Download Chapter 19 - The Citadel

Chapter 19
Policies and
Prospects
for Global
Economic Growth
Introduction
Builders in Brazil devote much time and
expense to obtain legal permits from local and
national government agencies.
Construction costs can be driven up by as much
as 400%.
In this chapter, you will learn why relatively
complicated, slow-moving, and expensive legal
systems are holding back economic growth in
Brazil and other developing countries.
Copyright © 2008 Pearson Addison Wesley. All rights reserved.
19-2
Learning Objectives
• Explain why population growth can have
uncertain effects on economic growth
• Understand why the existence of dead capital
retards investment and economic growth in
much of the developing world
• Describe how government inefficiencies have
contributed to the creation of relatively large
quantities of dead capital in the world’s
developing nations
Copyright © 2008 Pearson Addison Wesley. All rights reserved.
19-3
Learning Objectives (cont'd)
• Discuss the sources of international
investment funds for developing nations
and identify obstacles to international
investment in these nations
• Identify the key functions of the World Bank
and the International Monetary Fund
• Explain the basis for recent criticisms of
policymaking at the World Bank and the
International Monetary Fund
Copyright © 2008 Pearson Addison Wesley. All rights reserved.
19-4
Chapter Outline
• Labor Resources and
Economic Growth
• Capital Goods and Economic Growth
• Private International Financial Flows
as a Source of Global Growth
• International Institutions and Policies
for Global Growth
Copyright © 2008 Pearson Addison Wesley. All rights reserved.
19-5
Did You Know That...
• In Haiti, registering a new company takes
203 days, which is at least 198 days longer
than is required in the United States?
• In Sierra Leone, the cost of officially
establishing a business is 1,200 times the
average resident’s annual income?
• In Nigeria, to record a sale of land,
a business must complete 21
different procedures?
Copyright © 2008 Pearson Addison Wesley. All rights reserved.
19-6
Labor Resources
and Economic Growth
• Population growth does not
necessarily translate into an
increase in labor resources.
• In poor areas, many people do not
join the labor force, or they may
remain unemployed for long periods.
Copyright © 2008 Pearson Addison Wesley. All rights reserved.
19-7
Labor Resources
and Economic Growth (cont'd)
• We can express the growth rate of per capita
real GDP in a nation as the difference
between the rate of growth in real GDP and
the population growth rate.
• Hence, if real GDP grows at a rate of 4% per
year and population growth increases from 2
to 3%, then per capita real GDP will decline,
from 2 to 1%.
Copyright © 2008 Pearson Addison Wesley. All rights reserved.
19-8
Labor Resources
and Economic Growth (cont'd)
• Population growth can contribute to
economic growth.
• Whether population growth hinders or
contributes to economic growth
depends on where you live.
Copyright © 2008 Pearson Addison Wesley. All rights reserved.
19-9
Table 19-1 Population Growth
and Growth in Per Capita Real GDP
in Selected Nations Since 1965
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19-10
Labor Resources
and Economic Growth (cont'd)
• The role of economic freedom
 A crucial factor influencing economic
growth is the relative freedom of a
nation’s residents.
 Only 17 nations, with 17% of the world’s
people, grant their residents high degrees
of economic freedom.
Copyright © 2008 Pearson Addison Wesley. All rights reserved.
19-11
Labor Resources
and Economic Growth (cont'd)
• Economic Freedom
 The rights to own private property
and to exchange goods, services,
and financial assets with minimal
government interference
Copyright © 2008 Pearson Addison Wesley. All rights reserved.
19-12
Labor Resources
and Economic Growth (cont'd)
• The role of political freedom
 Political freedom: the right to openly
support and democratically select
national leaders
 Economic freedom tends to stimulate
economic growth, which then leads to
more political freedom.
Copyright © 2008 Pearson Addison Wesley. All rights reserved.
19-13
Labor Resources
and Economic Growth (cont'd)
• Question
 Why do you suppose that per capita real
GDP appears to be related to the extent to
which the rule of law prevails?
