POLITICAL ECONOMY OF GROWTH SECS-P01, CFU 9 Finance and Development academic year 2016-17

1. POLITICAL ECONOMY OF GROWTHSECS-P01, CFU 9Finance and Developmentacademic year 2016-17 3. INTRODUCTION TO GROWTH ECONOMICS Roberto Pasca di Magliano Fondazione Roma Sapienza-Cooperazione Internazionale roberto.pasca@uniroma1.it

2. Differences between Development and Growth Development: • newly-bornbackwardcountriesafter World War II • developmentis a four-legchairwhereinstitutional, social, civil and economicaspects are stabilised • interdisciplinarystudies Growth: • dominance of the economy over the behavior of institutions and individuals Mainaspects to be explained: • explainingwhygrowthisconcentrated in a fewcountries, whilemanyothers are stillwaitingalong the road • explaininghow some developingcountries are redeemed and crowding the group of the emergingcountries • Explaining the dynamicsthatmove the transitioncountries Roberto Pasca di Magliano

3. Changes in the world GDP

4. The free market and its consequences • The consequence of the free market hypothesis is all too obvious: the market works well only if it is left free (hence the famous expression “laissez faire”) • Therefore, the market, not only does not need any help, but if anything, just needs tobe freed of obstacles and regulations that might prevent its action • It is interesting to note that in this last consideration, one can find an argument that is often made in favour of the market, even nowadays: the market must be left free, it must not be caged Roberto Pasca di Magliano

5. The role of the State in the economy • The founder of the theory of the role of the State in the market is John Maynard Keynes, who published in 1936 “General Theory of Employment, Interest and Money” • The innovative idea is that the role of the State is fundamental. Indeed, the market can, according to Keynes, produce results that are not optimal, and the State’s role is to help the market • The duty of the State is on the one hand to mitigate and control the economic cycles and on the other hand to bring the market to a better situation (especially in terms of unemployment) than the one that the market itself would have been able to realize if operating alone. Roberto Pasca di Magliano

6. Role of public policy As in the short run, during recession, economy is influenced by aggregate demand public economic policies have to push aggregate demand towards the productive capacity of the economy The economic performance is influenced by a host of factors and sometimes behaves erratically, affecting production, employment, and inflation. Keynesian economists argue that private sector decisions sometimes lead to inefficient macroeconomic outcomes which require active policy responses by the public sector in order to stabilize output over the business cycle: • monetary policy actions by the Central Bank • fiscal policy actions by the government Keynesian economics advocates a mixed economy – mainly private sector, but with a role for government intervention during recessions. Roberto Pasca di Magliano

7. The market in the face of crisisOrigins of the financial crisis 2007/08 • Since the 1980s, liberal pressures and the dissemination of new and revolutionary communication technologies –ICT- have produced an enormous expansion of the financiary activities at the international level • This has been, on the one hand, one of the cornerstones of globalizationbut on the other it has also brought about the huge expansion of a market that is less stable and less predictable than the real markets • From the 1970s to the 1990s, the volume of trade grew exponentially: suffice it to say that since the early 80s to the mid 90s, the trade volume produced by mutual funds, pension funds and institutional investors has increased tenfold • The conjunction between the expansion of financial wealth, the introduction of new derivative contracts and the growth of the debts of advanced countries has led to finance taking over the real economy. These phenomena are at the origin of the widespread crisis exploding in 2008, slowing down the global economic growth, causing recession and unemployment government intervention during recessions. Roberto Pasca di Magliano

8. Financial Markets • Theymovevolumes of wealthbuilt on the trade of derivativesand otherproductsthat are detached from economicactivities, wherebyeveryturbulencegeneratespsychologicalrepercussionsnotonly on the stock marketsbutalso on the loans to businesses • They are maneuvered by investmentbanks and big investors, but are a cause of growingconcern for the small savers • They are particularlyvolatile, and aboveall, moody: perceptions of the market compared to hypotheticalscenariosmaygive rise to chainreactions • Theyinfluencerealactivitiesthroughbanks and otherfinancialintermediaries Roberto Pasca di Magliano

9. Reasons of the actual crisis • Manypeoplewhohavedenounced the end of a financialsystemrecall the need of rulesof supervision and surveillance • On the otherhand, the sameliberal view, whileitencourages private activity, alsoplacesit in a balancedinteractionbetween market and institutions • The presentcrisisoriginates in a guiltylack of governance, representative of the liberal culture thatwasindulged in during the times in which the strong economicgrowthfacilitatedfinancialactivities(Grennspan, Federal ReserveBank) • Investmentbanks, and notonly, havetakenadvantage of this, thrusting on muchhigherleverageratiosthanthose of the commercial banks, eventuallybringingabout the creation of high-riskfinancialproducts Roberto Pasca di Magliano

10. The actual crisis: potential solutions • EU’s approach: • Public participation in the capitals of banks in crisis, provided it goes to fuel the loan supplies (bailout System) • Private reforms and needs for stockholder to pay for that (bailin system) • Government guarantee both on deposits and interbank loans • Lighten the regulatory capital requirements of Basel 2 • Appeal to FDI by promoting cooperation agreements with Sovereign Funds • Greater flexibility in the budgetary constraints imposed by the Maastricht Treaty, revising the budgetary discipline • Boost the demand, by reducing the tax burden on families, in order to send a strong signal to the recovery of purchasing power • Review the rules regulating the financial and stock markets in order to fight the speculative designs that preceed the speculation over the economic and patrimonial consistency of businesses • Lower the minimum requirement for OPA in businesses to avoid hostile participations • Intervention of the European Stability Mechanism (ESM) and other monetary policies to support inflation rate Roberto Pasca di Magliano

11. Following lectures in details • From theories to models • Classicaltheories of development • The Keynesiangrowth model of Harrod-Domar • Neo-classicalmodels of growth: Solowapproach • Analysis of growthbasedon the production function • The new endogenousgrowththeory (NTC) and macrodeterminants of growth