Economic Growth Around the World Thorvaldur Gylfason Growing Together, Growing Apart West-Germany : East-Germany Austria : Czech Republic Finland : Estonia Economic system National economic output Taiwan : China South Korea : North Korea Rapid growth Botswana : Nigeria Kenya : Tanzania Thailand : Burma Tunisia : Morocco Economic policy? Spain : Argentina Mauritius : Madagascar Slow growth Time Botswana and Nigeria: GNP per Case 1 capita 1964-97 3500 Botswana 3000 Nigeria 2500 Current US$, 2000 Atlas method 1500 1000 500 0 64 67 70 73 76 79 82 85 88 91 94 97 19 19 19 19 19 19 19 19 19 19 19 19 Kenya, Tanzania, and Uganda: Case 2 GNP per capita 1964-97 500 450 Kenya 400 Tanzania 350 Uganda 300 Current US$, 250 Atlas method 200 150 100 50 0 64 67 70 73 76 79 82 85 88 91 94 97 19 19 19 19 19 19 19 19 19 19 19 19 Burma and Thailand: Case 3 GNP per capita 1960-97 700 Burma 600 Thailand 500 Local currency, 1988 prices, 400 1960 = 100 300 200 100 0 60 63 66 69 72 75 78 81 84 87 90 93 96 19 19 19 19 19 19 19 19 19 19 19 19 19 Barbados, Dominican Republic, Case 4 and Haiti: GNP per capita 1964-98 9000 Barbados 8000 Haiti 7000 Dominican Republic 6000 5000 Current US$, Atlas method 4000 3000 2000 1000 0 64 67 70 73 76 79 82 85 88 91 94 97 19 19 19 19 19 19 19 19 19 19 19 19 Egypt, Morocco, and Tunisia: Case 5 GNP per capita 1964-97 2500 Egypt 2000 Morocco Tunisia 1500 Current US$, Atlas method 1000 500 0 64 67 70 73 76 79 82 85 88 91 94 97 19 19 19 19 19 19 19 19 19 19 19 19 Argentina, Uruguay, and Spain: Case 6 GNP per capita 1964-97 16000 Argentina 14000 Spain 12000 Uruguay 10000 Current US$, Atlas method 8000 6000 4000 2000 0 64 67 70 73 76 79 82 85 88 91 94 97 19 19 19 19 19 19 19 19 19 19 19 19 Madagascar and Mauritius: Case 7 GNP per capita 1964-97 4500 4000 Madagascar Mauritius 3500 3000 Current US$, Atlas method 2500 2000 1500 1000 500 0 64 67 70 73 76 79 82 85 88 91 94 97 19 19 19 19 19 19 19 19 19 19 19 19 Chile and Zambia: Case 8 GNP per capita 1964-98 6000 Chile 5000 Zambia 4000 Current US$, Atlas method 3000 2000 1000 0 64 67 70 73 76 79 82 85 88 91 94 97 19 19 19 19 19 19 19 19 19 19 19 19 Economic Growth: The Short Run vs. the Long Run Economic growth Potential output National economic output in the long run Actual output Upswing Business cycles in the short run The crisis of 1997-98 is irrelevant to Asia’s Downswing long-term growth potential. Time Economic Growth: The Short Run vs. the Long Run To analyze the movements of actual output from year to year, viz., in the short run Need short-run macroeconomic theory Keynesian or neoclassical To analyze the path of potential output over long periods Need modern theory of economic growth Neoclassical or endogenous The Neoclassical Theory of Exogenous Economic Growth Traces the rate of growth of output per capita to a single source: Technological progress Hence, economic growth in the long run is immune to economic policy, good or bad. “To change the rate of growth of real output per head you have to change the rate of technical progress.” ROBERT M. SOLOW The New Theory of Endogenous Economic Growth Traces the rate of growth of output per capita to three main sources: Saving Efficiency Depreciation “The proximate causes of economic growth are the effort to economize, the accumulation of knowledge, and the accumulation of capital.” W. ARTHUR LEWIS Exogenous vs. Endogenous Growth The neoclassical view that economic growth in the long run is merely a matter of technology does not throw much light on the spectacular growth performance of Asia since the 1960s. The new view that long-run growth depends on saving, efficiency, and depreciation is more illuminating. Besides, it’s not really new, because Adam Smith knew this (1776). A Simple Model of Endogenous Growth Four building blocks: S=I Saving equals investment in equilibrium. S = sY Saving is proportional to income. I = K + K Investment involves addition to capital stock. Y = EK Output depends on quality and quantity of capital. A Simple Model of Endogenous Growth Implication: g = sE - Rate of economic growth equals Saving rate times Efficiency (i.e., the output/capital ratio) minus Depreciation Endogenous Growth in the Harrod-Domar Model You may recognize the endogenous growth model as a reinterpretation of the Harrod-Domar