What Makes Nations Grow

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What Makes Nations Grow?

• Week 2
• SF Intermediate Economics
• Professor Dermot McAleese

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OUTLINE

• ? Trends in economic growth
• ? Growth theories
• ? Human welfare and sustainable growth
• ? Policies for growth

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WHAT IS ECONOMIC GROWTH?

• ? Gross Domestic Product (GDP) - measure of
  economic growth
• ? GDP per capita - measure of standard of living
  
• Production frontier

Y
R2
T
R3
T1
Manufactures
R1
R
Food X
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Table 1. Share of world output, trade and
population ( share)

• Source European Economy (Brussels, no. 66,
  1998) WTO, 1999.

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Growth Rates 1965-99

• Source World Bank World Development Indicators
  2001.

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SEVEN STYLISED FACTS ON ECONOMIC GROWTH

• ? Growth - the norm
• ? Rich stayed rich
• ? Poor better off since 50s
• ? Acute poverty persists
• ? Diversity in performance since 60s
• ? Natural resources ? economic success
• ? Transition economies in trouble

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Table 6. Real GNP per person

• Source Computed from Angus Maddison, The World
  Economy A Millenium Perspective (Paris OECD,
  2001) and IMF, World Economic Outlook, May 1999.
  Purchasing power parities have been used for the
  developing countries.

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How Growth Rates Differ Experience of the
1990sTable 1. Negative Growth Countries (glt0)

• Note Total number of countries reporting
  negative growth figures is 173.
• Source World Bank, World Bank Atlas, 1999. IMF,
  World Economic Outlook, October 1999.

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How Growth Rates Differ Experience of the
1990sTable 2. Rapid Growth Countries (ggt4)

• Note Total number of countries reporting growth
  figures is 173 g average annual GNP per capita
  growth
• Source World Bank, World Bank Atlas, 1999. IMF,
  World Economic Outlook, October 1999.

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How Growth Rates Differ Experience of the
1990sTable 3. Modest Growth Countries ( 2 ? g
? 4)

• Note Total number of countries reporting growth
  figures is 173 g average annual GNP per capita
  growth
• Source World Bank, World Bank Atlas, 1999. IMF,
  World Economic Outlook, October 1999.

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How Growth Rates Differ Experience of the
1990sTable 4. Slow Growth Countries ( 0 ? g ?
2)

• Note Total number of countries reporting growth
  figures is 173 g average annual GNP per capita
  growth
• Source World Bank, World Bank Atlas, 1999. IMF,
  World Economic Outlook, October 1999.

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FORECAST REAL GDP GROWTH PER CAPITA 1998-2008
Source World Bank 1999
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of population living on less than 1 per day
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• From the earliest times down to the beginning of
  the eighteenth century, there was no very great
  change in the standard of life of the average man
  living in the civilised centres of the earth..
• This lack of progress was due to two reasons
• the remarkable absence of technical improvements
  
• and
• the failure of capital to accumulate.
• J. M. Keynes, Economic Possibilities for Our
  Grandchildren, (1930)

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HARROD-DOMAR MODEL

• g ?Y/Y (?K/Y) x (?Y/?K)
• I ?K S
• g (S/Y) . (?Y/?K)
• g (S/Y)/(?K /?Y)
• g s/v
• s marginal propensity to save
• v capital-output ratio

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GROWTH THEORIES

• ? Long term determinants
• ?productive efficiency
• ?allocative efficiency
• ? Quantity of inputs
• ?K, L
• ?I/GDP ratio
• ? Total factor productivity

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Implications of Harrod-Domar

• Focus on raising s (the savings rate) and
  lowering v (capital output ratio)
• How to raise s
• Govt saving
• Robust financial system
• Foreign aid/capital inflows
• Debt forgiveness
• How to lower v
• Use capital productively (v is not a given)
• Choose right industries (planning)
• Implement good policy (new consensus?)
• Rich countries will stay rich because they can
  afford to save. Poor will stay poor because they
  have no margin

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From HD model to present .

• Solow model capital inputs subject to law of
  diminishing marg productivity hence move to
  convergence
• Total factor productivity more important than
  high investment
• Endogenous growth model technology is
  endogenous, not exogenous. Importance of
  education, knowledge, which are not subject to
  diminishing marginal returns.

