Transcript Sources of Economic Growth

Sources of
Economic
Growth
Thorvaldur Gylfason
Pretoria, South Africa, June 2005
Outline
I. Pictures of growth
II. Determinants of growth
1.
2.
Saving and investment
Efficiency
a)
b)
c)
d)
e)
f)
Liberalization
Stabilization
Privatization
Education
Diversification
Institutions
III. Empirical evidence of growth
National economic output
Economic growth:
The short run vs. the long run
Economic growth
in the long run
Potential output
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
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
Growing
apart
Case B: 2% a year
Output per capita
Aspects of efficiency
 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
denotes a positive effect in the direction shown
+
Education
More sources of growth
Suppose our x is openness to trade; then …
Growth
+
Investment
+
+
Openness
denotes a positive effect in the direction shown
+
Education
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
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
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
Let’s do the arithmetic:
S = sY = I = K + K
= Y/E + Y/E
Rearranging terms we find
Y/E = sY - Y/E
Multiplying by E and dividing by Y gives
Y/Y = sE - 
A Simple Model of
Endogenous Growth
Bottom line

g = sE - 
Rate of economic growth equals
 Saving rate
times
 Efficiency (i.e., the output/capital ratio)
minus
 Depreciation
What this means
Three implications for growth
g  sE  
dg
0
ds
dg
0
dE
dg
0
d
4500
4000
Botswana
Nigeria
3500
3000
2500
2000
1500
1000
500
0
19
60
19
64
19
68
19
72
19
76
19
80
19
84
19
88
19
92
19
96
20
00
Case 1
Botswana and Nigeria: GDP per
capita 1960-2002 (1995 USD)
20.000
18.000
Spain
16.000
Argentina
14.000
12.000
10.000
8.000
6.000
4.000
2.000
0
19
60
19
64
19
68
19
72
19
76
19
80
19
84
19
88
19
92
19
96
20
00
Case 2
Spain and Argentina: GDP per
capita 1960-2002 (1995 USD)
5000
4500
Mauritius
4000
Madagascar
3500
3000
2500
2000
1500
1000
500
0
19
60
19
64
19
68
19
72
19
76
19
80
19
84
19
88
19
92
19
96
20
00
Case 3
Madagascar and Mauritius: GDP
per capita 1960-2002 (1995 USD)
A Tale of Two Countries
Country A
Country B
A Tale of Two Countries
Girls at primary school
Country A
Country B
100%
72%
A Tale of Two Countries
Girls at primary school
Investment ratio
Country A
Country B
100%
72%
25%
11%
A Tale of Two Countries
Country A
Country B
100%
72%
Investment ratio
25%
11%
Export ratio
58%
23%
Girls at primary school
A Tale of Two Countries
Country A
Country B
100%
72%
Investment ratio
25%
11%
Export ratio
58%
23%
Primary export ratio
33%
80%
Girls at primary school
A Tale of Two Countries
Country A
Country B
100%
72%
Investment ratio
25%
11%
Export ratio
58%
23%
Primary export ratio
33%
80%
Inflation
10%
18%
Girls at primary school
A Tale of Two Countries
Country A
Country B
100%
72%
Investment ratio
25%
11%
Export ratio
58%
23%
Primary export ratio
33%
80%
Inflation
10%
18%
Growth per capita
1960-2002
4.4%
-1.4%
Girls at primary school
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 per capita
1960-2002
4.4%
-1.4%
5000
4500
Mauritius
4000
Madagascar
3500
3000
2500
2000
1500
1000
500
0
19
60
19
64
19
68
19
72
19
76
19
80
19
84
19
88
19
92
19
96
20
00
Case 3
Madagascar and Mauritius: GDP
per capita 1960-2002 (1995 USD)
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
convergence?
