W4B Outline

1. W4B Outline • Two Classical Views of Trade and Growth • 1.1) Hume and Diffusion • 1.2) Smith and Networks • 2) The Current Size vs Institutions Debate • 2.1) Increasing Returns • 2.2) The Solow (Neo Classical) Camp • 3) Which way to better institutions? • The One Path vs Many Paths Debate: • What role for social consensus and democracy? • 3.1) S+W • 3.2) Rodrik • 3.3) Comparative Institutions

2. Two Classical Views of Growth David Hume 1740’s and 50’s Emphasis on the interactions between: forms of government law allows saving in free or monarchal gov. Saving and specialization from the incentives provided by imported goods and property rights trade+innovation diffuses production and legal innovations Fastest growth will occur where many small and free states are connected by commerce.

3. WON: Introduction and Plan pci (per capita income)= total product/ total population Replacing Smith’s ratio (# of useful people/ # not useful) With the currently used ratio (employment/population): Pci=(total product/employment)(employment/population) productivity employment ratio Differences in pci stem from the former as higher pci countries have in Smith’s view had lower employment ratios.

4. Smith: sources of growth Ch1’s three sources Skill or dexterity Set up time Specialized machinery By the end of Ch1 we see that the division of labor (specialization) occurs at level of: Individuals/firms/industries/nations/the globe

5. Smith: DoL and EoM Greater DoL lowers transport costs DoL EoM Larger markets allow larger firms and Specialization of firms

6. GDP Density http://www.cid.harvard.edu/caer2/htm/content/papers/paper39/paper39.htm

7. Size vs Institutions To what extent does growth come from: size, and agglomeration or local network economies vs better institutions? Former implies that the rich pull ahead, while the latter implies that any and all can catch up.

8. Size vs Institutions INSTITUTIONAL DIFFERECES EXPLAIN EVERYTHING Solow and diminishing MP with CRS is pretty much right, but we left out human capital and institutional differences. SIZE MATTERS Solow and CRS misses The boat. We need to make Technical change “endogenous” Paul Romer Hall and Jones Mankiw, David Romer, & Weil Different elements of Adam Smith Are emphasized by each camp.

9. Size Matters If… The economic size of a nation or region could determine its productivity if: Human Capital has important local “spillover effects”, e.g. the FIRE sector: finance, insurance and real estate. Physical Capital Goods are ‘lumpy’: you need larger economic size to efficiently use a larger variety of capital goods.

10. New Growth Policies To the extent that “externalities” are localized we may have MPB<MSB of production The marginal social benefit of producing high tech goods could be greater than the marginal private benefit from producing high tech goods because employers are contributing to the local pool of human capital which has network effects: each specialist is more productive because they can work with other specialists. Policy recommendation: production subsidy or employment/R&D/education subsidy.

11. A-K Endogenous Growth Model Y= AK What if the Marginal Product of Capital doesn’t Fall? Co 1 Co 2 time So called “A-K” growth model: Y=AK and/or y=Ak as k rises the income gap between countries continues to grow. There is no reason for countries to move towards common K/L as in Solow model.

12. Paul Romer Why might the Marginal Product of capital not fall? Because as a country gets economically bigger it Uses a wider array of “lumpy” capital goods. There is CRS to N and K, but you get more output with A greater diversity of capital goods. During the growth process the number of capital goods increases so the MP of capital does not fall.

13. Solow Supporters • Solow supporters assert that the Solow model does a • good job of explaining differences in growth rates and • per capita incomes between countries. • But it needs to be extended to take account of • human capital and • (2) technology gaps where technology needs to be • regarded as ‘labor augmenting’. • If we do so we see that ‘institutional quality’ or ‘governance’ • drives differences in technology and per worker output.

14. Hall and Jones They add human capital. They have A next to L, technical change in labor augmenting. Charles Jones and Robert Hall, NBER w6564 Why Do Some Countries Produce So Much More Output per Worker than Others? June 1999

15. Hall and Jones Variation in Y/L comes mostly from the variation in A. The next slide shows the relation between A and Y/L.

16. Productivity Differences Hall and Jones, NBER #6564

17. Hall and Jones Cont. What determines “A” the level of productivity? Hall and Jones make and index of Social Infrastructure: 5 survey indicators of governance quality 2 indicators of ‘openness’ to trade one of which Is Sachs and Warner’s

18. Hall and Jones Conclusion Differences in social infrastructure (gov quality and openness) explain differences in Y/L. Solow model does well if human capital and institutional differences are controlled for.

