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Openness and

Openness and. Growth. Or why international trade is good for economic growth. Thorvaldur Gylfason. Growing Apart. Different national economies have grown at different rates in the past

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Openness and

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  1. Openness and Growth Or why international trade is good for economic growth Thorvaldur Gylfason

  2. Growing Apart Different national economies have grown at different rates in the past Nations that started out in similar circumstances a few decades ago can have vastly different standards of living today Reasons for differences • Different economic systems • Different economic policies

  3. Growing Apart West-Germany : East-Germany Austria : Czech Republic Finland : Estonia Taiwan : China South Korea : North Korea Economic system Rapid growth Botswana : Nigeria Kenya : Tanzania Thailand : Burma Tunisia : Morocco Spain : Argentina Mauritius : Madagascar National economic output Economic policy? Slow growth Time

  4. Botswanaand Nigeria: GNP per capita 1964-2000 Case 1 Current US$, Atlas method

  5. Spain and Argentina: GNP per capita 1964-2000 Case 2 Current US$, Atlas method

  6. Mauritius and Madagascar: GNP per capita 1964-2000 Case 3 Current US$, Atlas method

  7. Economic Systems and Policies • Economic systems and growth • As a rule, mixed market economy grows more rapidly than centrally planned economy • Economic policies and growth • Policies that promote economic efficiency are also good for growth • Liberalization, stabilization, privatization • Education, diversification

  8. Extensive and Intensive Growth • Main determinants of economic growth • Saving and high-quality investment • Economic efficiency, including technology • Extensive growth through accumulation • Saving and investment • Intensive growth through better use of existing resources • More efficiency, better technology • Education

  9. Sources of growth: Investment and education + + denotes a positive effect in the direction shown +

  10. Sources of growth: Investment and education Adam Smith knew this, and more, as did Arthur Lewis Robert Solow raised doubts on long-run linkages Growth is exogenous + + denotes a positive effect in the direction shown +

  11. More sources of growth Arthur Lewis: x is mainly trade, stable politics, good weather Growth is endogenous + + + denotes a positive effect in the direction shown +

  12. Sources of Endogenous Growth Income per capita East Asia 400 High saving rates 300 200 OECD Medium saving rates Africa 100 Low saving rates 1965 1990

  13. Growth and Investment, 1965-98 109 countries Each ten percentage point increase in the investment ratio is associated with an increase in per capita growth by 1½% per year. Botswana 1½% 10% Let’s be more specific

  14. Growth and Investment, 1965-98 85 countries An increase in investment by 4% of GDP is associated with an increase in per capita growth by 1% per year. How about initial income? r = 0.65

  15. Growth and Education, 1965-98 86 countries An increase in secondary-school enrolment by 40% of each cohort goes along with an increase in per capita growth by 1% per year.

  16. Growth and Education, 1965-98 87 countries How about initial income? Positive but diminishing returns to education

  17. Efficiency is Key • Need economic policies that increase efficiency • Produce more output from given inputs • Takes fewer inputs to produce given output • More efficiency, better technology are two ways of increasing output per unit of input • So is more and better education • Trade increases efficiency and thereby also economic growth

  18. 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 means addition to capital stock • Y = EK • Output depends on quality and quantity of capital

  19. 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 - 

  20. A Simple Model of Endogenous Growth • Growth equation: • g = sE -  • Rate of economic growth equals • Saving rate • times • Efficiency • minus • Depreciation

  21. Sources of Endogenous Growth • 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

  22. Sources of Endogenous Growth • Five mainsources of increased efficiency • Liberalization of prices and trade increases efficiency, and thus is good for growth • Stabilization reduces the inefficiency associated with inflation, and thus is good for growth • Privatization reduces the inefficiency associated with state-owned enterprises, and thus … • Education makes the labor force more efficient • Technological progress also enhances efficiency • The possibilities are virtually endless!

  23. So 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 • Place strong emphasis on efficiency 1. Liberal price and trade regimes 2. Low inflation 3. Strong private sector 4. More and better education 5. Limited natural resources

  24. 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. • Compare North Korea with Hong Kong and Singapore • More efficiency is good for growth.

  25. Market Equilibrium and Economic Welfare Price Consumer surplus Supply A Total welfare gain associated with market equilibrium equals producer surplus (= ABE) plus consumer surplus (= BCE) B E Producer surplus Demand C Quantity

  26. Market Intervention and Economic Welfare Consumer surplus = AFGH Producer surplus = CGH Price Welfare loss Total surplus = AFGC Supply A F Price ceiling imposes a welfare loss equivalent to the triangle EFG J B E H Price ceiling G Demand C Quantity

  27. Liberalization Increases Economic Efficiency D Domestic, distorted price ratio H E Traditional output C G O Modern output

  28. Liberalization Increases Economic Efficiency World price ratio D Domestic, distorted price ratio H E If output gain = E and price distortion = c, then E = mc2 Price distortion Output gain Traditional output OC = modern output CA =traditional output OA = total output F C G O A B Modern output

  29. Liberalization Increases Economic Efficiency World price ratio Welfare gain Exports D K Domestic, distorted price ratio J H E Price distortion Output gain Traditional output Imports F C G O A B Modern output

  30. Liberalization Increases Economic Efficiency Transition takes time: From E to FviaM, N, and Q Welfare gain D J H E M Price distortion N Q Traditional output F C G O A B Modern output

  31. How Trade Increases Efficiency • Autarky breeds inefficiency • Trade with other nations increases efficiency by allowing • Specialization through comparative advantage • Exploitation of economies of scale • Promotion of free competition • Not only trade in goods and services, but also in capital and labor • “Four freedoms”

  32. How Trade Increases Efficiency • Trade also encourages international exchange of • Ideas • Information • Know-how • Technology • Trade is education • Which is also good for growth

  33. Large and Small Countries • Small countries need trade to extend their markets beyond their national borders • Large countries need trade less than small • Domestic trade replaces foreign trade • Evidence from around the world • Small countries have higher ratios of exports to GDP than large countries

  34. Selected Countries: Exports 1999-2000 (% of GDP)

  35. Empirical Evidence • Openness can be defined as export ratio adjusted for country size (e.g., population) • Evidence shows that open economies tend to grow more rapidly than closed economies • Trade encourages growth • Growth encourages trade • Other measures of openness yield a similar conclusion

  36. Openness and Growth 1965-98 87 countries An increase in openness by 14% of GDP is associated with an increase in per capita growth by 1% per year.

  37. Bottom Line • Increased openness stimulates economic efficiency and growth ... • ... as long as the gains from trade are well distributed • Continued globalization is thus by no means sure to succeed • Need to pay attention to distribution as well as growth The End

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