chapter four the importance of being efficient chapter 4 asks whether the poor countries are...

Chapter FourChapter Four

The Importance of Being EfficientThe Importance of Being EfficientThe Importance of Being EfficientThe Importance of Being Efficient

Chapter 4Chapter 4

Asks whether the poor countries are Asks whether the poor countries are catching up with the richcatching up with the rich

Discusses five major determinants of Discusses five major determinants of growth, besides saving and investmentgrowth, besides saving and investmentLiberalization, stabilization, privatization, Liberalization, stabilization, privatization,

education, and natural resourceseducation, and natural resources

Reviews recent empirical evidenceReviews recent empirical evidenceDoes growth respond to economic policy? Does growth respond to economic policy?

Outline

Yes!Yes!

The Importance of Being Efficient

There are only two qualities in the world: There are only two qualities in the world: efficiency and inefficiency, and two sorts of efficiency and inefficiency, and two sorts of people: the efficient and the inefficient.people: the efficient and the inefficient.

There are only two qualities in the world: There are only two qualities in the world: efficiency and inefficiency, and two sorts of efficiency and inefficiency, and two sorts of people: the efficient and the inefficient.people: the efficient and the inefficient.

A people among whom wealth is well A people among whom wealth is well distributed, and who have high ambitions, distributed, and who have high ambitions, are likely to accumulate a great deal of are likely to accumulate a great deal of public property.public property.

A people among whom wealth is well A people among whom wealth is well distributed, and who have high ambitions, distributed, and who have high ambitions, are likely to accumulate a great deal of are likely to accumulate a great deal of public property.public property.

GEORGE BERNARD SHAWGEORGE BERNARD SHAWGEORGE BERNARD SHAWGEORGE BERNARD SHAW

ALFRED MARSHALLALFRED MARSHALLALFRED MARSHALLALFRED MARSHALL


Economic growth is importantEconomic growth is importantEconomic growth is importantEconomic growth is important povertypovertypovertypoverty

unemploymentunemploymentunemploymentunemployment

homelessnesshomelessnesshomelessnesshomelessness

The Limits to GrowthThe Limits to GrowthThe Limits to GrowthThe Limits to Growth

Continued growth was considered well-nigh impossibleContinued growth was considered well-nigh impossibleContinued growth was considered well-nigh impossibleContinued growth was considered well-nigh impossibleEarth’s natural resources like oil and minerals are finiteEarth’s natural resources like oil and minerals are finiteEarth’s natural resources like oil and minerals are finiteEarth’s natural resources like oil and minerals are finite

Desirability of growth was even questionedDesirability of growth was even questionedDesirability of growth was even questionedDesirability of growth was even questioned

Output per head in the world Output per head in the world economy as a whole has economy as a whole has increased by almost a half increased by almost a half since 1970since 1970

Output per head in the world Output per head in the world economy as a whole has economy as a whole has increased by almost a half increased by almost a half since 1970since 1970

Pessimism was Pessimism was not confined to not confined to natural scientistsnatural scientists

Pessimism was Pessimism was not confined to not confined to natural scientistsnatural scientists


GDP is not a perfect measure of GDP is not a perfect measure of national economic output and national economic output and welfarewelfare

GDP is not a perfect measure of GDP is not a perfect measure of national economic output and national economic output and welfarewelfareEven when it is adjusted in keeping with purchasing powerEven when it is adjusted in keeping with purchasing powerEven when it is adjusted in keeping with purchasing powerEven when it is adjusted in keeping with purchasing power

… … reflects output without regard to inputsreflects output without regard to inputs… … reflects output without regard to inputsreflects output without regard to inputs

… … some nations work longer hours than otherssome nations work longer hours than others… … some nations work longer hours than otherssome nations work longer hours than others… … some run down their natural resourcessome run down their natural resources… … some run down their natural resourcessome run down their natural resources

… … does not reflect home productiondoes not reflect home production… … does not reflect home productiondoes not reflect home production

AbsoluteAbsolute economic growth vs. economic growth vs. relativerelative economic growth economic growthAbsoluteAbsolute economic growth vs. economic growth vs. relativerelative economic growth economic growth

Examples of Sweden, Ireland, and East AsiaExamples of Sweden, Ireland, and East AsiaExamples of Sweden, Ireland, and East AsiaExamples of Sweden, Ireland, and East Asia


Now we must ask:Now we must ask:Now we must ask:Now we must ask:

Do poor countries grow more rapidly than rich?Do poor countries grow more rapidly than rich?Do poor countries grow more rapidly than rich?Do poor countries grow more rapidly than rich?

Will the poor ultimately catch up?Will the poor ultimately catch up?Will the poor ultimately catch up?Will the poor ultimately catch up?

Or will the income gap separating them Or will the income gap separating them from the rich countries perhaps grow wider from the rich countries perhaps grow wider over time?over time?

Or will the income gap separating them Or will the income gap separating them from the rich countries perhaps grow wider from the rich countries perhaps grow wider over time?over time?

Growing together? Or growing apart?

These questions did not arise in the 1960s or These questions did not arise in the 1960s or 1970s1970sThese questions did not arise in the 1960s or These questions did not arise in the 1960s or 1970s1970sTwo main reasonsTwo main reasonsTwo main reasonsTwo main reasons

11.. Long-run economic growth was deemed Long-run economic growth was deemed exogenousexogenous11.. Long-run economic growth was deemed Long-run economic growth was deemed exogenousexogenousThe idea that it might take a long time to reach The idea that it might take a long time to reach

long-run equilibrium, where growth is long-run equilibrium, where growth is exogenousexogenous, , had not yet been born, let alone the idea that had not yet been born, let alone the idea that economic growth in the long run might be economic growth in the long run might be endogenousendogenous after all after all

The idea that it might take a long time to reach The idea that it might take a long time to reach long-run equilibrium, where growth is long-run equilibrium, where growth is exogenousexogenous, , had not yet been born, let alone the idea that had not yet been born, let alone the idea that economic growth in the long run might be economic growth in the long run might be endogenousendogenous after all after all

2.2. The information necessary to address the The information necessary to address the question of question of convergence vs. divergenceconvergence vs. divergence was was not yet at handnot yet at hand

2.2. The information necessary to address the The information necessary to address the question of question of convergence vs. divergenceconvergence vs. divergence was was not yet at handnot yet at handDifficulty in getting reliable statistical estimates Difficulty in getting reliable statistical estimates

of macroeconomic relationshipsof macroeconomic relationshipsDifficulty in getting reliable statistical estimates Difficulty in getting reliable statistical estimates of macroeconomic relationshipsof macroeconomic relationships


Changed in the 1980sChanged in the 1980sChanged in the 1980sChanged in the 1980s

International organizations International organizations had amassed a had amassed a wealth of wealth of economic dataeconomic data from national from national governmentsgovernments

International organizations International organizations had amassed a had amassed a wealth of wealth of economic dataeconomic data from national from national governmentsgovernments

… … could be used for could be used for assessing economic assessing economic growth growth across countriesacross countries and and over timeover time

… … could be used for could be used for assessing economic assessing economic growth growth across countriesacross countries and and over timeover time

… … comprehensive and user-comprehensive and user-friendly set of purchasing-friendly set of purchasing-power-parity-adjusted power-parity-adjusted measures of GDPmeasures of GDP

… … comprehensive and user-comprehensive and user-friendly set of purchasing-friendly set of purchasing-power-parity-adjusted power-parity-adjusted measures of GDPmeasures of GDP

… … better basis for cross-better basis for cross-country comparisons of country comparisons of incomesincomes and and living living standardsstandards than the raw than the raw figures from the national figures from the national income accountsincome accounts

… … better basis for cross-better basis for cross-country comparisons of country comparisons of incomesincomes and and living living standardsstandards than the raw than the raw figures from the national figures from the national income accountsincome accounts

The The endogenous growth revolutionendogenous growth revolution took place just as fresh data took place just as fresh data with which to test the new theory were becoming availablewith which to test the new theory were becoming availableThe The endogenous growth revolutionendogenous growth revolution took place just as fresh data took place just as fresh data with which to test the new theory were becoming availablewith which to test the new theory were becoming available


What are the facts of the matter? What are the facts of the matter?

Does economic growth across Does economic growth across countries converge?countries converge?

What are the facts of the matter? What are the facts of the matter?

Does economic growth across Does economic growth across countries converge?countries converge?

