The Analytics of Growth Dynamics

1. The Analytics of Growth Dynamics An Empirical Approach December, 2011

2. Outline • A Forecasting Scenario for 2012-14 • GrowthFacts • Policy Questions • The Centrality of economic growth • The relationship between globalization and economic growth • The Paradoxes of globalization • FromCorrelates to Fundamental Causes

3. The Analytics of Growth Dynamics: GDP Forecast 2011

4. A Forecasting Scenario for 2012-14 Real GDP Growth (PPPexchange rate) Real GDP Growth (Market exchange rates)

5. A Forecasting Scenario for 2012-14 Consumer price inflation(% av) Main Policy Interest Rates(%; end-period)

6. Tremendous divergence in per-capita incomes since 1750 Small number of countries, mainly in East and Southeast Asia, have consistently caught up with growth leaders Many countries have experienced growth spurts for a decade or two; but these have often fizzled out Low growth over long term for a large number of countries During the last two decades, China and (to a lesser extent) India have grown rapidly, while most other countries have experienced a growth slowdown. Growth facts

7. The Policy Questions • What determines the global growth rate of the leading countries in the last two centuries? • To what extent is this growth rate sustainable? Can it be increased? • What is the cause of the great differences between countries? • Why are so many countries lagging behind? • How can we support their development?

8. Accounting for global income disparities: within versus between countries • Assume you care only about your own consumption • Define rich and poor (within a country) as follows: • rich : having the same income level as people in the top decile (10%) of a country’s income distribution • poor: having the same income level as people in the bottom decile of a country’s income distribution • Define rich and poor country as follows • rich country: a country that is in the top decile of all countries ranked by per-capita GDP • poor country: a country that is in the bottom decile of all countries ranked by per-capita GDP

9. Inequities in income: within and across countries yj per-capita income (GDP) in country j; dj income share of decile d in country j; ydj average income level in decile d (=1,2,..,10) in country j. ydj = 10 x dj x yj (all figures in 2004 PPP-adjusted $)

10. Inequities in health: within and across countries Source: WHO, World Bank. * To be conservative, the distribution in Denmark is assumed to be same as in Madagascar.

11. Source: Bourguignon and Morrison (2002), via Pritchett (2003)

12. The Great Divergence Source: Maddison (2001), in 1990 international $

13. Major landmarks in economic growth Industrial revolution in Europe and the onset of “modern economic growth” (c.1750-1820) Source: Maddison (2001)

14. Per-capita GDP across various regions over the millennium Source: Maddison (2001). In 1990 PPP $.

15. Major landmarks in economic growth Absence of economic growth in Asia (except Japan) and Africa before 1950) Source: Maddison (2001)

16. Major landmarks in economic growth Japanese catchup post-1950 Source: Maddison (2001)

17. Major landmarks in economic growth A world divided between rich and poor countries Source: Maddison (2001)

18. How growth matters to poverty: back to poverty incidence (percent below $1.25 per day poverty line, in 2005 PPP $)

19. Source: Thomas (2007)

20. Source: Thomas (2007)

21. How does globalization contribute to economic growth? • Trade opportunities, capital flows, access to technology increase potential for catch-up • On the other hand, policies of free trade and free capital mobility do not necessarily provide the most conducive environment for domestic entrepreneurship, investment, and structural change. • Cf. relationships between tariffs and growth in late 19th century; downside of recent experience with financial globalization • What does the overall empirical record show?

22. Economic performance over time: is more globalization always better? Historical experience with growth 9 GDP per capita growth rate of fastest growing country/region (annual average, %) World GDP per capita growth rate (annual 8 average, %) 7 6 5 4 3 2 1 0 1000-1500 1500-1820 1820-1870 1870-1913 1913-1950 1950-73 1973-90 1990-2005 Western Europe United States Other Western Mexico Norway Japan South Korea China offshoots

23. Paradoxes of globalization (I)Countries that have benefited most from globalization are those that have not played by the rules …

24. Paradoxes of globalization (I)... while those that have, have performed worse

25. Paradoxes of globalization (I)Countries that have benefited the most from integration in the world economy are countries with non-standard policies *The index is a composite quantitative measure of “the 10 key ingredients of economic freedom such as low tax rates, tariffs, regulation, and government intervention, as well as strong property rights, open capital markets, and monetary stability.”

