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What Makes Nations Grow?
Week 2
SF Intermediate Economics
Professor Dermot McAleese
OUTLINE
 Trends in economic growth
 Growth theories
 Human welfare and sustainable
growth
 Policies for growth
WHAT IS ECONOMIC GROWTH?
 Gross Domestic Product (GDP) - measure of economic growth
 GDP per capita - measure of standard of living
Production frontier
Manufactur
es
Y
T
R2
R3
T1
R1
R
Food
X
Table 1. Share of world output, trade and population (%
share)
United States
European Union
Japan
Top three
Rest of world
Total
Output
Trade
Population
22
23
9
54
46
100
17
20
10
47
53
100
5
6
2
13
87
100
Source: European Economy (Brussels, no. 66, 1998); WTO, 1999.
Growth Rates 1965-99
Real GNP
Low income ($760 or less) countries(63) 5.9
Middle income countries
3.7
High income ($9,361 or more) countries (35)
3
Source: World Bank World Development Indicators 2001.
Real GNP
per head
(% p.a.)
Population
1998
(millions)
3.7
3536
1.9
1474
2.3
886
SEVEN STYLISED FACTS ON ECONOMIC
GROWTH
 Growth - the norm
 Rich stayed rich
 Poor better off since 50s
 Acute poverty persists
 Diversity in performance since 60s
 Natural resources  economic success
 Transition economies in trouble
Table 6. Real GNP per person
1900
1950
2000
Belgium
Denmark
Finland
France
Germany
Italy
Japan
Netherlands
Sw eden
UK
US
5039
4912
2774
2689
3718
2947
1993
4825
3793
5184
5336
7382
11064
7070
4942
5986
5097
3287
7991
9977
7729
12274
25216
25391
22305
24205
22391
21650
23640
23401
21084
21883
31942
China
India
South Korea
Argentina
540
659
904
2865
444
626
928
5162
3484
1951
13500
10199
Source: Computed from Angus Maddison, The World Economy: A Millenium
Perspective (Paris: OECD, 2001) and IMF, World Economic Outlook, May
1999. Purchasing power parities have been used for the developing countries.
Table: Developing countries, Distribution of growth rates (1990-2000)
Average annual
per capita real
growth rates
Number of
developing
countries
% of all
developing
countries
Population
(millions)
% of total
developing
world population
Negative growth
48
35.0
727
14.6
Moderate growth
65
47.4
1606
32.3
High growth
24
17.6
2636
53.1
137
100.0
4969
100.0
Total
Notes: Negative growth implies an average growth rate of less than 0%, moderate growth a rate of 0-3%,
high growth a rate in excess of 3.0 %. Developing countries refer to lower and middle income
countries in accordamce with World bank definitions.
Source: computed from World Bank, World Development Indicators, 2002.
How Growth Rates Differ: Experience of the 1990s
Table 1. Negative Growth Countries (g<0%)
Ukraine
Angola
Russia
Sierra Leone
Latvia
Lithuania
Romania
Algeria
Bulgaria
South Africa
Switzerland
Real GNP per
head 1990-1999
(% p.a.)
Population 1997
(millions)
-10.8
-10
-6.9
-5.7
-4.8
-4.7
-2.3
-1.6
-1
-0.2
-0.5
51
12
147
5
2
4
23
29
8
41
7
Note: Total number of countries reporting negative growth figures is 173.
Source: World Bank, World Bank Atlas, 1999. IMF, World Economic Outlook,
October 1999.
How Growth Rates Differ: Experience of the 1990s
Table 2. Rapid Growth Countries (g>4%)
China
Indonesia
Chile
Ireland
Korea
Singapore
India
Real GNP per
head 1990-1999
(% p.a.)
Population 1997
(millions)
9.5
5.9
5.8
7.4
5
6.4
4.2
1227
200
15
4
46
3
962
Note: Total number of countries reporting growth figures is 173; g = average annual GNP
per capita growth
Source: World Bank, World Bank Atlas, 1999. IMF, World Economic Outlook, October
1999.