Growth of GNP per capita 1965-1998 (%)
10
Botswana
8
China
r = rank
correlation
r = -0.09
Korea
6
Indonesia
Thailand
4
2
0
0
-2
No sign
that poor
countries 5
grow faster
than rich
10
15
Nicaragua
-4
Log of initial GDP per capita (1965)
Absolute convergence:
Growth rates
Growth of GDP per capita 1960-2000 (%)
15
y = -0,864x + 8,3057
R2 = 0,1821
10
5
0
4
6
8
10
-5
-10
Log of GNP per capita 1960
12
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
Investment and economic
growth
Growth of GNP per capita 1965-98, adjusted
for initial income (% per year)
6
r = 0.65
BotswanaBotswana
4
China
2
Thailand
0
0
5
10
15
20
25
4%
30
1%
35
-2
Jordan
-4
-6
Niger
Nicaragua
-8
Investm ent 1965-98 (% 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
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
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.
6.
7.
Liberal price and trade regimes
Low inflation
Strong private sector
More and better education
Limited, or well managed, natural resources
Social justice: equality
Sound institutions: democracy
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. South Korea and Singapore
Applies to trade in goods, services, capital
Darkness in
North-Korea
China
Japan
Exports and growth
1965-98
Growth per capita 1965-98, adjusted for size
(% per year)
8
r = 0.33
6
4
2
0
0
20
40
60
-2
-4
-6
Exports 1965-98 (% of GDP)
80
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
Stabilization and economic
growth: Regression results
Model
1
Inflation
distortion
-2.51
(2.07)
Natural
resources
Initial
income
Investment
Secondary
education
Population
growth
Adj. R2
0.04
Note: 87 countries, method is OLS, t-statistics are shown in parentheses.
Stabilization and economic
growth: Regression results
Inflation
distortion
Model
1
Model
2
-2.51
(2.07)
-2.46
(2.37)
-0.09
Natural
resources
(5.75)
Initial
income
Investment
Secondary
education
Population
growth
Adj. R2
0.04
0.30
Stabilization and economic
growth: Regression results
Inflation
distortion
Model
1
Model
2
Model
3
-2.51
(2.07)
-2.46
(2.37)
-2.26
(2.25)
-0.09
(5.75)
-0.10
(6.52)
Natural
resources
-0.45
Initial
income
(2.67)
Investment
Secondary
education
Population
growth
Adj. R2
0.04
0.30
0.35
Stabilization and economic
growth: Regression results
Inflation
distortion
Model
1
Model
2
Model
3
Model
4
-2.51
(2.07)
-2.46
(2.37)
-2.26
(2.25)
-1.95
(2.25)
-0.09
(5.75)
-0.10
(6.52)
-0.07
(5.01)
-0.45
(2.67)
-0.45
(3.05)
Natural
resources
Initial
income
0.15
Investment
(5.41)
Secondary
education
Population
growth
Adj. R2
0.04
0.30
0.35
0.51
Stabilization and economic
growth: Regression results
Inflation
distortion
Model
1
Model
2
Model
3
Model
4
Model
5
-2.51
(2.07)
-2.46
(2.37)
-2.26
(2.25)
-1.95
(2.25)
-1.97
(2.49)
-0.09
(5.75)
-0.10
(6.52)
-0.07
(5.01)
-0.04
(2.93)
-0.45
(2.67)
-0.45
(3.05)
-1.10
(5.39)
0.15
(5.41)
0.09
(3.36)
Natural
resources
Initial
income
Investment
1.24
Secondary
education
(4.24)
Population
growth
Adj. R2
0.04
0.30
0.35
0.51
0.60
Stabilization and economic
growth: Regression results
Inflation
distortion
Model
1
Model
2
Model
3
Model
4
Model
5
Model
6
-2.51
(2.07)
-2.46
(2.37)
-2.26
(2.25)
-1.95
(2.25)
-1.97
(2.49)
-1.61
(2.14)
-0.09
(5.75)
-0.10
(6.52)
-0.07
(5.01)
-0.04
(2.93)
-0.04
(2.49)
-0.45
(2.67)
-0.45
(3.05)
-1.10
(5.39)
-1.27
(6.42)
0.15
(5.41)
0.09
(3.36)
0.10
(3.74)
1.24
(4.24)
1.07
(3.82)
Natural
resources
Initial
income
Investment
Secondary
education*
-0.56
Population
growth
Adj. R2
(3.42)
0.04
0.30
0.35
0.51
0.60
0.64
* An increase in secondary-school enrolment by a third increases growth by 1%.
