Benchmarking the performance of an economy is a way to identify factors that hold private investment in a country low.<sup>11</sup> Since benchmarking for growth diagnostics is done with the objective of identifying the key constraints to private investment and growth, it is important to select an appropriate group of comparator countries. The core group of comparators must consist of countries that share similar characteristics with the country of interest, and are at a similar stage of development, but it should also include good performers in the region, as well as regional averages for countries in different income groups. The group of comparators however can vary depending on the question one needs to address. For example, when one would like to assess whether the cost of capital is high in a country, the group of comparators must include countries with similar credit worthiness ratings. When addressing questions about logistics and transport costs, the group of comparators must include land-locked countries with similar types of traded goods.

While useful for identifying problem areas, benchmarking for growth diagnostics has limitations and should be used with caution. Comparisons in benchmarking exercises are meaningful only if the indicators are constructed following procedures that are consistent across countries. It is therefore important to use databases that are transparently documented in terms of data sources and data construction methods. A change in the set of comparator countries for an indicator may change the conclusions from a benchmarking exercise, suggesting that benchmarking should be used jointly with other methods to shed light on constraints to growth. Evidence that a country ranks low on a given indicator does not imply that the area is a ‘binding’ constraint to growth. There are countries that rank very low in terms of corruption, for instance, but have booming economies. Finally, economists should be aware of what the indicators used in benchmarking exercises measure and how they are constructed. This is especially important for indicators that proxy difficult to measure aspects of the business environment.

Benchmarking is only one approach to identifying the key factors constraining private investment in a country. A thorough growth diagnostics exercise necessitates other methods including analyses based on macroeconomic, investment climate and trade data, industry studies, and other sources. This type of in-depth growth analysis is presented here in the case of Mongolia and can be used as an example of “how to” of growth diagnostics in the context of other low income countries. Next section lays out the steps we follow to formulate a growth diagnosis.

> 11 Benchmarking, initially used only in industry, is now widely applied in many areas. Benchmarking the investment climate, for instance, involves comparing different aspects of a country’s investment climate with those of their competitors. Benchmarking is also used in order to identify the potential for productivity improvements, for instance, that of labor productivity. Hausmann, Rodrik and Velasco (2005) also use benchmarking to identify binding constraints.

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