The World The World Economy:Economy:No Convergence No Convergence

Figure 4.1Figure 4.1

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GDP per capita in 1970 (IUSD)

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China

Niger

Argentina

Norway

45°

Hong Kong

Mozambique

Mauritius

Jordan

Philippines

Suriname

Bangladesh

Barbados

Rwanda

Poland


The High-Income Countries:Convergence

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Singapore

Hong Kong

Ireland

United States

New Zealand

Iceland

Switzerland

Luxembourg

Israel

Japan

Errors of Measurement of Initial Income May Create an Illusion of Convergence

Initial incomeInitial income

CurrentincomeCurrentincome

Biased regression lineBiased regression line

A

B

45°

C

DUnbiased regression lineUnbiased regression line

E

F

GrowthGrowth

Figure 4.3Figure 4.3Figure 4.3Figure 4.3


Convergence means that the Convergence means that the regressionregressionline AB is flatter than the 45° lineline AB is flatter than the 45° line

Convergence means that the Convergence means that the regressionregressionline AB is flatter than the 45° lineline AB is flatter than the 45° line

Can be interpreted in two ways:Can be interpreted in two ways:Can be interpreted in two ways:Can be interpreted in two ways:

A.A.The rate of growth, reflected by the distance The rate of growth, reflected by the distance betweenbetweenthe two lines, declines as initial income the two lines, declines as initial income increasesincreases

A.A.The rate of growth, reflected by the distance The rate of growth, reflected by the distance betweenbetweenthe two lines, declines as initial income the two lines, declines as initial income increasesincreasesB.B. The range of current income, measured by the The range of current income, measured by the vertical distance between points A and B in the vertical distance between points A and B in the figure, is narrower than the range of initial incomes, figure, is narrower than the range of initial incomes, which is measured by the horizontal distance which is measured by the horizontal distance between A and B - i.e. the distribution of incomes between A and B - i.e. the distribution of incomes across countries is more even than beforeacross countries is more even than before

B.B. The range of current income, measured by the The range of current income, measured by the vertical distance between points A and B in the vertical distance between points A and B in the figure, is narrower than the range of initial incomes, figure, is narrower than the range of initial incomes, which is measured by the horizontal distance which is measured by the horizontal distance between A and B - i.e. the distribution of incomes between A and B - i.e. the distribution of incomes across countries is more even than beforeacross countries is more even than before


Two interpretations of convergenceTwo interpretations of convergenceTwo interpretations of convergenceTwo interpretations of convergence

I. I. ‘Beta convergence’:‘Beta convergence’: Economic growth is Economic growth is related to initial related to initial incomeincome

I. I. ‘Beta convergence’:‘Beta convergence’: Economic growth is Economic growth is related to initial related to initial incomeincome

II. II. ‘Sigma convergence’:‘Sigma convergence’: The distribution of national The distribution of national income per head becomes income per head becomes more even across more even across countries over timecountries over time

II. II. ‘Sigma convergence’:‘Sigma convergence’: The distribution of national The distribution of national income per head becomes income per head becomes more even across more even across countries over timecountries over time

Closely related but not identicalClosely related but not identicalClosely related but not identicalClosely related but not identical

The dispersion of GNP per capita across The dispersion of GNP per capita across countries may become less even over time countries may become less even over time for various reasons, even if economic for various reasons, even if economic growth is inversely related to initial income growth is inversely related to initial income per se.per se.

The dispersion of GNP per capita across The dispersion of GNP per capita across countries may become less even over time countries may become less even over time for various reasons, even if economic for various reasons, even if economic growth is inversely related to initial income growth is inversely related to initial income per se.per se.

Figure 4.4 Figure 4.4 demonstratedemonstrate

s the s the distinctiondistinction

Figure 4.4 Figure 4.4 demonstratedemonstrate

s the s the distinctiondistinction

Beta ConvergenceBeta Convergence Does Not Does Not Necessarily Generate Necessarily Generate Sigma Sigma ConvergenceConvergence

TimeTime

RichRich

Poorbeforeshock

Poorbeforeshock

Pooraftershock

Pooraftershock

Panel APanel A Panel BPanel B

TimeTime

RichIncomeper head

Incomeper head

Poor


Incomeper head

Incomeper head

The Low- and Middle-Income Countries: No Convergence

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45°

SenegalLesotho

Pakistan

Nicaragua

Korea

Saudi Arabia

Chad

Seychelles

Portugal

Turkey

Indonesia

Puerto Rico

South Africa

Figure 4.5


In sum, there seems to be some empirical In sum, there seems to be some empirical evidence of evidence of convergence among rich convergence among rich countries,countries, but not among poor countries but not among poor countries

In sum, there seems to be some empirical In sum, there seems to be some empirical evidence of evidence of convergence among rich convergence among rich countries,countries, but not among poor countries but not among poor countries

How do these findings rhyme with How do these findings rhyme with our two main theories of economic our two main theories of economic growth?growth?

Absolute vs. conditionalconvergence

Exogenous growthExogenous growthExogenous growthExogenous growth

If our data reflect output per capita in long-run If our data reflect output per capita in long-run equilibriumequilibriumIf our data reflect output per capita in long-run If our data reflect output per capita in long-run equilibriumequilibrium… … then the Solow model predicts then the Solow model predicts neither convergence nor neither convergence nor divergencedivergence

… … then the Solow model predicts then the Solow model predicts neither convergence nor neither convergence nor divergencedivergenceIn Solow’s model, long-run growth of output per In Solow’s model, long-run growth of output per capita depends solely on capita depends solely on technological progresstechnological progress, a , a wholly exogenous phenomenon from our economic wholly exogenous phenomenon from our economic point of viewpoint of view

In Solow’s model, long-run growth of output per In Solow’s model, long-run growth of output per capita depends solely on capita depends solely on technological progresstechnological progress, a , a wholly exogenous phenomenon from our economic wholly exogenous phenomenon from our economic point of viewpoint of view

If our data describe countries at different stages of If our data describe countries at different stages of their dynamic adjustment path towards the Solovian their dynamic adjustment path towards the Solovian long-run equilibrium, then the plot thickens a bit ...long-run equilibrium, then the plot thickens a bit ...

If our data describe countries at different stages of If our data describe countries at different stages of their dynamic adjustment path towards the Solovian their dynamic adjustment path towards the Solovian long-run equilibrium, then the plot thickens a bit ...long-run equilibrium, then the plot thickens a bit ...

Absolute vs. conditional convergence

Suppose that the only difference Suppose that the only difference between rich countries and poor is that between rich countries and poor is that the rich have more the rich have more capital per workercapital per worker than the poorthan the poor

Suppose that the only difference Suppose that the only difference between rich countries and poor is that between rich countries and poor is that the rich have more the rich have more capital per workercapital per worker than the poorthan the poor

Saving ratesSaving ratesSaving ratesSaving rates PopulatioPopulation growthn growthPopulatioPopulation growthn growth

TechnologicTechnological progressal progressTechnologicTechnological progressal progress

… … then they will then they will ultimately have ultimately have also the same also the same output per output per capitacapita

… … then they will then they will ultimately have ultimately have also the same also the same output per output per capitacapita

… … which means which means that the poor that the poor countries must countries must converge on the converge on the richrich

… … which means which means that the poor that the poor countries must countries must converge on the converge on the richrich

Absolute Absolute convergencconvergenc

ee

Absolute Absolute convergencconvergenc

ee

Same ...Same ...

Absolute Convergence:Absolute Convergence:Poor Countries Grow More RapidlyPoor Countries Grow More Rapidlythan the Rich Ones in the Medium Runthan the Rich Ones in the Medium Run

E

BB

AA

CC

OOCapital per workerCapital per worker

Incomeper capita

Incomeper capita

Poor country’s initial income per headPoor country’s initial income per head

Rich country’s initialRich country’s initialincome per headincome per headRich country’s initialRich country’s initialincome per headincome per head

Long-run equilibriumLong-run equilibrium

Figure Figure 4.64.6



To test the validity of the medium-term To test the validity of the medium-term dynamic implications of the Solow model for dynamic implications of the Solow model for convergenceconvergence

To test the validity of the medium-term To test the validity of the medium-term dynamic implications of the Solow model for dynamic implications of the Solow model for convergenceconvergence… … one must allow for the possibility that the rich one must allow for the possibility that the rich

andandpoor countries differ in poor countries differ in more ways than onemore ways than one

… … one must allow for the possibility that the rich one must allow for the possibility that the rich andandpoor countries differ in poor countries differ in more ways than onemore ways than one

Saving ratesSaving ratesSaving ratesSaving rates

Standards of efficiencyStandards of efficiencyStandards of efficiencyStandards of efficiency Population growth ratesPopulation growth ratesPopulation growth ratesPopulation growth rates

DepreciationDepreciationDepreciationDepreciation

Suppose we now correct for all these differences by regressing Suppose we now correct for all these differences by regressing the growth of output per capita across countries on all these the growth of output per capita across countries on all these potential determinants of growth, and then ask whether poor potential determinants of growth, and then ask whether poor countries grow more rapidly than rich countries, other things countries grow more rapidly than rich countries, other things being equal - i.e. after all these other differences have been being equal - i.e. after all these other differences have been taken into consideration. Then what?taken into consideration. Then what?

Suppose we now correct for all these differences by regressing Suppose we now correct for all these differences by regressing the growth of output per capita across countries on all these the growth of output per capita across countries on all these potential determinants of growth, and then ask whether poor potential determinants of growth, and then ask whether poor countries grow more rapidly than rich countries, other things countries grow more rapidly than rich countries, other things being equal - i.e. after all these other differences have been being equal - i.e. after all these other differences have been taken into consideration. Then what?taken into consideration. Then what?


If the answer is yesIf the answer is yes, we have , we have conditional conditional convergenceconvergence. Poor countries then converge on . Poor countries then converge on rich countries on the condition that they have rich countries on the condition that they have the same saving rate, the same efficiency, and the same saving rate, the same efficiency, and so onso on

If the answer is yesIf the answer is yes, we have , we have conditional conditional convergenceconvergence. Poor countries then converge on . Poor countries then converge on rich countries on the condition that they have rich countries on the condition that they have the same saving rate, the same efficiency, and the same saving rate, the same efficiency, and so onso onRecallRecall Figure 4.1: Figure 4.1: No evidence of No evidence of absolute convergence in the world as a absolute convergence in the world as a wholewhole

RecallRecall Figure 4.1: Figure 4.1: No evidence of No evidence of absolute convergence in the world as a absolute convergence in the world as a wholewholeSeveral empirical studies have shown that, Several empirical studies have shown that, when the necessary adjustments have been when the necessary adjustments have been made, the rate of growth of output per made, the rate of growth of output per capita is inversely related to the initial level capita is inversely related to the initial level of output per capitaof output per capita

Several empirical studies have shown that, Several empirical studies have shown that, when the necessary adjustments have been when the necessary adjustments have been made, the rate of growth of output per made, the rate of growth of output per capita is inversely related to the initial level capita is inversely related to the initial level of output per capitaof output per capita

Absolute vs. conditionalconvergenceDoes this Does this finding of finding of conditional conditional convergenceconvergence help us help us discriminate discriminate among among competing competing explanations of explanations of economic economic growth?growth?

