Download Principles of Economic Growth

Openness
and
Or why
international
trade is good
for economic
growth
Thorvaldur Gylfason
Growing Apart
Different national economies have
grown at different rates in the past
Nations that started out in similar
circumstances a few decades ago can
have vastly different standards of
living today
Reasons for differences
Different economic systems
Different economic policies
National economic output
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
Botswana and Nigeria:
GNP per capita 1964-2000
4000
3500
3000
Botswana
Nigeria
2500
2000
1500
1000
500
19
60
19
64
19
68
19
72
19
76
19
80
19
84
19
88
19
92
19
96
20
00
0
Current US$,
Atlas method
Spain and Argentina:
GNP per capita 1964-2000
18000
16000
Argentina
14000
Spain
12000
10000
8000
6000
4000
2000
19
60
19
64
19
68
19
72
19
76
19
80
19
84
19
88
19
92
19
96
20
00
0
Current US$,
Atlas method
Mauritius and Madagascar:
GNP per capita 1964-2000
Current US$,
Atlas method
4500
4000
Mauritius
3500
Madagascar
3000
2500
2000
1500
1000
500
19
60
19
64
19
68
19
72
19
76
19
80
19
84
19
88
19
92
19
96
20
00
0
Economic Systems and
Policies
Economic systems and growth
As a rule, mixed market economy grows
more rapidly than centrally planned
economy
Economic policies and growth
Policies that promote economic efficiency
are also good for growth
Liberalization, stabilization, privatization
Education, diversification
Extensive and Intensive
Growth
Main determinants of economic growth
Saving and high-quality investment
Economic efficiency, including technology
Extensive growth through accumulation
Saving and investment
Intensive growth through better use of
existing resources
More efficiency, better technology
Education
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
Robert Solow
raised doubts on
long-run linkages
+
Growth
Investment
+
+
Education
denotes a positive effect in the direction shown
More sources of
growth
Arthur Lewis: x is mainly trade, stable
politics, good weather
Growth
+
Investment
+
+
x
denotes a positive effect in the direction shown
+
Education
Sources of Endogenous
Growth
Income
per capita
400
East Asia
300
200
OECD
100
Africa
1965
1990
Growth and Investment,
1965-98
Let’s be
more
specific
Growth per capita (% per year)
10
Each ten percentage point
increase in the investment
ratio is associated with an
increase in per capita
growth by 1½% per year.
8
6
Botswana
1½%
4
10%
2
0
0
10
20
30
-2
-4
-6
Investment (% of GDP)
40
50
Growth and Investment,
1965-98
How
about
initial
income?
Annual grow th of GNP per capita 1965-98, adjusted for
initial incom e (%)
6
An increase in investment by
4% of GDP is associated with
an increase in per capita
growth by 1% per year.
4
2
Thailand
Ireland
0
0
5
10
15
20
25
30
-2
Jordan
Chad
-4
Nicaragua
-6
r = 0.65
-8
Gross dom estic investm ent 1965-1998 (% of GDP)
35
Growth and Education,
1965-98
An increase in
secondary-school
enrolment by 40%
of each cohort goes
along with an
increase in per
capita growth by
1% per year.
Growth per capita (% per year)
10
8
6
4
2
0
0
20
40
60
80
100
120
-2
-4
Secondary-school enrolment 1980-97 (% )
140
Growth and Education,
1965-98
How
about
initial
income?
Annual grow th of GNP per capita 1965-98, adjusted
for initial incom e (%)
6
4
2
Thailand
Japan
Finland
0
0
20
40
60
80
100
120
-2
Jamaica
Ghana
-4
-6
Positive but diminishing
returns to education
-8
Gross secondary-school enrolm ent 1980-97 (%)
Efficiency is Key
Need economic policies that increase
efficiency
Produce more output from given inputs
Takes fewer inputs to produce given output
More efficiency, better technology are two
ways of increasing output per unit of input
So is more and better education
Trade increases efficiency and thereby
also economic growth
A Simple Model of
Endogenous Growth
Four building blocks:
S=I
Saving equals investment in equilibrium
S = sY
Saving is proportional to income
I = K + K
Investment means addition to capital stock
Y = EK
Output depends on quality and quantity of capital
A Simple Model of
Endogenous Growth
Let´s do the arithmetic:
S = sY = I = K + K
= Y/E + Y/E
Rearranging terms we find
Y/E = sY - Y/E
Multiplying by E and dividing by Y gives
Y/Y = sE - 
A Simple Model of
Endogenous Growth
Growth equation:
g = sE - 
Rate of economic growth equals
 Saving rate
times