model where growth depends on A. the saving rate B. the capital/output ratio C. the depreciation rate Sources of Endogenous Growth I Saving Fits real world experience quite well No coincidence that, in East Asia, saving rates of 30- 40% of GDP went along with rapid economic growth No coincidence either that many African economies with saving rates around 10% of GDP have been stagnant OECD countries: saving rates of about 20% of GDP Important implication for economic policy: Economic stability with low inflation and positive real interest rates spurs saving, which is good for growth. Sources of Endogenous Growth I Income per capita 400 East Asia 300 200 OECD 100 Africa 1965 1990 Growth and Investment, 109 countries 1965-98 10 Each ten percentage point Botswana 8 increase in the investment Growth per capita (% per year) ratio is associated with an 6 increase in per capita growth by 1½% per year. 4 1½% 2 10% 0 0 10 20 30 40 50 -2 -4 -6 Investment (% of GDP) 33 sub- Saharan Growth and Investment, African countries 1965-98 10 Each ten percentage point 8 increase in the investment ratio is associated with an Growth per capita (% per year) 6 increase in per capita growth by 1½% per year. 4 2 0 0 10 20 30 40 50 -2 -4 -6 Investment (% of GDP) Sources of Endogenous Growth II Depreciation The effect of depreciation on growth is related to that of saving and investment on growth. Unprofitable investment in the past reduces the quality of capital and makes it depreciate more rapidly, necessitating more replacement investment to make up for economic and physical wear and tear. The more national saving has to be set aside for replacement investment, the less will be available for the buildup of new capital. Investment: Quantity and Quality Compare Botswana and Tanzania: In Botswana, the share of State-Owned Enterprises in total investment fell from 16% in 1985-90 to 12% in 1990-97. In Tanzania, the SOE share of investment fell from 46% in 1985-90 to 23% in 1990-97. This is probably a good sign. Privatization helps improve investment. Investment: Quantity and Quality Investment quality, however, is not only a question of public vs. private enterprise. Sound banking is also important. It takes sound commercial banks, usually privately owned banks motivated by profit rather than by political concerns, to channel household savings into high-quality investment. Sources of Endogenous Growth III Efficiency Also fits real world experience quite well Technical progress is good for growth because it allows us to squeeze more output out of given inputs. And that is exactly what increased efficiency is all about! Thus, technology is best viewed as an aspect of general economic efficiency. Important implication for economic policy: Everything that increases economic efficiency, no matter what, is also good for growth. Sources of Endogenous Growth III Five sources of increased efficiency 1. Liberalization of prices and trade increases efficiency, which is good for growth. 2. Stabilization reduces the inefficiency associated with inflation, which is good for growth. 3. Privatization reduces the inefficiency associated with state-owned enterprises, which … 4. Education makes the labor force more efficient. 5. Technological progress also enhances efficiency. The possibilities are virtually endless! Sources of Endogenous Growth III This is good news. If growth were merely a matter of technology, we would not be able to do much about it … … except to follow technology-friendly policies by supporting R&D and such. But if growth depends on saving and efficiency, there are things that we can do, in the private sector as well as through the public sector, to foster rapid economic growth. Because everything that is good for saving and efficiency is also good for growth. What to Do to Encourage Economic Growth Maintain strong incentives to save Keep inflation low and real interest rates positive Maintain financial system in good health so as to channel saving into high-quality investment Foster efficiency 1. Liberal price and trade regimes 2. Low inflation 3. Strong private sector 4. More and better education 5. Limited, or well managed, natural resources 1 Liberalization and Economic Growth Liberalization of prices means that markets, not bureaucrats, are