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
Growth of GNP per capita 1978-92 (%)
State-owned enterprises
and economic growth
8
r = -0.35
6
4
2
0
-2
-4
-6
.0
.1
.2
.3
.4
Share of SOEs in employment 1978-91 (%)
4
Education, health, 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
Growth of GNP per capita 1965-98, adjusted
for initial income (% per year)
6
r = 0.72
4
Thailand
2
Finland
0
0
20
40
60
80
-2
100
120
New Zealand
Jamaica
-4
-6
-8
Secondary enrolm ent 1980-97 (% of cohort)
Growth of GDP per capita 1960-2000, adjusted
for initial income (% per year)
Birth care and
growth
8
6
4
2
0
0
20
40
60
80
-2
-4
-6
-8
Births attended by skilled health staff
1975-2000 (% of total)
100
Growth of GDP per capita 1960-2000, adjusted
for initial income (% per year)
Life expectancy
and growth
8
6
4
2
0
0
20
40
60
-2
-4
-6
-8
Life expectancy 1960
80
Health expenditure and
economic growth
Growth of GDP per capita 1960-2000, adjusted
for initial income (% per year)
8
6
4
2
0
0
5
10
-2
-4
-6
-8
Health expenditure 1990-2000 (% of GDP)
15
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 (foreign capital)
Rent seeking (social capital)
Education (human capital)
Investment (real capital)
Recent literature
Four main linkages, again
1. Dutch disease
 Hurts level or composition of exports
and FDI
2. Rent seeking
 Protectionism, corruption, oppression
3. Education
 False sense of security
 Poor quality of policies and institutions
4. Investment
Enter natural resources
Growth
+
–
–
?
Investment
x
–
Initial Income
+
Education
+
–
Natural Capital
Natural resource abundance hurts investment and
education, and hence also growth
Natural capital and
economic growth
Growth of GNP per capita 1965-98, adjusted
for initial income (%)
6
4
2
Australia
0
0
20
40
60
-2
-4
-6
Venezuela
r = -0.64
-8
Share of natural capital in national w ealth
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
Growth of GNP per capita 1965-98, adjusted
for initial income (% per year)
6
Korea
Korea
4
China
France
2
Norway
Thailand
Lesotho
Brazil
Brazil
0
0
-2
10
20
30
40
50
Sweden
-4
r = -0.50
-6
Gini index of inequality
60
70
South Africa
South Africa
Central
African
Republic
Sierra Leone
Equality is
good for
growth:
No visible
sign that
equality
stands in
the way of
economic
growth
7
Democracy and
economic growth
Two views:
1. Democracy is good for growth
 Facilitates change of government
 Makes it easier to replace bad
governments with better ones
2. Democracy is bad for growth
 Too much democracy interferes with
farsighted policy making by playing into
the hands of pressure groups and such
What is the empirical evidence?
1990: When the world
changed
Growth and political
liberties, 1965-98
Brazil
Growth of GNP per capita 1965-98, adjusted
for initial income (% per year)
6
Botswana
4
Korea
China
2
0
0
2
4
6
8
-2
-4
-6
Venezuela
r = -0.62
Central
African
NigerRepublic
-8
Index of political liberties 1972-90
Democracy
is good for
growth:
No visible
sign that
democracy
stands in
the way of
economic
growth
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
sound institutions
... 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
(Accra, 1968)
What else?
These lessons are borne out by experience
from around the world
Additional lessons:
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 manmade, 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