Ownership and Growth

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Ownership and Growth
Thorvaldur Gylfason
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Presentation in Two Parts

• General discussion of economic growth and the
  analytical background of the paper
• Specific discussion of the topic at hand public
  vs. private ownership and the difference it makes
  for growth
• Joint work with Tryggvi Thor Herbertsson and
  Gylfi Zoega

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Economic Growth

• As old as economics itself
• Adam Smith, John Stuart Mill, Alfred Marshall,
  Joseph Schumpeter were all growth theorists
• Then Harrod and Domar came along, summarizing the
  old literature by
• g sE - ?
• where E Y/K.
• This means, inter alia, that saving is good for
  growth.

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Economic Growth The Short Run vs. the Long Run
Economic growth in the long run
Potential output
Actual output
Upswing
National economic output
Business cycles in the short run
Thus, increased saving may reduce actual output,
while increasing potential output.
Downswing
Time
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Economic Growth The Short Run vs. the Long Run

• To analyze the movements of actual output from
  year to year, viz., in the short run
• Need short-run macroeconomic theory
• Keynesian or neoclassical
• To analyze the path of potential output over long
  periods
• Need modern theory of economic growth
• Neoclassical or endogenous

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Economic Growth Solows Rebellion

• Solow rebelled against Harrod and Domar by
  pointing out that economic growth in the long run
  must be exogenous.
• In the long run, growth depends solely on
  population growth and technological progress g
  n q
• To show this, Solow made E Y/K endogenous.
• Hence, saving cannot affect long-run growth.

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Why not?

• Take another look at
• g sE - ?
• When s increases, E begins to decrease, according
  to Solow, and continues to do so until g is
  restored to its intial, exogenously determined
  value.
• This occurs essentially because an increase in s
  increases K, so that E Y/K goes down.

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Economic Growth The Solow Model

• But this approach distracted attention from two
  key questions
• How long is the long run?
• Is it possible that the long run is so long as to
  be almost irrelevant from the point of view of
  economic policy?
• What determines output per head?
• Is is possible that the level of output per head
  is endogenous in the long run even if its rate of
  growth is not?

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Economic Growth The Solow Model
In long-run steady-state equilibrium at A, growth
is exogenous g n q
y Y/L
A
E
k K/L
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Economic Growth The Solow Model
The parameter A represents technology and
efficiency.
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The Neoclassical Theory of Exogenous Economic
Growth
Traces the rate of growth of output per capita to
a single source
Technological progress
Hence, economic growth in the long run is immune
to economic policy, good or bad
To change the rate of growth of real output per
head you have to change the rate of technical
progress. ROBERT SOLOW
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The New Theory of Endogenous Economic Growth

• Traces the rate of growth of output per capita to
  three main sources
• Saving
• Efficiency
• Depreciation

Meanwhile, on the ranch ...
The proximate causes of economic growth are the
effort to economize, the accumulation of
knowledge, and the accumulation of
capital. ARTHUR LEWIS
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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 involves addition to capital stock.
• Y EK
• Output depends on quality and quantity of
  capital.

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Endogenous Growth in the Harrod-Domar Model

• This version of the endogenous growth model is
  simply a restatement of the Harrod-Domar model
• where growth depends on
• A. the saving rate
• B. the capital/output ratio
• C. the depreciation rate

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The Main Point about Endogenous Growth

• If it increases economic efficiency, it is also
  good for growth.
• This idea seems to go a long way towards
  explaining per capita income differentials of 30
  or 60 across countries.
• And even if long-run growth is exogenous, the
  level of income is endogenous.
• This is why endogenous growth theory is perhaps
  best viewed as an extension of the Solow model of
  exogenous growth.

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Specific Model
Two equations in two unknowns
Now, assume learning by doing
It follows that
and that
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A Picture of the Model
g
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sE - ?
A
q
n
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Properties of the Model
s E ? n
g - 0
q - -
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Sources of Endogenous Growth

• Saving
• Fits real world experience quite well.
• No coincidence that, in East Asia, saving rates
  of 30-40 of GDP went along with rapid economic
  growth.
• No coincidence either that many African economies
  with saving rates around 10 of GDP have been
  stagnant.
• OECD countries saving rates of about 20 of GDP
• Important implication for economic policy
• Economic stability with low inflation and
  positive real interest rates encourages saving,
  and thus is good for growth.