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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

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TOTAL FACTOR PRODUCTIVITY (TFP/MFP)

• ?advances in technology
• ?redistribution of resources to higher
  productivity sector
• ?terms of trade
• ?institutional and political stability
• ?quality of the labour force
• (human skills and motivation)
• ?better business organisation
• ?economic policy

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The Neoclassical Theory of Exogenous Economic
Growth

• emphasises Technological Progress
• As an exogenous source of long term growth
• Tends to underestimate the role of economic
  policy

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The Theory of Endogenous Economic Growth

• Traces growth to a variety of sources such as
• Initial starting point
• Investment
• Economic Policy

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HUMAN WELFARE AND SUSTAINABLE GROWTH

• ? Leisure and the household economy
• ? Income distribution
• ? GNP and the environment
• ?GNP and human development indicators
• ?Sustainable growth

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GDP AS MEASURE OF WELFARE
Household economy Voluntary activities Black
economy (positive aspects) Leisure Inputs
classified as output (police, defence
spending) Environmental degradation Exhaustion of
natural resources Sustainable growth.
ADD
SUBTRACT
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Does Economic Growth Happiness?

• Weak correlation between economic growth and
  happiness index (Are you feeling satisfied with
  your life)
• Sources Andrew Oswald, University of Warwick
• Robert Frankel, Yale University

• But, correlation exists between income
  distribution and happiness. More unequal
  societies have more unhappiness

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WHY?

• 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

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POLICY PRESCRIPTION FOR GROWTH

• ? Competition and economic efficiency
• ?Price stability and fiscal consolidation
• ?Outward orientated policies
• ?Government to complement market forces
• ?Stable and transparent institutional
  framework
• ?Competition policy
• ?Labour market policy
• ?Infrastructure
• ?Education system

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LESSONS FROM EAST ASIAN MIRACLE

• PRUDENT FISCAL AND MONETARY MANAGEMENT
• Macroeconomic stability is negatively
  correlated with growth
• as measured by inflation, fiscal deficits and
  parallel exchange rate premiums
• SECURE AND EFFECTIVE FINANCIAL SYSTEM
• HEAVY INVESTMENT IN HUMAN CAPITAL ESPECIALLY IN
  BASIC EDUCATION
• KEEPING PRICE DISTORTIONS TO A MINIMUM
• Foreign trade
• Labour market
• ENSURING EASY ACCESS TO FOREIGN TECHNOLOGY RATHER
  THAN ATTEMPTING A PATH OF SELF-RELIANCE
• AVOID BIAS AGAINST AGRICULTURE
• Note Selective government intervention in
  industrial sector had mixed results major
  problem is bureaucratic deficit

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CONVERGENCE?

•  
• ? Endogenous growth theory
• (once ahead, always ahead)
• ? Technological spillovers
• (poor can piggy-back on the rich)
• ? Empirical evidence
• (2 rate of convergence)
• ? Conditional convergence
• (openess, education and governance)

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Table 5. Explaining Indias Relative Growth
Performance
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Table 7a. How Growth Rates Differ 1965-98

• Source World Bank World Development Indicators
  2000.

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Table 8. GDP growth rates in former socialist
countries

• Source European Bank for Reconstruction and
  Development, Transition Report, 1999

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Table 9. Investment and growth

• Source European Economy (Brussels no. 16,
  1999).

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Table 10. HDI ranking selected countries

• Source Human Development Report 2000, Oxford
  University Press, 2000.

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Table 11. East Asia

• Source The World Bank Atlas 1999.

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KOREA vs ZAMBIA A STORY OF Total Factor
Productivityexercise 3, p 36

• TFP is a residual
• TFP includes advances in technology,
  concentration on high productivity sectors,
  improved terms of trade, institutional and
  political stability, quality of the labour force

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Why does TFP differ?

• Various levels of innovation imperfect
  information between countries
• Research and Development, education,
  infrastructure, government investment
• TFP is high if countries create a dynamic of
  innovation

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• Zambia
• low education
• high protection
• bad government investment
• bad geographical location

• Korea
• high education standards
• emphasis on high-tech and automotive industries
• good geographical location
• organised banking sector