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19-14
International Example: The Rule of
Law and Per Capita Real GDP
• Failure to abide by the rule of law makes the
return on capital dependent more on the
whims of individuals than on laws.
• Property rights become less secure,
which discourages individuals and
businesses from investing and using
property for productive purposes.
• The growth-reducing effects of a breakdown
in the rule of law should show up in the form
of lower levels of per capital real GDP.
Copyright © 2008 Pearson Addison Wesley. All rights reserved.
19-15
Figure 19-1 The Relationship Between
Adherence to the Rule of Law and Per
Capita Real GDP
Copyright © 2008 Pearson Addison Wesley. All rights reserved.
19-16
Capital Goods and Economic Growth
• A fundamental problem developing
countries face is that a significant
portion of their capital goods, or
manufactured resources that may
be used to produce other items in
the future, is what economists call
dead capital.
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19-17
Capital Goods
and Economic Growth (cont'd)
• Dead Capital
 Any capital resource that lacks clear title
of ownership
 A resource that people cannot readily
allocate to its most efficient use
 Is among the most significant impediments
to growth in poor nations
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19-18
Capital Goods
and Economic Growth (cont'd)
• Dead capital and inefficient production
 Nontransferable physical structures are
valued at more than $9 trillion in
developing nations.
• Dead capital and economic growth
 Disincentives to invest in new capital
goods can greatly hinder economic growth.
Copyright © 2008 Pearson Addison Wesley. All rights reserved.
19-19
Capital Goods
and Economic Growth (cont'd)
• Government inefficiencies, investment,
and growth
 Governments in many of the world’s
poorest nations place tremendous
obstacles in the way of entrepreneurs.
 These entrepreneurs are interested in
owning capital goods and directing them to
profitable opportunities.
Copyright © 2008 Pearson Addison Wesley. All rights reserved.
19-20
Capital Goods
and Economic Growth (cont'd)
• Government inefficiencies, investment,
and growth
 In a nation with a stifling government
bureaucracy regulating the uses of capital
goods, newly created capital will all too
likely become dead capital.
 Thus, government inefficiency can be a
major barrier to economic growth.
Copyright © 2008 Pearson Addison Wesley. All rights reserved.
19-21
Figure 19-2 Bureaucratic
Inefficiency and Economic Growth
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19-22
Private International Financial Flows
as a Source of Global Growth
• Question
 Given the large volume of inefficiently
employed capital goods in developing
nations, what can be done to promote
greater global growth?
Copyright © 2008 Pearson Addison Wesley. All rights reserved.
19-23
Private International Financial Flows
as a Source of Global Growth (cont'd)
• Answers
 One approach is to rely on private markets
 Another is to entrust the world’s
governments
Copyright © 2008 Pearson Addison Wesley. All rights reserved.
19-24
Private International Financial Flows
as a Source of Global Growth (cont'd)
• Private investment in
developing nations
 Each year since 1995, at least $150 billion
in private funds have flowed to developing
nations in the form of purchases of bonds
or stock.
 Nearly all funds that flow into developing
countries due so to finance investment
projects in those nations.
Copyright © 2008 Pearson Addison Wesley. All rights reserved.
19-25
Private International Financial Flows
as a Source of Global Growth (cont'd)
• Economists group international flows of
investment funds into three categories.
1. Loans from banks and other sources
2. Portfolio investment
3. Foreign direct investment
Copyright © 2008 Pearson Addison Wesley. All rights reserved.
19-26
Private International Financial Flows
as a Source of Global Growth (cont'd)
• Portfolio Investment
 The purchase of less than 10% of the
shares of ownership in a company in
another nation
• Foreign Direct Investment
 The acquisition of more than 10% of the
shares of ownership in a company in
another nation
Copyright © 2008 Pearson Addison Wesley. All rights reserved.
