Transcript Principles of Economic Growth

Economic
Growth
Around the
World
Thorvaldur Gylfason
National economic output
Growing Together,
Growing Apart
West-Germany : East-Germany
Austria : Czech Republic
Economic system
Finland : Estonia
Taiwan : China
South Korea : North Korea
Rapid growth
Botswana : Nigeria
Kenya : Tanzania
Thailand : Burma
Economic policy?
Tunisia : Morocco
Spain : Argentina
Mauritius : Madagascar
Slow growth
Time
3500
Botswana
3000
Nigeria
2500
2000
Current US$,
Atlas method
1500
1000
500
19
97
19
94
19
91
19
88
19
85
19
82
19
79
19
76
19
73
19
70
19
67
0
19
64
Case 1
Botswana and Nigeria: GNP per
capita 1964-97
500
450
Kenya
400
Tanzania
350
Uganda
300
Current US$,
Atlas method
250
200
150
100
50
19
97
19
91
19
94
19
88
19
82
19
85
19
76
19
79
19
73
19
67
19
70
0
19
64
Case 2
Kenya, Tanzania, and Uganda:
GNP per capita 1964-97
700
Burma
600
500
400
Thailand
Local currency,
1988 prices,
1960 = 100
300
200
100
0
19
60
19
63
19
66
19
69
19
72
19
75
19
78
19
81
19
84
19
87
19
90
19
93
19
96
Case 3
Burma and Thailand:
GNP per capita 1960-97
9000
Barbados
8000
Haiti
7000
Dominican Republic
6000
5000
Current US$,
Atlas method
4000
3000
2000
1000
19
97
19
94
19
91
19
88
19
85
19
82
19
79
19
76
19
73
19
70
19
67
0
19
64
Case 4
Barbados, Dominican Republic,
and Haiti: GNP per capita 1964-98
2500
Egypt
Morocco
2000
Tunisia
1500
Current US$,
Atlas method
1000
500
19
97
19
94
19
91
19
88
19
85
19
82
19
79
19
76
19
73
19
70
19
67
0
19
64
Case 5
Egypt, Morocco, and Tunisia:
GNP per capita 1964-97
16000
Argentina
14000
Spain
Uruguay
12000
10000
Current US$,
Atlas method
8000
6000
4000
2000
19
97
19
94
19
91
19
88
19
85
19
82
19
79
19
76
19
73
19
70
19
67
0
19
64
Case 6
Argentina, Uruguay, and Spain:
GNP per capita 1964-97
4500
4000
3500
3000
Madagascar
Mauritius
Current US$,
Atlas method
2500
2000
1500
1000
500
19
82
19
85
19
88
19
91
19
94
19
97
0
19
64
19
67
19
70
19
73
19
76
19
79
Case 7
Madagascar and Mauritius:
GNP per capita 1964-97
6000
Chile
5000
4000
Zambia
Current US$,
Atlas method
3000
2000
1000
19
97
19
94
19
91
19
88
19
85
19
82
19
79
19
76
19
73
19
70
19
67
0
19
64
Case 8
Chile and Zambia:
GNP per capita 1964-98
National economic output
Economic Growth:
The Short Run vs. the Long Run
Economic growth
in the long run
Potential output
Actual output
Upswing
Downswing
Business cycles
in the short run
The crisis of 1997-98
is irrelevant to Asia’s
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 3040% 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
Growth per capita (% per year)
10
Each ten percentage point
increase in the investment
ratio is associated with an
increase in per capita
growth by 1½% per year.
8
6
Botswana
1½%
4
10%
2
0
0
10
20
30
-2
-4
-6
Investment (% of GDP)
40
50
Growth and Investment,
1965-98
10
Each ten percentage point
increase in the investment
ratio is associated with an
increase in per capita
growth by 1½% per year.
8
Growth per capita (% per year)
33 subSaharan
African
countries
6
4
2
0
0
10
20
30
-2
-4
-6
Investment (% of GDP)
40
50
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.
2.
3.
4.
5.
Liberal price and trade regimes
Low inflation
Strong private sector
More and better education
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
Growth per capita (% per year)
10
8
Botswana
China
6
Korea
Singapore
Hong Kong
Each 50 percentage point increase
in the trade ratio is associated
with an increase in per capita
growth by almost 1% per year.
4
2
0
0
50
100
150
200
250
-2
United Arab Emirates
-4
-6
Trade (% of ppp-adjusted GDP)
NB: UAE, Hong Kong, and Singapore.
300
350
Growth and Trade,
1965-98
10
Each 20 percentage point
increase in the trade ratio is
associated with an increase in per
capita growth by 1% per year.
8
Growth per capita (% per year)
32 subSaharan
African
countries
6
4
2
0
0
20
40
60
-2
-4
-6
Trade (% of ppp-adjusted GDP)
80
100
Growth and Foreign Direct
100
countries Investment, 1965-98
Growth per capita (% per year)
10
Each three percentage
point increase in the
FDI ratio is associated
with an increase in
per capita growth by
almost 1% per year.
8
6
Botswana
Singapore
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.
Growth and Foreign Direct
Investment, 1965-98
10
Growth per capita (% per year)
31 subSaharan
African
countries
Each one percentage point increase in the
FDI ratio is associated with an increase in
per capita growth by almost 1% per year.
8
Botswana
6
4
2
0
0
2
4
6
-2
-4
Foreign direct investment (% of ppp-adjusted GDP)
Relationship depends on the inclusion of Botswana.
8
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=
2
mc
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
An increase in
secondary-school
enrolment by 40%
of each cohort goes
along with an
increase in per
capita growth by
1% per year.
Growth per capita (% per year)
10
8
6
4
2
0
0
20
40
60
80
100
120
-2
-4
Secondary-school enrolment 1980-97 (% )
140
Growth and Education,
1965-98
10
Growth per capita (% per year)
33 subSaharan
African
countries
Each two percentage point
increase in the education
expenditure ratio is associated
with an increase in per capita
growth by about 1% per year.
8
6
4
2
0
0
1
2
3
4
5
6
-2
-4
-6
Public expenditure on education (% of GNP)
7
8
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
increase in the natural
capital share goes along
with a decrease in per
capita growth by nearly
1% per year.
Growth per capita (% per year)
8
6
4
2
0
0
10
20
30
40
50
-2
-4
Share of natural capital in national wealth (%)
Abundant natural resources, if not well managed,
appear harmful to growth.
60
Abundant
natural
resources
appear to
crowd out
human
resources.
Public expenditure on education (% of GNP)
Natural Resources and
90
countries Education
9
An 18 percentage point
increase in the natural
capital share is associated
with a decrease in public
expenditure on education
by 1% of GNP.
8
7
6
5
4
3
2
1
0
0
10
20
30
40
Share of natural capital in national wealth (%)
50
60
Natural Resources and
45
countries Corruption
10
New Zealand
9
Abundant
natural
resources
appear to
go along
with
corruption.
Corruption index
8
7
6
5
4
3
2
1
0
0
5
10
15
20
Share of natural capital in national wealth (%)
25
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 manmade, 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
These slides can be viewed on my website:
Done
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.