19. Two Policy Perspectives on Growth and Development Best Practice Washington Consensus Market discipline Small Gov. Little Stabilization Policy Openness (Trade and Fin.) Strong “Conditionality” Sachs+Warner Many Paths, (Local Knowledge) Democratic compromise Social Consensus And Stability for Investment Active Macro Policy? Gov. regulation +Soc. insurance Room for policy deviation Rodrik

20. Intro to Growth Policy Debate Sachs and Warner: one best practice policy gov. generally a grabbing hand limits to gov. intervention/expropriation via privatization and rules “Market Discipline” Rodrik: there are many paths to high pci attention to both gov’s helping hand and its grabbing hand democracy and consensus as means and ends. “National Self Discovery”

21. S+W review of pessimists • Pessimists look at divergence results and say… • We live in a world in which wealthier countries • enjoy faster technical change (Romer) • 2. There is a convergence club and you need a certain • amount of human capital to join (Baumol) • Each country has a different “potential” output level. • They only grow quickly up to this level (Barrow)

22. All you need is openness… Filter countries by: Politics: 1) Socialist 2) Domestic unrest 3) very low civil rights PNQ “political nonqualifiers” Openness: 1) import quota coverage 2) export monopolies SSA data only 3) Socialist 4) BMP black market premium of 30% or more A BMP occurs when the rate at which (say) dollars can be bought on the market (the street) is much higher than the official exchange rate. It is similar in impact to a tariff.

23. S+W Openness Results S+W Openness Results Table 3 Growth Rates 1970-89 qualify filtered out High n.a. PNQ Income 2.45 -0.175 ONQ -0.226 BothNQ Low 2.056 PNQ Income 4.745 1.0338 ONQ 0.598 BothNQ

24. S+W all co’s S+W BPEA 1995

25. S+W open co’s S+W BPEA 1995

26. S+W closed co’s S+W BPEA 1995

27. Rodrik Rebuts S+W don’t really have an openness measure. They have a mix of SSA (export monopoly) and macro imbalances (BMP) which probably reflect lack of social consensus and democracy. Anyway investment is far more important than openness. You need social stability for investment confidence, you can easily succeed with deviations away from free trade. (Subsidies, Protection) Social consensus is difficult in ethnically fragmented societies. (As ex-colonies tend to be.) Multi-party parliamentary systems reduce fears and maintain stability.

28. Rodrik: Democracies do better

29. Rodrik: ethnic divisions really require political compromise

30. Rodrik: Gov. Compromise+Consensus “Imperial” or Unchecked Presidencies Are Bad

31. Rodrik Democ. and Macro Shocks Political access allows adustment to shocks

32. Same Idea Again

33. Rodrik Inequality-Democracy

34. http://www.cid.harvard.edu/cidwp/pdf/097.pdf

36. Dani RodrikGrowth Diagnostics2005http://ksghome.harvard.edu/~drodrik/barcelonafinalmarch2005.pdf • Gov. reform effort and attention are limited. • Public’s toleration for reforms will be greater if initial reforms produce growth. • Given this opportunity cost reforms must be focused on the most important issues and constraints.

38. 3 cases-examples • Brazil • El Salvador • Both had far reaching reforms after 1980 • Low growth relative to potential • Dominican Republic • Very little reform, but targeted at its constraint • Faster growth

39. Brazil savings constrained, high interest rates and growth moves with BOP (an external constraint). El Salvador lower interest rates and borrowing does not hit external constraints. • El Salvador a low return to capital co. • Brazil a high return to capital.

40. ok ok El Salvador

41. El Salvador

42. Brazil-High Private Return so…

44. Brazil low savings

45. Brazil has twice pop of Mexico but half its value of exports, more for. Lending will only temporarily lift growth—savings has to be increased domestically.

47. Brazil

48. DR • Growth drivers • Tourism • Maquila • Remittances • Banking crisis in 2001 as Tourism collapses, then exchange rate and gov deficit problems hit. • Focus on SR deficit problems, banks and returning to strong 3 sector growth before wide ranging reform effort!

50. New Comparative Econ. Gov as Helping vs Grabbing Hand Market Failure vs State Failure Importance of property rights: Property titles, credit markets and liable terminals Which legal institutions do best at protecting diffuse property rights? Example: Ownership concentration, Bankruptcy Protections, and Minority Stock Holders.