Download Lecture 2

Sources of
Economic
Growth
Thorvaldur Gylfason
Outline
I. Pictures of growth
II. Determinants of growth
1.
2.
Saving and investment
Efficiency
a)
b)
c)
d)
e)
f)
Liberalization
Stabilization
Privatization
Education
Diversification
Distribution
III. Empirical evidence of growth
National economic output
Economic growth:
The short run vs. the long run
Economic growth
in the long run
Potential output
Actual output
Upswing
Business cycles
in the short run
Downswing
Time
Economic growth:
The short run vs. the long run
To analyze the movements of actual output
from year to year, viz., in the short run
Need short-run macroeconomic theory
Keynesian or neoclassical
To analyze the path of potential output over
long periods
Need modern theory of economic growth
Neoclassical or endogenous
National economic output
Growing together,
growing apart
West-Germany : East-Germany
Austria : Czech Republic
Economic system
Finland : Estonia
Taiwan : China
South Korea : North Korea
Rapid growth
Botswana : Nigeria
Kenya : Tanzania
Thailand : Burma
Economic policy?
Tunisia : Morocco
Spain : Argentina
Mauritius : Madagascar
Slow growth
Time
Growing
apart
Case B: 2% a year
Output per capita
 Efficiency
 Economic system
 Economic policy
Threefold
difference after
60 years
Case A: 0.4% a year
0
60
Years
Sources of growth:
Investment and education
Growth
+
Investment
+
+
Education
denotes a positive effect in the direction shown
Sources of growth:
Investment and education
Adam Smith knew this, and more, as did Arthur Lewis
Growth
+
Investment
+
+
Education
denotes a positive effect in the direction shown
More sources of growth
Arthur Lewis: x is trade, stable politics, good weather
But Solow carried the day: long-run growth is exogenous!
Growth
+
Investment
+
+
x
denotes a positive effect in the direction shown
+
Education
More sources of growth
Suppose our x is openness to trade; then …
Growth
+
Investment
+
+
Openness
denotes a positive effect in the direction shown
+
Education
The Neoclassical Theory of
Exogenous Economic 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 to economic
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
The New Theory of Endogenous
Economic Growth
Traces the rate of growth of output per
capita to two main sources:
Saving
Efficiency
“The proximate causes of economic growth are
the effort to economize, the accumulation of
knowledge, and the accumulation of capital.”
W. ARTHUR LEWIS
3500
Botswana
3000
2500
Nigeria
Current US$,
Atlas method
2000
1500
1000
500
0
19
60
19
64
19
68
19
72
19
76
19
80
19
84
19
88
19
92
19
96
20
00
Case 1
Botswana and Nigeria: GNP per
capita 1962-2001
2500
Tunisia
2000
1500
Egypt, Arab Rep.
Morocco
Current US$,
Atlas method
1000
500
0
19
60
19
64
19
68
19
72
19
76
19
80
19
84
19
88
19
92
19
96
20
00
Case 2
Egypt, Morocco, and Tunisia:
GNP per capita 1962-2001
4500
4000
Madagascar
3500
Mauritius
3000
2500
Current US$,
Atlas method
2000
1500
1000
500
0
19
60
19
64
19
68
19
72
19
76
19
80
19
84
19
88
19
92
19
96
20
00
Case 3
Madagascar and Mauritius:
GNP per capita 1962-2001
A Tale of Two Countries
Country A
Country B
A Tale of Two Countries
Girls at primary school
Country A
Country B
100%
72%
A Tale of Two Countries
Girls at primary school
Investment ratio
Country A
Country B
100%
72%
25%
11%
A Tale of Two Countries
Country A
Country B
100%
72%
Investment ratio
25%
11%
Export ratio
58%
23%
Girls at primary school
A Tale of Two Countries
Country A
Country B
100%
72%
Investment ratio
25%
11%
Export ratio
58%
23%
Primary export ratio
33%
80%
Girls at primary school
A Tale of Two Countries
Country A
Country B
100%
72%
Investment ratio
25%
11%
Export ratio
58%
23%
Primary export ratio
33%
80%
Inflation
10%
18%
Girls at primary school
A Tale of Two Countries
Country A
Country B
100%
72%
Investment ratio
25%
11%
Export ratio
58%
23%
Primary export ratio
33%
80%
Inflation
10%
18%
3%
-2%
Girls at primary school
Growth per capita
A Tale of Two Countries
And the countries are:
Mauritius
Madagascar
Girls at primary school
100%
72%
Investment ratio
25%
11%
Export ratio
58%
23%
Primary export ratio
33%
80%
Inflation
10%
18%
3%
-2%
Growth 1965-98
4500
4000
Madagascar
3500
Mauritius
3000
2500
Current US$,
Atlas method
2000
1500
1000
500
0
19
60
19
64
19
68
19
72
19
76
19
80
19
84
19
88
19
92
19
96
20
00
Case 3
Madagascar and Mauritius:
GNP per capita 1962-2001
Exogenous vs. endogenous
growth
The neoclassical view
that economic growth in the long run is merely a
matter of technology does not throw much light
on the impressive growth performance of Asia
since the 1960s, or on growth differentials
The new view
that long-run growth depends on saving and
efficiency is more illuminating
Besides, it’s not really new, because Adam Smith
knew this (1776)
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
Enter initial income
Conditional
convergence
Growth
+
–
Investment
+
?
