To Grow or Not to Grow: That is the Question

1. To Grow or Not to Grow:That is the Question Thorvaldur Gylfason

2. Outline • Pictures of growth • Determinants of growth • Saving and investment • Efficiency • Liberalization • Stabilization • Privatization • Diversification • Empirical evidence of growth

3. Economic growth: The short run vs. the long run Economic growth in the long run Potential output Actual output Upswing National economic output Business cycles in the short run The crisis of 1997-98 isirrelevantto Asia’s long-term growth potential. Downswing Time

4. Economic growth: The short run vs. the long run • To analyze the movements ofactualoutput from year to year, viz., in theshortrun • Need short-run macroeconomic theory • Keynesian or neoclassical • To analyze the path ofpotentialoutput overlongperiods • Need moderntheory of economic growth • Neoclassical or endogenous

5. Growing together, growingapart 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

6. Growing apart Divide into 72 by the growth rate to find the number of years it takes of income per head to double Country B: 2% a year • Efficiency • Economic system • Economic policy Threefold difference after 60 years Output per capita Country A: 0.4% a year 60 0 Years

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

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

9. More sources of growth Arthur Lewis:xis trade, stable politics, good weather But Solow carried the day: long-run growth is exogenous + + + denotes a positive effect in the direction shown +

10. Botswanaand Nigeria: GNP per capita 1964-99 Case 1 Current US$, Atlas method

11. Kenya, Tanzania, and Uganda: GNP per capita 1964-99 Case 2 Current US$, Atlas method

12. Burma and Thailand: GNP per capita 1960-97 Case 3 Local currency, 1988 prices, 1960 = 100

13. Barbados, Dominican Republic, and Haiti: GNP per capita 1964-99 Case 4 Current US$, Atlas method

14. Egypt, Morocco, and Tunisia: GNP per capita 1964-99 Case 5 Current US$, Atlas method

15. Argentina, Uruguay, and Spain: GNP per capita 1964-99 Case 6 Current US$, Atlas method

16. Madagascar and Mauritius: GNP per capita 1964-99 Case 7 Current US$, Atlas method

17. Chile and Zambia: GNP per capita 1964-99 Case 8 Current US$, Atlas method

18. Ireland and Greece:GNP per capita 1964-99 Case 9 Current US$, Atlas method Why?

19. More sources of growth Arthur Lewis:xis trade, stable politics, good weather But Solow carried the day: long-run growth is exogenous + + + denotes a positive effect in the direction shown +

20. Ireland and Greece:Investment 1960-99 (% of GDP) Investment is good for growth, but hardly explains the growth differential between Ireland and Greece

21. Ireland and Greece:Expenditure on education 1960-96 (% of GNP) Education is good for growth

22. Ireland and Greece:Exports 1960-99 (% of GNP) Foreign trade is good for growth

23. The Neoclassical Theory ofExogenousEconomic Growth Traces the rate of growth of output per capita to a single source: Technological progress Hence, economic growth in the long run is immune toeconomic policy, good or bad. “To change the rate of growth of real output per head you have to change the rate of technical progress.” ROBERT M. SOLOW

24. The New Theory ofEndogenousEconomic Growth • Traces the rate of growth of output per capita to three main sources: • Saving • Efficiency • Depreciation “The proximate causes of economic growth are the effort to economize, the accumulation of knowledge, and the accumulation of capital.” W. ARTHUR LEWIS

25. Exogenous vs. endogenous growth • The neoclassical view • that economic growth in the long run is merely a matter oftechnologydoes not throw much light on the spectacular growth performance of Asia since the 1960s. • The new view • that long-run growth depends onsaving, efficiency, anddepreciationis more illuminating. • Besides, it’s not really new, because Adam Smith knew this (1776).

26. One crucial implication of exogenous growth • The neoclassical view • If two countries are identical (same saving rate, same population growth, same technology), then their income per head will ultimately be the same. • This means that poor countries must grow faster than – catch up with! – rich countries: “conditional convergence” • Endogenous growth theory does not have this implication.

27. Enter initial income Conditional convergence + + – ? + denotes a positive effect in the direction shown + denotes a negative effect in the direction shown –

28. Absolute convergence? Do poor countries catch up? r = rank correlation r = -0.09 Botswana No sign that poor countries grow faster than rich China Korea Thailand Indonesia Conditional convergence does not entail absolute convergence Nicaragua 85 countries

29. Enternatural resources Endogenous growth:xcan be almost anything! Dutch disease and rent seeking + + – ? – + denotes a positive effect in the direction shown + denotes a negative effect in the direction shown –

30. A simple model ofendogenous growth • Four building blocks: • S = I • Saving equals investment in equilibrium. • S = sY • Saving is proportional to income. • I = K + K • Investment involves addition to capital stock. • Y = EK • Output depends on quality and quantity of capital.

