Economic Growth, Poverty Reduction, and Foreign Aid: The New Agenda

1. Economic Growth, Poverty Reduction, and Foreign Aid: The New Agenda John B. Taylor Under Secretary for International Affairs United States Treasury April 22, 2002

2. A New Economic Development Agenda • Goal: to increase economic growth and reduce poverty in the poorest countries of the world • Special importance since 9/11 • Part of a broader international economic agenda • Restoring growth in the industrial countries. • Reducing instability in financial markets, especially emerging markets. • Combating the financing of terrorism • Tending to key bilateral relations: Russia, China • Trade promotion authority and free trade in general

3. 33_05 1.3 billion people, less than $1 per day ½ world’s population, less than $2 per day U.S. average, $90 day. Why?

4. The Reason is Productivity • Productivity = output (Y) per hour of work (L) = Y/L • Sometimes called labor productivity • It’s “the explanation” why some countries are rich and other countries are poor • Countries that are behind in productivity are behind in income per capita • Productivity growth is how to achieve higher income per capita • And to reduce poverty. • Growth accounting: Y/L depends on capital (K/L) and technology (T)

5. Prediction of Economics • If there are no barriers to the flow and use of technology and capital, then countries or regions that are behind in productivity should have higher productivity growth: they should catch-up • Two issues to consider: • In theory, capital should flow to where it is low relative labor and its returns are relatively high • Spread of technology through education, foreign investment, internet, etc.

6. GROWTH RATE OF 33_01 PRODUCTIVITY OR Poor but growing more rapidly GROWTH RATE OF INCOME PER CAPITA Catch-up line Rich but growing more slowly LEVEL OF PRODUCTIVITY OR LEVEL OF INCOME PER CAPITA

7. GROWTH RATE OF 33_02 INCOME PER CAPITA, 1880-1980 3.5 Florida Texas 3.0 Illinois New York 2.5 California 2.0 States in the United States: Catch-Up Clearly Seen Nevada 1.5 1.0 0.5 300 1,000 5,000 INCOME PER CAPITA IN 1880 (RATIO SCALE)

8. 33_03 ANNUAL GROWTH RATE OF REAL GDP PER CAPITA (PERCENT) More Advanced Countries: Catch-Up Seen Here Too 6 Japan 5 Portugal Spain 4 Italy Greece France Canada 3 U.S.A. 2 1 2,000 4,000 6,000 8,000 10,000 0 REAL GDP PER CAPITA IN 1960

9. 33_04 ANNUAL GROWTH RATE OF REAL GDP PER CAPITA (PERCENT) All Countries: Not Much Catch-Up Seen Yet South Korea 8 Singapore Hong Kong 6 4 U.S.A. 2 Sri Lanka Bangladesh 0 Ethiopia -2 0 2,000 4,000 6,000 8,000 10,000 REAL GDP PER CAPITA IN 1960

10. Recent productivity trends(percent change per year) • South East Asia: 2.7 • United States: 2 • Europe: 1 • Latin America: 0.7 • Japan near 0 • Africa below 0

11. So, why isn’t there more catch-up? • Very difficult question; entire field of economic development. • An economic answer: There must be some barriers to the spread and to the use of technology and capital

12. Barriers to Investment and Technology • Poor governance: • no rule of law, corruption, • creates disincentives to invest, to start up new firms, to expand existing firms, • high risks • Too many restrictions on people trying to trade or to use or implement new technology, • low returns • Poor Education

13. Why isn’t more capital flowing in? • Investment opportunities look better elsewhere, United States, China, • Risk of financial crises • “Sudden stop” after Asian and Russian financial crises of late 1990s • $154 billion per year from 1992-1997 • $50 billion per year from 1998-2000 • Decline in foreign assistance

14. The New Agenda • Increase foreign aid • (1) Bilateral foreign aid to be increased by 50% from about $10 billion per year to $15 billion per year • (2) Contribution to World Bank, International Development Association (IDA) increase by 18% • (3) Larger fraction of IDA aid in form of outright grants rather than loans • Let policy performance determine which countries get aid for economic development

15. Millennium Challenge Account • Good policy performance in three areas: • “Ruling justly” (lack of corruption) • “Investing in people” (good education, health policy) • “Encouraging economic freedom” (reduce trade barriers) • Theory and evidence says that these will increase productivity growth • Now working on objective criteria in each area: • using “growth regression” research over last 10 years • Each of the three areas are different: policy v. output • Needs to be simple, robust • Ideas, help, welcome!

16. Performance Based IDA Replenishment • U.S. is proposing to increase IDA by 18% in the current replenishment (first increase in 10 years) • Year One: $850 million • Year Two: $950 million • Year Three: $1,050 million • Each $100 million increment in year two and three would depend on performance in combating disease and improving education • Have not yet convinced everyone to go along

17. From Loans to Grants • U.S. has proposed converting 50 percent of IDA loans to grants • Loans already have highly favorable terms • Yet not being paid back, and there are calls for debt forgiveness • So we want to “Stop the Debt” • Grants can be tied to performance, example, better test scores in basic skills • But not yet an agreement with Europe/Japan, though work has gone on for one year

18. An Addition to the Millennium Goals: Productivity Growth • Countries with lower productivity than the U.S. should grow faster than the U.S. • The greater the productivity gap between the U.S. and a country the greater should be the productivity growth rate in that country • Could the goal be quantified? • Productivity gap 5 times  growth rate difference 2 • Productivity gap 10 times  growth rate difference 4 • Productivity gap 90 times  growth rate difference ?

19. Poverty and Productivity Growth • Some argue that the focus on economic growth will mean less focus on poverty reduction. • Simple logic: With productivity 90 times lower in poor countries, “catch up” completely dominates changes in the income distribution • Empirical evidence: • Higher productivity growth increases the income per capita of the lowest quintile by about the same amount as the other quintiles.