26. Paradoxes of globalization (II)Financial globalization has produced frequent and painful crises… Source: Jeanne and Ranciere (2005)

27. Paradoxes of globalization (II)… and has forced countries to engage in costly strategies of self-insurance

28. Paradoxes of globalization (II)… with the result that capital now flows in the “wrong” direction Source: Prasad, Rajan and Subramanian (2006)

29. Paradoxes of globalization (III)For the vast majority of countries, domestic policies trump (nearly) everything else when it comes to economic growth • A parable of two countriesCountry A … has preferential, free access to the US market for its exports … can send several millions of its citizens to the US as workers … receives huge volumes of direct investment … is totally plugged in to US production chains … for which the US Treasury stands ready to as lender of last resort … has effective security guarantee from the US military Does globalization get better than this? • Whereas B is a country for which … the US maintains a trade embargo, and does not have diplomatic relations … which receives neither aid nor any other kind of assistance … and which is kept outside international organizations like the WTO … which is prevented from borrowing from the IMF and WB. • Which country did better?

30. What drives growth in developing countries? Four models of growth: • Foreign borrowing-led growth • countries in the periphery of EU in 1990s, LA in 1970s, … • Commodity booms • 19th century, many African countries in the last decade • Growth based on deep integration • Goods and factor market integration + institutions + transfers (convergence within EU) • Structural transformation-led growth • From low-productivity traditional products to modern, mostly manufacturing activities (and lately increasingly into tradable services) • Based not on (static) comparative advantage, but on producing what richer countries produce • Japan, S. Korea, China Only the last is a realistic possibility for most countries

31. Deep vs. shallow integration as drivers of convergence • EU versus NAFTA models • One is hard because it entails legal, institutional, political integration • Labor mobility, in addition to capital and product-market integration • Embedded within EU-wide institutions • Acquis communautaire (>100,000 pages) • European Court of Justice • European Central Bank and a common currency (for most) • Significant inter-regional transfers • Growing pains of a quasi-federal political system • The other is comparatively easy • But only the first has the potential to foster economic convergence • The EU model not in the cards for most developing countries

32. Where did real growth come from? • High-growth countries are those that are able to undertake rapid structural transformation • from low-productivity (“traditional”) to high-productivity (“modern”) activities • to tradables in particular • and to industrial activities within tradables • and also in more recent times, tradable services • Economic rationale: modern tradables are under-produced in laissez-faire because they suffer disproportionately from the market and institutional failures that are rampant in poor nations (Rodrik 2009)

33. What has worked: “productivist” policies • Sound “fundamentals” • Market-friendly policies • Macro stability • But also: • Industrial policies in support of new economic activities • Undervalued currencies to promote tradables • A certain degree of repression of finance, to enable: • Development banking • Subsidized credit • Undervaluation

34. … combined with an enabling external environment • Permissive of industrial policies • At least under GATT and • Until recently • No pressure to liberalize finance and capital accounts • Until recently • Willing to absorb excess supply of tradables • U.S. attitude of benign neglect towards current account deficits • BW I and II • Unconcerned with undervaluation in developing countries • Again, until recently

35. From this perspective, existing global rules leave lots to be desired… • Trade regime • Agreements on subsidies, TRIMs, TRIPs, and other negotiations on services  narrowing room for “industrial policies” • International capital markets • Financial codes and standards  no roles for development banking and credit market interventions • Monetary rules • CB independence and “free floating”  no role for exchange rate as developmental policy instrument

36. Growth Economics: Rethinking The Links income endogenous endowments productivity trade institutions partly endogenous geography exogenous

37. Growth Economics: Rethinking The Links income endowments productivity 4 trade institutions 1, 2 3 geography (Jared Diamond, Jeffrey Sachs)

