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Principles of Economic Growth

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Principles of Economic Growth Powered By Docstoc
					Sources of
Economic
Growth

      Thorvaldur Gylfason
Outline
I. Pictures of growth
II. Determinants of growth
  1.    Saving and investment
  2.    Efficiency
       a)   Liberalization
       b)   Stabilization
       c)   Privatization
       d)   Education
       e)   Diversification
       f)   Distribution
III. Empirical evidence of growth
                           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


                                 Downswing

                                                 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
                           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
                    Growing
                    apart
                                                   Case B: 2% a year
                         Efficiency
Output per capita




                         Economic system
                         Economic policy        Threefold
                                                 difference after
                                                 60 years

                                                   Case A: 0.4% a year


                    0                       60        Years
    Sources of growth:
    Investment and education


                               Growth
                  +                                    +


         Investment                          Education
+   denotes a positive effect in the direction shown
    Sources of growth:
    Investment and education
    Adam Smith knew this, and more, as did Arthur Lewis


                               Growth
                  +                                    +


          Investment                         Education
+   denotes a positive effect in the direction shown
    More sources of growth
Arthur Lewis: x is trade, stable politics, good weather
But Solow carried the day: long-run growth is exogenous!

                                  Growth
                    +                                   +
                                       +
         Investment                   x                Education



+   denotes a positive effect in the direction shown
    More sources of growth
    Suppose our x is openness to trade; then …



                                  Growth
                    +                                   +
                                       +
         Investment             Openness               Education



+   denotes a positive effect in the direction shown
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 two main sources:
    Saving
    Efficiency


   ―The proximate causes of economic growth are
   the effort to economize, the accumulation of
   knowledge, and the accumulation of capital.‖

                                    W. ARTHUR LEWIS
         Botswana and Nigeria: GNP per
Case 1   capita 1962-2001
          3500
                      Botswana
          3000
                      Nigeria

          2500   Current US$,
                 Atlas method
          2000


          1500


          1000


          500


            0
            60

            64

            68

            72

            76

            80

            84

            88

            92

            96

            00
          19

          19

          19

          19

          19

          19

          19

          19

          19

          19

          20
         Egypt, Morocco, and Tunisia:
Case 2   GNP per capita 1962-2001
          2500
                     Tunisia
                     Egypt, Arab Rep.
          2000
                     Morocco

          1500
                 Current US$,
                 Atlas method

          1000



          500



            0
            60

            64

            68

            72

            76

            80

            84

            88

            92

            96

            00
          19

          19

          19

          19

          19

          19

          19

          19

          19

          19

          20
         Madagascar and Mauritius:
Case 3   GNP per capita 1962-2001
          4500

          4000       Madagascar

          3500       Mauritius

          3000   Current US$,
          2500
                 Atlas method

          2000

          1500

          1000

          500

            0
            60

            64

            68

            72

            76

            80

            84

            88

            92

            96

            00
          19

          19

          19

          19

          19

          19

          19

          19

          19

          19

          20
A Tale of Two Countries
          Country A   Country B
A Tale of Two Countries
                          Country A   Country B

Girls at primary school    100%        72%
A Tale of Two Countries
                          Country A   Country B

Girls at primary school    100%        72%
Investment ratio           25%         11%
A Tale of Two Countries
                          Country A   Country B

Girls at primary school    100%        72%
Investment ratio           25%         11%
Export ratio               58%         23%
A Tale of Two Countries
                          Country A   Country B

Girls at primary school    100%        72%
Investment ratio           25%         11%
Export ratio               58%         23%
Primary export ratio       33%         80%
A Tale of Two Countries
                          Country A   Country B

Girls at primary school    100%        72%
Investment ratio           25%         11%
Export ratio               58%         23%
Primary export ratio       33%         80%
Inflation                  10%         18%
A Tale of Two Countries
                          Country A   Country B

Girls at primary school    100%        72%
Investment ratio           25%         11%
Export ratio               58%         23%
Primary export ratio       33%         80%
Inflation                  10%         18%
Growth per capita           3%          -2%
A Tale of Two Countries
And the countries are:    Mauritius   Madagascar

Girls at primary school   100%          72%
Investment ratio           25%          11%
Export ratio               58%          23%
Primary export ratio       33%          80%
Inflation                  10%          18%
Growth 1965-98              3%          -2%
         Madagascar and Mauritius:
Case 3   GNP per capita 1962-2001
          4500

          4000       Madagascar

          3500       Mauritius

          3000   Current US$,
          2500
                 Atlas method

          2000

          1500

          1000

          500

            0
            60

            64

            68

            72

            76

            80

            84

            88

            92

            96

            00
          19

          19

          19

          19

          19

          19

          19

          19

          19

          19

          20
      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 impressive growth performance of Asia
    since the 1960s, or on growth differentials
The new view
  that long-run growth depends on saving and
    efficiency is more illuminating
  Besides, it’s not really new, because Adam Smith
    knew this (1776)
One crucial implication of
exogenous growth
The neoclassical view
  If two countries are identical (same
    saving rate, same population growth,
    same technology), then their income
    per head will ultimately be the same
  This means that poor countries must
    grow faster than – catch up with! – rich
    countries: ―conditional convergence‖
  Endogenous growth theory does not have
    this implication
    Enter initial income

Conditional
convergence                       Growth
                  +                                    +
                           –           ?
     Investment                        x               Education
                                             +
                 Initial Income            Natural Capital

+   denotes a positive effect in the direction shown

–   denotes a negative effect in the direction shown
Absolute                                                                                   r = rank
convergence?                                                                               correlation

                                         10

                                                                        Botswana
                                                                                        r = -0.09
                                          8
Growth of GNP per capita 1965-1998 (%)


