Economic growth around the world
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Economic Growth Around the World. Thorvaldur Gylfason. Growing Together, Growing Apart. West-Germany : East-Germany Austria : Czech Republic Finland : Estonia Taiwan : China South Korea : North Korea. Economic system. Rapid growth. Botswana : Nigeria Kenya : Tanzania

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Economic Growth Around the World

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Economic growth around the world

Economic Growth Around the World

Thorvaldur Gylfason


Endogenous growth in the harrod domar model

Growing Together,

Growing Apart

West-Germany : East-Germany

Austria : Czech Republic

Finland : Estonia

Taiwan : China

South Korea : North Korea

Economic system

Rapid growth

Botswana : Nigeria

Kenya : Tanzania

Thailand : Burma

Tunisia : Morocco

Spain : Argentina

Mauritius : Madagascar

National economic output

Economic policy?

Slow growth

Time


Endogenous growth in the harrod domar model

Botswanaand Nigeria: GNP per capita 1964-97

Case 1

Current US$,

Atlas method


Endogenous growth in the harrod domar model

Kenya, Tanzania, and Uganda: GNP per capita 1964-97

Case 2

Current US$,

Atlas method


Endogenous growth in the harrod domar model

Burma and Thailand:

GNP per capita 1960-97

Case 3

Local currency,

1988 prices,

1960 = 100


Endogenous growth in the harrod domar model

Barbados, Dominican Republic, and Haiti: GNP per capita 1964-98

Case 4

Current US$,

Atlas method


Endogenous growth in the harrod domar model

Egypt, Morocco, and Tunisia:

GNP per capita 1964-97

Case 5

Current US$,

Atlas method


Endogenous growth in the harrod domar model

Argentina, Uruguay, and Spain:

GNP per capita 1964-97

Case 6

Current US$,

Atlas method


Endogenous growth in the harrod domar model

Madagascar and Mauritius:

GNP per capita 1964-97

Case 7

Current US$,

Atlas method


Endogenous growth in the harrod domar model

Chile and Zambia:

GNP per capita 1964-98

Case 8

Current US$,

Atlas method


Endogenous growth in the harrod domar model

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

The crisis of 1997-98

is irrelevant to Asia’s

long-term growth potential.

Downswing

Time


Endogenous growth in the harrod domar model

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


Endogenous growth in the harrod domar model

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 M. SOLOW


Endogenous growth in the harrod domar model

The New Theory of Endogenous Economic Growth

  • Traces the rate of growth of output per capita to three main sources:

    • Saving

    • Efficiency

    • Depreciation

“The proximate causes of economic growth are the effort to economize, the accumulation of knowledge, and the accumulation of capital.”

W. ARTHUR LEWIS


Endogenous growth in the harrod domar model

Exogenous vs. Endogenous Growth

  • The neoclassical view

    • that economic growth in the long run is merely a matter of technology does not throw much light on the spectacular growth performance of Asia since the 1960s.

  • The new view

    • that long-run growth depends on saving, efficiency, and depreciation is more illuminating.

    • Besides, it’s not really new, because Adam Smith knew this (1776).


Endogenous growth in the harrod domar model

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.


  • Endogenous growth in the harrod domar model

    A Simple Model of Endogenous Growth

    • Implication:

    • g = sE - 

    • Rate of economic growth equals

    • Saving rate

      • times

  • Efficiency (i.e., the output/capital ratio)

    • minus

  • Depreciation


  • Endogenous growth in the harrod domar model

    Endogenous Growth in the Harrod-Domar Model

    • You may recognize the endogenous growth model as a reinterpretation of the Harrod-Domar model

      • where growth depends on

      • A. the saving rate

      • B. the capital/output ratio

      • C. the depreciation rate


    Endogenous growth in the harrod domar model

    Sources of Endogenous Growth I

    • 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 spurs saving, which is good for growth.


    Endogenous growth in the harrod domar model

    Sources of Endogenous Growth I

    Income

    per capita

    East Asia

    400

    High saving rates

    300

    200

    OECD

    Medium saving rates

    Africa

    100

    Low saving rates

    1965

    1990


    Endogenous growth in the harrod domar model

    Growth and Investment, 1965-98

    109 countries

    Each ten percentage point increase in the investment ratio is associated with an increase in per capita growth by 1½% per year.

    Botswana

    1½%

    10%


    Endogenous growth in the harrod domar model

    33 sub-Saharan African countries

    Growth and Investment, 1965-98

    Each ten percentage point increase in the investment ratio is associated with an increase in per capita growth by 1½% per year.


    Endogenous growth in the harrod domar model

    Sources of Endogenous Growth II

    • Depreciation

      • The effect of depreciation on growth is related to that of saving and investment on growth.