allowed to set prices. Mixed market economy is more efficient than central planning. Compare former Soviet Union with the US and Europe Liberalization of trade allows specialization according to comparative advantage. Free trade is more efficient than self-sufficiency. North Korea and Cuba vs. Hong Kong and Singapore Applies to trade in goods, services, capital. Growth and Trade, 105 countries 1965-98 10 Botswana 8 China Singapore Growth per capita (% per year) 6 Korea Hong Kong 4 Each 50 percentage point increase in the trade ratio is associated 2 with an increase in per capita growth by almost 1% per year. 0 0 50 100 150 200 250 300 350 -2 United Arab Emirates -4 -6 Trade (% of ppp-adjusted GDP) NB: UAE, Hong Kong, and Singapore. 32 sub- Saharan Growth and Trade, African countries 1965-98 10 Each 20 percentage point 8 increase in the trade ratio is associated with an increase in per Growth per capita (% per year) 6 capita growth by 1% per year. 4 2 0 0 20 40 60 80 100 -2 -4 -6 Trade (% of ppp-adjusted GDP) Growth and Foreign Direct 100 countries Investment, 1965-98 10 Each three percentage 8 point increase in the FDI ratio is associated Singapore Growth per capita (% per year) with an increase in Botswana 6 per capita growth by almost 1% per year. 4 2 0 0 2 4 6 8 10 12 14 -2 -4 Foreign direct investment (% of ppp-adjusted GDP) Qualification: Relationship rests on Botswana and Singapore. 31 sub- Saharan Growth and Foreign Direct African countries Investment, 1965-98 10 Each one percentage point increase in the 8 FDI ratio is associated with an increase in Growth per capita (% per year) per capita growth by almost 1% per year. Botswana 6 4 2 0 0 2 4 6 8 -2 -4 Foreign direct investment (% of ppp-adjusted GDP) Relationship depends on the inclusion of Botswana. 2 Stabilization and Economic Growth Stabilization of prices means that distortions associated with inflation are reduced. Inflation distorts the choice between real and financial capital by punishing money holdings, and thus creates inefficiency in production. Inflation thus involves a tax, the inflation tax. An inefficient tax compared with most other taxes. Inflation also creates uncertainly which tends to discourage trade and investment. Inflation also tends to result in overvaluation of currency, thus hurting exports and growth. 3 Privatization and Economic Growth Privatization means that profit-oriented owners and able managers are allowed to direct enterprises. Profit motive replaces political considerations as the guiding principle of business operations. Profit-maximizing owners generally want to appoint managers and staff on merit rather than on the basis of political connections, for example. Private enterprise is generally more efficient than state-owned enterprises. Same Story Time and Again Free trade is good for growth Reduces the inefficiency that results from restrictions on trade Price stability is good for growth Reduces inefficiency resulting from inflation Privatization is good for growth Reduces inefficiency resulting from SOEs Education is good for growth Reduces the inefficiency that results from inadequate education Same Story Time and Again Can describe this by simple arithmetic The efficiency gain from eliminating an economic distortion (trade restrictions, inflation, unnecessary state intervention, insufficient education) is directly proportional to the square of the distortion: E = mc2 E stands for efficiency gain, m is a multiplicative constant, and c is the distortion E= mc2 If the distortion is substantial (severe trade restrictions, high inflation, big SOE sector, poor education), then reducing or eliminating the distortion can increase efficiency and growth a great deal. We can see this by plugging appropriate numbers into the formula and also by econometric research, where the theory is compared with experience (i.e., economic statistics). 