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What Makes Nations Grow?

What Makes Nations Grow?. Week 2 SF Intermediate Economics Professor Dermot McAleese. OUTLINE.  Trends in economic growth  Growth theories  Human welfare and sustainable growth  P olicies for growth. WHAT IS ECONOMIC GROWTH?.

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What Makes Nations Grow?

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  1. What Makes Nations Grow? Week 2 SF Intermediate Economics Professor Dermot McAleese

  2. OUTLINE Trends in economic growth Growth theories Human welfare and sustainable growth Policies for growth

  3. WHAT IS ECONOMIC GROWTH? Gross Domestic Product (GDP)- measure of economic growth  GDP per capita - measure of standard of living Production frontier Y R2 T R3 T1 Manufactures R1 R Food X

  4. Table 1. Share of world output, trade and population (% share) Source: European Economy (Brussels, no. 66, 1998); WTO, 1999.

  5. Growth Rates 1965-99 Source: World Bank World Development Indicators 2001.

  6. SEVEN STYLISED FACTS ON ECONOMIC GROWTH Growth - the norm Rich stayed rich Poor better off since 50s  Acute poverty persists  Diversity in performance since 60s  Natural resources  economic success  Transition economies in trouble

  7. Table 6.Real GNP per person Source: Computed from Angus Maddison, The World Economy: A Millenium Perspective (Paris: OECD, 2001) and IMF, World Economic Outlook, May 1999. Purchasing power parities have been used for the developing countries.

  8. How Growth Rates Differ: Experience of the 1990sTable 1. Negative Growth Countries (g<0%) Note: Total number of countries reporting negative growth figures is 173. Source: World Bank, World Bank Atlas, 1999. IMF, World Economic Outlook, October 1999.

  9. How Growth Rates Differ: Experience of the 1990sTable 2. Rapid Growth Countries (g>4%) Note: Total number of countries reporting growth figures is 173; g = average annual GNP per capita growth Source: World Bank, World Bank Atlas, 1999. IMF, World Economic Outlook, October 1999.

  10. How Growth Rates Differ: Experience of the 1990sTable 3. Modest Growth Countries ( 2%  g  4%) Note: Total number of countries reporting growth figures is 173; g = average annual GNP per capita growth Source: World Bank, World Bank Atlas, 1999. IMF, World Economic Outlook, October 1999.

  11. How Growth Rates Differ: Experience of the 1990sTable 4. Slow Growth Countries ( 0%  g  2%) Note: Total number of countries reporting growth figures is 173; g = average annual GNP per capita growth Source: World Bank, World Bank Atlas, 1999. IMF, World Economic Outlook, October 1999.

  12. FORECAST REAL GDP GROWTH PER CAPITA 1998-2008 Source: World Bank 1999

  13. % of population living on less than $1 per day

  14. From the earliest times down to the beginning of the eighteenth century, there was no very great change in the standard of life of the average man living in the civilised centres of the earth….. This lack of progress was due to two reasons: the remarkable absence of technical improvements and the failure of capital to accumulate. J. M. Keynes, Economic Possibilities for Our Grandchildren, (1930)

  15. HARROD-DOMAR MODEL g = Y/Y = (K/Y) x (Y/K) I = K = S g = (S/Y) . (Y/K) g = (S/Y)/(K /Y) g = s/v s = marginal propensity to save v = capital-output ratio

  16. GROWTH THEORIES  Long term determinants productive efficiency allocative efficiency  Quantity of inputs K, L I/GDP ratio  Total factor productivity

  17. Implications of Harrod-Domar • Focus on raising s (the savings rate) and lowering v (capital output ratio) • How to raise s: Govt saving Robust financial system Foreign aid/capital inflows Debt forgiveness • How to lower v: Use capital productively (v is not a “given”) Choose right industries (planning) Implement good policy (new consensus?) • Rich countries will stay rich – because they can afford to save. Poor will stay poor because they have no margin

  18. From HD model to present …. • Solow model – capital inputs subject to law of diminishing marg productivity – hence move to convergence • Total factor productivity more important than high investment • Endogenous growth model – technology is endogenous, not exogenous. Importance of education, knowledge, which are not subject to diminishing marginal returns.