Does this Does this finding of finding of conditional conditional convergenceconvergence help us help us discriminate discriminate among among competing competing explanations of explanations of economic economic growth?growth?

Conditional convergenceConditional convergence is is consistent with the medium-consistent with the medium-term dynamic implications of term dynamic implications of the neoclassical model, but in the neoclassical model, but in the long run, according to that the long run, according to that model, all countries bump model, all countries bump against the same ceilingagainst the same ceiling

Conditional convergenceConditional convergence is is consistent with the medium-consistent with the medium-term dynamic implications of term dynamic implications of the neoclassical model, but in the neoclassical model, but in the long run, according to that the long run, according to that model, all countries bump model, all countries bump against the same ceilingagainst the same ceiling

Counter-examples:Counter-examples:Counter-examples:Counter-examples: SingaporeSingaporeSingaporeSingapore IrelanIrelanddIrelanIrelandd

‘‘2 per cent per capita growth seems to be as 2 per cent per capita growth seems to be as good as it gets in the long run for a country that good as it gets in the long run for a country that

is already rich’is already rich’

‘‘2 per cent per capita growth seems to be as 2 per cent per capita growth seems to be as good as it gets in the long run for a country that good as it gets in the long run for a country that

is already rich’is already rich’ROBERT BARROROBERT BARROROBERT BARROROBERT BARRO

Hong KongHong KongHong KongHong Kong

Absolute vs. conditional convergenceBut even if conditional convergence is consistent But even if conditional convergence is consistent with the medium-term dynamic implications of the with the medium-term dynamic implications of the Solow modelSolow model, it is not necessarily incompatible , it is not necessarily incompatible with the theory of with the theory of endogenous growth in the long endogenous growth in the long runrun

What does the theory of endogenous growth tell What does the theory of endogenous growth tell us about the us about the relative economic growthrelative economic growth of rich and of rich and poor countries?poor countries?

Endogenous growth theoryEndogenous growth theory

Poor countries will grow faster than, and thus Poor countries will grow faster than, and thus converge on, richer countries if and only if the converge on, richer countries if and only if the poor countries either poor countries either savesave a higher proportion of a higher proportion of their incomes than the rich, are more their incomes than the rich, are more efficientefficient, or , or have less have less depreciationdepreciation

Why the Why the Saving RateSaving RateVaries Directly with Varies Directly with IncomeIncome

IncomeIncome

ConsumptionConsumption

ConsumptionfunctionConsumptionfunction

A

B

PoorPoor RichRichO



Figure 4.8

Figure 4.8

The Saving Rate Varies Directlywith Income

-0,60

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GNP per capita in 1995 (USD)

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United Arab Emirates

Albania

Angola

Singapore

Zaire

Lebanon

Denmark

Gabon

Egypt

Thailand

Mexico

Brazil

Argentina

Uganda

Absolute vs. conditional convergence

We have no basis here for believing that We have no basis here for believing that

poor countries save more and, poor countries save more and,

therefore, grow faster than rich therefore, grow faster than rich

countries. On the other hand, saving countries. On the other hand, saving

rates have increased in several rates have increased in several

developing countries in recent years in developing countries in recent years in

response to more efficient financial response to more efficient financial

intermediation and higher rates of intermediation and higher rates of

return, which conform more closely to return, which conform more closely to

the scarcity value of capital than beforethe scarcity value of capital than before

We have no basis here for believing that We have no basis here for believing that

poor countries save more and, poor countries save more and,

therefore, grow faster than rich therefore, grow faster than rich

countries. On the other hand, saving countries. On the other hand, saving

rates have increased in several rates have increased in several

developing countries in recent years in developing countries in recent years in

response to more efficient financial response to more efficient financial

intermediation and higher rates of intermediation and higher rates of

return, which conform more closely to return, which conform more closely to

the scarcity value of capital than beforethe scarcity value of capital than before

Poverty traps

A poor country may become stuck in perennial povertyA poor country may become stuck in perennial povertyA poor country may become stuck in perennial povertyA poor country may become stuck in perennial poverty

… … cannot afford to cannot afford to savesave as much of its income as as much of its income as would be necessary for its income to risewould be necessary for its income to rise… … cannot afford to cannot afford to savesave as much of its income as as much of its income as would be necessary for its income to risewould be necessary for its income to rise

… … unwilling or unable to accept the unwilling or unable to accept the reduction in reduction in consumptionconsumption in the short run that is necessary to in the short run that is necessary to increase saving enough to lay the basis for more increase saving enough to lay the basis for more rapid growth in the medium or long run, other rapid growth in the medium or long run, other things being equalthings being equal

… … unwilling or unable to accept the unwilling or unable to accept the reduction in reduction in consumptionconsumption in the short run that is necessary to in the short run that is necessary to increase saving enough to lay the basis for more increase saving enough to lay the basis for more rapid growth in the medium or long run, other rapid growth in the medium or long run, other things being equalthings being equal

This is changingThis is changingThis is changingThis is changing

Unwillingness or inability to save and invest more is Unwillingness or inability to save and invest more is not the only possible reason why countries get not the only possible reason why countries get caught in poverty traps. There are at least caught in poverty traps. There are at least three three other potentially important additional explanations other potentially important additional explanations for this ...for this ...

Unwillingness or inability to save and invest more is Unwillingness or inability to save and invest more is not the only possible reason why countries get not the only possible reason why countries get caught in poverty traps. There are at least caught in poverty traps. There are at least three three other potentially important additional explanations other potentially important additional explanations for this ...for this ...

Poverty traps: Explanations

Population growthPopulation growth

Externalities, imperfect Externalities, imperfect competition, and the possibility of competition, and the possibility of low-income-slow-growth equilibria - low-income-slow-growth equilibria - i.e. i.e. poverty trapspoverty traps

EducationEducation


… … may simply be telling us that more may simply be telling us that more rapid population growth results in less rapid population growth results in less income per head rather than the other income per head rather than the other way roundway round

Population Growth VariesInversely with Income

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Pop

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ChinaIndia

Kenya

Mexico

Saudi Arabia

SwedenUruguay

Qatar

BruneiMalawi

Macedonia

Greece

Kazakstan

Jordan

United Arab Emirates


The first twenty years: The path of The first twenty years: The path of output per capita with and without an output per capita with and without an increase in population growth from 1% increase in population growth from 1% per year to 3%per year to 3%

0

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0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Years

Before

After (Exogenous growth)

After (Endogenous growth)

Poverty traps

ExternalitiesExternalitiesExternalitiesExternalities

Imperfect competitionImperfect competitionImperfect competitionImperfect competition

Possibility of low-income-slow-growth equilibriaPossibility of low-income-slow-growth equilibriaPossibility of low-income-slow-growth equilibriaPossibility of low-income-slow-growth equilibria

No single entrepreneur wants to make the move No single entrepreneur wants to make the move from the traditional to the modern sector on his from the traditional to the modern sector on his own, for alone he would be doomed to failureown, for alone he would be doomed to failure

No single entrepreneur wants to make the move No single entrepreneur wants to make the move from the traditional to the modern sector on his from the traditional to the modern sector on his own, for alone he would be doomed to failureown, for alone he would be doomed to failure

This may be another part of the reason why many This may be another part of the reason why many poor countries have failed to poor countries have failed to industrializeindustrialize and have and have instead become mired too long in too much instead become mired too long in too much agriculture and perpetual povertyagriculture and perpetual poverty

This may be another part of the reason why many This may be another part of the reason why many poor countries have failed to poor countries have failed to industrializeindustrialize and have and have instead become mired too long in too much instead become mired too long in too much agriculture and perpetual povertyagriculture and perpetual poverty

Poverty traps

EducationEducationEducationEducation

… … just another form of investmentjust another form of investment… … just another form of investmentjust another form of investment

… … but in but in humanhuman rather than in real or financial capital rather than in real or financial capital… … but in but in humanhuman rather than in real or financial capital rather than in real or financial capital

If abject poverty restricts the accumulation of real If abject poverty restricts the accumulation of real and financial capital, it would seem likely to restrict and financial capital, it would seem likely to restrict also the accumulation of also the accumulation of human capitalhuman capital

If abject poverty restricts the accumulation of real If abject poverty restricts the accumulation of real and financial capital, it would seem likely to restrict and financial capital, it would seem likely to restrict also the accumulation of also the accumulation of human capitalhuman capital

Education depends on income and the other way round. Education depends on income and the other way round. Hence, at least one aspect of economic efficiency is less Hence, at least one aspect of economic efficiency is less favourable in poor countries than in rich countries, favourable in poor countries than in rich countries, which, like less saving, would lead us to expect poor which, like less saving, would lead us to expect poor countries to grow less rapidly than rich countries, other countries to grow less rapidly than rich countries, other things being equalthings being equal

Education depends on income and the other way round. Education depends on income and the other way round. Hence, at least one aspect of economic efficiency is less Hence, at least one aspect of economic efficiency is less favourable in poor countries than in rich countries, favourable in poor countries than in rich countries, which, like less saving, would lead us to expect poor which, like less saving, would lead us to expect poor countries to grow less rapidly than rich countries, other countries to grow less rapidly than rich countries, other things being equalthings being equal


