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What Makes Nations Grow? MSc EPS Hilary term 2013 (S3) Professor Dermot McAleese OUTLINE 1) Trends in economic growth 2) Growth theories 3) Human welfare and sustainable growth 4) Economic convergence 5) Policies for growth 2 WHAT IS ECONOMIC GROWTH? Gross Domestic Product (GDP) - measure of economic growth GDP per capita - level of output per person Production frontier Manufactures T R2 R3 T1 R M O F Food R1 T1 T 3 WHAT IS ECONOMIC GROWTH? Manufactures T R2 R3 T1 R M O F Food R1 T1 T 4 Trends in Economic Growth 5 SIX STYLISED FACTS ON ECONOMIC GROWTH Growth - the norm Rich stayed rich Poor better off since 1950s Diversity in performance Acute poverty persists Natural resources economic success 6 1. Growth is the Norm Growth Rates 1965-2005 Real GDP Real GDP per head (% p.a.) Population 2000 (millions) 3.7 3722 1.9 1433 2.3 903 Low income ($760 or less) countries(63) 5.9 Middle income countries 3.7 High income ($9,361 or more) countries (35) 3 Source: World Bank World Development Indicators 2001. Note difference in pop figures since 2000. Low income now 2495m and middle income 2738m. In 2002 China graduated from low income to the lower middle income bracket. 7 SourcIMF WEO Apr09 8 2. The Rich stayed rich Table 6. Real GNP per person 1900 1950 2000 Table 2.1 GNP per person for selected industrial countries at constant 2002 US $ Belgium Denmark Finland Belgium France Germany Denmark Italy Finland Japan France Netherlands Germany Sw eden Italy UK Japan US Netherlands Sweden China United Kingdom India South Korea United States Argentina 1900 5236 5104 2882 2794 3941 3062 2071 5013 3941 5386 5544 5039 4912 2774 2689 3718 2947 1993 4825 3793 5184 5336 1950 11064 7382 2002 25391 7070 7670 4942 11495 5986 7346 5097 5135 3287 6219 7991 9977 5296 7729 3415 12274 22305 26019 24205 22391 34281 21650 26660 23640 25888 23401 26493 21084 21622 21883 36492 31942 540 659 904 2865 5162 10199 8303 10366 444 8030 626 12753 928 25216 26596 28993 3484 26460 1951 13500 36680 Source: Computed from Angus Maddison, The World Economy: A Millenial Source: Computed from Angus Maddison, The World Economy: A Millenium Perspective (Paris: OECD, 2001) and the International Monetary Fund, World Perspective (Paris: OECD, 2001) and IMF, World Economic Outlook, May Economic Outlook , April 2002. 1999. Purchasing power parities have been used for the developing countries. 9 Rich stayed rich: Real GNP per person (1900, 1950, 2002) $ Finland France Germany Italy Japan Netherlands Sweden UK US Morocco China India South Korea Argentina Mexico 2774 2689 3718 2947 1993 4825 3793 5184 5336 807 540 659 904 2865 1116 7070 4942 5986 5097 3287 7991 9977 7729 12274 1455 444 626 928 5162 2011 22305 24205 22391 21650 23640 23401 21084 21883 31942 2693 3484 1951 13500 10199 9021 10 Source: Computed from Angus Maddison, The World Economy: A Millenium Perspective (Paris: OECD, 2001) Rich families also stay rich – rich parents have rich children If you are twice as rich as the average of your generation in… The US and the UK : your children can expect to be 40% higher income than the average for their generation and your grandchildren 16% richer than average for their generation. Denmark, your children can expect to be 15% better off than average for their generation. Similar results for Sweden and Canada Miles Corak, University of Ottawa; Gary Solon University of Michigan 11 12 13 Know-how keeps rich countries rich … Owning capital also important … Source: World Bank Global Economic Prospects 2008 14 3. Poor Countries are better off since the 1950s • Life expectancy has roughly doubled (Gap between developed and developing countries’ life expectancy was 30 yrs in 1950, 10 years in 2000) • Proportion of children attending school has risen from less than 50% to more than 75% • Average GDP per person has doubled • China and India two most populous countries in the world have been driving forces in this improvement DMcA p. 15 15 Growth Rates 1965-2008 Real GDP Real GDP per head (% p.a.) Population 2000 (millions) 3.7 3722 1.9 1433 Low income ($755 or less) countries(60) 5.9 Middle income countries 3.7 Source: World Bank World Development Indicators 2001. 