How Growth Rates Differ: Experience of the 1990s
Table 3. Modest Growth Countries ( 2%  g  4%)
Australia
United Kingdom
Denmark
United States
France
Canada
Pakistan
2.9
2.7
2.8
2.8
2.1
2.1
2
19
59
5
267
59
30
65
Note: Total number of countries reporting growth figures is 173; g = average
annual GNP per capita growth
Source: World Bank, World Bank Atlas, 1999. IMF, World Economic Outlook,
October 1999.
How Growth Rates Differ: Experience of the 1990s
Table 4. Slow Growth Countries ( 0%  g  2%)
Brazil
Austria
Greece
New Zealand
Italy
Japan
Nigeria
Morocco
Real GNP per
head 1990-1999
(% p.a.)
Population 1997
(millions)
1.9
1.9
1.6
1.2
1.3
1
0.7
0.2
164
8
11
4
58
126
118
27
Note: Total number of countries reporting growth figures is 173; g = average annual GNP
per capita growth
Source: World Bank, World Bank Atlas, 1999. IMF, World Economic Outlook, October 1999.
Source: World Bank 1999
South Asia
SubSahanran
Africa
Middle
East & N.
Africa
Latin
America &
Caribbean
Europe &
Central
Asia
East Asia
& Pacific
Highincome
countries
%
FORECAST REAL GDP GROWTH PER CAPITA
1998-2008
6
5
4
3
2
1
0
% of population living on less than $1 per day
Sub-Saharan Africa
South Asia
Latin America and the Caribbean
East Asia and Pacific
Eastern Europe and Central Asia
Middle East and North Africa
0
10
20
1998
30
1987
40
50
From the earliest times down to the beginning of the eighteenth
century, there was no very great change in the standard of life of the
average man living in the civilised centres of the earth…..
This lack of progress was due to two reasons:
the remarkable absence of technical improvements
and
the failure of capital to accumulate.
J. M. Keynes, Economic Possibilities for Our Grandchildren, (1930)
HARROD-DOMAR MODEL
g = Y/Y = (K/Y) x (Y/K)
I = K = S
g = (S/Y) . (Y/K)
g = (S/Y)/(K /Y)
g = s/v
s = marginal propensity to save
v = capital-output ratio
GROWTH THEORIES
 Long term determinants
productive efficiency
allocative efficiency
 Quantity of inputs
K, L
I/GDP ratio
 Total factor productivity
Implications of Harrod-Domar
• Focus on raising s (the savings rate) and lowering v
(capital output ratio)
• How to raise s:
Govt saving
Robust financial system
Foreign aid/capital inflows
Debt forgiveness
• How to lower v:
Use capital productively (v is not a “given”)
Choose right industries (planning)
Implement good policy (new consensus?)
• Rich countries will stay rich – because they can
afford to save. Poor will stay poor because they
have no margin
From HD model to present ….
• Solow model – capital inputs subject to law of
diminishing marg productivity – hence move to
convergence
• Total factor productivity more important than high
investment
• Endogenous growth model – technology is
endogenous, not exogenous. Importance of
education, knowledge, which are not subject to
diminishing marginal returns.
Total Factor Productivity (TFP)
A growing body of evidence suggests that, even
after physical and human capital accumulation are
accounted for, something else accounts for the
bulk of cross country differences in the level and
growth rate of GDP per head. Economists
typically refer to the something else as total factor
productivity
Easterly and Levine What have we learned from a decade of
empirical research on growth? The World Bank Economic Review
No 2 2001
TOTAL FACTOR PRODUCTIVITY
(TFP/MFP)
advances in technology
redistribution of resources to higher productivity sector
terms of trade
institutional and political stability
quality of the labour force
(human skills and motivation)
better business organisation
economic policy
The Neoclassical Theory of
Exogenous Economic Growth
emphasises Technological Progress
As an exogenous source of long term growth
Tends to underestimate the role of economic
policy
The Theory of Endogenous
Economic Growth
Traces growth to a variety of sources such as
Initial starting point
Investment
Economic Policy
HUMAN WELFARE AND SUSTAINABLE
GROWTH
 Leisure and the household economy
 Income distribution
 GNP and the environment
GNP and human development indicators
Sustainable growth
GDP AS MEASURE OF WELFARE
ADD:
Household economy
Voluntary activities
Black economy (positive aspects)
Leisure
SUBTRACT:
Inputs classified as output (police, defence
spending)
Environmental degradation
Exhaustion of natural resources
Sustainable growth.
