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Chapter 3

Chapter 3. Norton Media Library. Chapter 3. Economic Growth: Concepts and Patterns. Dwight H. Perkins Steven Radelet David L. Lindauer. Why some countries rich and others poor? Why some countries grow while others grow slowly or not at all?

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Chapter 3

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  1. Chapter 3 Norton Media Library Chapter 3 Economic Growth: Concepts and Patterns Dwight H. Perkins Steven Radelet David L. Lindauer

  2. Why some countries rich and others poor? • Why some countries grow while others grow slowly or not at all? • How did some East Asian countries advance from poverty to relative prosperity in just 30 years? • Why many African countries remain in deep poverty? • Sustained development and poverty reduction cannot occur in the absence of economic growth 2

  3. Divergent Patterns of Economic Growth since 1960 • After 1960s LDCs begin to diverge • For example per capital income in Thailand was $1100 and that of Zambia was $1200 • Thailand now has per capita income of $7000, but Zambia is about $900? • What happened? Growth difference: Thailand grew over 4.5% and Zambia growth was -0.6% (negative)

  4. See table 3.1 for Average Growth Rates across countries 1960-2003: • Negative Growth (Nigeria, Zambia,Chad, etc) <0 • Slow Growth (Kenya, Ghana, Rwanda, Argentina) 0.12<G<1.3 • Moderate growth (Lesotho, Egypt, Brazil, India)2.1<G< 2.75 • Rapid Growth (Botswana, Malaysia, South Korea, Singapore 3.32<G< 6.3 • Industrial Countries (Japan USA, Canada, UK) Japan= 4.11, USA= 2.43 4

  5. Notice that small differences in growth rates can a make huge difference, especially over time.

  6. Why is Botswana Successful (Read Box 3.1) • Between 1970-90, Botswana was the fastest growing country in the world at about 8% per year. • But at independence in 1965, it was poor it had 100 high school graduates and 22 college graduates. • What is the main source of success: Good policies and strong institution and democratic government • Protection of property rights and minimal corruption including civil service base on merit not on patronage • These has led to highest per capital income and best HDI • Recent challenge: High HIV/AIDS infection rate has reversed this.

  7. Factor Accumulation, Productivity Growth, and Economic Growth • What determine economic growth? and what are the characteristics that distinguish fast growing from slower growing countries? • Many factors that are important to growth: the amount and type of I, education and health care systems, natural resources, quality of institutions... • At the core of most economic growth theories: the relationship between (L, K) and Q. • What is the relationship between output and income?

  8. Factor Accumulation, Productivity Growth, Econ. Growth • Economic growth depends on 2 basic processes: • Factor Accumulation: increase in the size of capital stock and labor force. More machines, factories, buildings, roads, electricity, computers and tools along with better trained workers • Productivity Growth: Amount of output per unit of machine or worker: increases in 2 ways by greater efficiency-specialization, and technological change. • This can be explained using production function • Q= f (L, K, etc…)

  9. Fig. 3.1 Basic Sources of Growth: Production function Q=f(K)-capital accumulation) Factor Accumulation 9

  10. Fig. 3.1 bottom: Productivity Gains Productivity Gains 10

  11. Saving, Investment & Capital Accumulation Key Elements of Economic Growth • New investment increases the capital stock • Investment (I) is financed through savings (S) I=f(S) • Savings comes from income of GDP S= f(GDP) • These decisions are made by consumers, firms corporations, & governments • Sustaining Growth requires both generating new investment and making sure it is productive & employment creating.

  12. Sources of Growth Analysis • Solow Model: Explores the contribution of each factor to increase to output: Q(K, L, Productivity gains) • Growth Accounting or Source of Growth Analysis • gY= (Wk x gK) + (WL x gL)+ a • gY= growth of income • gK, gL= growth of capital and labor • Wk, WL= share in total income of wages and returns

  13. a= rate of change in TFP, rate of productivity of inputs= residual • “a” measures the contribution to production of efficiency, technology, and other influences on productivity. 13

  14. Example of Growth Accounting • Assume the following: gY=0.05 (GDP) • gK=0.07 (7 percent),gL=.02 (labor growth) • WL=0.06 share of labor in income (6%) • WK= 0.04 (share of capital in income (4%) • Substitute in gY= WKgK + wLgL + a • 0.05= (0.4 x 0.07) +( 0.6 x0.02) + a • a= 0.01 or 1 percent

  15. These figures tell us the degree to which K accumulation, L accumulation, and TFP growth each contribute to the overall rate of growth of 5%. • Note that TFP counts for 20% of total growth. • The growth in K-stock is 56%: (0.4x0.07)/0.05 • The growth in L-force is 24%: (0.02x0.6)/0.05 • In this example, K-accumulation is the main driver of growth 15

  16. 2 problems: • What are the factors causing a to improve? • a is measured with error 16

  17. Economic Growth Across Countries 1960-2003: table 3.1 • Negative Growth (Nigeria, Chad, Senegal) • Slow Growth (Kenya, Ghana, South Africa) • Moderate Growth (Lesotho, Egypt, Brazil) • Rapid Growth (Botswana, Malaysia, S.Korea, Thailand) • Industrial Countries (Japan, US, Canada)

  18. Sources of Growth Across Countries 1960-2000 (1980s) based on table 3.2 • Country/Region: Output(Q) K Education TFP • Brazil -1.63 0.16 0.68 -2.47 • Ethiopia -1.74 1.11 0.27 -3.12 • Ghana -1.14 -1.23 o.15 0.07 • Africa -1.06 -0.07 0.42 -1.41 • East Asia 4.36 2.45 0.66 1.25 • Latin America -1.77 0.04 0.47 -2.28 • Middle East 1.15 0.55 0.53 0.07 • South Asia 0.68 1.02 0.42 2.25

  19. Characteristics of Rapidly Growing Countries • 1. Macroeconomic stability • 2. Investment in Health and Education • 3. Effective Governance and Institutions • 4. Favorable Environment to Private Enterprise • 5. Favorable Geography or location?