      • Unprofitable investment in the past reduces the quality of capital and makes it depreciate more rapidly, necessitating more replacement investment to make up for economic and physical 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.


    Investment quantity and quality

    Investment: Quantity and Quality

    • Compare Botswana and Tanzania:

      • In Botswana, the share of State-Owned Enterprises in total investment fell from 16% in 1985-90 to 12% in 1990-97.

      • In Tanzania, the SOE share of investment fell from 46% in 1985-90 to 23% in 1990-97.

    • This is probably a good sign.

      • Privatization helps improve investment.


    Investment quantity and quality1

    Investment: Quantity and Quality

    • Investment quality, however, is not only a question of public vs. private enterprise.

    • Sound banking is also important.

      • It takes sound commercial banks, usually privately owned banks motivated by profit rather than by political concerns, to channel household savings into high-quality investment.


    Endogenous growth in the harrod domar model

    Sources of Endogenous Growth III

    • Efficiency

      • Also fits real world experience quite well

        • Technical progress is good for growth because it allows us to squeeze more output out of given inputs.

        • And 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.


    Endogenous growth in the harrod domar model

    Sources of Endogenous Growth III

    • Five sources of increased efficiency

      • Liberalization of prices and trade increases efficiency, which is good for growth.

      • Stabilization reduces the inefficiency associated with inflation, which is good for growth.

      • Privatization reduces the inefficiency associated with state-owned enterprises, which …

      • Education makes the labor force more efficient.

      • Technological progress also enhances efficiency.

      • The possibilities are virtually endless!


    Endogenous growth in the harrod domar model

    Sources of Endogenous Growth III

    • 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 R&D 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.


    Endogenous growth in the harrod domar model

    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

    • Foster efficiency

      1. Liberal price and trade regimes

      2. Low inflation

      3. Strong private sector

      4. More and better education

      5. Limited, or well managed, natural resources

    Recap


    Endogenous growth in the harrod domar model

    1

    Liberalization and Economic Growth

    • Liberalization of prices means that markets, not bureaucrats, are allowed to set prices.

      • Mixed market economy is more efficient than central planning.

        • Compare former Soviet Union with the US and Europe

    • Liberalization of trade allows specialization according to comparative advantage.

      • Free trade is more efficient than self-sufficiency.

        • North Korea and Cuba vs. Hong Kong and Singapore

    • Applies to trade in goods, services, capital.


    Endogenous growth in the harrod domar model

    Growth and Trade, 1965-98

    105 countries

    Botswana

    China

    Singapore

    Korea

    Hong Kong

    Each 50 percentage point increase in the trade ratio is associated with an increase in per capita growth by almost 1% per year.

    United Arab Emirates

    NB: UAE, Hong Kong, and Singapore.


    Endogenous growth in the harrod domar model

    32 sub-Saharan African countries

    Growth and Trade, 1965-98

    Each 20 percentage point increase in the trade ratio is associated with an increase in per capita growth by 1% per year.


    Endogenous growth in the harrod domar model

    Growth and Foreign Direct Investment,1965-98

    100 countries

    Each three percentage point increase in the FDI ratio is associated with an increase in per capita growth by almost 1% per year.

    Singapore

    Botswana

    Qualification: Relationship rests on Botswana and Singapore.


    Endogenous growth in the harrod domar model

    31 sub-Saharan African countries

    Growth and Foreign Direct Investment, 1965-98

    Each one percentage point increase in the FDI ratio is associated with an increase in per capita growth by almost 1% per year.

    Botswana

    Relationship depends on the inclusion of Botswana.


    Endogenous growth in the harrod domar model

    2

    Stabilization and Economic Growth

    • Stabilization of prices means that distortions associated with inflation are reduced.

      • Inflation distorts the choice between real and financial capital by punishing money holdings, and thus creates inefficiency in production.

      • Inflation thus involves a tax, the inflation tax.

        • An inefficient tax compared with most other taxes.

      • Inflation also creates uncertainly which tends to discourage trade and investment.

      • Inflation also tends to result in overvaluation of currency, thus hurting exports and growth.


    Endogenous growth in the harrod domar model

    3

    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.

      • Private enterprise is generally more efficient than state-owned enterprises.


    Endogenous growth in the harrod domar model

    Same Story Time and Again

    • Free trade is good for growth

      • Reduces the inefficiency that results from restrictions on trade

    • Price stability is good for growth

      • Reduces inefficiency resulting from inflation

    • Privatization is good for growth

      • Reduces inefficiency resulting from SOEs

    • Education is good for growth

      • Reduces the inefficiency that results from inadequate education


    Endogenous growth in the harrod domar model

    Same Story Time and Again

    • Can describe this by simple arithmetic

    • The efficiency gain from eliminating an economic distortion (trade restrictions, inflation, unnecessary state intervention, insufficient education) is directly proportional to the square of the distortion:

    • E = mc2

      • E stands for efficiency gain, m is a multiplicative constant, and c is the distortion


    Endogenous growth in the harrod domar model

    E = mc2

    If the distortion is substantial (severe trade restrictions, high inflation, big SOE sector, poor education), then reducing or eliminating the distortion can increase efficiency and growth a great deal.