19-27
Figure 19-3 Sources of International
Investment Funds
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19-28
Private International Financial Flows
as a Source of Global Growth (cont'd)
• Obstacles to international investment
 Markets for loans, bonds, and
stocks in developing countries
susceptible to problems relating to
asymmetric information
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19-29
Private International Financial Flows
as a Source of Global Growth (cont'd)
• Asymmetric information as a barrier to
financing global growth
 Adverse selection problems arise
 Moral hazard another problem
Copyright © 2008 Pearson Addison Wesley. All rights reserved.
19-30
Private International Financial Flows
as a Source of Global Growth (cont'd)
• Question
 To what countries do most residents of
developing nations allocate the majority of
their own foreign direct investment?
Copyright © 2008 Pearson Addison Wesley. All rights reserved.
19-31
International Example:
Investing in the Usual Places
• Residents of developing nations have
increased their FDI in highly developed
nations by 250% since 2000.
• Over two-thirds of the funds residents of
developing nations allocate go to the
United States, Japan, and nations of
the European Monetary Union.
Copyright © 2008 Pearson Addison Wesley. All rights reserved.
19-32
Private International Financial Flows
as a Source of Global Growth (cont'd)
• International Financial Crisis
 The rapid withdrawal of foreign
investments and loans from a nation
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19-33
International Institutions and Policies
for Global Growth
• Since 1945, the world’s governments
have taken an active role in
supplementing private markets.
• Two international institutions, the World
Bank and the International Monetary
Fund, have been at the center of
government-directed efforts.
Copyright © 2008 Pearson Addison Wesley. All rights reserved.
19-34
International Institutions and Policies
for Global Growth (cont'd)
• The World Bank
 A multinational agency that specializes in
making loans to about 100 developing
nations in an effort to promote their longterm development and growth
 Loans are made to finance improved
irrigation systems, roads, and
better hospitals.
Copyright © 2008 Pearson Addison Wesley. All rights reserved.
19-35
Figure 19-4 The Distribution of
World Bank Lending Since 1990
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19-36
International Institutions and Policies
for Global Growth (cont'd)
• The International Monetary Fund
 A multinational organization that aims to
promote world economic growth through
more financial stability
 The IMF assists developing countries
primarily by making loans to
their governments.
Copyright © 2008 Pearson Addison Wesley. All rights reserved.
19-37
International Institutions and Policies
for Global Growth (cont'd)
• When a country joins the IMF, it
deposits funds into an account called
a quota subscription.
• These funds are measured in terms of
an international unit of accounting
called special drawing rights (SDRs).
Copyright © 2008 Pearson Addison Wesley. All rights reserved.
19-38
International Institutions and Policies
for Global Growth (cont'd)
• SDRs have a value based on
a weighted average of four
key currencies
 The euro, the pound sterling, the yen, and
the dollar
 At present, one SDR is equal to just
under $1.50.
Copyright © 2008 Pearson Addison Wesley. All rights reserved.
19-39
International Institutions and Policies
for Global Growth (cont'd)
• Quota Subscription
 A nation’s account with the International
Monetary Fund, denominated in special
drawing rights
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19-40
Figure 19-5
IMF Quota Subscriptions
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19-41
International Institutions and Policies
for Global Growth (cont'd)
• Questions
 Are the World Bank and the IMF part of the
solution or part of the problem?
 Does the World Bank really have a
mission anymore?
Copyright © 2008 Pearson Addison Wesley. All rights reserved.
19-42
International Institutions and Policies
for Global Growth (cont'd)
• Rethinking long-term development
lending: a main theme of development
economics has been market reforms.
 Markets work better when a developing
nation has more effective institutions.
 Basic
property rights
 Well-run
legal systems
 Uncorrupt
government agencies
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19-43
International Policy Example:
Using Catastrophe Bonds to Aid
Drought-Stricken Nations
• The World Food Program is poised to
implement a program that will rely on
catastrophe bonds to help when
droughts take place.
• Could catastrophe bonds replace other
forms of aid and lending, such as World
Bank and other assistance programs?
Copyright © 2008 Pearson Addison Wesley. All rights reserved.