Primary-School Enrolment Varies Directly with Income

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0,80

1,00

1,20

1,40

100 1000 10000 100000


Pri

mary

-sch

ool en

rolm

en

t in

19

93

Pri

mary

-sch

ool en

rolm

en

t in

19

93

Madagascar

MauritiusMaldives

Vietnam

Italy

PeruZimbabwe

Niger

Swaziland

Finland

Tanzania

Guinea

Togo

Slovakia

Poverty traps

But other things are not equalBut other things are not equalBut other things are not equalBut other things are not equal

Economic efficiency depends on a host of factorsEconomic efficiency depends on a host of factorsEconomic efficiency depends on a host of factorsEconomic efficiency depends on a host of factors

There is no way There is no way a prioria priori to tell how, when all is to tell how, when all is said and done, said and done, economic efficiencyeconomic efficiency varies with varies with income per capitaincome per capita

There is no way There is no way a prioria priori to tell how, when all is to tell how, when all is said and done, said and done, economic efficiencyeconomic efficiency varies with varies with income per capitaincome per capitaConsequently, there is no way either Consequently, there is no way either a prioria priori to to tell whether poor countries can be expected tell whether poor countries can be expected automatically to catch up with the rich countries automatically to catch up with the rich countries or notor not

Consequently, there is no way either Consequently, there is no way either a prioria priori to to tell whether poor countries can be expected tell whether poor countries can be expected automatically to catch up with the rich countries automatically to catch up with the rich countries or notor not‘‘Rapid economic growth is available to those Rapid economic growth is available to those countries with adequate natural resources which countries with adequate natural resources which make the effort to achieve it’make the effort to achieve it’

‘‘Rapid economic growth is available to those Rapid economic growth is available to those countries with adequate natural resources which countries with adequate natural resources which make the effort to achieve it’make the effort to achieve it’

ARTHUR LEWISARTHUR LEWIS

Poverty traps

Long and hard look at Long and hard look at economic efficiencyeconomic efficiencyLong and hard look at Long and hard look at economic efficiencyeconomic efficiency

Crucial determinant of economic Crucial determinant of economic growth, with or without convergencegrowth, with or without convergenceCrucial determinant of economic Crucial determinant of economic growth, with or without convergencegrowth, with or without convergence

Definition of efficiencyDefinition of efficiency::The amount of national The amount of national economic output that is economic output that is being produced with being produced with given inputs or, in a given inputs or, in a narrower sense, with a narrower sense, with a given stock of capital at given stock of capital at full employmentfull employment

Definition of efficiencyDefinition of efficiency::The amount of national The amount of national economic output that is economic output that is being produced with being produced with given inputs or, in a given inputs or, in a narrower sense, with a narrower sense, with a given stock of capital at given stock of capital at full employmentfull employment

Together with saving, Together with saving, efficiencyefficiency is the is the primus primus motormotor of economic of economic growth, whether it is growth, whether it is medium-term growth à medium-term growth à la Solow or long-run la Solow or long-run growth according to the growth according to the endogenous-growth endogenous-growth modelmodel

Together with saving, Together with saving, efficiencyefficiency is the is the primus primus motormotor of economic of economic growth, whether it is growth, whether it is medium-term growth à medium-term growth à la Solow or long-run la Solow or long-run growth according to the growth according to the endogenous-growth endogenous-growth modelmodelBottom line:Bottom line:

If it is good for efficiency, it is also good for If it is good for efficiency, it is also good for growthgrowth

Bottom line:Bottom line: If it is good for efficiency, it is also good for If it is good for efficiency, it is also good for

growthgrowth

Case 1: Liberalization

Foreign tradeForeign tradeForeign tradeForeign trade Qualitative efficiency-Qualitative efficiency-enhancing effects of enhancing effects of increased tradeincreased trade

Qualitative efficiency-Qualitative efficiency-enhancing effects of enhancing effects of increased tradeincreased trade

How large are How large are these effects these effects likely to be?likely to be?

How large are How large are these effects these effects likely to be?likely to be?

Quantify the links Quantify the links between trade and growth between trade and growth through efficiency, and through efficiency, and report recent report recent empirical empirical evidenceevidence

Quantify the links Quantify the links between trade and growth between trade and growth through efficiency, and through efficiency, and report recent report recent empirical empirical evidenceevidence

ReallocationReallocationReallocationReallocation

Two sectors of economic activityTwo sectors of economic activityTwo sectors of economic activityTwo sectors of economic activity traditionaltraditionaltraditionaltraditional

modernmodernmodernmodern

Liberalization Increases Economic Efficiency: The Reallocation Effect

Modern outputModern output

Traditionaloutput

Traditionaloutput

World price ratioWorld price ratio

DD

G

Domestic, distorted price ratioDomestic, distorted price ratio

F

E

A B

C

Price distortionPrice distortion

HHJJ

ImportsImports

ExportsExports

O

L

KK

MN

Q

WelfaregainWelfaregain



The larger the initial The larger the initial price distortionprice distortion resulting from the restriction on foreign resulting from the restriction on foreign tradetrade

The larger the initial The larger the initial price distortionprice distortion resulting from the restriction on foreign resulting from the restriction on foreign tradetrade

… … the more costly the distortion will be in the more costly the distortion will be in terms of total output forgone and, therefore, terms of total output forgone and, therefore, the larger will be the the larger will be the output gainoutput gain from from eliminating the distortioneliminating the distortion

… … the more costly the distortion will be in the more costly the distortion will be in terms of total output forgone and, therefore, terms of total output forgone and, therefore, the larger will be the the larger will be the output gainoutput gain from from eliminating the distortioneliminating the distortion

Three more points need to be madeThree more points need to be madeThree more points need to be madeThree more points need to be made

First:First: National output at full employment has been National output at full employment has been increasedincreased

by a change in economic policyby a change in economic policy

First:First: National output at full employment has been National output at full employment has been increasedincreased

by a change in economic policyby a change in economic policy… … by the abolition of a prohibitive tariff in this caseby the abolition of a prohibitive tariff in this case… … by the abolition of a prohibitive tariff in this caseby the abolition of a prohibitive tariff in this case

… … using the available factors of production more efficientlyusing the available factors of production more efficiently… … using the available factors of production more efficientlyusing the available factors of production more efficiently


Second:Second: Foreign trade allows consumption to differ from productionForeign trade allows consumption to differ from productionSecond:Second: Foreign trade allows consumption to differ from productionForeign trade allows consumption to differ from production… … thus enabling the country to reach thus enabling the country to reach beyond the confines of its own production beyond the confines of its own production possibilitiespossibilities

… … thus enabling the country to reach thus enabling the country to reach beyond the confines of its own production beyond the confines of its own production possibilitiespossibilities... a more efficient allocation of resources at full... a more efficient allocation of resources at fullemployment under free trade allows a country toemployment under free trade allows a country toconsume more of everything, including, in particular, consume more of everything, including, in particular, the commodity whose domestic production has the commodity whose domestic production has decreaseddecreased

... a more efficient allocation of resources at full... a more efficient allocation of resources at fullemployment under free trade allows a country toemployment under free trade allows a country toconsume more of everything, including, in particular, consume more of everything, including, in particular, the commodity whose domestic production has the commodity whose domestic production has decreaseddecreased

Third:Third: There is no presumption that the transition from There is no presumption that the transition from the the original pre-trade equilibrium at E in Figure original pre-trade equilibrium at E in Figure 4.12 to the 4.12 to the final free-trade equilibrium at F will be final free-trade equilibrium at F will be painlesspainless

Third:Third: There is no presumption that the transition from There is no presumption that the transition from the the original pre-trade equilibrium at E in Figure original pre-trade equilibrium at E in Figure 4.12 to the 4.12 to the final free-trade equilibrium at F will be final free-trade equilibrium at F will be painlesspainless

Because Because liberalizationliberalization increases economic increases economic efficiency, it will also boost efficiency, it will also boost economic growtheconomic growthBecause Because liberalizationliberalization increases economic increases economic efficiency, it will also boost efficiency, it will also boost economic growtheconomic growth

OutputOutput

Timet1 t2

E

F

I

K

N

Q

The Path of Output Following Economic Liberalization is Shaped Like a Sickle

MOO

AA

BB



ReorganizationReorganizationReorganizationReorganization

Liberalization may induce firms in the previously Liberalization may induce firms in the previously protected industry to protected industry to reorganizereorganize their production their production by by economizingeconomizing in various ways, adopting new and in various ways, adopting new and better techniques of production, and so onbetter techniques of production, and so on

Liberalization may induce firms in the previously Liberalization may induce firms in the previously protected industry to protected industry to reorganizereorganize their production their production by by economizingeconomizing in various ways, adopting new and in various ways, adopting new and better techniques of production, and so onbetter techniques of production, and so on

The example of The example of New ZealandNew ZealandThe example of The example of New ZealandNew Zealand

Empirical evidenceEmpirical evidenceEmpirical evidenceEmpirical evidence

How large are the output gains from liberalization?How large are the output gains from liberalization?How large are the output gains from liberalization?How large are the output gains from liberalization?