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Sources of Endogenous Growth
Income per capita
East Asia
400
High saving rates
300
200
OECD
Medium saving rates
Africa
100
Low saving rates
1965
1990
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Sources of Endogenous Growth

• Examples
• Oil shocks
• Soviet collapse

• Depreciation
• The effect of depreciation on growth is related
  to that of saving on growth.
• Unprofitable investment in the past reduces the
  quality of capital and thus makes it depreciate
  more rapidly, necessitating more replacement
  investment to make up for wear and tear.
• The more national saving has to be set aside for
  replacement investment, the less will be
  available for the buildup of new capital.

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Sources of Endogenous Growth

• Efficiency
• Also fits real world experience quite well
• Technical progress good for growth because it
  allows us to squeeze more output from given
  inputs.
• But that is exactly what increased efficiency is
  all about!
• Thus, technology is best viewed as an aspect of
  general economic efficiency.
• Important implication for economic policy
• Everything that increases economic efficiency, no
  matter what, is also good for growth.

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Sources of Endogenous Growth

• Five sources of increased efficiency
• Liberalization of prices and trade increases
  efficiency, and thus is good for growth.
• Stabilization reduces the inefficiency associated
  with inflation, and thus is good for growth.
• Privatization reduces the inefficiency associated
  with state-owned enterprises, and thus
• Education makes the labor force more efficient.
• Technological progress also enhances efficiency.
• The possibilities are virtually endless!

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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 RD 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.

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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. Liberal price and trade regimes
• 2. Low inflation
• 3. Strong private sector
• 4. More and better education

Recap
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The Bottom Line

• Whatever increases efficiency also increases
  economic growth.
• Solow Output per head increases, and growth also
  increases for a while.
• Romer Economic growth increases (and thereby
  also output per head).
• This idea has triggered a large empirical
  literature since the early 1990s.

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My Work in this Area Three Main Channels

• High inflation hurts growth.
• Follows directly from
• Inflation may reduce both saving and efficiency.
• Excessive dependence on natural resources impedes
  growth.
• Has to do with
• The Dutch disease
• Rent seeking
• Education
• Public vs. private ownership

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Which brings me, at last, to the point of this
paper ...
Privatization and Economic Growth

• Privatization means that profit-oriented owners
  and able managers are allowed to direct
  enterprises.
• Profit motive replaces political considerations
  as the guiding principle of business operations.
• Profit-maximizing owners generally want to
  appoint managers and staff on merit rather than
  on the basis of political connections, for
  example.
• Hypothesis Private enterprise is generally more
  efficient than state-owned enterprises.

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The Model
We derive r r(v) by applying Romers model of
expanding product variety.
Start with optimal growth à la Ramsey
Then assume
Why?
with

• SOEs may be inefficient, and may thus depend on
  low interest and little growth.
• SOEs produce low-quality output, so that
  privatization increases quality (i.e.,
  efficiency) and growth.

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What is the evidence?
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Empirical Results

• Correlation analysis
• To explore the relationship between SOEs and
  relative productivity, investment, and education
• Regression analysis
• To attempt to provide a fuller picture of the
  interrelations among these variables

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Sample of Countries
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Correlation -0.40
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Correlation -0.50
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Correlation -0.58
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Correlation -0.35
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Interpretation

• An increase in the SOEs employment share by 10
  percentage points is associated with a decrease
  in annual economic growth by almost 1.
• A large SOE sector generally goes hand in hand
  with slow growth.
• No country with an SOE sector accounting for more
  than 10 of employment had economic growth of 2
  per year or more.
• Sole exception Côte dIvoire.

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Regression Results
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Regression Results
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Regression Results
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Regression Results
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Regression Results
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Regression Results
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Regression Results
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Regression Results
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Summary of Results

• An increase in SOE employment reduces investment
  and education and thereby also economic growth
  indirectly.
• An increase in SOE labor share by 10 reduces
  growth by 1 (t 2.1).
• An increase in SOE output reduces economic growth
  directly.
• An increase in SOE output share by 10 reduces
  growth by 0.3 (t 2.1).
• An increase in SOE debt reduces growth.

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Conclusion

• Across countries, SOE activity is inversely
  related to
• Relative productivity of labor in SOE sector
• Investment
• Education
• Economic growth 1978-1992 varies inversely with
  the size of the SOE sector.
• An increase in SOE labor share by 10 reduces
  growth by 0.5 to 1 across countries, cet. par.
• So, privatization may be good for growth.
• But it needs to be implemented with care.