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Macroeconomic Analysis 2003 Convergence or Conditional Convergence Lecture 7 1 Contents • • • • • • • • • Definition of Convergence and Divergence Evidence of divergence among UK regions Labour and capital mobility and convergence Steady State in Autarky and Globalisation Evidence for Conditional Convergence Poverty Trap: why pigs cannot become elephants? Does more trade lead to convergence? Results of growth studies Exercises Lecture 7 2 Meaning of Convergence and Divergence Prediction of convergence Solow Model: Catching up under Growing apart High income High income Y/P Income Y/P Divergence Low ncome Low income Time Time Poor country should grow at faster rate then a rich country Experience of African countries Lecture 7 3 Two concepts of Economic Convergence Mean Differerence Dispersion Measure Convergence g g Time ln y ln y i R R R ln Yt 0 1 t LI 1 Low income regions should grow faster than high income region 2 t HI 1 Time Standard Deviation i ,t Convergence t N 1 Lecture 7 4 Evidence for Lack of Sigma and Beta Convergence in the Per capita Income among the UK Regions, 1993-1998 Ann. Growth rate % 1993 1994 1995 1996 1997 1998 United Kingdom 9,671 10,170 10,619 11,185 11,871 12,548 4.34 England 9,852 10,349 10,771 11,384 12,141 12,845 4.42 East Riding and North Lincolnshire 9,289 9,680 10,130 10,920 11,490 11,759 Kingston Upon Hull, City of 9,319 9,787 10,325 10,886 11,538 11,850 4.00 East Riding of Yorkshire 8,268 8,487 8,741 9,799 9,996 10,051 3.26 10,236 10,741 11,325 12,059 12,939 13,402 London 14,110 14,798 15,251 15,885 17,158 18,566 4.57 Scotland 9,614 10,168 10,818 11,162 11,429 12,117 3.86 Northern Ireland5 7,610 8,114 8,654 8,964 9,507 9,754 4.14 Wales 7,978 8,393 8,900 9,240 9,562 10,063 3.87 1,934 2,210 2,537 North and North East Lincolnshire 3.93 4.49 Sigma Convergence Standard Deviation 1,806 1,894 Lecture 7 1,905 5 Marginal productivity of Capital in Rich and Poor Countries and Capital Accumulation in Autarky MPKP MPKR rp rR KR Lecture 7 KP 6 Marginal productivity of Capital in Rich and Poor Countries and Capital Accumulation After Globalisation MPKP MPKR rP rp RG rR KR Lecture 7 KP 7 Marginal productivity of Labour in Rich and Poor Countries Before and After Globalisation MPLP MPLR wR wR’ LR LP’ LR’ Lecture 7 LP 8 Who Gain and Who Lose From Globalisation? Capitalists in rich countries and workers in poor countries gain. rp rR MPKR MPKP wR wR’ wp’ MPLR MPLR’ wp MPLP’ MPLP Lecture 7 9 Savers Households, Corporations and Government Intermediaries Banks, Insurance Companies, Building Societies, Trusts, Stock and Bonk Markets Investors Small, Medium and Large Private, Public, Domestic and Foreign Lecture 7 10 Factor Mobility and Convergence Yi Ai K i Li 1 KMobil e yes Convergen ce No no convergenc e 1 and 0 1 0 1 and 1 Lmobile KMobile Lmobile KMobile Lmobile yes no yes yes Yes no yes no no no Lecture 7 11 Factors Promoting Convergence • Domestic factors – – – – – – • Global factors Saving Investment Population growth rate Human capital Technology Development of infrastructure – Sound economic policy – Homogenous and stable society – Transparent rules and regulations – Trade of goods and services – Inflow and outflow of capital – Emigration or immigration of skilled and unskilled labour – Adoption of better technology – Growth of the global economy – Peace/Oil prices Lecture 7 12 Autarky and Saving and Capital (Gartner (2003:262) has similar example) Country A Country B YA K A0.5 L0A.5 A 0.1 YB K B0.5 L0B.5 s A 0.2 sB 0 B 0.1 What is the capital stock in the steady state in A in Autarky? How much do workers get? How much do owners of capital get? sK A0.5 L0A.5 A K A 0.2 K A0.5 10 0.1K A K A 400 What is the capital stock in the steady state in B in Autarky? How much do workers get? How much do owners of capital