Let’s map the magnitude of the output gains as a Let’s map the magnitude of the output gains as a function of just two variables: the function of just two variables: the original price original price distortiondistortion and the and the share of the modern sectorshare of the modern sector at at the end of the daythe end of the day

Let’s map the magnitude of the output gains as a Let’s map the magnitude of the output gains as a function of just two variables: the function of just two variables: the original price original price distortiondistortion and the and the share of the modern sectorshare of the modern sector at at the end of the daythe end of the day

Table 4.1Table 4.1Table 4.1Table 4.1

Static output gains: the proportional once-Static output gains: the proportional once-and-for-all increase in total output resulting and-for-all increase in total output resulting from liberalization (%)from liberalization (%)

Panel A. Gains from reallocation

No gain fromreorganization

Modern-sectorshare = 0.5



100% tariff 7 10 13

200% tariff 13 18 25

300% tariff 16 25 34

400% tariff 19 29 40

Panel B. Gains from reallocation and reorganizationPanel B. Gains from reallocation and reorganization

Productivity risesby 90% of distortion




100% tariff 12 17 23

200% tariff 23 33 45

300% tariff 30 44 61

400% tariff 34 52 73


According to Table 4.1, the static According to Table 4.1, the static output gainsoutput gains from liberalization can be from liberalization can be quite largequite large

According to Table 4.1, the static According to Table 4.1, the static output gainsoutput gains from liberalization can be from liberalization can be quite largequite large

The The reallocation effectreallocation effect alone ranges alone rangesfrom 7% to 40% of outputfrom 7% to 40% of outputThe The reallocation effectreallocation effect alone ranges alone rangesfrom 7% to 40% of outputfrom 7% to 40% of output

When the When the reorganization effectreorganization effect is isadded, the total effect ranges added, the total effect ranges from 12% to 73% of outputfrom 12% to 73% of output

When the When the reorganization effectreorganization effect is isadded, the total effect ranges added, the total effect ranges from 12% to 73% of outputfrom 12% to 73% of output

Table 4.2Table 4.2

Dynamic output gains: The growth of Dynamic output gains: The growth of output increases with increased output increases with increased efficiency through liberalization (output efficiency through liberalization (output growth in %)growth in %)

Depreciationrate = 0.05

Efficiency1/4

Efficiency 1/3

Efficiency 1/2

Saving rate 0.1 -2.5 -1.7

0.0

Saving rate 0.2 0.0 1.7 5.0

Saving rate 0.3 2.5 5.0 10.0

Saving rate 0.4 5.0 8.3 15.0


The higher the saving The higher the saving rate, the larger the rate, the larger the dynamic output gaindynamic output gain resulting from a given resulting from a given increase in efficiency increase in efficiency through liberalizationthrough liberalization

The higher the saving The higher the saving rate, the larger the rate, the larger the dynamic output gaindynamic output gain resulting from a given resulting from a given increase in efficiency increase in efficiency through liberalizationthrough liberalization

These numbers These numbers indicate that indicate that liberalization can liberalization can have substantial have substantial effects on economic effects on economic growth over timegrowth over time

These numbers These numbers indicate that indicate that liberalization can liberalization can have substantial have substantial effects on economic effects on economic growth over timegrowth over time

How do these hypothetical results squareHow do these hypothetical results squarewith hard empirical evidence of the linkswith hard empirical evidence of the links

between trade and growth?between trade and growth?

How do these hypothetical results squareHow do these hypothetical results squarewith hard empirical evidence of the linkswith hard empirical evidence of the links

between trade and growth?between trade and growth?

Let us look at Figure 4.15Let us look at Figure 4.15

Increased Openness Goes Alongwith Higher Income

10

100

1000

10000

100000

-100% -50% 0% 50% 100% 150%

Openness (actual exports minus predicted exports in percent of GNP, 1994)

GN

P p

er

cap

ita in

19

95

(U

SD

)G

NP p

er

cap

ita in

19

95

(U

SD

)

SingaporeAustralia

United KingdomChile

Cape Verde

Guyana

Mongolia

Japan

MalaysiaBulgaria

Azerbaijan

Denmark

Central African Rep.

Sweden



Measure of opennessMeasure of opennessMeasure of opennessMeasure of openness

Examples of:Examples of:Examples of:Examples of: ChinaChinaChinaChina KenyaKenyaKenyaKenya ArgentinaArgentinaArgentinaArgentina ThailandThailandThailandThailand

Tendency for GNP per capita andTendency for GNP per capita andopenness to go hand in handopenness to go hand in handTendency for GNP per capita andTendency for GNP per capita andopenness to go hand in handopenness to go hand in hand

The relationship may reciprocal, that is, The relationship may reciprocal, that is, opennessopennessis good for growth and vice versais good for growth and vice versa

The relationship may reciprocal, that is, The relationship may reciprocal, that is, opennessopennessis good for growth and vice versais good for growth and vice versaThe regression line is intended to provide a rough The regression line is intended to provide a rough impression of the pattern that would emerge in the impression of the pattern that would emerge in the absence of any other influences on income per absence of any other influences on income per head and openness, or if all such influences head and openness, or if all such influences happened to cancel outhappened to cancel out

The regression line is intended to provide a rough The regression line is intended to provide a rough impression of the pattern that would emerge in the impression of the pattern that would emerge in the absence of any other influences on income per absence of any other influences on income per head and openness, or if all such influences head and openness, or if all such influences happened to cancel outhappened to cancel out


Income per head and Income per head and openness are both openness are both endogenous variables. endogenous variables. In principle, they can In principle, they can move in the same move in the same direction or in direction or in opposition directions, opposition directions, depending on the depending on the exogenous influences exogenous influences that impinge on them. that impinge on them. Economic theory Economic theory predicts that an predicts that an exogenous increase in exogenous increase in tariff protection would tariff protection would reduce both income per reduce both income per head and openness in head and openness in the long run ...the long run ...

Income per head and Income per head and openness are both openness are both endogenous variables. endogenous variables. In principle, they can In principle, they can move in the same move in the same direction or in direction or in opposition directions, opposition directions, depending on the depending on the exogenous influences exogenous influences that impinge on them. that impinge on them. Economic theory Economic theory predicts that an predicts that an exogenous increase in exogenous increase in tariff protection would tariff protection would reduce both income per reduce both income per head and openness in head and openness in the long run ...the long run ...

... thereby giving rise ... thereby giving rise to a positive to a positive relationship between relationship between income and income and openness, other openness, other things being equal. A things being equal. A simulta-neous simulta-neous increase in the saving increase in the saving rate and in tariff rate and in tariff protection, on the protection, on the other hand, might other hand, might very well yield a very well yield a different pattern, different pattern, where higher where higher incomes seemed to incomes seemed to go along with less go along with less openness. Thus openness. Thus anything is possible.anything is possible.

... thereby giving rise ... thereby giving rise to a positive to a positive relationship between relationship between income and income and openness, other openness, other things being equal. A things being equal. A simulta-neous simulta-neous increase in the saving increase in the saving rate and in tariff rate and in tariff protection, on the protection, on the other hand, might other hand, might very well yield a very well yield a different pattern, different pattern, where higher where higher incomes seemed to incomes seemed to go along with less go along with less openness. Thus openness. Thus anything is possible.anything is possible.


Relatively few econometric studies have reported Relatively few econometric studies have reported significant effects of freer trade on economic significant effects of freer trade on economic growthgrowth

Relatively few econometric studies have reported Relatively few econometric studies have reported significant effects of freer trade on economic significant effects of freer trade on economic growthgrowthDefinition of openness as ‘the fraction of years Definition of openness as ‘the fraction of years duringduringwhich the country is rated as an open economy’ which the country is rated as an open economy’ reflectsreflects

Definition of openness as ‘the fraction of years Definition of openness as ‘the fraction of years duringduringwhich the country is rated as an open economy’ which the country is rated as an open economy’ reflectsreflectsA.A. black-market foreign-exchange premia black-market foreign-exchange premiaA.A. black-market foreign-exchange premia black-market foreign-exchange premia

C.C. the scope of its export marketing board the scope of its export marketing boardC.C. the scope of its export marketing board the scope of its export marketing board

B.B. whether the country was socialist or not whether the country was socialist or notB.B. whether the country was socialist or not whether the country was socialist or not

D.D. the coverage of quotas on imports of the coverage of quotas on imports of intermediate and capital goodsintermediate and capital goodsD.D. the coverage of quotas on imports of the coverage of quotas on imports of intermediate and capital goodsintermediate and capital goods


These studies report a strong, positive effects of These studies report a strong, positive effects of openness on economic growth: the growth rate of GDP openness on economic growth: the growth rate of GDP per capita was 2½% higher in fully open economies per capita was 2½% higher in fully open economies than in completely closed ones from 1970 to 1989, than in completely closed ones from 1970 to 1989, other things being equalother things being equal

These studies report a strong, positive effects of These studies report a strong, positive effects of openness on economic growth: the growth rate of GDP openness on economic growth: the growth rate of GDP per capita was 2½% higher in fully open economies per capita was 2½% higher in fully open economies than in completely closed ones from 1970 to 1989, than in completely closed ones from 1970 to 1989, other things being equalother things being equal

A few others have also reported similar results for A few others have also reported similar results for developing countries, that is, that economic growth is developing countries, that is, that economic growth is related to measures of outward orientation, price related to measures of outward orientation, price distortions, tariffs, and other trade interventions: distortions, tariffs, and other trade interventions: more more opennessopenness and and less distortionsless distortions mean mean more growthmore growth

A few others have also reported similar results for A few others have also reported similar results for developing countries, that is, that economic growth is developing countries, that is, that economic growth is related to measures of outward orientation, price related to measures of outward orientation, price distortions, tariffs, and other trade interventions: distortions, tariffs, and other trade interventions: more more opennessopenness and and less distortionsless distortions mean mean more growthmore growth

As always, though, the benefits are probably mutual, As always, though, the benefits are probably mutual, that is, foreign trade and investment are good for growth that is, foreign trade and investment are good for growth and vice versaand vice versa

As always, though, the benefits are probably mutual, As always, though, the benefits are probably mutual, that is, foreign trade and investment are good for growth that is, foreign trade and investment are good for growth and vice versaand vice versa

More Foreign Investment Goes Along with Higher Income

10

100

1000

10000

-0,05 0,00 0,05 0,10 0,15

Foreign direct investment 1970-1995 (share of GNP)