Efficiency
minus

Depreciation
Sources of Endogenous
Growth
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
Sources of Endogenous
Growth
Five main sources of increased efficiency
1. Liberalization of prices and trade increases
efficiency, and thus is good for growth
2. Stabilization reduces the inefficiency associated
with inflation, and thus is good for growth
3. Privatization reduces the inefficiency associated
with state-owned enterprises, and thus …
4. Education makes the labor force more efficient
5. Technological progress also enhances efficiency
The possibilities are virtually endless!
So What to Do to Encourage
Economic Growth
Maintain strong incentives to save
Keep inflation low and real interest rates positive
Maintain financial system in good health
so as to channel saving into high-quality investment
Place strong emphasis on efficiency
1.
2.
3.
4.
5.
Liberal price and trade regimes
Low inflation
Strong private sector
More and better education
Limited natural resources
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.

Compare North Korea with Hong Kong and Singapore
More efficiency is good for growth.
Market Equilibrium and
Economic Welfare
Price
A
B
C
Consumer
surplus
E
Producer
surplus
Supply
Total welfare gain associated
with market equilibrium equals
producer surplus (= ABE) plus
consumer surplus (= BCE)
Demand
Quantity
Market Intervention and
Economic Welfare
Price
Welfare
loss
A
J
F
B
E
H
Consumer surplus = AFGH
Producer surplus = CGH
Total surplus = AFGC
Supply
Price ceiling imposes a
welfare loss equivalent to
the triangle EFG
Price ceiling
G
C
Demand
Quantity
Liberalization Increases
Economic Efficiency
D
H
Domestic,
distorted
price ratio
E
Traditional
output
C
O
Modern output
G
Liberalization Increases
Economic Efficiency
World price ratio
D
H
If output gain = E and
price distortion = c,
then E = mc2
Traditional
output
OC = modern output
CA = traditional output
OA = total output
O
Domestic,
distorted
price ratio
E
Price
distortion
Output
gain
F
C
Modern output
G
A
B
Liberalization Increases
Economic Efficiency
World price ratio
Welfare
gain
Exports
D
K
J
H
E
Price
distortion
Output
gain
Traditional
output
Domestic,
distorted
price ratio
Imports
F
G
C
O
Modern output
A
B
Liberalization Increases
Economic Efficiency
Transition
takes time:
From E to F
via M, N,
and Q
Welfare
gain
D
J
H
E
M
Traditional
output
N
Q
Price
distortion
F
C
O
Modern output
G
A
B
How Trade Increases
Efficiency
Autarky breeds inefficiency
Trade with other nations increases
efficiency by allowing
1. Specialization through comparative
advantage
2. Exploitation of economies of scale
3. Promotion of free competition
Not only trade in goods and services, but
also in capital and labor
“Four freedoms”
How Trade Increases
Efficiency
Trade also encourages international
exchange of
Ideas
Information
Know-how
Technology
Trade is education
Which is also good for growth
Large and Small
Countries
Small countries need trade to extend
their markets beyond their national
borders
Large countries need trade less than
small
Domestic trade replaces foreign trade
Evidence from around the world
Small countries have higher ratios of
exports to GDP than large countries
Selected Countries: Exports
1999-2000 (% of GDP)
90
80
70
60
50
40
30
20
10
0
United Japan Germany Belgium Ireland Estonia
States
Empirical Evidence
Openness can be defined as export ratio
adjusted for country size (e.g.,
population)
Evidence shows that open economies
tend to grow more rapidly than closed
economies
Trade encourages growth
Growth encourages trade
Other measures of openness yield a
similar conclusion
Openness and Growth
1965-98
Annual growth of GNP per capita 1965-98, adjusted for
initial income (%)
6
4
Korea
2
Malaysia
Belgium
0
-40
-30
-20
-10
0
10
20
30
40
-2
Guinea Bissau
-4
-6
An increase in openness by
14% of GDP is associated
with an increase in per capita
growth by 1% per year.
-8
Actual less predicted exports 1965-98 (% of GDP)
Bottom Line
Increased openness stimulates
economic efficiency and growth ...
... as long as the gains from trade are
well distributed
Continued globalization is thus by no
means sure to succeed
Need to pay attention to distribution
as well as growth