economic growth.

Provides a ranking of capacities by importance for policy prioritization.

Abstract

I extend the concept of absorptive capacity, used in the analysis of firms, to a framework applicable to the national level. First, employing confirmatory factor analyses on 47 variables, I build 13 composite factors crucial to measuring six national level capacities: technological capacity, financial capacity, human capacity, infrastructural capacity, public policy capacity, and social capacity. My data cover most low- and middle-income- economies (LMICs), eligible for the World Bank's International Development Association (IDA) support between 2005 and 2019. Second, I analyze the relationship between the estimated capacity factors and economic growth while controlling for some of the incoming flows from abroad and other confounders that might influence the relationship. Lastly, I conduct K-means cluster analysis and then analyze the results alongside regression estimates to glean patterns and classifications within the LMICs. Results indicate that enhancing infrastructure (ICT, energy, trade, and transport), financial (apparatus and environment), and public policy capacities is a prerequisite for attaining economic growth. Similarly, I find improving human capital with specialized skills positively impacts economic growth. Finally, by providing a ranking of which capacity is empirically more important for economic growth, I offer suggestions to governments with limited budgets to make wise investments. Likewise, my findings inform international policy and monetary bodies on how they could better channel their funding in LMICs to achieve sustainable development goals and boost shared prosperity.