GN

P p

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cap

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19

95

(U

SD

)G

NP p

er

cap

ita in

19

95

(U

SD

)

Madagascar

Nigeria

Ghana

Thailand BotswanaMauritius

St. Kitts and Nevis

Yemen

Slovenia

Figure 4.16


Tariff distortions reduce efficiencyTariff distortions reduce efficiencyand economic growthand economic growthTariff distortions reduce efficiencyTariff distortions reduce efficiencyand economic growthand economic growth

International tradeInternational tradeInternational tradeInternational trade Public financePublic financePublic financePublic finance

Domestic tax distortionsDomestic tax distortionsDomestic tax distortionsDomestic tax distortions

Efficiency lossesEfficiency lossesEfficiency lossesEfficiency losses … … bound to impedebound to impedeeconomic growtheconomic growth

… … bound to impedebound to impedeeconomic growtheconomic growth

The The welfare gainwelfare gain from removing a tax from removing a tax distortion is proportional to the square of distortion is proportional to the square of the initial distortion, a well-known result in the initial distortion, a well-known result in welfare economicswelfare economics

The The welfare gainwelfare gain from removing a tax from removing a tax distortion is proportional to the square of distortion is proportional to the square of the initial distortion, a well-known result in the initial distortion, a well-known result in welfare economicswelfare economics

Case 2: Stabilization

We can approach We can approach inflationinflation in much in much thethesame way as trade restrictionssame way as trade restrictions

We can approach We can approach inflationinflation in much in much thethesame way as trade restrictionssame way as trade restrictions… … also creates also creates economiceconomic distortionsdistortions, at least in , at least in productionproduction… … also creates also creates economiceconomic distortionsdistortions, at least in , at least in productionproduction

Two types of capitalTwo types of capitalTwo types of capitalTwo types of capital

Real capitalReal capitalReal capitalReal capital Financial capitalFinancial capitalFinancial capitalFinancial capital

Inflation tends to distort the use of inputsInflation tends to distort the use of inputsInflation tends to distort the use of inputsInflation tends to distort the use of inputs

… … creates inefficiency, which impedes economic growthcreates inefficiency, which impedes economic growth… … creates inefficiency, which impedes economic growthcreates inefficiency, which impedes economic growth

Stabilization Increases Economic Efficiency

Financial capitalFinancial capital

Realcapital

Realcapital

Undistorted price ratioUndistorted price ratio

B

G

F

EE

A

Inflation Inflation distortiondistortionInflation Inflation distortiondistortion

45°

Output afterOutput after

Output beforeOutput before

Distorted price ratioDistorted price ratio

CC

DD

H

O



Suppose the government now eliminates inflationSuppose the government now eliminates inflationSuppose the government now eliminates inflationSuppose the government now eliminates inflation

Virtually the same story as theVirtually the same story as theearlier one about liberalizationearlier one about liberalizationVirtually the same story as theVirtually the same story as theearlier one about liberalizationearlier one about liberalization

The output gain from The output gain from economic stabilizationeconomic stabilization, which is , which is measured in units of financial capital by the bold measured in units of financial capital by the bold segment AB on the horizontal axis, is directly segment AB on the horizontal axis, is directly proportional to the square of the proportional to the square of the inflation distortioninflation distortion, just , just as in the case of the as in the case of the trade distortiontrade distortion

The output gain from The output gain from economic stabilizationeconomic stabilization, which is , which is measured in units of financial capital by the bold measured in units of financial capital by the bold segment AB on the horizontal axis, is directly segment AB on the horizontal axis, is directly proportional to the square of the proportional to the square of the inflation distortioninflation distortion, just , just as in the case of the as in the case of the trade distortiontrade distortion

Take a look at Figure 4.17Take a look at Figure 4.17Take a look at Figure 4.17Take a look at Figure 4.17

And so, by increasing the amount of output produced by And so, by increasing the amount of output produced by a given bundle of inputs, represented by the original a given bundle of inputs, represented by the original equilibrium point E in Figure 4.17, equilibrium point E in Figure 4.17, stabilizationstabilization increases increases economic efficiencyeconomic efficiency and thereby also and thereby also economic growtheconomic growth

And so, by increasing the amount of output produced by And so, by increasing the amount of output produced by a given bundle of inputs, represented by the original a given bundle of inputs, represented by the original equilibrium point E in Figure 4.17, equilibrium point E in Figure 4.17, stabilizationstabilization increases increases economic efficiencyeconomic efficiency and thereby also and thereby also economic growtheconomic growth


Less inflationLess inflationLess inflationLess inflation

… … less inflation tax revenue to the governmentless inflation tax revenue to the government… … less inflation tax revenue to the governmentless inflation tax revenue to the government

If the revenue shortfall is met by cuts in wasteful spendingIf the revenue shortfall is met by cuts in wasteful spendingIf the revenue shortfall is met by cuts in wasteful spendingIf the revenue shortfall is met by cuts in wasteful spending

… … the the efficiency gainsefficiency gains from stabilization will be greater still from stabilization will be greater still… … the the efficiency gainsefficiency gains from stabilization will be greater still from stabilization will be greater still

If it is met by increasing other taxesIf it is met by increasing other taxesIf it is met by increasing other taxesIf it is met by increasing other taxes

… … one one tax distortiontax distortion is being replaced by another is being replaced by another… … one one tax distortiontax distortion is being replaced by another is being replaced by another

The use of money as an input in production The use of money as an input in production gives rise to an inverse relationship between gives rise to an inverse relationship between the real rate of interest and the rate of the real rate of interest and the rate of inflation. Increased inflation induces firms to inflation. Increased inflation induces firms to switch from money to real capital, which switch from money to real capital, which reduces the marginal product of capital and reduces the marginal product of capital and hence also the real rate of interest. This effect hence also the real rate of interest. This effect is frequently compounded by is frequently compounded by capital market capital market imperfectionsimperfections which decrease real interest which decrease real interest further, sometimes far below zero, in the further, sometimes far below zero, in the wake of increased inflation.wake of increased inflation.

The use of money as an input in production The use of money as an input in production gives rise to an inverse relationship between gives rise to an inverse relationship between the real rate of interest and the rate of the real rate of interest and the rate of inflation. Increased inflation induces firms to inflation. Increased inflation induces firms to switch from money to real capital, which switch from money to real capital, which reduces the marginal product of capital and reduces the marginal product of capital and hence also the real rate of interest. This effect hence also the real rate of interest. This effect is frequently compounded by is frequently compounded by capital market capital market imperfectionsimperfections which decrease real interest which decrease real interest further, sometimes far below zero, in the further, sometimes far below zero, in the wake of increased inflation.wake of increased inflation.


Empirical evidenceEmpirical evidenceEmpirical evidenceEmpirical evidence

The more money is used in production and The more money is used in production and the more severe the initial inflation problem, the more severe the initial inflation problem, the larger the output gain from eliminating the larger the output gain from eliminating inflationinflation

The more money is used in production and The more money is used in production and the more severe the initial inflation problem, the more severe the initial inflation problem, the larger the output gain from eliminating the larger the output gain from eliminating inflationinflation

What is the empirical evidence What is the empirical evidence on inflation and growth?on inflation and growth?What is the empirical evidence What is the empirical evidence on inflation and growth?on inflation and growth?

The The general conclusiongeneral conclusion is that a 45-point drop in is that a 45-point drop in inflation from 50% to 5% a year increases the inflation from 50% to 5% a year increases the rate of growth of output per capita by 1-2 rate of growth of output per capita by 1-2 percentage pointspercentage points

The The general conclusiongeneral conclusion is that a 45-point drop in is that a 45-point drop in inflation from 50% to 5% a year increases the inflation from 50% to 5% a year increases the rate of growth of output per capita by 1-2 rate of growth of output per capita by 1-2 percentage pointspercentage points


Table 4.3Table 4.3

Financial/realcapital ratio

0.11


0.25


0.5


1.0

20 %inflation

0.8 1.3 1.9 2.1

50 %inflation

1.5 2.7 3.7 4.2

100 %inflation

2.2 4.0 5.6 6.2

200 %inflation

3.0 5.3 7.4 8.3

Static output gains from Static output gains from stabilization (%)stabilization (%)

Table 4.4Table 4.4Table 4.4Table 4.4

The effect on economic growth per capita of a decrease in inflation from 50% to 5% per year

Number ofcountries

Period Data Effect ongrowth (inpercent)

Fischer (1991) 73 1970-1985 Cross section 2.1

Gylfason (1991) 37 1980-1985 Cross section 2.0

Roubini and Sala-i-Martin (1992)

98 1960-1985 Cross section 2.2

De Gregorio (1993) 12 1950-1985 Cross section 0.7

Fischer (1993) 80 1960-1989 Cross section 1.8

Barro (1995) 100 1960-1990 Cross section 1.0-1.5

Gylfason andHerbertsson (1996)

145-170 1960-1992 Panel data 0.6-1.3

Barro (1997) 80-87 1960-1990 Panel data 1.3-1.8

Bruno and Easterly(1998)

97 1961-1992 Panel data 1.2

Gylfason (1999) 160 1985-1994 Cross section 2.4

Inflation may have other effects as wellInflation may have other effects as wellInflation may have other effects as wellInflation may have other effects as well

… … on on consumptionconsumption and and savingsaving, for example, for example… … on on consumptionconsumption and and savingsaving, for example, for example

Experience seems to indicate that Experience seems to indicate that high inflation hurts growthhigh inflation hurts growthExperience seems to indicate that Experience seems to indicate that high inflation hurts growthhigh inflation hurts growth