16 Source: UN MDG Report 2007 17 4. DIVERSITY IN PERFORMANCE China, India, South East Asia Latin America North Africa/ Middle East Sub-Saharan Africa 18 GDP per capita growth 1971-2010 1971-80 1981-90 1991-2003 2001-10 Asia 3.2 4.9 5.3 6.9 Latin America 3.3 -0.9 1.6 2.0 Middle East/N. Africa 4.0 -0.6 1.2 2.8 Sub-Saharan Africa 0.7 -1.1 -0.2 3.5 High Income Countries 2.6 2.5 1.8 1.7 World Bank Washington DC 19 Europe’s Growth , World Bank Washington DC 2012 20 South Asia Middle East & N. Europe & Central 10 8 6 4 2 0 Highincome % REAL GROWTH IN GDP PER PERSON 2001-2012 Source: World Bank Global Economic Prospects 2012 21 5. Acute Poverty Persists % living below $1 (PPP) a day Sub-Saharan Africa South Asia Latin America and the Caribbean East Asia and Pacific Eastern Europe and Central Asia Middle East and North Africa 0 20 2005 40 60 1987 S Chen and M Ravallion “The Developing World is Poorer than we Thought ..” Policy Research Paper 4703 World Bank August 2008 22 Decline in income poverty 1981-2005 Share of people living on less than $1 (PPP US$) a day (%) Region 1981 1990 2005 East Asia 68.7 40.6 9.5 Europe & Central Asia 0.7 0.8 3.4 Latin America 7.4 7.1 5.0 MENA 3.6 2.3 2 South Asia 41.9 33.6 24.3 Subsaharan Africa 39.2 45.9 39.2 World 41.7 29.8 16.1 Source Chen and Ravallion World Bank August 2008 Table 7 23 The Bottom Billion The Third World has shrunk. For forty years the development challenge has been a rich world of one billion people facing a poor world of five billion people. … By 2015 however it will be apparent that this way of conceptualising development has become outdated. Most of the five billion are developing often at an amazing speed. The real challenge of development is there is a group of countries at the bottom that are falling behind and often falling apart. Paul Collier The Bottom Billion: Why the Poorest Countries are failing and what can be done about it? Oxford University Press 2008 24 6. Natural resources economic success Major oil producers and economic growth GDP per capita GDP per capita Oil reserves (end- Years of remaining grow th 1975-2005 $2005(PPP) 03, barrels bn) reserves Saudi Arabia 263 73 -2.0 15,711 Iran, Islamic Rep. 127 93 -0.2 7,968 Iraq 118 100+ na na United Arab Emirates 100 100+ -2.6 25,514 Kuwait 96 100+ -0.5 26,321 Venezuela 77 72 -1.0 6,632 Russian Federation 73 22 -0.7 10,845 Libya 32 66 2.5 6,621 Nigeria 30 43 -0.1 1,128 Source: World Bank, Economist July 17th 2004, UNDP Human Dev Report 2007/8 26 The Natural Resources (NR) trap • Voracity effect: Revenues from natural resources leads to big govt, insufficient total investment and bad (‘corrupt’) investment decisions • Oil and other surplus from NR are unsuited to the pressures generated by electoral competition (Nigeria) • NR attract FDI, but often in bad circumstances (China’s investment in Angola, Chad) A probabilistic tendency, not a law … exceptions Norway, Botswana See Collier ch 3 27 Growth Theories 28 WHERE ECONOMICS BEGAN Adam Smith, Wealth of Nations, 1776 Productivity the key to wealth of nations (not gold, not balance of trade surplus) Productivity enhanced by specialisation Dexterity Saving of time Machinery invented by workmen Specialisation increased by enlarging the extent of the market Extent of market limited by Trade barriers Monopoly ‘Invisible hand’ will even look after the poor! ‘in a well-governed society, opulence extends itself to the lowest ranks of the people’ 29 30 The Model α 1-α Y=AK L log Y = log A + a log K + (1-a) log L • L = Labour • K = Capital Stock minus 4% depreciation plus investment rate (% of GDP) • A = Total factor productivity (TFP) 31 GROWTH THEORIES Quantity of inputs Labour --- population growth, participation rates, hours worked per