  19. Total Factor Productivity (TFP) A growing body of evidence suggests that, even after physical and human capital accumulation are accounted for, something else accounts for the bulk of cross country differences in the level and growth rate of GDP per head. Economists typically refer to the something else as total factor productivity Easterly and Levine What have we learned from a decade of empirical research on growth? The World Bank Economic Review No 2 2001

  20. TOTAL FACTOR PRODUCTIVITY (TFP/MFP) advances in technology redistribution of resources to higher productivity sector terms of trade institutional and political stability quality of the labour force (human skills and motivation) better business organisation economic policy

  21. The Neoclassical Theory of Exogenous Economic Growth emphasises Technological Progress As an exogenous source of long term growth Tends to underestimate the role of economic policy

  22. The Theory of Endogenous Economic Growth Traces growth to a variety of sources such as Initial starting point Investment Economic Policy

  23. HUMAN WELFARE AND SUSTAINABLE GROWTH  Leisure and the household economy  Income distribution  GNP and the environment GNP and human development indicators Sustainable growth

  24. GDP AS MEASURE OF WELFARE Household economy Voluntary activities Black economy (positive aspects) Leisure Inputs classified as output (police, defence spending) Environmental degradation Exhaustion of natural resources Sustainable growth. ADD: SUBTRACT:

  25. Weak correlation between economic growth and happiness index (‘Are you feeling satisfied with your life’) Sources: Andrew Oswald, University of Warwick Robert Frankel, Yale University But, correlation exists between income distribution and happiness. More unequal societies have more unhappiness Does Economic Growth = Happiness?

  26. WHY? • Many goods are ‘Positional goods’ – status symbols • Externalities – e.g. if everyone has a car, congestion costs increase • Relative poverty creates major feelings of unhappiness • Longevity is good, but leads to high medical bills

  27. POLICY PRESCRIPTION FOR GROWTH Competition and economic efficiency Price stability and fiscal consolidation Outward orientated policies Government to complement market forces Stable and transparent institutional framework Competition policy Labour market policy Infrastructure Education system

  28. LESSONS FROM EAST ASIAN “MIRACLE” • PRUDENT FISCAL AND MONETARY MANAGEMENT “Macroeconomic stability* is negatively correlated with growth” *as measured by inflation, fiscal deficits and parallel exchange rate premiums • SECURE AND EFFECTIVE FINANCIAL SYSTEM • HEAVY INVESTMENT IN HUMAN CAPITAL ESPECIALLY IN BASIC EDUCATION • KEEPING PRICE DISTORTIONS TO A MINIMUM • Foreign trade • Labour market • ENSURING EASY ACCESS TO FOREIGN TECHNOLOGY RATHER THAN ATTEMPTING A PATH OF SELF-RELIANCE • AVOID BIAS AGAINST AGRICULTURE Note: Selective government intervention in industrial sector had “mixed” results – major problem is bureaucratic deficit Source: “Reinvigorating Growth in Developing Countries”, IMF, Washington DC, July 1996.

  29. CONVERGENCE?  Endogenous growth theory (once ahead, always ahead)  Technological spillovers (poor can “piggy-back” on the rich)  Empirical evidence (2% rate of convergence)  Conditional convergence (openess, education and governance)

  30. Table 5. Explaining India’s Relative Growth Performance

  31. Table 7a. How Growth Rates Differ 1965-98 Source: World Bank World Development Indicators 2000.

  32. Table 8. GDP growth rates in former socialist countries Source: European Bank for Reconstruction and Development, Transition Report, 1999

  33. Table 9. Investment and growth Source: European Economy (Brussels: no. 16, 1999).

  34. Table 10. HDI ranking – selected countries Source: Human Development Report 2000, Oxford University Press, 2000.

  35. Table 11. East Asia Source: The World Bank Atlas 1999.

  36. KOREA vs ZAMBIA A STORY OF Total Factor Productivityexercise 3, p 36 • TFP is a residual • TFP includes: advances in technology, concentration on high productivity sectors, improved terms of trade, institutional and political stability, quality of the labour force

  37. Why does TFP differ? • Various levels of innovation + imperfect information between countries • Research and Development, education, infrastructure, government investment • TFP is high if countries create a dynamic of innovation

  38. Korea high education standards emphasis on high-tech and automotive industries good geographical location organised banking sector Zambia low education high protection bad government investment bad geographical location

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