To grow or not to grow: Why institutions must make a difference

1. To grow or not to grow: Why institutions must make a difference Thorvaldur Gylfason

2. Why growth rates differ • If technology matters for economic growth, as it must, then … • General economic efficiency must also make a difference for growth • Economic policy • Institutions • Institutions or geography? • False contrast • There is room for both, side by side

3. Why growth rates differ Resource depletion drag Dutch disease Rent seeking + + – + + Political and economic diversification

4. Growth and political liberties, 1965-98 r = rank correlation Democracy is good for growth: No visible sign that democracy stands in the way of economic growth Brazil Botswana China Korea Venezuela Central African Republic Niger r = -0.62 85 countries

5. Growth and political liberties, 1965-98 Political liberty is good for growth because oppression breeds inefficiency, and so does corruption Brazil Botswana China Korea Venezuela Central African Republic Niger r = -0.62

6. Growth and natural capital, 1965-98 An increase in the natural capital share by 8% goes along with a decrease in per capita growth by 1% per year. Australia Venezuela r = -0.64 85 countries

7. Natural capital tends to crowd out Recent literature But Norway is, so far at least, an exception Six main linkages: • Resource depletion drag • Dutch disease Hurts level, composition, or volatility of exports • Rent seeking Protectionism, corruption, oppression • False sense of security Poor quality of policies and institutions • Education 6. Investment Foreign capital Social capital Human capital Real capital

8. Natural resource abundanceand economic structure Hypothesis: Dependence hurts growth, even if abundance may help Resource poor, resource dependent (Chad, Mali) Resource rich, resource dependent (OPEC) Resource dependence Resource poor, resource free (Jordan, Panama) Resource rich, resource free (Canada, USA) Resource abundance

9. Empirical research strategy Study 85 industrial and developing countries from 1965 to 1998 Look for cross-country patterns in data from the World Bank Dig deeper through regression analysis • Recognize interconnections among several key determinants of growth by estimating a system of simultaneous equations by Seemingly Unrelated Regression method

10. Regression results Recursive system Note: 85 observations. Method of estimation is SUR. t-statistics are shown within parentheses.

11. Investment is good for growth Regression results Note: 85 observations. Method of estimation is SUR. t-statistics are shown within parentheses.

12. Education is good for growth Regression results Note: 85 observations. Method of estimation is SUR. t-statistics are shown within parentheses.

13. Civil liberties are good for growth Regression results Index goes from 1 (full civil liberties) to 7 (negligible civil liberties) Note: 85 observations. Method of estimation is SUR. t-statistics are shown within parentheses.

14. Population growth hurts growth Regression results Note: 85 observations. Method of estimation is SUR. t-statistics are shown within parentheses.

15. Conditional convergence: 2% per year Regression results Note: 85 observations. Method of estimation is SUR. t-statistics are shown within parentheses.

16. Abundance is good for growth Regression results Note: 85 observations. Method of estimation is SUR. t-statistics are shown within parentheses.

17. Dependence is bad for growth Regression results Note: 85 observations. Method of estimation is SUR. t-statistics are shown within parentheses.

18. Dependence is bad for growth Regression results Note: 85 observations. Method of estimation is SUR. t-statistics are shown within parentheses.

19. Dependence is bad for education Regression results Note: 85 observations. Method of estimation is SUR. t-statistics are shown within parentheses.

20. Regression results Indirect effect through education is -0.77·0.02 -0.02 Note: 85 observations. Method of estimation is SUR. t-statistics are shown within parentheses.

21. Dependence is bad for investment Regression results Note: 85 observations. Method of estimation is SUR. t-statistics are shown within parentheses.

22. Regression results Indirect effect through investment is -0.26·0.08 -0.02 Note: 85 observations. Method of estimation is SUR. t-statistics are shown within parentheses.

23. Dependence is bad for liberty Regression results Note: 85 observations. Method of estimation is SUR. t-statistics are shown within parentheses.

24. Regression results Indirect effect through civil liberties is 0.04·(-0.27) -0.01 Note: 85 observations. Method of estimation is SUR. t-statistics are shown within parentheses.

25. Regression results Total effect is -0.08 + (-0.77)·0.02 + (-0.26)·0.08 + 0.04·(-0.27) -0.13 Liberties and resources both matter for growth Note: 85 observations. Method of estimation is SUR. t-statistics are shown within parentheses.

26. What if abundance is not given? Regression results Total effect is -0.13 + [0.05 + (0.54)·0.02 + (0.16)·0.08 + (-0.05)·(-0.27)  0.09]·wealth per person African dummy adds nothing Note: 85 observations. Method of estimation is SUR. t-statistics are shown within parentheses.

27. Regression results Total effect of natural capital on growth is negative as long as wealth per head is below $150K Note: 85 observations. Method of estimation is SUR. t-statistics are shown within parentheses.

28. What is the upshot? • Growth differentials across countries can be explained by several different interconnected factors • Private initiatives (investment, fertility) • Public policies (education) • Institutions (democracy) • Geography (natural resources) • In particular, institutions survive the presence of geography, and vice versa

29. Case in point: Norway The problem is not the existence of natural wealth as such ... but rather the failureto avert the dangers that accompany the gifts of nature Norway is, so far, a success story Government takes in 80% of oilrent and invests it mostly in foreign securities No signs of damage to growth potential, at least not yet

30. Why Norway has succeeded where OPEC and others failed Long tradition of democracy and market economy in Norway since before the advent of oil • Large-scale rent seeking was averted as oil was defined as a common- property resource from the beginning • Adequate investment performance • Excellent education record

31. Why Norway has succeeded where OPEC and others failed Even so, Norway faces challenges • Some (weak) signs of Dutch disease • Stagnant exports, sluggish FDI • Limited interest in EU and EMU • Some signs also of unwillingness to undertake difficult reforms • Health care provision • Pensions Management of oil fund transferred from Ministry of Finance to Central Bank 1999

32. Bottom line These slides can be viewed on my website: www.hi.is/~gylfason Growth requires accumulation and efficient use of capital • Physical capital through strong incentives to save and invest • Human capital via education, training, & less fertility in LDCs • Social capital through democracy, etc. Fin Financial and foreign capital: Same story