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NS4053 Winter Term 2014 Growth, Convergence and Income Distribution Introduction I • Kemal Dervis and Homi Kharas, Growth, Convergence and Income Distribution: An Introduction (Brookings, November 2014 • Introduces several of the main themes in the course – growth, convergence and income distribution • I. With differential recoveries from the 2008-09 global economic crisis a number of new debates on growth • Some economies argue an era of secular stagnation lies ahead unless vigorous policy actions are taken • Other economists argue that ongoing and pending technological change is likely to lead to an acceleration in growth • Stagnation thesis usually applied to the advanced countries, but sometimes to the global economy as a whole – can emerging economies decouple and sustain growth on their own? 2 Introduction II • II. Second debate is on the convergence between average incomes in the lower- and middle-income emerging economies and that in the advanced economies • Until post-WWII period no doubt considerable divergence • In 1776 per capita income in Netherlands about four times that in poorer countries • Two centuries later the Netherlands was 40 times richer than China, 24 times richer than India and 10 times richer than Thailand • In the aggregate, this divergence slowed markedly in the 1950s with average incomes in all EMDEVs (emerging and developing economies) picked up pace • Then starting in the late 1980s a processes of convergence seems to have taken hold – average income in EMDEVs growing much faster over 1989-2014. 3 Introduction III • Today, the Netherlands is only five times richer than China and Thailand and 11 times richer than India • Major question – • Is this convergence going to last? or • Was rapid convergence a temporary phenomenon? • III. The third debate centers on income distribution – intense, contemporary debate over capitalism • Is growth relevant if increases in income largely accrue to the top 10 or even 1% of the population? • Seems to be happening in the U.S. and the U.K • Is there an inherent long-run tendency towards greater inequality in a market economy? • Is there a possible link between possible secular stagnation and income distribution? • How does inequality in the world relate to inequality in particular 4 countries? Overview: Three Interlinked Debates I • Secular stagnation debate confusing: • Does it refer to slower potential output growth? or • • Slower growth of actual output? Potential growth may be slowing because of trends in: • technological change, • educational advancement, aging, and • • • debt-induced underinvestment in public goods and infrastructure Slowdown in observed output growth can also be due to gaps between actual and potential output. Hansen/Summers view that this form of stagnation may threaten the U.S. economy or advanced economies as a whole. Reason: • Desired aggregate savings has increased compared to desired aggregate investment • Real interest rate needed to restore macroeconomic equilibrium may be negative 5 Overview: Three Interlinked Debates II • Less clear is whether this form of secular stagnation applies to the global economy • Has global investment demand and the global supply of saving shifted so that there is a global savings glut? • Requiring a global real interest rate that is negative? • Is it desirable therefore to link the secular stagnation debate to the convergence debate? • If secular stagnation affects all countries, then convergence may disappear. • If it is more of a phenomenon affecting rich countries, then convergence could continue. • In this case, it may be that growth in the emerging world might actually provide the demand impulse needed for the advanced economies 6 Overview: Three Interlinked Debates III • The income distribution debate is itself linked to both the growth and convergence debate. • If take population of the world as a whole and focus on an inequality indicator for that population, increasing inequality within countries will lead to increases in the global inequality index. • But convergence – catch up by the developing countries – will lead to a decrease in world inequality index. • Has an important bearing on global demand • While we see stress on the struggling middle class in advanced countries resulting from wage stagnation and growing withincountries inequalities – • Also see emergence of a global middle class in the rest of the world – especially Asia • Clearly one has to clearly define what one means by inequality. 7 Overview: Three Interlinked Debates IV • Whether inequality is good or bad for growth has been debated over the years • Classical economists felt savings were needed to finance investment and therefore inequality good because higher income groups do most of the savings • These theories focus on changes in potential output as the real determinant on growth. • Recent research suggests the opposite view • IMF research suggests there have been more episodes of sustained rapid growth in societies that are relatively more equal • More stable socially, politically and financially – factors that seem to outweigh the classical link to savings. • Keynesian link diametrically opposed to classical link – problem of excess savings and increased income inequality makes the problem worse – here focus is on actual rather than potential 8 output The Tree Debates • The rest of the paper contains some technical terms that we will have to discuss before delving into the arguments – we should return to these debates after developing the neoclassical model with its emphasis on the sources of growth. 9