x
Education
+
Initial Income
+
–
Natural Capital
denotes a positive effect in the direction shown
denotes a negative effect in the direction shown
Absolute
convergence?
r = rank
correlation
Growth of GNP per capita 1965-1998 (%)
10
Botswana
8
No sign
that poor
countries
grow faster
than rich
6
4
China
r = -0.09
Korea
Indonesia
Thailand
2
0
0
2
4
6
8
10
-2
Nicaragua
-4
Log of initial GDP per capita (1965)
12
Conditional
convergence
does not
entail absolute
convergence
Sources of endogenous
growth I
Saving
Fits real world experience quite well
No coincidence that, in East Asia, saving rates of 3040% of GDP went along with rapid economic growth
No coincidence either that many African economies
with saving rates around 10% of GDP have been
stagnant
OECD countries: saving rates of about 20% of GDP
Important implication for economic policy:
Economic stability with low inflation and positive real
interest rates spurs saving, which is good for growth
Investment and economic
growth
Growth of GNP per capita 1965-1998, adjusted for initial
income (% per year)
6
An increase in investment by
4% of GDP is associated with an
increase in per capita growth by
1% per year
4
2
Botswana
Thailand
0
0
5
10
15
20
25
30
-2
-4
4%
1%
Jordan
-6
r = 0.65
Nicaragua
-8
Gross domestic investment 1965-1998 (% of GDP)
35
Sources of endogenous
growth II
Efficiency
Also fits real world experience quite well
Technical progress is good for growth because it allows
us to squeeze more output out of given inputs
And that is exactly what increased efficiency is all
about!
Thus, technology is best viewed as an aspect of
general economic efficiency
Important implication for economic policy:
Everything that increases economic efficiency, no
matter what, is also good for growth
Sources of endogenous
growth II
Five sources of increased efficiency
1. Liberalization of prices and trade increases
efficiency, which is good for growth
2. Stabilization reduces the inefficiency associated
with inflation, which is good for growth
3. Privatization reduces the inefficiency associated
with state-owned enterprises, which …
4. Education makes the labor force more efficient
5. Technological progress also enhances efficiency
The possibilities are virtually endless!
Sources of endogenous
growth II
This is good 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
supporting R&D and such
But if growth depends on saving and efficiency,
there are things that we can do, in the private
sector as well as through the public sector, to
foster rapid economic growth
Because everything that is good for saving and
efficiency is also good for growth
1
Liberalization and economic
growth
Liberalization of prices means that markets,
not bureaucrats, are allowed to set prices
Mixed market economy is more efficient than
central planning
Compare former Soviet Union with the US and Europe
Liberalization of trade allows specialization
according to comparative advantage
Free trade is more efficient than self-sufficiency
North Korea and Cuba vs. Hong Kong and Singapore
Applies to trade in goods, services, capital
Openness to trade and
growth 1965-98
Annual growth of GNP per capita 1965-98, adjusted for
initial income (%)
6
r = 0.40
4
Korea
2
Malaysia
Belgium
0
-40
-30
-20
-10
0
10
20
30
40
-2
Guinea Bissau
-4
-6
-8
An increase in openness by
14% of GDP is associated
with an increase in per capita
growth by 1% per year
Actual less predicted exports 1965-98 (% of GDP)
2
Stabilization and economic
growth
Stabilization of prices means that distortions
associated with inflation are reduced
 Inflation distorts the choice between real and
financial capital by punishing money holdings,
and thus creates inefficiency in production
 Inflation thus involves a tax, the inflation tax
An inefficient tax compared with most other taxes
 Inflation also creates uncertainly which tends
to discourage trade and investment
 Inflation also tends to result in overvaluation
of currency, thus hurting exports and growth
3
Privatization and economic
growth
Privatization means that profit-oriented
owners and able managers are allowed to
direct enterprises
Profit motive replaces political considerations as
the guiding principle of business operations
Profit-maximizing owners generally want to appoint
managers and staff on merit rather than on the
basis of political connections, for example
Private enterprise is generally more efficient
than state-owned enterprises
4
Education and economic
growth
Education means a better trained and hence