Does Economic Growth =
Happiness?
Weak correlation
between economic
growth and happiness
index (‘Are you
feeling satisfied with
your life’)
Sources: Andrew Oswald, University of Warwick
Robert Frankel, Yale University
But, correlation exists
between income
distribution and
happiness. More
unequal societies have
more unhappiness
WHY?
• Many goods are ‘Positional goods’ – status
symbols
• Externalities – e.g. if everyone has a car,
congestion costs increase
• Relative poverty creates major feelings of
unhappiness
• Longevity is good, but leads to high
medical bills
POLICY PRESCRIPTION FOR GROWTH
 Competition and economic efficiency
Price stability and fiscal consolidation
Outward orientated policies
Government to complement market forces
Stable and transparent institutional framework
Competition policy
Labour market policy
Infrastructure
Education system
LESSONS FROM EAST ASIAN “MIRACLE”
1.
PRUDENT FISCAL AND MONETARY MANAGEMENT
“Macroeconomic stability* is negatively correlated with growth”
*as measured by inflation, fiscal deficits and parallel exchange rate premiums
2.
SECURE AND EFFECTIVE FINANCIAL SYSTEM
3.
HEAVY INVESTMENT IN HUMAN CAPITAL ESPECIALLY IN BASIC EDUCATION
4.
KEEPING PRICE DISTORTIONS TO A MINIMUM
•
•
Foreign trade
Labour market
5.
ENSURING EASY ACCESS TO FOREIGN TECHNOLOGY RATHER THAN
ATTEMPTING A PATH OF SELF-RELIANCE
6.
AVOID BIAS AGAINST AGRICULTURE
Note: Selective government intervention in industrial sector had “mixed” results – major problem is
bureaucratic deficit
CONVERGENCE?
 Endogenous growth theory
(once ahead, always ahead)
 Technological spillovers
(poor can “piggy-back” on the rich)
 Empirical evidence
(2% rate of convergence)
 Conditional convergence
(openess, education and governance)
Table: Developing Countries, Growth rates 1990-2000
Average annual
per capita real
growth rates
Number of
developing
countries
% of all
developing
countries
Population
(millions)
% of total
developing
world population
Negative growth
48
35.0
727
14.6
Moderate growth
65
47.4
1606
32.3
High growth
24
17.6
2636
53.1
137
100.0
4969
100.0
Total
Notes: Negative growth is an average growth rate of less than 0%, moderate growth a rate of 0-3%,
high growth a rate in excess of 3%. Developing countries refer to lower and middle income
countries in accordance with World Bank definitions.
Source: computed from World Bank, World Development Indicators, 2002.
Table 5. Explaining India’s Relative Growth Performance
Average Value (%)
Factors contributing growth during 1970-95
Investment/GDP
Net FDI/GDP
Trade/GDP
Government consumption/GDP
Secondary school enrollment rate
Convergence effect and other factors
Real per capita GDP growth (1970-95)
India
East Asia
Estimated difference in
contribution to growth
rates (%)
21.9
0.1
4.5
10.3
35.2
8.8
…
2.4
29.6
2.5
113.5
10.4
50.5
8.4
…
5.7
-1.2
-0.8
-1.1
0
-0.3
0
0.2
-3.3
Table 7a. How Growth Rates Differ 1965-98
Real
GNP
Real GNP
per head
(% p.a.)
