Transcript Chapter 19

Macroeconomics
ECON 2301
Fall 2009
Marilyn Spencer, Ph.D.
Professor of Economics
Chapter 19
Announcement: Bonus
Extra Credit Opportunity
 Attend the SEA economic forum Nov. 23,
7 p.m., in the UC Lonestar Ballrooms
A&B.
 Sign in with me.
 To earn up to 4 points of extra credit:
Email me your summary, in 50-100 words,
before the start of class on Mon., Nov. 30.
Announcement: Students Who
Completed the JA Option
 You must sign up, in class by Nov. 18, for
your presentation.
 I am circulating sign-up sheets now through
Nov. 18.
 If you fail to sign up in class by Nov. 18,
you will not be allowed to present, so you
will forfeit presentation credit.
Chapter 19: Policies and Prospects for
Global Economic Growth
Introduction
In 2008, a contagion swept around the globe. The source
of the contagion was a sharp decline in U.S. housing prices
that generated a collapse in the values of numerous housingrelated financial assets. Many investors responded by
removing their funds from U.S. and European banks.
Does this event send a signal to developing nations that
they should not copy industrialized nations by relying on
private financing?
To answer this question, we will need to examine how
international flows of private investment funds influence
economic growth, which is a key topic in this chapter.
Learning Objectives: After you’ve studied
this chapter, you should be able to…
1. Explain why population growth can have uncertain effects on
economic growth
2. Understand why the existence of dead capital retards investment
and economic growth in much of the developing world
3. Describe how government inefficiencies have contributed to the
creation of relatively large quantities of dead capital in the
world’s developing nations
4. Discuss the sources of international investment funds for
developing nations and identify obstacles to international
investment in these nations
5. Identify the key functions of the World Bank and the
International Monetary Fund
6. Explain the basis for recent criticisms of policymaking at the
World Bank and the International Monetary Fund
Chapter Outline
 Labor Resources and Economic Growth
 Capital Goods and Economic Growth
 Private International Financial Flows as a
Source of Global Growth
 International Institutions and Policies for
Global Growth
Did You Know That...
 When the president of the Republic of the Congo recently
visited New York City for a few days, his office paid for
44 rooms at the Waldorf-Astoria Hotel and ran up a bill of
$252,000?
 The government of the Republic of the Congo paid these
expenses just a few months after receiving aid packages
from the IMF and the World bank totaling $2.9 billion.
 The Republic of Congo already had $9 billion in existing
debts. More than 3 million people (>70% of the citizens)
earn incomes of less than $3/day.
 Evaluating the activities of the World Bank and the IMF is
one key topic of this chapter.
Labor Resources and Economic Growth
 Population growth does not necessarily translate into an
increase in labor resources.
 In poor areas, many people do not join the labor force, or
they may remain unemployed for long periods.
 We can express the growth rate of per capita real GDP in a
nation as the difference between the rate of growth in real
GDP and the population growth rate.
Hence, if real GDP grows at a rate of 4% per year and
population growth increases from 2 to 3%, then per
capita real GDP will decline, from 2%to 1%.
Labor Resources and Economic Growth (cont'd)
 Population growth can contribute to economic growth.
 Whether population growth hinders or contributes to
economic growth depends on where you live:
How that population growth occurs in your
country/region.
Policies and procedures in your country/region
Table 19-1 Population Growth and Growth in Per Capita
Real GDP in Selected Nations Since 1970
Labor Resources and Economic Growth (cont'd)
 The role of economic freedom
A crucial factor influencing economic growth
is the relative freedom of a nation’s residents.
Only 17 nations, with 17% of the world’s
people, grant their residents high degrees of
economic freedom.
Labor Resources and Economic Growth (cont'd)
 Economic Freedom: The rights to own private
property and to exchange goods, services, and
financial assets with minimal government
interference
 The role of political freedom
Political freedom: the right to openly support
and democratically select national leaders
Economic freedom tends to stimulate economic
growth, which then leads to more political
freedom.
Labor Resources and Economic
Growth (cont'd)
 Question
Why do you suppose that per capita real GDP
appears to be related to the extent to which the
rule of law prevails?
Capital Goods and Economic Growth (cont'd)
 Dead Capital: Any capital resource that lacks
clear title of ownership
A resource that people cannot readily allocate
to its most efficient use
Is among the most significant impediments to
growth in poor nations
Capital Goods and Economic Growth (cont'd)
 Dead capital and inefficient production
Nontransferable physical structures are valued
at more than $9 trillion in developing nations.