worker, unemployment rate Capital --- physical (I/GDP ratio) --- human (education) Total factor productivity Y = A.f(L, K). dA/A = dY/Y – a.dL/L – b. dK/K where a = wL/y and b = rK/y. This is the growth accounting approach. Y = g + h.L +j. K + f. A etc prod function approach. Total factor productivity (A) 32 is unobservable. Also called multi-factor productivity SOURCES OF REAL GDP GROWTH (1999-2005) Capital Labor TFP China 3.3 0.7 5.1 9.1 East Asia 1.7 1.5 2.0 5.2 South East Europe 1.1 0.2 2.0 3.3 Latin America 0.9 1.7 -- 2.6 Source World Bank Unleashing Prosperity 2008 (forthcoming) 33 OECD Economic Surveys: China, Feb 2010 34 Total Factor Productivity (TFP) A growing body of evidence suggests that, even after physical and human capital accumulation are accounted for, something else accounts for the bulk of cross country differences in the level and growth rate of GDP per head. Economists typically refer to the something else as total factor productivity Easterly and Levine What have we learned from a decade of empirical research on growth? The World Bank Economic Review No 2 2001 Baking a cake with exactly same set of ingredients. Some do it very well and produce splendid and varied cakes. Others make a mess of it. How to explain. TFP differs across industries and across firms within industries. 35 TOTAL FACTOR PRODUCTIVITY (TFP/MFP) advances in technology redistribution of resources from low- to high-productivity sectors terms of trade institutional and political stability quality of the labour force (human skills and motivation) economic policy 36 Implications of TFP findings • Raise investment and saving : Govt and private domestic saving Private and public capital inflow Foreign aid/Debt forgiveness • Reduce capital output ratio : Use capital productively (competition, education) Choose right industries (market/planning?) Implement good policy (new consensus?) • New approaches focus on knowledge economy, governance, political stability 37 Population and economic growth • High population growth adversely linked with standard of living • Stabilisation of population growth leads to transitional gain as dependency rate falls • Zero or negative population growth also has adverse implications for living standards. High elderly dependency becomes the next “problem” 38 China’s population TOTAL (thousands) 1,550,000 1,500,000 1,450,000 1,400,000 1,350,000 1,300,000 1,250,000 1,200,000 1,150,000 1,100,000 2000 2010 2020 2030 2040 2050 39 Age dependency rates for selected countries 1960-1999 1.2 1.1 1 0.9 China 0.8 India 0.7 Japan 0.6 Morocco 0.5 0.4 0.3 1960 1970 1980 1990 1999 Note: age dependency = (pop 0-14 + pop 65+)/pop 15-64 Source: World Bank WDI 40 China’s age dependency ratio 2000-2045 65.0 60.0 55.0 50.0 45.0 40.0 35.0 30.0 2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 41 ELDERLY (age 65+) DEPENDENCY RATIOS 2000 China Elderly pop (m) Active Pop (m) Elderly dependency ratio (%) 88 853 12 Japan 22 87 25 United States 36 186 20 China’s elderly ratios: 2010 – 16 elderly per 100 workers 2025 - 32 elderly per 100 workers 2050 - 61 elderly per 100 workers Increase from 88m in 2000 to 438m in 2050 Source: World Bank, Center for Strategic and International Studies Wash DC. Updated data in Table L, HDR 2009. 42 World’s largest countries by population (million) 2007 2050 China 1329 India 1658 India 1169 China 1409 Unites States 306 United States 402 Indonesia 232 Indonesia 297 Brazil 192 Pakistan 292 Pakistan 164 Nigeria 289 Bangladesh 159 Brazil 254 Nigeria 148 Bangladesh 254 Russian Federation 142 Congo 187 Japan 128 Ethiopia 183 43 Population growth: Uganda case study Despite HIV rate that peaked at 30% in the 1990s Uganda now has one of the world’s fastest growing populations. 30m 2007, 60m 2030, 103m 2050. President Museveni thought this was desirable, and that higher population should be a target for Uganda’s policy! 