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Thorvaldur Gylfason Overview of general theme of conference: economic governance and sustained growth Picture to be presented will be painted with a broad brush, covering Main determinants of efficiency and growth Empirical cross-country growth patterns observed Main task: Set stage, without explicit Balkan content, for local as well as regional analyses to follow Like politics, all growth economics focusing on economic policy and institutions is local Our standard of living today depends on one thing only, by definition: economic growth Rich countries are rich because they grew rapidly over long periods Poor countries are poor because they did not grow rapidly enough So why do some countries grow more rapidly than others? Why, e.g., did Thailand leave Zambia so far behind in one generation? Hard to think of anything else (Lucas) Thailand and Zambia started out in a similar position and grew apart Thailand pursued growth-friendly policies, stressing liberal trade, stability, private enterprise, and education GDP per capita 1960-2003 (US$ at 2000 prices) 2400 THAILAND 2000 ZAMBIA 1600 1200 800 400 0 60 65 70 75 80 85 90 95 00 Argentina and Sweden went hand in hand 1900-1930 and then grew apart Sweden pursued free trade, liberal democracy, and income equality, and avoided high inflation Argentina did not GDP per capita 1900-2003 (US$ at 1990 prices) 24000 20000 ARGENTINA SWEDEN 16000 12000 8000 4000 0 1900 1925 1950 1975 2000 What makes countries grow Economic efficiency and growth Economic policies and institutions Education and health care Business governance Monetary and financial policies and institutions External governance Empirical evidence of cross-country linkages between governance and growth as we go along First things first: Output is produced by labor, capital, and other inputs Output per capita can grow through accumulation of capital through saving and investment Output per capita, however, cannot grow through population growth, on the contrary But, output per capita can grow through improvements in labor, via investments in human capital: Education and health care Investment and education: Key drivers of growth Why do education and health care matter? Because they increase labor productivity This is also why technological progress is good for growth Technological progress enables firms to squeeze more output from given inputs But so does increased efficiency! Latin American story about air fares Increased efficiency is tantamount to technological progress, which helps growth In sum, output per capita depends on the quantity and quality of inputs Quantity of inputs can be increased through accumulation, esp. capital accumulation Quality of inputs – their productivity! – can be increased through increased efficiency Education and health Liberalization Stabilization Privatization Aspects of institutions lifts labor productivity, thereby increasing overall economic efficiency and growth of output From unskilled to skilled labor Data for 131 countries, 1960-2000 Per capita growth adjusted for initial income (%) Education r = rank correlation r = 0.50 6 4 2 0 -2 -4 -6 0 20 40 60 80 100 Secondary school-enrolment rate (%) is another way to provide more and better education to children Produce fewer children to increase their average “quality” 163 countries, 1960-2000 Pefr capita growth adjusted for initial income (%) There r = -0.54 6 4 2 0 -2 -4 -6 -8 1 2 3 4 5 6 7 Fertility (number of children) 8 public health, reflected in longevity, is also conducive to increased labor productivity and economic growth 156 countries, 1960-2000 Per capita growth adjusted for initial income (%) Good r = 0.54 6 4 2 0 -2 -4 -6 -8 30 40 50 60 70 Life expectancy 1960 (years) 80 spending on health care also spurs economic growth Close connection between public health and health care, i.e., between output and input 162 countries, 1960-2000 Per capita growth adjusted for initial income (%) Increased r = 0.40 6 4 2 0 -2 -4 -6 -8 0 2 4 6 8 10 12 Health expenditure (% of GDP) 14 of prices increases efficiency in resource allocation Liberalization of trade increases efficiency in division of labor 163 countries, 1960-2000 Per capita growth adjusted for initial income (%) Liberalization r = 0.26 6 4 2 0 -2 -4 -6 -8 0 40 80 120 160 Exports (% of GDP) 200 are not a good