One key example of the post-1990s literature is the volume Economic Growth in the
1990s: Learning from a Decade of Reform (World Bank, 2005). It concludes that
although the necessary fundamentals for growth, such as a stable macroeconomic
environment, enforcement of property rights, openness to trade, and effective
government, are key factors in the growth process, they are not the whole story. This
work and the work of the Growth Commission highlight the diverse ways in which the
fundamentals can interact with policies and institutional setups in different country
contexts.
An important insight from this stream of research is that numerous distortions exist
at any time in a given country, and that some are more important than others.
Moreover, as posited in the theory of the second best, it can actually be welfare reducing
to institute reforms that remove some distortions as long as other distortions remain,
which is the case in all real economies.13
Targeting the distortion associated with the biggest multiplier,14 and therefore the
largest direct welfare impact, is a good alternative since the second best effects are
typically hard to estimate with accuracy. Other options include targeting all distortions