56% of population is under the age of 18 Fertility rate remains 7 children per woman Uganda’s pop growth 3.6% in 2008 and in recent yrs Kenya and Yemen > 4% SSA growth in labor force 1993-2003 was 2.8% This increase in numbers wiped out the benefits of growth. Economists have attributed 40% of east Asia’s per capita growth between 1965-1990 to its “beneficial” population structure – and to the decline in its dependency ratio. 44 CLASS EXERCISE: RECENT GROWTH EXPERIENCE 1. How many countries have experienced annual average growth in real GDP per head <1% during the period 1970-2008? Do these countries have any special economic or geographic characteristics that separate them from positive growing countries? 2. What countries experienced rapid GDP per head growth (>3% p.a.)? Do they have any common characteristics? What lessons do they have to offer to the negative growth countries? 3. From a general view of the statistics and reading of chapter 2 and HDR 2010 tables, is the global trend one of convergence of living standards between poor and rich countries, or is the process one of “the rich getting richer and the poor getting poorer”? 45 Class Exercise Explain how an increase in these variables would affect growth of GDP per capita : • • • • • • • • Initial income level Initial level of schooling Population growth Investment/GDP ratio Terms of trade Degree of openness/globalisation Government consumption/GDP Democracy 46 Class exercises (2) • Q for D 4, p. 39 • Q for D 5, p. 39 (Asia vs Africa) (growth of firm vs growth of economy) • E4, p. 39 • E 6, p. 40 (India and China case) 47 Exercise 6 p.40 a) India's per capita GDP was $2675 in 2002 (PPP basis). Assuming a growth rate of 3 per cent per person was sustained, how many years will it take India to reach the average per capita GDP level in developed countries of about $28,744? b) Suppose developed countries continue to grow at 2 per cent per year, how long before India catches up with the developed countries? Comment on the plausibility of these projections? c) Do the same exercise for China. Assume China’s GDP per capita is $5003 (PPP) in 2003, take $30,300 as figure for developed countries and assume China’s per capita GDP grows at 7% p.a. 48 Question for Discussion “With appropriate economic policies and institutions, rapid economic growth is achievable almost anywhere.” Thorvaldur Gylfason Principles of Economic Growth 1999 Do you agree? 49 Human Welfare and Economic Growth 50 Source: Deutsche Bank Research “Measures of Well being” Sept 2006 51 TOGDP IMPROVE GDP AS MEASURE WELFARE …. AS MEASURE OF OF WELFARE ADD: Add: Household economy Leisure Voluntary activities Household contribution Shadow economy (positive aspects) Voluntary activities Leisureeconomy (positive aspects) Shadow SUBTRACT: Subtract: Environmental damage Inputs classified as output (police, defence Depletion of natural resources spending) Inputs classified as output (defence, cost of pollution control) Environmental degradation Take accountExhaustion of: of natural resources Income distribution 52 GDP and Human Development Index HDI is a weighted average of data on: GDP per head Life expectancy at birth Years of schooling and adult literacy HDI and GDP per head ranking is very similar (see next table) High income, better health and more education tend to improve at the same time Research continues on direction of causality. 53 The basic purpose of development is to enlarge people’s choices. .. People often value achievements that do not show up at all, or not immediately, in income or growth figures: greater assess to knowledge, better nutrition and health services, more secure livelihoods, security against crime and physical violence, satisfying leisure hours, political and cultural freedoms and sense of participation in community activities. The objective of development is to create an enabling environment for people to enjoy long, healthy and creative lives. Mahbub ul Haq Founder the the Human Development Report 54 When there are large changes in inequality (more generally a change in income distribution) gross domestic product (GDP) or any other aggregate computed per capita may not provide an accurate assessment of the situation in which most people find themselves. If inequality increases enough relative to the increase in average per capita GDP, most people can be worse off even though average income is increasing Report by the Commission on the Measurement of Economic Performance and Social Progress, J Stiglitz, A Sen and J Fitoussi Paris 2009 . Report presented to the President of France. 