… … but where the but where the thresholdthreshold between high and between high and low inflation lies in this context - at 40% per low inflation lies in this context - at 40% per year? 20%? 10%? - is not yet knownyear? 20%? 10%? - is not yet known

… … but where the but where the thresholdthreshold between high and between high and low inflation lies in this context - at 40% per low inflation lies in this context - at 40% per year? 20%? 10%? - is not yet knownyear? 20%? 10%? - is not yet known



More Inflation Goes Along with Lower Income

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0 0,1 0,2 0,3 0,4 0,5 0,6 0,7 0,8 0,9 1

Inflation distortion 1970-1995

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Argentina

BrazilMexico

Uruguay

Austria

Nicaragua

Latvia

Spain

Zambia

Ecuador

Burundi

Israel

Barbados

Sierra Leone

Simultaneous Determination of Simultaneous Determination of InflationInflation and and Economic GrowthEconomic Growth

Economic growth

InflationInflation

M

GG

E

45°

This intercept varies directly with the This intercept varies directly with the saving ratesaving rateand with autonomous and with autonomous efficiencyefficiency, , and inversely with and inversely with depreciationdepreciation

This intercept varies directly with the This intercept varies directly with the saving ratesaving rateand with autonomous and with autonomous efficiencyefficiency, , and inversely with and inversely with depreciationdepreciation

This intercept equals This intercept equals the the budget deficit/GNP budget deficit/GNP ratioratio times times velocityvelocity

This intercept equals This intercept equals the the budget deficit/GNP budget deficit/GNP ratioratio times times velocityvelocity



Inflation and Saving:Weak Connection

-0,10

0,00

0,10

0,20

0,30

0,40

0,50

0,60

0,0 0,1 0,2 0,3 0,4 0,5 0,6 0,7 0,8 0,9 1,0

Inflation distortion 1970-1995

Savin

g r

ate

19

70

-19

95

Savin

g r

ate

19

70

-19

95

Burundi

Sierra Leone NicaraguaIsrael

Barbados Uruguay

ZambiaSpain

Mexico

Ecuador

Brazil

Argentina

Austria Latvia Russia

Armenia


An Increase in the Government Budget Deficit or in Velocity Increases Inflation and Reduces Economic Growth

Economic growth

InflationInflation

M’

G

E

45°

FF

M

Why does Why does velocityvelocity increase? Inflation increase? Inflation has increased, and inflation reflects has increased, and inflation reflects the cost of holding money. People the cost of holding money. People flee from money into real estate, flee from money into real estate, foreign currency, indexed bonds, foreign currency, indexed bonds, etc., in order to protect themselves etc., in order to protect themselves against the inflation.against the inflation.

Why does Why does velocityvelocity increase? Inflation increase? Inflation has increased, and inflation reflects has increased, and inflation reflects the cost of holding money. People the cost of holding money. People flee from money into real estate, flee from money into real estate, foreign currency, indexed bonds, foreign currency, indexed bonds, etc., in order to protect themselves etc., in order to protect themselves against the inflation.against the inflation.

An example of how An example of how inflationinflation can increase of can increase of

itself, and sometimes spin itself, and sometimes spin out of controlout of control

An example of how An example of how inflationinflation can increase of can increase of

itself, and sometimes spin itself, and sometimes spin out of controlout of control



An Increase in the Saving Rate or in Autonomous Efficiency or a Decrease in Depreciation Increases Economic Growth and Reduces Inflation

Economic growthEconomic growth

InflationInflation

M

G

E

45°

G’

FF

Increased Increased efficiencyefficiency through liberalization through liberalization or other means is not only good for growth, or other means is not only good for growth, but tends to reduce inflation as well. This is but tends to reduce inflation as well. This is because liberalization boosts the supply because liberalization boosts the supply side of the economy and should be side of the economy and should be expected to stem inflation accordingly.expected to stem inflation accordingly.

Increased Increased efficiencyefficiency through liberalization through liberalization or other means is not only good for growth, or other means is not only good for growth, but tends to reduce inflation as well. This is but tends to reduce inflation as well. This is because liberalization boosts the supply because liberalization boosts the supply side of the economy and should be side of the economy and should be expected to stem inflation accordingly.expected to stem inflation accordingly.

An increase in the An increase in the saving saving raterate shifts the G line shifts shifts the G line shifts up and to the right, so that up and to the right, so that

growth increases and growth increases and inflation decreases. A inflation decreases. A

decrease in depreciation has decrease in depreciation has the same effect.the same effect.

An increase in the An increase in the saving saving raterate shifts the G line shifts shifts the G line shifts up and to the right, so that up and to the right, so that

growth increases and growth increases and inflation decreases. A inflation decreases. A

decrease in depreciation has decrease in depreciation has the same effect.the same effect.



Digression on Africa: Why is it different?Digression on Africa: Why is it different?Digression on Africa: Why is it different?Digression on Africa: Why is it different?

… … weak private sectorweak private sector… … weak private sectorweak private sector

… … excessive reliance on natural resourcesexcessive reliance on natural resources… … excessive reliance on natural resourcesexcessive reliance on natural resources

… … geographygeography… … geographygeography

… … other factors that tend to perpetuate povertyother factors that tend to perpetuate poverty… … other factors that tend to perpetuate povertyother factors that tend to perpetuate poverty

Countries of Sub-Saharan AfricaCountries of Sub-Saharan AfricaCountries of Sub-Saharan AfricaCountries of Sub-Saharan Africa

… … characterized by high inflation and slow growthcharacterized by high inflation and slow growth… … characterized by high inflation and slow growthcharacterized by high inflation and slow growth


Why has Africa been so inflation-prone?Why has Africa been so inflation-prone?Why has Africa been so inflation-prone?Why has Africa been so inflation-prone?

… … immature financial marketsimmature financial markets… … immature financial marketsimmature financial markets

… … which have biased the financing of which have biased the financing of fiscal deficits towards printing money rather fiscal deficits towards printing money rather than issuing bonds than issuing bonds

… … which have biased the financing of which have biased the financing of fiscal deficits towards printing money rather fiscal deficits towards printing money rather than issuing bonds than issuing bonds ... ... fragile bankingfragile banking... ... fragile bankingfragile banking

Sub-Saharan African economies are Sub-Saharan African economies are more closedmore closed than the world economy than the world economy at largeat large

Sub-Saharan African economies are Sub-Saharan African economies are more closedmore closed than the world economy than the world economy at largeat large

… … less less opennessopenness means less economic means less economic growth and more inflation, other things growth and more inflation, other things being equalbeing equal

… … less less opennessopenness means less economic means less economic growth and more inflation, other things growth and more inflation, other things being equalbeing equal

It is not necessarily inflation in itself, It is not necessarily inflation in itself, through its tendency to distort firms’ through its tendency to distort firms’ choices between choices between realreal and and financial financial capitalcapital and households’ choices between and households’ choices between consumption and saving, that impedes consumption and saving, that impedes economic efficiency and growth economic efficiency and growth

It is not necessarily inflation in itself, It is not necessarily inflation in itself, through its tendency to distort firms’ through its tendency to distort firms’ choices between choices between realreal and and financial financial capitalcapital and households’ choices between and households’ choices between consumption and saving, that impedes consumption and saving, that impedes economic efficiency and growth economic efficiency and growth Rather, or simultaneously, perhaps, it Rather, or simultaneously, perhaps, it could be that inflation is a could be that inflation is a commoncommon denominatordenominator for for imperfectimperfect institutionsinstitutions, , unsoundunsound policiespolicies, and , and other factors that together help other factors that together help undermine economic efficiency and undermine economic efficiency and growthgrowth

Rather, or simultaneously, perhaps, it Rather, or simultaneously, perhaps, it could be that inflation is a could be that inflation is a commoncommon denominatordenominator for for imperfectimperfect institutionsinstitutions, , unsoundunsound policiespolicies, and , and other factors that together help other factors that together help undermine economic efficiency and undermine economic efficiency and growthgrowth


Case 3: Privatization

ReallocationReallocationReallocationReallocation

Output is produced in two waysOutput is produced in two waysOutput is produced in two waysOutput is produced in two ways Private sectorPrivate sectorPrivate sectorPrivate sector

Public sectorPublic sectorPublic sectorPublic sectorPrivate and public output Private and public output differs in qualitydiffers in qualityPrivate and public output Private and public output differs in qualitydiffers in quality

ReorganizationReorganizationReorganizationReorganization

NumbersNumbersNumbersNumbers How large are the How large are the efficiency gains from efficiency gains from privatization?privatization?

How large are the How large are the efficiency gains from efficiency gains from privatization?privatization?

