highlight that countries need to be more aware of these features to maintain sustainable development paths.

# _<u>Economic Development and Economic Structure</u>_

An increase in the initial income level (relative to the G7 GDP) decreases the probability of being in either of the higher growth clusters and increases the probability of being in one of the lower growth clusters. This is consistent with income convergence—growth rates are expected to be lower at higher levels of initial income. Interestingly, vulnerability is also a factor—cluster V is more likely than cluster L. This is a control for level of development, which can be related to the income convergence path. Also, we controlled for a country’s progress with its transition path was not statistically significant, but this could reflect the particular transition measure used. Specifically, we used the real GDP deviation from the pre-transition peak, but other measures, such as EBRD transition indicators, may be worth exploring.

A larger oil trade balance (as a percent of exports and imports) reduces the likelihood of being in a lower growth cluster. Specifically, it reduces the probability of being in lower growth and higher vulnerability (V) cluster and the lower growth and lower vulnerability (L) cluster. Conversely, it increases the probability of being in either of the higher growth clusters—and much more so in cluster G than in cluster H.

# _<u>Economic Policies</u>_

A key challenge for emerging markets going forward is to what extent economic policies serve to avoid the worst of all possible outcomes (that is, cluster V); in other words, a high risk (increased vulnerability) and low reward (lower growth) scenario is clearly suboptimal. The main findings are,

- Counter-cyclical fiscal policies seem to lead to an increase in the probability of being in the lower growth and lower vulnerability (L) cluster at the cost of reducing the likelihood of all the other three clusters. This result could be reflecting the fact that fiscal policy is generally tightened when countries have already started showing growing imbalances and signs of vulnerability. Whatever its source, a counter-cyclical fiscal policy serves to slowdown overheating economies and reduce vulnerabilities; not a surprising result, but in line with traditional policy advice. In sum, countercyclical fiscal policies seem to have an effect on both the growth dimension and the vulnerability dimension and, in particular, are likely to lead to cluster L.

- Monetary tightening reduces vulnerability and, perhaps surprisingly, seems to support growth. An increase in monetary tightening reduces the probability of being in the lower growth and higher vulnerability (V) cluster and increases the probability of being in the higher growth and lower vulnerability (G) cluster. Here too the effect appears to be across both the growth and the vulnerability dimensions, but mainly through increasing the likelihood of cluster G.

- Greater exchange rate flexibility is likely to shift a country to a higher growth and higher vulnerability (H) scenario and, more importantly, lead it away from the two lower growth outcomes—cluster V and L. The effect appears to be primarily across the growth dimension, in particular on cluster H.

- De jure measures of capital account liberalization suggest these policies are not good for growth as they appear to shift countries away from clusters G and H while at the same time increasing the likelihood these countries shift to clusters V or L; in other words, the effect is primarily across the growth dimension. In sum, capital account liberalization has a negative growth impact. This

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