  20. Macroeconomic stability • Macroeconomic implies avoiding inflation and recession. • An extreme case of high inflation: Zaire/Congo =2800%, more recently Zimbabwe 4000%! Primarily by printing too much money to pay for deficit • Political instability in the form of civil war, military coups, cross-border wars are rampant in Africa • 2/3 of African states suffer from conflict • See figures 3.2, 3.3

  21. Fig. 3.2: Inflation and Growth in 1990s 18

  22. Fig. 3.3: GDP per capita before and After Civil War 19

  23. Investment in Education and Health ( Human Capital) • Investment on Human capital is a key as it translates to longer life, healthier and productive population. • Health and Education are both input or means and outcome (goal) of development. • Increase in the level and quality of Education and health is crucial

  24. Fig. 3.4: Growth and Life Expectancy Relations 21

  25. Effective Governance and Institutions • Douglas North study shows relationship between economic growth, the rule of law, extent of corruption , property rights and quality of government bureaucracy, and other measures of institutional quality • Economic Growth = F( Institutions..) • Other factors: effective private sector, civil society groups, and free press, political competition, etc..

  26. Fig. 3.5: Governance and Growth 23

  27. Institutions, Governance & Growthread box 3.2 on page 82-83 • 5 institutions are necessary according to Rodrik and Sumbramanian (2003-Finance & Development) • 1. market institutions that protect property rights • 2. Market regulating institutions that deal with market failure • 3. Market stabilizing institutions to control inflation • 4. Market legitimizing institutions such as social protection and insurance • 5.Political institutions determine how a country is governed: level of democracy, transparency, free press, participatory politics, and competitive parties. See Figure 3.5 Governance and Growth

  28. Favorable Environment for Private Enterprise • Growth depends on millions of private citizens making decision to save, invest, work, educate, etc • Agricultural policies are central in Africa since 70-80% of the population lives from agriculture • Hernando de Soto: The Mystery of Capital • Heavy business regulation and weak property rights under mine or kill businesses • The degree of openness to international trade and influence matters see Figure 3.6

  29. Fig. 3.6: Degree of Openness 26

  30. Does Geography Matter? • Most economically developed states are in Temperate climate Zone. Most developing countries are in the tropics. “The effect of climate”: Andrew Kamrack argument. • Does being land locked matter? (no coast line). Yes and no • Botswana is land locked but it is most successful African Economy • Switzerland and Austria are land locked yet they are wealthy countries.

  31. Fig. 3.7: The Destiny of Geography? 28

  32. Fig. 3.8: Growth and Geography 29

  33. Production Function & Diminishing Returns • The Concept of Production function • Q= Output= f( Labor, Capital, Land, etc) • Principle of Diminishing Marginal Product • (See Figure 3.9) • Implications of diminishing returns of capital for developing & African countries

  34. Implications of Diminishing marginal product of Capital • Poor countries have a potential to grow more rapidly since they face capital scarcity • Richer countries with capital abundant grow slowly • Since poor countries have more potential to grow faster they can catch up with rich countries • Examples: China, India, etc..This has not happened in Africa except in Botswana. Why?

  35. Fig. 3.9: The effect of Diminishing Marginal Product of Capital 32

  36. The Convergence Debate: Is there convergence? • There may be convergence among open economies that share the same features • For example East Asian Economies since 1965 (Sachs and Warner, 1995) • Other studies show there no evidence of absolute convergence but there may be conditional convergence. (See figure 3.2)

  37. Fig. 3.11: Conditional Convergence Among OECD Countries 35

  38. Fig. 3.12 36

  39. Economic Growth & Structural Change • Growth involves more than increases in per capita income and rise in factor productivity • Structural change must take place in 4 ways • 1.Proportion of output from agriculture declines, share of manufacturing & services rise • 2.Proportion of Labor engaged in agriculture declines and labor force in industry rises • 3.Population becomes more urbanized & cities and towns grow over time • 4. Greater share of output is sold in markets. • 5. Ignoring agriculture in early stage is a mistake

  40. Reasons for the Decline of Share of Agriculture • 1. Engel’s Law: as income the share of expenditure on food declines and expenditure on non-food such as recreation, clothing, housing, etc rises. • 2. Productivity gains in agriculture frees labor for non-agricultural goods or manufacturing and service production. Technology (improved seeds, fertilizer, machinery,etc) allows less labor to produce food • Example in 18th & 19th century the majority of Americans were in agriculture, now only 3% of US population is engaged in agriculture and 97% in industry and services. 41

  41. Fig. 3.13: Structural transformation among four developing countries 39

  42. Fig. 3.14 40

  43. Fig. 3.15: Decreasing Share of Rural Population with income rise 41

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