    We can see this by plugging appropriate numbers into the formula and also by econometric research, where the theory is compared with experience (i.e., economic statistics).


    Endogenous growth in the harrod domar model

    4

    Education and Economic Growth

    • Education means a better trained and hence more efficient work force.

      • Need to provide primary and secondary education to all, especially females

      • Need to provide tertiary education to a greatly increased number of people

      • Need increased public commitment to education

      • This requires both increased public expenditure on education and probably also increased scope for private sector involvement in education.


    Endogenous growth in the harrod domar model

    Growth and Education, 1965-98

    86 countries

    An increase in secondary-school enrolment by 40% of each cohort goes along with an increase in per capita growth by 1% per year.


    Endogenous growth in the harrod domar model

    33 sub-Saharan African countries

    Growth and Education, 1965-98

    Each two percentage point increase in the education expenditure ratio is associated with an increase in per capita growth by about 1% per year.


    Natural resources and economic growth

    5

    Natural Resources and Economic Growth

    • Natural resources, if not well managed, may turn out to be, at best, a mixed blessing.

    • Three possible channels

      • Education

      • Dutch disease

      • Rent seeking

        What is the evidence?


    Endogenous growth in the harrod domar model

    Natural Resources and Economic Growth 1965-98

    86 countries

    A ten percentage point increase in the natural capital share goes along with a decrease in per capita growth by nearly 1% per year.

    Abundant natural resources, if not well managed, appear harmful to growth.


    Endogenous growth in the harrod domar model

    Natural Resources and Education

    90 countries

    An 18 percentage point increase in the natural capital share is associated with a decrease in public expenditure on education by 1% of GNP.

    Abundant natural resources appear to crowd out human resources.


    Endogenous growth in the harrod domar model

    Natural Resources and Corruption

    45 countries

    Abundant natural resources appear to go along with corruption.


    What is the upshot

    What Is the Upshot?

    • Economic growth responds to public policy.

    • In particular, by encouraging

      • saving and investment of high quality

      • foreign trade and investment

      • education

    • ... the government can help foster rapid economic growth.


    Sir arthur lewis got it right

    Sir Arthur Lewis Got It Right

    Since the second world war it has become quite clear that rapid economic growth is available to those countries with adequate natural resources which make the effort to achieve it.

    W. ARTHUR LEWIS

    (1968)


    What else

    What Else?

    • These lessons are borne out by experience from around the world.

    • Additional lessons:

      • Too much inflation hurts saving, investment, and trade — and thereby also growth.

      • Too much SOE activity hurts the quality of investment and education — and growth.

      • Too much agriculture and, more generally, natural resource dependence, if not well managed, hurts education and trade — and thereby also growth.

      • Too rapid population growth also tends to impede economic growth.


    Reservations

    Reservations

    • Even so, the question of rapid growth is, of course, a bit more complicated.

    • We also need to address a host of political, social,and cultural questions as well as questions of natural conditions, climate, and public health — which would take us too far afield.

    • But the main point remains:

      • To grow or not to grow is in large measure a matter of choice.

      • Many of the constraints on growth are man-made, and can be removed.


    In conclusion it can be done

    In Conclusion: It Can Be Done

    Economic growth makes a difference, especially in poor countries.

    A question literally of life and death

    And not only in poor countries,

    • for there is poverty amid plenty in rich countries

      Recall the main point of Gunnar Myrdal’s Asian Drama (1968):

    • It was that the Asian economies were incapable of rapid economic growth!

      New growth theory suggests that similar claims about Africa will also be proven wrong.


    In conclusion it can be done1

    In Conclusion: It Can Be Done

    There has been much progress in economic policy and performance around the world in the 1990s.

    • Growth-friendly reforms have been widely embraced

      • among ordinary people and politicians across the political spectrum, not only in Asia, but also, increasingly, in other parts of the world, including Africa.

        Yet, various special interest groups try to resist.


    In conclusion it can be done2

    In Conclusion: It Can Be Done

    These slides can be viewed on my website:

    www.hi.is/~gylfason/copenhagen.ppt

    ‘Reformers have the idea that change can be achieved by brute sanity.’

    The End

    George Bernard Shaw

    To grow or not to grow is in large measure a matter of choice.


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