                                                  No sign            China            Korea
                                          6       that poor
                                                  countries       Indonesia         Thailand
                                          4       grow faster
                                                  than rich
                                          2
                                                                                                                Conditional
                                          0                                                                     convergence
                                              0        2         4           6         8          10       12   does not
                                         -2                                                                     entail absolute
                                                                                               Nicaragua        convergence
                                         -4
                                                           Log of initial GDP per capita (1965)
      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
Investment and economic
growth
                                                           6
Growth of GNP per capita 1965-1998, adjusted for initial
                                                                    An increase in investment by
                                                                                                                Botswana
                                                                    4% of GDP is associated with an
                                                           4
                                                                    increase in per capita growth by
                                                                    1% per year
                                                           2
                                                                                                         Thailand
                income (% per year)




                                                           0
                                                                0        5      10      15       20        25       30       35

                                                           -2

                                                                                                                    Jordan
                                                           -4                                1%
                                                                                  4%
                                                           -6
                                                                                             Nicaragua
                                                                     r = 0.65
                                                           -8
                                                                       Gross domestic investment 1965-1998 (% of GDP)
     Sources of endogenous
     growth II
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 II
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 II
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
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
Openness to trade and
growth 1965-98
                                                                                            6
Annual growth of GNP per capita 1965-98, adjusted for
                                                              r = 0.40
                                                                                            4
                                                                                                     Korea


                                                                                            2
                                                                                                                   Malaysia
                 initial income (%)




                                                                                                                            Belgium
                                                                                            0
                                                        -40       -30      -20       -10         0     10        20        30     40

                                                                                            -2


                                                                                            -4
                                                              Guinea Bissau
                                                                                                            An increase in openness by
                                                                                            -6              14% of GDP is associated
                                                                                                            with an increase in per capita
                                                                                                            growth by 1% per year
                                                                                            -8
                                                                        Actual less predicted exports 1965-98 (% of GDP)
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
 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
  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
Growth and education,
1965-98
                                               6
                                                                An increase in secondary-school
                                                                enrolment by 25% of each cohort goes
                                               4
 Grow th of GNP per capita 1965-98, adjusted


                                                                along with an increase in per capita
                                                                growth by 1% per year
       for initial incom e (% per year)



                                               2
                                                        Thailand                                   Japan
                                                                                                         Finland
                                               0
                                                    0      20        40        60          80      100         120
                                               -2

                                                                    Ghana
                                                                                 Jamaica        r = 0.72
                                               -4


                                               -6                      Positive but decreasing
                                                                       returns to education
                                               -8
                                                        Secondary-school enrolm ent 1980-97 (% of cohort)
5   Natural resources and
    economic growth

    Natural resources, if not well managed,
       may turn out to be, at best, a mixed
       blessing
    Four possible channels
         Dutch disease
         Rent seeking
         Education
         Investment
    What is the evidence?
Recent literature

Four main linkages:
  1. Dutch disease
      Hurts level or composition of exports
  2. Rent seeking
      Protectionism, corruption
  3. Education
  4. False sense of security
      Poor quality of policies and institutions
  5. Investment
  Enter natural resources


                           Growth
            +                               +
                   –         ?          –
   Investment                x              Education
                       –            +        –
           Initial Income        Natural Capital

Natural resource abundance hurts investment and
education, and hence also growth
              Natural capital and
              economic growth
                                                                        6
               Growth of GNP per capita 1965-98, adjusted for initial                                       An increase in the
                                                                                                            natural capital share by
                                                                        4
                                                                                                            8% goes along with a
                                                                             8 Asian countries              decrease in per capita
                                                                        2       S/Y = 0.32                  growth by 1% per year

                                                                                                Australia
                                   income (%)




                                                                        0
                                                                             0      10         20           30      40        50        60

                                                                        -2
r = rank
correlation                                                             -4                                  8 African countries
                                                                                            Venezuela
                                                                                                                S/Y = 0.05
                                                                        -6

                                                                                                      r = -0.64
                                                                        -8
                                                                                 Share of natural capital in national wealth 1994 (%)
6   Inequality and
    economic growth

    Two views:
      1. Inequality is good for growth
         Too much equality weakens incentives to
          work, save, and acquire an education
      2. Inequality is bad for growth
         Too much inequality reduces social
          cohesion and creates conflict
    What is the empirical evidence?
Growth and inequality,
1965-98
                                                                                            An increase in Gini
                                                  6
                                                           y = -0,0799x + 2,1297
                                                                                            index by 12 points
                                                                                            goes along with a
Per capita growth 1965-98, adjusted for initial
                                                                R2 = 0,1968
                                                                               Korea        decrease in per
                                                  4
                                                                                            capita growth by
                                                                 France
                                                                                            almost 1% per year
                                                                            Thailand
                                                                                                                            No
             income (% per year)




                                                  2
                                                                                                  Lesotho
                                                                                                                            discernible
                                                                                                     Brazil
                                                  0                                                                         sign that
                                                       0            20                 40           60
                                                                                                   South Africa
                                                                                                                       80
                                                                                                                            equality
                                                                      Sweden
                                                  -2                                                                        stands in
                                                                                                            Central
                                                                                                            African
                                                                                                                            the way of
                                                  -4                                                        Republic        economic
                                                           r = -0.50
                                                                                                                            growth
                                                  -6
                                                                                 Gini index
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
   economic diversification
   and perhaps also equality
... 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, investment, 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
Conclusion: It can
be done These slides – and more! – can be viewed
               on my website: www.hi.is/~gylfason

To grow or not to
grow is in large
measure a matter
of choice