 Dead capital and economic growth
Disincentives to invest in new capital goods
can greatly hinder economic growth.
Capital Goods and Economic Growth (cont'd)
 Government inefficiencies, investment, and
growth
Governments in many of the world’s poorest
nations place tremendous obstacles in the way
of entrepreneurs.
These entrepreneurs are interested in owning
capital goods and directing them to profitable
opportunities.
Capital Goods and Economic Growth (cont'd)
 Government inefficiencies, investment, and
growth
In a nation with a stifling government
bureaucracy regulating the uses of capital
goods, newly created capital will all too likely
become dead capital.
Thus, government inefficiency can be a major
barrier to economic growth.
Figure 19-1 Bureaucratic Inefficiency
and Economic Growth
Sources: International Monetary Fund; World Bank.
Capital Goods and Economic Growth (cont’d)
 Access to credit matters
2006 Nobel Peace Prize winner Muhammad
Yunus of Bangladesh contends that access to
private credit is vital for promoting economic
growth in poverty-stricken countries.
Microlenders are banking institutions that
specialize in making very small loans to
entrepreneurs trying to lift themselves from
poverty.
Figure 19-2 The Ratio of Private Credit to GDP in
Selected Nations
Source: Federal Reserve Bank of St. Louis.
Private International Financial Flows as a Source of
Global Growth
 Question
Given the large volume of inefficiently
employed capital goods in developing nations,
what can be done to promote greater global
growth?
 Answers
One approach is to rely on private markets.
Another is to entrust the world’s governments.
Private International Financial Flows as a Source of
Global Growth (cont'd)
 Private investment in developing nations
Each year since 1995, at least $150 billion in
private funds have flowed to developing
nations in the form of purchases of bonds or
stock.
Nearly all funds that flow into developing
countries due so to finance investment projects
in those nations.
Private International Financial Flows as a Source of
Global Growth (cont'd)
Economists group international flows of
investment funds into three categories.
1. Loans from banks and other sources
2. Portfolio investment: The purchase of less than
10% of the shares of ownership in a company
in another nation
3. Foreign direct investment: The acquisition of
more than 10% of the shares of ownership in a
company in another nation
Figure 19-3 Sources of International
Investment Funds
Source: International Monetary Fund (including estimates)
Private International Financial Flows as a Source of
Global Growth (cont'd)
 Obstacles to international investment
Markets for loans, bonds, and stocks in
developing countries susceptible to problems
relating to
• Asymmetric information
• Adverse selection
• Moral hazard
International Institutions and
Policies for Global Growth
 Since 1945, the world’s governments have
taken an active role in supplementing
private markets.
 Two international institutions, the World
Bank and the International Monetary Fund,
have been at the center of governmentdirected efforts.
International Institutions and Policies for Global
Growth (cont'd)
 The World Bank: A multinational agency
that specializes in making loans to about
100 developing nations in an effort to
promote their long-term development and
growth
Loans are made to finance improved irrigation
systems, roads, and better hospitals.
Figure 19-4 The Distribution of
World Bank Lending Since 1990
Source: World Bank.
International Institutions and Policies for
Global Growth (cont'd)
 The International Monetary Fund: A
multinational organization that aims to
promote world economic growth through
more financial stability
The IMF assists developing countries primarily
by making loans to their governments.
International Institutions and Policies for
Global Growth (cont'd)
 When a country joins the IMF, it deposits
funds into an account called a quota
subscription: A nation’s account with the
International Monetary Fund, denominated
in special drawing rights
International Institutions and Policies for
Global Growth (cont'd)
 These funds are measured in terms of an
international unit of accounting called special
drawing rights (SDRs).
 SDRs have a value based on a weighted average of
four key currencies
The euro, the pound sterling, the yen, and the
dollar
At present, one SDR is equal to just under $1.50.
International Example: The IMF Rethinks
Nations’ Voting Shares
 A nation’s IMF quota subscription determines
how much the country can borrow from the IMF
under the organization’s standard credit
arrangements.
 It also determines the nation’s voting power
within the IMF.
 Nevertheless, many nations’ shares of quota
subscriptions do not correspond to their relative
importance in the world economy.
