Economic Growth, Poverty Reduction, and Foreign Aid: The New Agenda

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Economic Growth, Poverty Reduction, and Foreign
Aid The New Agenda

• John B. Taylor
• Under Secretary for International Affairs
• United States Treasury
• April 22, 2002

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A New Economic Development Agenda

• Goal to increase economic growth and reduce
  poverty in the poorest countries of the world
• Special importance since 9/11
• Part of a broader international economic agenda
• Restoring growth in the industrial countries.
• Reducing instability in financial markets,
  especially emerging markets.
• Combating the financing of terrorism
• Tending to key bilateral relations Russia, China
• Trade promotion authority and free trade in
  general

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33_05
1.3 billion people, less than 1 per day ½
worlds population, less than 2 per day U.S.
average, 90 day. Why?
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The Reason is Productivity

• Productivity output (Y) per hour of work (L)
  Y/L
• Sometimes called labor productivity
• Its the explanation why some countries are
  rich and other countries are poor
• Countries that are behind in productivity are
  behind in income per capita
• Productivity growth is how to achieve higher
  income per capita
• And to reduce poverty.
• Growth accounting Y/L depends on capital (K/L)
  and technology (T)

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Prediction of Economics

• If there are no barriers to the flow and use of
  technology and capital, then countries or regions
  that are behind in productivity should have
  higher productivity growth they should catch-up
• Two issues to consider
• In theory, capital should flow to where it is low
  relative labor and its returns are relatively
  high
• Spread of technology through education, foreign
  investment, internet, etc.

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Poor but growing more rapidly
GROWTH RATE OF
33_01
PRODUCTIVITY
OR
GROWTH RATE OF
INCOME PER CAPITA
Catch-up line
Rich but growing more slowly
LEVEL OF PRODUCTIVITY
OR
LEVEL OF INCOME PER CAPITA
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GROWTH RATE OF
33_02
INCOME PER CAPITA, 1880-1980
3.5
Florida
Texas
3.0
Illinois
New York
2.5
California
2.0
States in the United States Catch-Up Clearly Seen
Nevada
1.5
1.0
0.5
300
1,000
5,000
INCOME PER CAPITA IN 1880
(RATIO SCALE)
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33_03
ANNUAL GROWTH RATE OF
REAL GDP PER CAPITA
(PERCENT)
More Advanced Countries Catch-Up Seen Here Too
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Japan
5
Portugal
Spain
4
Italy
Greece
France
Canada
3
U.S.A.
2
1
10,000
4,000
6,000
2,000
8,000
0
REAL GDP PER CAPITA IN 1960
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33_04
ANNUAL GROWTH RATE OF
REAL GDP PER CAPITA
(PERCENT)
All Countries Not Much Catch-Up Seen Yet
8
South Korea
Singapore
Hong Kong
6
4
U.S.A.
2
Sri Lanka
Bangladesh
0
Ethiopia
-2
0
10,000
4,000
6,000
2,000
8,000
REAL GDP PER CAPITA IN 1960
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Recent productivity trends(percent change per
year)

• South East Asia 2.7
• United States 2
• Europe 1
• Latin America 0.7
• Japan near 0
• Africa below 0

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So, why isnt there more catch-up?

• Very difficult question entire field of economic
  development.
• An economic answer There must be some barriers
  to the spread and to the use of technology and
  capital

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Barriers to Investment and Technology

• Poor governance
• no rule of law, corruption,
• creates disincentives to invest, to start up new
  firms, to expand existing firms,
• high risks
• Too many restrictions on people trying to trade
  or to use or implement new technology,
• low returns
• Poor Education

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Why isnt more capital flowing in?

• Investment opportunities look better elsewhere,
  United States, China,
• Risk of financial crises
• Sudden stop after Asian and Russian financial
  crises of late 1990s
• 154 billion per year from 1992-1997
• 50 billion per year from 1998-2000
• Decline in foreign assistance

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The New Agenda

• Increase foreign aid
• (1) Bilateral foreign aid to be increased by 50
  from about 10 billion per year to 15 billion
  per year
• (2) Contribution to World Bank, International
  Development Association (IDA) increase by 18
• (3) Larger fraction of IDA aid in form of
  outright grants rather than loans
• Let policy performance determine which countries
  get aid for economic development

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Millennium Challenge Account

• Good policy performance in three areas
• Ruling justly (lack of corruption)
• Investing in people (good education, health
  policy)
• Encouraging economic freedom (reduce trade
  barriers)
• Theory and evidence says that these will increase
  productivity growth
• Now working on objective criteria in each area
• using growth regression research over last 10
  years
• Each of the three areas are different policy v.
  output
• Needs to be simple, robust
• Ideas, help, welcome!

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Performance Based IDA Replenishment

• U.S. is proposing to increase IDA by 18 in the
  current replenishment (first increase in 10
  years)
• Year One 850 million
• Year Two 950 million
• Year Three 1,050 million
• Each 100 million increment in year two and three
  would depend on performance in combating disease
  and improving education
• Have not yet convinced everyone to go along

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From Loans to Grants

• U.S. has proposed converting 50 percent of IDA
  loans to grants
• Loans already have highly favorable terms
• Yet not being paid back, and there are calls for
  debt forgiveness
• So we want to Stop the Debt
• Grants can be tied to performance, example,
  better test scores in basic skills
• But not yet an agreement with Europe/Japan,
  though work has gone on for one year

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An Addition to the Millennium Goals Productivity
Growth

• Countries with lower productivity than the U.S.
  should grow faster than the U.S.
• The greater the productivity gap between the U.S.
  and a country the greater should be the
  productivity growth rate in that country
• Could the goal be quantified?
• Productivity gap 5 times ? growth rate difference
  2
• Productivity gap 10 times ? growth rate
  difference 4
• Productivity gap 90 times ? growth rate
  difference ?

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Poverty and Productivity Growth

• Some argue that the focus on economic growth will
  mean less focus on poverty reduction.
• Simple logic With productivity 90 times lower in
  poor countries, catch up completely dominates
  changes in the income distribution
• Empirical evidence
• Higher productivity growth increases the income
  per capita of the lowest quintile by about the
  same amount as the other quintiles.