indicator of openness because size matters So look at import duties as well Higher duties hurt growth, but connection is weak 147 countries, 1960-2000 Per capita growth adjusted for initial income (%) Exports r r== -0.23 0.20 6 4 2 0 -2 -4 -6 -8 0 10 20 30 40 50 60 70 Share of import duties in tax revenues (%) Economic theory is clear, from Adam Smith (1776) on: external as well as internal trade is good for growth Good external governance is good for growth Autarky spells disaster, always and everywhere Darkness in North-Korea increases efficiency by reducing production distortions, uncertainty, inflation tax, and overvaluation 164 countries, 1960-2000 Per capita growth adjusted for initial income (%) Stabilization r = -0.46 r = -0.46 6 4 2 0 -2 -4 -6 -8 0.0 0.2 0.4 0.6 Inflation distortion 0.8 1.0 inflation is a sure sign of lax fiscal and monetary policies, so sound policies support rapid growth Sound financial institutions, incl. independent central banks, also support rapid growth Per capita growth adjusted for initial income (%) High r = -0.46 r = -0.46 6 4 2 0 -2 -4 -6 -8 0.0 0.2 0.4 0.6 Inflation distortion 0.8 1.0 Privatization r = -0.35 8 Per capita growth (% per year) replaces political motives by profit motive in business Private enterprise is usually more efficient than stateowned enterprises 38 countries, 1978-92 6 4 2 0 -2 -4 -6 .0 .1 .2 .3 .4 Share of SOEs in employment (%) Growth differentials across countries can be traced to several different interconnected factors Private initiatives Investment Fertility Public policies Education Health care Liberalization Stabilization Privatization This is not all, however Institutions and geography Institutions (Aspects of social capital) Geography Corruption Inequality Liberal democracy Primary production (Agriculture, mining, etc.) Natural resource dependence Institutions or geography? False contrast There is room for both, side by side views Corruption greases wheels of production and exchange and thus helps growth Corruption breeds inefficiency and hurts growth 88 countries, 1960-2000 Per capita growth adjusted for initial income (%) Two r = 0.69 6 4 2 0 -2 -4 -6 0 2 4 6 8 10 12 Corruption perceptions index More corruption good business governance is good for growth Argument can be extended to other aspects, such as secure property rights and effective bankruptcy laws Same story Per capita growth adjusted for initial income (%) So, r = 0.69 6 4 2 0 -2 -4 -6 0 2 4 6 8 10 12 Corruption perceptions index More corruption views Inequality sharpens incentives and thus helps growth Inequality endangers social cohesion and hurts growth 117 countries, 1960-2000 Per capita growth adjusted for intial income (%) Two r = -0.27 6 4 2 0 -2 -4 -6 -8 10 20 30 40 50 60 Gini index of inequality 70 views Political oppression restrains special interest groups and thus helps growth Political oppression breeds inefficiency and hurts growth 117 countries, 1960-2000 Per capita growth adjusted for initial income (%) Two r = -0.64 6 4 2 0 -2 -4 -6 0 1 2 3 4 5 6 Political oppression 7 8 two views Democracy plays into hands of special interest groups that hurt growth Democracy facilitates change of government and helps growth 143 countries, 1960-2000 Per capita growth adjusted for initial income (%) Again, rr = = 0.50 0.48 6 4 2 0 -2 -4 -6 -8 -12 -8 -4 0 4 Democracy 8 12 is an important source of technological innovation and progress and thereby also of economic growth 156 countries, 1960-2000 Per capita growth adjusted for initial income (%) Manufacturing r = 0.48 8 6 4 2 0 -2 -4 -6 0 20 40 60 80 100 Share of manufactures in exports (%) and mining are low-skill labor intensive and offer few spillover benefits to other industries Natural resources: Mixed blessing if not well managed 156 countries, 1960-2000 Per capita growth adjusted for initial income (%) Agriculture rr == -0.59 0.48 6 4 2 0 -2 -4 -6 -8 0 10 20 30 40 50 60 Primary production (% of GDP) 70 Economic growth is available to all who make the effort to achieve it (Lewis) High-quality growth requires accumulation of capital as well as economic efficiency through good governance: judicious policy undertakings and sound institutions Education, family planning, health care Free trade, stable prices, private enterprise Honesty, equality, liberty, democracy Not too much dependence on agriculture and natural resources