more efficient work force
 Need to provide primary and secondary
education to all, especially females
 Need to provide tertiary education to a greatly
increased number of people
 Need increased public commitment to education
 This requires both increased public expenditure
on education and probably also increased scope
for private sector involvement in education
Same story time and
again
Free trade is good for growth
Reduces the inefficiency that results from
restrictions on trade
Price stability is good for growth
Reduces inefficiency resulting from inflation
Privatization is good for growth
Reduces inefficiency resulting from SOEs
Education is good for growth
Reduces the inefficiency that results from
inadequate education
Growth and education,
1965-98
Grow th of GNP per capita 1965-98, adjusted
for initial incom e (% per year)
6
An increase in secondary-school
enrolment by 25% of each cohort goes
along with an increase in per capita
growth by 1% per year
4
2
Thailand
Japan
Finland
0
0
20
40
60
-2
Jamaica
Ghana
80
100
r = 0.72
-4
-6
Positive but decreasing
returns to education
-8
Secondary-school enrolm ent 1980-97 (% of cohort)
120
5
Natural resources and
economic growth
Natural resources, if not well managed,
may turn out to be, at best, a mixed
blessing
Four possible channels




Dutch disease
Rent seeking
Education
Investment
What is the evidence?
Recent literature
Four main linkages:
1. Dutch disease
Hurts level or composition of exports
2. Rent seeking
Protectionism, corruption
3. Education
4. False sense of security
Poor quality of policies and institutions
5. Investment
Enter natural resources
Growth
+
–
–
?
Investment
x
–
Initial Income
+
Education
+
–
Natural Capital
Natural resource abundance hurts investment and
education, and hence also growth
Natural capital and
economic growth
r = rank
correlation
Growth of GNP per capita 1965-98, adjusted for initial
income (%)
6
An increase in the
natural capital share by
8% goes along with a
decrease in per capita
growth by 1% per year
4
2
8 Asian countries
S/Y = 0.32
Australia
0
0
10
20
30
40
50
-2
-4
Venezuela
8 African countries
S/Y = 0.05
-6
r = -0.64
-8
Share of natural capital in national wealth 1994 (%)
60
6
Inequality and
economic growth
Two views:
1. Inequality is good for growth
 Too much equality weakens incentives to
work, save, and acquire an education
2. Inequality is bad for growth
 Too much inequality reduces social
cohesion and creates conflict
What is the empirical evidence?
Growth and inequality,
1965-98
Per capita growth 1965-98, adjusted for initial
income (% per year)
6
y = -0,0799x + 2,1297
R2 = 0,1968
Korea
4
France
Thailand
2
An increase in Gini
index by 12 points
goes along with a
decrease in per
capita growth by
almost 1% per year
Lesotho
Brazil
0
0
-2
20
40
60
80
South Africa
Sweden
Central
African
Republic
-4
r = -0.50
-6
Gini index
No
discernible
sign that
equality
stands in
the way of
economic
growth
What is the upshot?
Economic growth responds to public policy
In particular, by encouraging
 saving and investment of high quality
 foreign trade and investment
 education
 economic diversification
 and perhaps also equality
... the government can help foster rapid
economic growth
Sir Arthur Lewis got it right
Since the second world
war it has become quite
clear that rapid economic
growth is available to
those countries with
adequate natural
resources which make the
effort to achieve it.
W. ARTHUR LEWIS
(1968)
What else?
These lessons are borne out by experience
from around the world
Additional lessons:
Too much inflation hurts saving, investment,
and trade — and thereby also growth
Too much SOE activity hurts the quality of
investment and education — and growth
Too much agriculture and, more generally,
natural resource dependence, if not well
managed, hurts education, investment, and
trade — and thereby also growth
Too rapid population growth also tends to
impede economic growth
Reservations
Even so, the question of rapid growth is, of
course, a bit more complicated
We also need to address a host of political,
social, and cultural questions as well as
questions of natural conditions, climate,
and public health — which would take us
too far afield
But the main point remains:
 To grow or not to grow is in large measure a
matter of choice
 Many of the constraints on growth are manmade, and can be removed
Conclusion: It can
be done These slides – and more! – can be viewed
on my website: www.hi.is/~gylfason
To grow or not to
grow is in large
measure a matter
of choice