get? 0.0 K B0.5 10 0.1K B K B 0 YB 0 Becomes a beggar country. YA 200 Lecture 7 13 Impacts of Globalisation in Output and Income What is the capital stock in the steady state in A and B if there is a free mobility of capital? Country A Country B K A KB K K A KB K Country A saves for both countries. It receives rental income from country B. Country B does not save but can borrow capital from country A. 0.2 10K 0.5 0.5 10K 0.5 0.1K K K 15 225 YB K 0.5 L0B.5 2250.5 10 150 2 YA K 0.5 L0A.5 2250.5 10 150 GNP in country B = GDP+Investment Receipts GNPA = 150+75 = 225 Capitalists gain and workers lose in country A. Lecture 7 Country B need to pay capital income to Country A. GNP in country B = GDPInvestment Payments GNPB = 150-75 = 75 Country B gains from the capital transfers. 14 Evidence for Beta-Convergence in Europe: Growth Rate of Per Capita Income and Its level in 1960 Evidence of Converngence in Europe 4.500 Annual growth rate of per cap income 4.000 gr Power (gr) 3.500 3.000 2.500 2.000 1.500 1.000 0.500 0.000 0 5000 10000 15000 Lecture 7 Per capita income in 1960 20000 25000 30000 15 GDP per capita (constant 1995 US$) 1960 2000 Y00/Y60 growth rate (1960-2000) Austria 10596 32763 3.092016 2.822 Belgium 10335 30830 2.983067 2.732 Denmark 16287 38521 2.365138 2.152 Finland 9769 32024 3.278125 2.968 France 10611 29811 2.809443 2.582 Greece 3818 13105 3.432425 3.083 Hungary 1514 5425 3.584302 3.191 Ireland 5462 27741 5.079002 4.063 Italy 6606 20885 3.161663 2.878 Luxembourg 15772 56372 3.574182 3.184 Netherlands 11999 30966 2.580715 2.370 Norway 11322 37954 3.352235 3.024 Portugal 2735 12794 4.678735 3.858 Spain 4620 17798 3.852798 3.372 Sweden 13165 31206 2.370376 2.158 Switzerland 26245 46737 1.780796 1.443 United Kingdom 9496 21667 2.281698 2.062 Lecture 7 16 Lack Evidence of Convergence among Middle and Low Income Countries:Average Annual Growth Rate of Per Capita Income (%) and Its level in 1960 1960 angrrate Central African Republic 457 -0.746708 Chad 290 -0.713465 Ghana 450 -0.2145 Haiti 547 -0.997717 Madagascar 383 -1.106759 Nicaragua 638 -0.785382 Niger 386 -1.606578 Senegal 670 -0.238649 Sierra Leone 223 -1.041848 Venezuela, RB 3720 -0.299503 Zambia 648 -1.256572 1960 agrrate China 112 4.989179 Hong Kong, China 3008 5.214552 Ireland 5462 4.062741 Korea, Rep. 1325 5.720737 Japan 8399 4.186912 Malta 1177 5.404178 Portugal 2734 3.858026 Singapore 2676 5.890155 Thailand 465 4.492804 Conditional Convergence Lecture 7 17 Results from Cross Country Growth Studies -1 A low initial level of income is associated with higher growth rate in subsequent period when other variables are held constant. Growth rates are higher when the ratio of investment to GDP is higher. Growth rates are higher in countries which have larger stock of human capital per capita. These are reflected in terms of enrolment in the primary and secondary schools. Population growth rates are negatively associated with growth rates. Lecture 7 18 Results from Cross Country Growth Studies -2 Countries with distorted markets have lower growth rates. Distortions occur in exchange rates and prices or by impediments to a free and fair trade. Countries with efficient financial system have higher growth rates. Size of the financial markets is measured as a ratio of liquid assets to the GDP. Countries with political instability have lower growth rates. Frequency of revolutions, wars and coups are used to measure political instability. Lecture 7 19 Economic Convergence Acrross Major Industrial Countries Japan had lower income in the beginning and had an astonishing growth rate from 1960 to 1990 and it overtook all OECD countries in per capita income 50,000 40,000 France 35,000 Italy Japan United Kingdom United States 30,000 25,000 20,000 15,000 France, Germany UK and USA show significant process of convergence 10,000 5,000 