55 The commonly used statistics may not be capturing some phenomena, which have an increasing impact on the well-being of citizens. For example, traffic jams may increase GDP as a result of the increased use of gasoline, but obviously not the quality of life. Moreover, if citizens are concerned about the quality of air, and air pollution is increasing, then statistical measures which ignore air pollution will provide an inaccurate estimate of what is happening to citizens’ well-being. Or a tendency to measure gradual change may be inadequate to capture risks of abrupt alterations in the environment such as climate change. Report by the Commission on the Measurement of Economic Performance and Social Progress, J Stiglitz, A Sen and J Fitoussi Paris 2009 56 HDR 2011 57 Developing countries: HDI GDP per cap South Korea 12 35 Chile 45 59 Mexico 53 58 Saudi Arabia 59 40 Brazil 73 79 China 101 Philippines 97 124 HDR2011 Turkey 83 63 China 89 85 Algeria 104 88 South Africa 129 78 Indonesia 111 121 Egypt 123 103 Morocco 114 104 India 119 114 Botswana 125 60 Zambia 164 176 Source: HDR 2010 S Leone 158 175 Note: Blue denotes a better HDI ranking, Red denotes a better GDP per capita ranking.58 1) Does GDP growth = Happiness? 2) Does GDP level = Happiness? 1) Weak correlation between economic growth and happiness index (‘Are you feeling satisfied with your life’) 2) Weak correlation between income level and happiness up to a certain threshold. Beyond that threshold, income distribution matters more. More unequal societies have more unhappiness Sources: Andrew Oswald, University of Warwick Robert Frankel, Yale University 59 Happiness and income: the weakest link 60 Source: Deutsche Bank Research “Measures of Well Being: there is more to it than GDP”, 8 September 2006 61 62 Peter Sanfey “Does Transition make you happy?” EBRD working paper no 91, April 2005 63 Layard (continued) 64 Why do GDP and Happiness differ? • Many goods are ‘Positional goods’ – status symbols • Externalities – e.g. if everyone has a car, congestion costs increase • Relative poverty creates major feelings of unhappiness • Longevity is good, but leads to high medical bills and rise in dependency ratio 65 Policy Implications 66 Supply-side policies are crucial Nomura “Europe will work” March 2011 67 68 POLICY PRESCRIPTION FOR GROWTH Give priority to economic efficiency Government should complement rather than replace market forces Poor macro management significantly impairs growth Outward orientated policies help growth Economic environment should encourage and mobilise individual effort in a socially productive way 69 Conclusions • Growth a complex process, no easy blueprint • Economic consensus policies help most countries and some more than others, but it is not sufficient • Economic growth will not occur when there is political instability and absence of property rights. Hence emphasis on TFP, institutions, governance and stability • We still have big gaps in knowledge about key binding constraints on growth. They differ from country to country • Climate change and sustainable growth are pushing up the agenda 70 Question for Discussion The growth of global trade has been wonderful for Asia. But don’t count on trade to help the bottom billion. Based on present trends, it seems more likely to lock yet more of the bottom-billion countries into the natural resource trap than to save them through export diversification Paul Collier The Bottom Billion p. 87 71