International Example: The IMF Rethinks
Nations’ Voting Shares (cont’d)
 The IMF is in the process of developing a plan to
reconfigure nations’ voting power within the organization.
 One factor complicating this endeavor is that countries
with relative voting power exceeding their economies’
shares of world GDP do not wish to give up any of their
voting rights.
 Ultimately, the IMF may address the issue simply by
creating additional voting rights and granting these “extra”
voting rights to underrepresented countries.
International Institutions and Policies for
Global Growth (cont'd)
 The World Bank’s Mission
To make loans to developing nations that fund
projects incapable of attracting private financing from
investors at home or abroad.
However, the World Bank makes many loans to
countries that have no trouble attracting financing.
Some observers contend that a number of countries
that receive funds are inappropriate recipients of
development assistance (i.e. China)
International Institutions and Policies for
Global Growth (cont'd)
 Asymmetric information & the World Bank and
the IMF:
Conditions on loans exist to reduce adverse
selection and moral hazard problems but are
often imprecise
Have the World Bank and the IMF contributed
to international financial crises?
International Institutions and Policies for
Global Growth (cont'd)
 Rethinking long-term development lending:
A main theme of development economics has
been market reforms.
Markets work better when a developing nation
has more effective institutions:
Basic property rights
Well-run legal systems
Uncorrupt government agencies
International Institutions and Policies for
Global Growth (cont'd)
 Alternative institutional structures for limiting
financial crises
Many proposals for change diverge sharply.
Economists recommend improvements in
standards.
 Question
Is it time to replace the World Bank and the
IMF?
Issues and Applications: Private International
Investment - Source of Instability or
Engine of Economic Growth?
 As shown in Figure 19-3, in recent years there has been a
gradual decrease in bank loans as a source of private
funding in developing nations.
 As this source of funds has declined, private international
investment has increased.
 Figure 19-5 indicates that portfolio investment has been
much more volatile than direct foreign investment. This
tends to be associated with lower economic growth.
Figure 19-5 Worldwide Flows of Portfolio Stock
Investment, Portfolio Bond Investment &
Foreign Direct Investment Since 1990
Source: World Bank
Issues and Applications: Private International
Investment - Source of Instability or Engine of
Economic Growth? (cont'd)
 Argentina, Venezuela, and South Africa have experienced
more volatile flows of international investment because
these low-growth nations have received much more
portfolio investment than foreign direct investment.
 In contrast, Indonesia, Pakistan, and China are recipients
of larger shares of global foreign direct investment and
have experience much faster rates of economic growth.
Summary of Learning Objectives
1. Effects of population growth and personal
freedoms on economic growth
Increased population growth has contradictory effects
on economic growth.
There is evidence of a positive relationship between
economic freedom and growth.
Summary of Learning Objectives (cont'd)
2. Why dead capital deters investment and slows
economic growth:
Few people in less developed countries establish legal
ownership of capital.
Unofficially owned resources are known as dead
capital.
In many developing nations, there is a disincentive to
accumulate capital, which limits growth prospects.
Summary of Learning Objectives (cont'd)
3. Government inefficiencies and dead capital in
developing nations
A negative relationship between government
inefficiency and economic growth
4. Sources of international investment funds and
obstacles to investing in developing nations:
Sources include bank loans, portfolio investment, and
foreign direct investment
Obstacles include problems relating to asymmetric
information such as adverse selection and moral hazard
Summary of Learning Objectives (cont'd)
5. The functions of the World Bank and the
International Monetary Fund
The World Bank’s function is to finance capital
investment.
A fundamental duty of the IMF is to stabilize
international financial flows.
Summary of Learning Objectives (cont'd)
6. The basis for recent criticisms of the World Bank
and IMF policymaking:
The World Bank has extended credit to
companies and governments that could have
obtained private funds.
The World Bank and IMF have failed to
effectively deal with adverse selection and
moral hazard, suggesting more stringent
conditions on credit access are needed.
Wednesday, November 25
 We will not hold class that day.
 I will hold extended office hours
that afternoon, 1-5 p.m.
 Use your class time for one or more
of these activities:
Write your summary of the
Monday evening panel.
Study for exam 3.
Prepare for your JA presentation.
Consult with me.
Exam 3
 Wednesday, December 2
 Chapters 15, 16 & 19
 Same format as earlier exams
 Review in class on Mon., Nov. 23, and
possibly Mon., Nov. 30