Lecture 7 00 20 98 19 96 19 94 19 92 19 90 19 88 19 86 19 84 19 82 19 80 19 78 19 76 19 74 19 72 19 70 19 68 19 66 19 64 19 62 19 60 0 19 Per Capita Income in 1995 US dollars 45,000 20 Disparity in GNP Per Capita at Purchasing Power Parity,2001 (US $): A Lot of Divergence 35000 GNP at Purchasing Pow er Parity,2001 30000 25000 20000 15000 10000 5000 0 h Hi g id dl e M Lo w W or ld US A 21 UK G ha na an za ni a Ug an da Ne pa l ta n ak is ga po re Ja pa n ng Ko ng Ch i na Lecture 7 Evidence for Convergence of Output Gap Among Major Industrail Countries (IMF) 6 Output gap% =100*[(Trend GDP-Actual GDP)/Actual GDP] 4 2 19 79 19 80 19 82 19 84 19 86 19 88 19 90 19 92 19 94 19 96 19 98 20 00 20 02 Percent of GDP 0 -2 -4 -6 FRANCE GERMANY JAPAN UNITED KINGDOM UNITED STATES -8 Lecture 7 -10 22 Evidence for Conditional Convergence Across All Countries Low income countries grow slower than middle income countries, which grow faster than high income countries. Conditional Convergence Lecture 7 23 Why the investment rate is not the same across all OECD Countries? Feldstien-Horioka Puzzle Lecture 7 24 Openness and Growth: Evidence from the OECD Countries 1980-2000 Average annual growth rate of py 6.00 5.00 Series1 Poly. (Series1) 4.00 3.00 2.00 1.00 0.00 0.00 50.00 100.00 150.00 200.00 250.00 Ratio of Trade Volume to GDP Lecture 7 25 Conditional convergence 1. There is no relation between initial GDP (most studies take 1960 as the base year) and the growth rates if both developed and developing economies are taken together. 2. Many studies suggest evidence for convergence among OECD countries(so called rich country club), states of the US, provinces of Canada and prefectures of Japan. 3. There are arguments suggesting that developing economies have different steady state than of developed economies. Why? Story of squirrel and elephant. Lecture 7 26 Poverty Trap Productivity of capital does not only depend upon the amount of capital but depends upon amount of human capital. Countries with lower human capital are in danger of being caught in poverty trap. MPK e cost Capital stock Marginal product of capital is less than the cost of capital and capital stock gradually diminishes before point e. Cost is less than MPK after e more capital is accumulated. Lecture 7 27 Is this caused by the barriers to adopt a good technology? Or by Lauddites? Lecture 7 28 Can a Penguin become a Cat or a Pig become an Elephant? Lecture 7 29 Increasing Return, Poverty Threshold and Stability of the Steady State y=f(k) y I =(n+d)k Points b and o are unstable steady states a sy b Big Push o k0 Poor SS k2 Poverty TH Lecture 7 k1 30 yH Critical Capital Stock for Control in Population Growth Rate y k y Y L i n k H H b i n k L L S sy sk a yL nH > nL KH PovTH Low ss trap Lecture 7 Kss k K L 31 Economic Growth Policies Increase in public and private saving Development of human capital Removal of distortions in investment Institutional reform (rule of law) Macroeconomic stability Carefully designed redistribution policy Social security reform Lecture 7 32 Policy Issues: Tax, Saving and Consumption • What is the impact in consumption and saving in the above model – If there is a 20 percent tax on interest income? – If there is a 20 percent subsidy in it? – What sort of tax system is better for increasing the ratio of saving? Does a higher rate of VAT promote saving or consumption? – Does a higher rate of tax on labour income encourage or discourage saving? – Does a higher rate of tax on pension income increase saving or consumption? Lecture 7 33 Exercises • Calculate annual growth rates between 1960 and 2000 across G7 and for countries with growth miracles and growth disasters • Calculation of positive externality and economic growth (Spill-over Effects). • Closing the productivity gap • Conditional convergence Lecture 7 34