Population
1998
(millions)
East Asia
South Asia
Latin America
Sub-Saharan Africa
7.5
4.9
3.5
2.6
5.7
2.7
1.3
-0.3
1817
1305
502
627
World
3.2
1.4
5897
Source: World Bank World Development Indicators 2000.
Table 8. GDP growth rates in former socialist countries
1989-94
1995-99
Decline and recovery…
Estonia
Latvia
Lithuania
Albania
Czech Rep.
Hungary
Poland
Slovak Rep.
Slovenia
-6.6
-8.3
-6.6
-2.7
-1.3
-2.6
-1.1
-3.8
-2.8
5.1
3.2
4.2
5.4
1.8
3.1
5.7
5.2
3.9
Decline and fall…
Russia
Ukraine
Bulgaria
Romania
-6.8
-10.3
-5
-4.9
1.9
5.9
1.6
1.4
Source: European Bank for Reconstruction and Development, Transition Report, 1999
Table 9. Investment and growth
1961-70
1971-80
1981-90
1991-2000
Investment/GDP ratios
EU
US
Japan
EU
23.4
23
20.4
19
4.8
3
2.4
2
18.1
19.1
18.3
16
Source: European Economy (Brussels: no. 16, 1999).
32.2
32.7
29.1
29
Growth rates
US
Japan
4.2
3.2
2.9
2.5
10.1
4.4
4
1.4
Table 10. HDI ranking – selected countries
Industrial countries
Canada
US
Sweden
Netherlands
Japan
UK
France
Switzerland
Germany
Denmark
Italy
Hungary
Poland
Developing countries
Singapore
South Korea
Argentina
Mexico
Malaysia
Romania
Brazil
China
South Africa
Indonesia
India
Zambia
Uganda
HDI value
HDI rank
GDP rank per capita
0.935
0.929
0.926
0.925
0.924
0.918
0.917
0.915
0.911
0.911
0.903
0.817
0.81
1
3
6
8
9
10
12
13
14
15
19
43
44
9
3
27
19
14
22
17
7
20
11
24
49
83
0.881
0.854
0.887
0.784
0.772
0.77
0.747
0.706
0.697
0.67
0.563
0.42
0.409
24
31
35
55
61
64
74
99
103
109
128
153
158
5
55
64
71
79
109
88
129
79
141
163
195
185
Source: Human Development Report 2000, Oxford University Press, 2000.
Table 11. East Asia
Real GDP growth rate
Population
(millions)
1998
Indonesia
Malaysia
Thailand
Singapore
Hong Kong
Korea
China
GDP per person
Exports/GDP
(US$ PPP)
1991-1997 1998-2000
1998
203.7
22.2
61.1
3.2
6.7
46.4
1238
Source: The World Bank Atlas 1999.
288
7,450
6,633
27,545
21,960
12,471
3,285
2.7
8.6
6.7
8.4
5.3
7.2
1.2
-2.4
-1.6
-0.6
2.1
-1.1
0.4
7
53.9
114.4
58.9
152.5
125.1
48.7
19.1
KOREA vs ZAMBIA
A STORY OF Total Factor Productivity
exercise 3, p 36
Y
 K 
 A* f 

L
 L 
• TFP is a residual
• TFP includes: advances in technology, concentration on
high productivity sectors, improved terms of trade,
institutional and political stability, quality of the labour
force
Why does TFP differ?
• Various levels of innovation + imperfect
information between countries
• Research and Development, education,
infrastructure, government investment
• TFP is high if countries create a dynamic of
innovation
45
Investment/GDP Korea vs Zambia
40
35
30
25
20
15
10
5
19
60
19
64
19
68
19
72
19
76
19
80
19
84
19
88
19
92
19
96
0
Zambia
South Korea
Korea
• high education
standards
• emphasis on high-tech
and automotive
industries
• good geographical
location
• organised banking
sector
Zambia
• low education
• high protection
• bad government
investment
• bad geographical
location