19-44
International Institutions and Policies
for Global Growth (cont'd)
• Alternative institutional structures for
limiting financial crises
 Many proposals for change
diverge sharply.
 Economists recommend improvements
in standards.
Copyright © 2008 Pearson Addison Wesley. All rights reserved.
19-45
International Institutions and Policies
for Global Growth (cont'd)
• Question
 Is it time to replace the World Bank and
the IMF?
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19-46
Issues and Applications: Bogging
Down Business in Brazil
• Brazil’s legal system, which is based on a 245-article
constitution that is among the world’s lengthiest, and includes a
labor law containing 922 articles, is perhaps the most
complicated in the Western Hemisphere.
• This helps explain why the average time required for a firm to
resolve a legal dispute is 81 weeks, which is 36 weeks longer
than in the United States.
• Laying off a worker requires a Brazilian business to incur an
expense equivalent to paying the worker for 165 weeks,
whereas a U.S. firm normally faces a layoff expense no greater
than 8 weeks’ worth of wage payments to the employee.
Copyright © 2008 Pearson Addison Wesley. All rights reserved.
19-47
Issues and Applications: Bogging
Down Business in Brazil (cont'd)
• Since 2000, international investors have
been more hesitant to allocate funds to
Brazilian business projects.
• The World Bank committed to providing
the Brazilian government $500 million in
so-called competitiveness loans.
Copyright © 2008 Pearson Addison Wesley. All rights reserved.
19-48
Issues and Applications: Bogging
Down Business in Brazil (cont'd)
• Critics of these loans worry the
willingness of the World Bank to step in
reduces the incentive for legal reform.
• The end result of World Bank credits
and IMF bailouts, they worry, may
perpetuate Brazil’s legal labyrinth.
Copyright © 2008 Pearson Addison Wesley. All rights reserved.
19-49
Summary Discussion
of Learning Objectives
• Effects of population growth and
personal freedoms on economic growth
 Increased population growth has
contradictory effects on economic growth.
 There is evidence of a positive relationship
between economic freedom and growth.
Copyright © 2008 Pearson Addison Wesley. All rights reserved.
19-50
Summary Discussion
of Learning Objectives (cont'd)
• Why dead capital deters investment
and slows economic growth
 Few people in less developed countries
establish legal ownership of capital.
 Unofficially owned resources are known as
dead capital.
 In many developing nations, there is a
disincentive to accumulate capital, which
limits growth prospects.
Copyright © 2008 Pearson Addison Wesley. All rights reserved.
19-51
Summary Discussion
of Learning Objectives (cont'd)
• Government inefficiencies and dead
capital in developing nations
 A negative relation between government
inefficiency and economic growth
Copyright © 2008 Pearson Addison Wesley. All rights reserved.
19-52
Summary Discussion
of Learning Objectives (cont'd)
• Sources of international investment
funds and obstacles to investing in
developing nations
 Sources include bank loans, portfolio
investment, and foreign direct investment
 Obstacles include problems relating to
asymmetric information such as adverse
selection and moral hazard
Copyright © 2008 Pearson Addison Wesley. All rights reserved.
19-53
Summary Discussion
of Learning Objectives (cont'd)
• The functions of the World Bank and
the International Monetary Fund
 The World Bank’s function is to finance
capital investment.
 A fundamental duty of the IMF is to
stabilize international financial flows.
Copyright © 2008 Pearson Addison Wesley. All rights reserved.
19-54
Summary Discussion
of Learning Objectives (cont'd)
• The basis for recent criticisms of the
World Bank and IMF policymaking
 The World Bank has extended credit to
companies and governments that could
have obtained private funds.
 The World Bank and IMF have failed to
effectively deal with adverse selection and
moral hazard, suggesting more stringent
conditions on credit access are needed.
Copyright © 2008 Pearson Addison Wesley. All rights reserved.
19-55
End of
Chapter 19
Policies and
Prospects
for Global
Economic Growth