4 Education and Economic Growth Education means a better trained and hence more efficient work force. Need to provide primary and secondary education to all, especially females Need to provide tertiary education to a greatly increased number of people Need increased public commitment to education This requires both increased public expenditure on education and probably also increased scope for private sector involvement in education. Growth and Education, 86 countries 1965-98 10 An increase in secondary-school enrolment by 40% 8 of each cohort goes Growth per capita (% per year) along with an 6 increase in per capita growth by 4 1% per year. 2 0 0 20 40 60 80 100 120 140 -2 -4 Secondary-school enrolment 1980-97 (% ) 33 sub- Saharan Growth and Education, African countries 1965-98 10 Each two percentage point 8 increase in the education Growth per capita (% per year) expenditure ratio is associated 6 with an increase in per capita growth by about 1% per year. 4 2 0 0 1 2 3 4 5 6 7 8 -2 -4 -6 Public expenditure on education (% of GNP) 5 Natural Resources and Economic Growth Natural resources, if not well managed, may turn out to be, at best, a mixed blessing. Three possible channels Education Dutch disease Rent seeking What is the evidence? Natural Resources and 86 countries Economic Growth 1965-98 10 A ten percentage point 8 increase in the natural capital share goes along Growth per capita (% per year) 6 with a decrease in per capita growth by nearly 4 1% per year. 2 0 0 10 20 30 40 50 60 -2 -4 Share of natural capital in national wealth (%) Abundant natural resources, if not well managed, appear harmful to growth. Natural Resources and 90 countries Education 9 Public expenditure on education (% of GNP) 8 An 18 percentage point increase in the natural 7 capital share is associated with a decrease in public 6 expenditure on education 5 by 1% of GNP. 4 Abundant 3 natural 2 resources 1 appear to 0 crowd out 0 10 20 30 40 50 60 human Share of natural capital in national wealth (%) resources. Natural Resources and 45 countries Corruption 10 New Zealand 9 8 7 Corruption index 6 5 4 Abundant 3 natural 2 resources appear to 1 go along 0 with 0 5 10 15 20 25 corruption. Share of natural capital in national wealth (%) What Is the Upshot? Economic growth responds to public policy. In particular, by encouraging saving and investment of high quality foreign trade and investment education ... the government can help foster rapid economic growth. Sir Arthur Lewis Got It Right Since the second world war it has become quite clear that rapid economic growth is available to those countries with adequate natural resources which make the effort to achieve it. W. ARTHUR LEWIS (1968) What Else? These lessons are borne out by experience from around the world. Additional lessons: Too much inflation hurts saving, investment, and trade — and thereby also growth. Too much SOE activity hurts the quality of investment and education — and growth. Too much agriculture and, more generally, natural resource dependence, if not well managed, hurts education and trade — and thereby also growth. Too rapid population growth also tends to impede economic growth. Reservations Even so, the question of rapid growth is, of course, a bit more complicated. We also need to address a host of political, social, and cultural questions as well as questions of natural conditions, climate, and public health — which would take us too far afield. But the main point remains: To grow or not to grow is in large measure a matter of choice. Many of the constraints on growth are man- made, and can be removed. In Conclusion: It Can Be Done Economic growth makes a difference, especially in poor countries. A question literally of life and death And not only in poor countries, for there is poverty amid plenty in rich countries Recall the main point of Gunnar Myrdal’s Asian Drama (1968): It was that the Asian economies were incapable of rapid economic growth! New growth theory suggests that similar claims about Africa will also be proven wrong. In Conclusion: It Can Be Done There has been much progress in economic policy and performance around the world in the 1990s. Growth-friendly reforms have been widely embraced among ordinary people and politicians across the political spectrum, not only in Asia, but also, increasingly, in other parts of the world, including Africa. Yet, various special interest groups try to resist. In Conclusion: It Can Be Done These slides can be viewed on my website: www.hi.is/~gylfason/copenhagen.ppt ‘Reformers have the idea that change can be achieved by brute sanity.’ George Bernard Shaw To grow or not to grow is in large measure a matter of choice.