38. The Analytics Of Growth Dynamics: FromCorrelates to Fundamental Causes • The Correlates of economic growthare physical capital, human capital and technology. • But these are only proximate causes of economic growth and economic success: • why do certain societies fail to improve their technologies, invest more in physical capital, and accumulate more human capital? • To illustrate this point further: • how did South Korea and Singapore manage to grow, while Nigeria failed to take advantage of the growth opportunities? • If physical capital accumulation is so important, why did Nigeria not invest more in physical capital? • If education is so important, why our education levels in Nigeria still so low and why is existing human capital not being used more effectively? • The answer to these questions is related to the fundamental causes of economic growth. • We can think of the following list of potential fundamental causes: • luck (or multiple equilibria) ;geographicdifferences; institutionaldifferences; cultural differences • An important caveat should be noted: discussions of geography, institutions and culture can sometimes be carried out without explicit reference to growth models or even to growth empirics. But it is only by formulating parsimonious models of economic growth and confronting them with data that we can gain a better understanding of both the proximate and the fundamental causes of economic • growth.

39. The Analytics Of Growth Dynamics: From Correlates to Fundamental Causes

40. The Analytics of Growth Dynamics: The Role of Finance Elements of Rapid Growth: • What are the reasonably robust empirical correlates of economic growth: • Macroeconomic stability • Stable, predictable “property rights” (institutional quality) • Financial sector • Something about external policies • Government’s role in finance: • Governments need to do • More and better in some areas • Less in others • And to recognize how finance without frontiers is changing what they can do, and can achieve • Because finance matters for growth and poverty reduction, and we have the evidenceidence • What has been empirically prooved: • Strength of relationship between finance and growth • Importance of legal and information base • Importance of private sector monitoring for development and stability • Cautions on deposit insurance • The cost of state ownership • The benefits of foreign banking • How technology is leading to finance without frontiers • What should not be done: • To ‘leave finance to the market.’ • To privatize banks all at once • Open up to entry to foreign financial firms and leave it to them. • Open to capital flows without robust regulatory system.

41. “Augmented” Washington Consensus the previous 10 items, plus: 1. Fiscal discipline 2. Reorientation of public expenditures 3. Tax reform 4. Financial liberalization 5. Unified and competitive exchange rates 6. Trade liberalization 7. Openness to DFI 8. Privatization 9. Deregulation 10.Secure Property Rights Growth Economics: The Washington Consensus Original Washington Consensus 11. Corporate governance 12. Anti-corruption 13. Flexible labor markets 14. WTO agreements 15. Financial codes and standards 16. “Prudent” capital-account opening 17. Non-intermediate exchange rate regimes 18. Independent central banks/inflation targeting 19. Social safety nets 20. Targeted poverty reduction

42. Disappointments of the Washington Consensus • Latin America: Only 3 countries have grown faster during the 1990s than in the 1950-80 period (and one of those 3 is [was] Argentina!) • Countries in transition from socialism: Real output below 1990 levels in all but four former socialist economies; poverty rates remain higher 1990 even in the most successful countries (e.g., Poland) • Sub-Saharan Africa: Results remain very disappointing, and far worse than those obtained prior to the late 1970s • Widening income gaps: Income inequalities have worsened in most of the countries that have adopted the WC agenda • Frequent and painful financial crises: East Asia, Brazil, Russia, Argentina, Turkey.

43. Questions about the augmented WC • Feasibility • Can all of it be done together? • Priorites • Which reforms first? • Relevance • Does the recipe correspond to actual experience of successful cases? • Uniformity • Is there really one way? Economic principles do not map into a unique set of institutional arrangements

44. Hence the chief shortcoming with global economic arrangements … • is not that they present inadequate levels of market access for developing nations • Doha round and agriculture a sideshow • No developing country’s growth potential is significantly constrained at present due to inadequate market access • but that they are premised on the notion that removing remaining impediments to trade in goods, services and capital are the primary lever with which to achieve convergence • thus forcing developing nations to trade valuable “policy space” in exchange for ephemeral gains in market access