31. A simple model of endogenousgrowth • Implication: • g = sE -  • Rate of economic growth equals • Saving rate • times • Efficiency (i.e., the output/capital ratio) • minus • Depreciation

32. Endogenous growth in the Harrod-Domar model • You may recognize the endogenous growth model as a reinterpretation of theHarrod-Domar model • where growth depends on • A.the saving rate • B.the capital/output ratio • C.the depreciation rate

33. Sources of endogenous growthI • Saving • Fits real worldexperiencequite well • No coincidence that, in East Asia, saving rates of30-40%of GDP went along with rapid economic growth • No coincidence either that many African economies with saving rates around10%of GDP have been stagnant • OECD countries: saving rates of about20%of GDP • Important implication foreconomic policy: • Economic stability withlow inflationand positive real interest rates spurs saving, which isgood for growth.

34. Sources of endogenous growthI Income per capita East Asia 400 High saving rates 300 200 OECD Medium saving rates Africa 100 Low saving rates 1965 1990

35. 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% South Africa

36. 33 sub-SaharanAfrican countries Growth and investment, 1965-98 Each ten percentage point increase in the investment ratio is associated with an increase in per capita growth by 1½% per year.

37. Growth and investment, 1975-1998 11 MEFMI countries Each ten percentage point increase in the investment ratio is associated with an increase in per capita growth by 1½% per year.

38. Investmentand economic growth An increase in investment by 4% of GDP is associated with an increase in per capita growth by 1% per year. Botswana Thailand Jordan 1% 4% Nicaragua r = 0.65 85 countries

39. Sources of endogenous growthII • Depreciation • The effect of depreciation on growth is related to that of saving and investment on growth. • Unprofitable investment in the past reduces thequality of capitaland makes it depreciate more rapidly, necessitating more replacement investment to make up for economic and physical wear and tear. • The more national saving has to be set aside for replacement investment, the less will be available for thebuildup of new capital.

40. Investment: Quantity andquality • Compare Botswana and Tanzania: • InBotswana, the share of State-Owned Enterprises in total investment fell from 16% in 1985-90 to 12% in 1990-97. • InTanzania, the SOE share of investment fell from 46% in 1985-90 to 23% in 1990-97. • This is probably a good sign. • Privatization helpsimprove investment.

41. Investment: Quantity and quality • Investment quality, however, is not only a question of public vs. private enterprise. • Sound bankingis also important. • It takes sound commercial banks, usuallyprivately ownedbanks motivated by profit rather than by political concerns, to channel household savings intohigh-quality investment.

42. Sources of endogenousgrowth II • Efficiency • Also fits real world experience quite well • Technical progress is good for growth because it allows us tosqueeze more output out of given inputs. • And that is exactly what increasedefficiencyis all about! • Thus, technology is best viewed as an aspect of general economic efficiency. • Important implication foreconomic policy: • Everything that increases economic efficiency, no matter what, is alsogood for growth.

43. Sources of endogenous growthII • Five sources of increased efficiency • Liberalizationof prices and trade increases efficiency, which isgood for growth. • Stabilization reduces the inefficiency associated with inflation, which isgood for growth. • Privatizationreduces the inefficiency associated with state-owned enterprises, which … • Educationmakes the labor force more efficient. • Technological progressalso enhances efficiency. • The possibilities are virtually endless!

44. Sources of endogenous growth II • This isgood 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 supportingR&Dand such. • But if growth depends on saving and efficiency, there are things that wecan do, in the private sector as well as through the public sector, to foster rapid economic growth. • Becauseeverything that is good for saving and efficiency is also good for growth.

45. What to do toencourage economic growth • Maintain strong incentives tosave • Keep inflationlow andreal interest ratespositive • Maintainfinancial systemin good health • so as to channel saving into high-quality investment • Foster efficiency 1.Liberal price and trade regimes 2.Low inflation 3.Strong private sector 4.More and better education 5.Limited, or well managed, natural resources 6.Reasonable equality Recap

46. 1 Liberalization and economic growth • Liberalization of pricesmeans that markets, not bureaucrats, are allowed to set prices. • Mixed market economy ismore efficientthan central planning. • Compare former Soviet Union with the US and Europe • Liberalization of tradeallows specialization according to comparative advantage. • Free trade ismore efficientthan self-sufficiency. • North Korea and Cuba vs. Hong Kong and Singapore • Applies to trade in goods, services, capital.

47. Growth and trade, 1965-98 105 countries Botswana China Singapore Korea Hong Kong Each 50 percentage point increase in the trade ratio is associated with an increase in per capita growth by almost 1% per year. United Arab Emirates NB: UAE, Hong Kong, and Singapore.

48. 32 sub-Saharan African countries Growth and trade, 1965-98 Each 20 percentage point increase in the trade ratio is associated with an increase in per capita growth by 1% per year.

49. Growth and trade, 1975-1998 11 MEFMI countries Each ten percentage point increase in the trade ratio is associated with an increase in per capita growth by almost 1% per year.

50. Openness and growth 1965-98 r = 0.40 87 countries An increase in openness by 14% of GDP is associated with an increase in per capita growth by 1% per year.