Privatization Increases Economic Efficiency: The Reallocation Effect

Private outputPrivate output

PublicoutputPublicoutput


DD

G


FF

EE

A B

N

Price andqualitydistortion

Price andqualitydistortion

HH

O

JJ

K45°


Privatization Increases Economic Efficiency: The Reorganization Effect

Private outputPrivate output

PublicoutputPublicoutput


DD

G


FF

EE

A B

Price andquality distortion

Price andquality distortion

O

LL

M

C

45°


Table 4.5Table 4.5

Static output gains: the proportional Static output gains: the proportional once-and-for-all increase in total output once-and-for-all increase in total output resulting from privatization (%)resulting from privatization (%)

Panel A. Gains from reallocationPanel A. Gains from reallocation

No gain fromreorganization

Private-sectorshare = 0.5



100% differential 7 10 13



400 % differential 19 29 40

Panel B. Gains from reallocation and reorganizationPanel B. Gains from reallocation and reorganization

Productivity rises by90% of differential









More State Enterprise Goes Along with Less Income

100

1000

10000

0,00 0,10 0,20 0,30 0,40 0,50 0,60 0,70 0,80

Share of state-owned enterprises in employment 1970-1995

GN

P p

er

cap

ita in

19

95

(U

SD

)G

NP p

er

cap

ita in

19

95

(U

SD

)

Madagascar

Mauritius

Korea

Grenada

Colombia

GhanaBenin

Trinidad and Tobago

Sri Lanka

Mali

Gabon

Tunisia

Bolivia

Guinea

Case 3: Privatization

Private vs. publicPrivate vs. public ownership of the ownership of the means of production is one thingmeans of production is one thingPrivate vs. publicPrivate vs. public ownership of the ownership of the means of production is one thingmeans of production is one thing

… … and theand the sizesize of the public sector is anotherof the public sector is another… … and theand the sizesize of the public sector is anotherof the public sector is another

In general, it is not possible to state thatIn general, it is not possible to state thatsmall governmentsmall government is good for growth,is good for growth,neither in theory nor practiceneither in theory nor practice

In general, it is not possible to state thatIn general, it is not possible to state thatsmall governmentsmall government is good for growth,is good for growth,neither in theory nor practiceneither in theory nor practice

Tax burden and economic efficiencyTax burden and economic efficiencyTax burden and economic efficiencyTax burden and economic efficiency The exampleThe exampleofof Sweden SwedenThe exampleThe exampleofof Sweden Sweden

What does the government do with What does the government do with the tax revenue it raises?the tax revenue it raises?What does the government do with What does the government do with the tax revenue it raises?the tax revenue it raises?

Case 4: Education,health, and distribution

The case for a close connection The case for a close connection between between educationeducation and and economic economic growthgrowth

The case for a close connection The case for a close connection between between educationeducation and and economic economic growthgrowth…… clear already to Adam Smith and his followersclear already to Adam Smith and his followers…… clear already to Adam Smith and his followersclear already to Adam Smith and his followers

… … to Mill, this was an obviousto Mill, this was an obviouseconomic and social necessityeconomic and social necessity

… … to Mill, this was an obviousto Mill, this was an obviouseconomic and social necessityeconomic and social necessity

Since the early 1990s, numerous empirical Since the early 1990s, numerous empirical studies have sought to identify the studies have sought to identify the major major determinantsdeterminants of economic growth based on of economic growth based on an econometric scrutiny of the new an econometric scrutiny of the new international data banks that became international data banks that became available in the late 1980savailable in the late 1980s

Since the early 1990s, numerous empirical Since the early 1990s, numerous empirical studies have sought to identify the studies have sought to identify the major major determinantsdeterminants of economic growth based on of economic growth based on an econometric scrutiny of the new an econometric scrutiny of the new international data banks that became international data banks that became available in the late 1980savailable in the late 1980s

While many variables have been found to affect While many variables have been found to affect growth significantly in few studies, and the list growth significantly in few studies, and the list is quite long, only a few variables have been is quite long, only a few variables have been confirmed, in study after study, to be confirmed, in study after study, to be economically and statistically significant and economically and statistically significant and robust determinants of growthrobust determinants of growth

While many variables have been found to affect While many variables have been found to affect growth significantly in few studies, and the list growth significantly in few studies, and the list is quite long, only a few variables have been is quite long, only a few variables have been confirmed, in study after study, to be confirmed, in study after study, to be economically and statistically significant and economically and statistically significant and robust determinants of growthrobust determinants of growth

The problem is this:The problem is this:

Because economic efficiency is Because economic efficiency is unobservableunobservable, , it needs to be represented by its proximate it needs to be represented by its proximate determinants in empirical studies, and the determinants in empirical studies, and the potential determinants of efficiency are potential determinants of efficiency are virtually virtually countlesscountless

Because economic efficiency is Because economic efficiency is unobservableunobservable, , it needs to be represented by its proximate it needs to be represented by its proximate determinants in empirical studies, and the determinants in empirical studies, and the potential determinants of efficiency are potential determinants of efficiency are virtually virtually countlesscountless


To complicate matters further, several of the To complicate matters further, several of the determinantsdeterminants of efficiency are themselves of efficiency are themselves unobservableunobservable

To complicate matters further, several of the To complicate matters further, several of the determinantsdeterminants of efficiency are themselves of efficiency are themselves unobservableunobservable

for example, educationfor example, educationfor example, educationfor example, education

… … and, moreover, they tend to be closely and, moreover, they tend to be closely interrelatedinterrelated,,

so that their effects on growth can be difficult toso that their effects on growth can be difficult todistinguish by econometric methodsdistinguish by econometric methods

… … and, moreover, they tend to be closely and, moreover, they tend to be closely interrelatedinterrelated,,

so that their effects on growth can be difficult toso that their effects on growth can be difficult todistinguish by econometric methodsdistinguish by econometric methods

One can never be sure whether the One can never be sure whether the explanatory explanatory variablesvariables that are suggested as significant that are suggested as significant determinants of economic growth belong in the determinants of economic growth belong in the regression as explanations in their own right or regression as explanations in their own right or represent some other excluded factorsrepresent some other excluded factors

One can never be sure whether the One can never be sure whether the explanatory explanatory variablesvariables that are suggested as significant that are suggested as significant determinants of economic growth belong in the determinants of economic growth belong in the regression as explanations in their own right or regression as explanations in their own right or represent some other excluded factorsrepresent some other excluded factors


Various Various proxiesproxies for educational attainment for educational attainmentVarious Various proxiesproxies for educational attainment for educational attainmentYears of Years of schoolingschoolingYears of Years of schoolingschooling

School enrolment ratesSchool enrolment ratesSchool enrolment ratesSchool enrolment rates

Government expenditure on Government expenditure on educationeducationGovernment expenditure on Government expenditure on educationeducation

Imperfect proxies, because they measure output by Imperfect proxies, because they measure output by input: no account is taken of the input: no account is taken of the qualityquality of an of an educationeducation

Imperfect proxies, because they measure output by Imperfect proxies, because they measure output by input: no account is taken of the input: no account is taken of the qualityquality of an of an educationeducation

General impression conveyed by the empirical literature ...General impression conveyed by the empirical literature ...General impression conveyed by the empirical literature ...General impression conveyed by the empirical literature ...

Figure 4.11Figure 4.11 indicates a direct association indicates a direct association between GNP per capita and primary-school between GNP per capita and primary-school enrolmentenrolment

Figure 4.11Figure 4.11 indicates a direct association indicates a direct association between GNP per capita and primary-school between GNP per capita and primary-school enrolmentenrolment

The same message emerges more clearly in The same message emerges more clearly in Figure 4.26Figure 4.26The same message emerges more clearly in The same message emerges more clearly in Figure 4.26Figure 4.26



Secondary-School Enrolment Varies Directly with Income

0,00

0,20

0,40

0,60

0,80

1,00

1,20

100 1000 10000 100000


Seco

nd

ary

-sch

ool en

rolm

en

t in

S

eco

nd

ary

-sch

ool en

rolm

en

t in

1

99

31

99

3

Finland

Italy

Madagascar

Maldives

Mauritius

Niger

Peru

Slovak Rep.

Swaziland

Tanzania

TogoVietnam

Zimbabwe

The human-capital interpretation of the link between The human-capital interpretation of the link between education and economic growth calls for the education and economic growth calls for the consideration of other factors that seem likely to help consideration of other factors that seem likely to help increase or improve the increase or improve the stock of human capitalstock of human capital

The human-capital interpretation of the link between The human-capital interpretation of the link between education and economic growth calls for the education and economic growth calls for the consideration of other factors that seem likely to help consideration of other factors that seem likely to help increase or improve the increase or improve the stock of human capitalstock of human capital

Taking Taking life expectancylife expectancy as a proxy for national as a proxy for national health ...health ...Taking Taking life expectancylife expectancy as a proxy for national as a proxy for national health ...health ...... ... good healthgood health and and longevitylongevity are no doubt are no doubt

good for growth and vice versagood for growth and vice versa... ... good healthgood health and and longevitylongevity are no doubt are no doubt

good for growth and vice versagood for growth and vice versa

Equality in the Equality in the distributiondistribution of income and wealth of income and wealthEquality in the Equality in the distributiondistribution of income and wealth of income and wealth

... ... well distributed wealth is good forwell distributed wealth is good forgrowth through human capitalgrowth through human capital

... ... well distributed wealth is good forwell distributed wealth is good forgrowth through human capitalgrowth through human capital


Increased public and private commitment to Increased public and private commitment to educationeducation around the world has almost around the world has almost surely increased both equality and growthsurely increased both equality and growth

Increased public and private commitment to Increased public and private commitment to educationeducation around the world has almost around the world has almost surely increased both equality and growthsurely increased both equality and growth

In our times and earlier, gross inequality In our times and earlier, gross inequality has tended to be associated with has tended to be associated with social social and economic conflictand economic conflict, which seems , which seems likely to impede economic efficiency and likely to impede economic efficiency and growthgrowth

In our times and earlier, gross inequality In our times and earlier, gross inequality has tended to be associated with has tended to be associated with social social and economic conflictand economic conflict, which seems , which seems likely to impede economic efficiency and likely to impede economic efficiency and growthgrowth


Longer Lives Go Along with Higher Income

100

1000

10000

100000

30 35 40 45 50 55 60 65 70 75 80

Life expectancy at birth in 1995 (years)

GN

P p

er

cap

ita in

19

95

GN

P p

er

cap

ita in

19

95

China

India

Russia

Belgium

Fiji

Honduras

Hungary

Panama

Guinea-Bissau

Tanzania

Japan

AlbaniaAngola

Canada


Table 4.6Table 4.6

20/20 ratio Gini indexSweden 4.6 …Indonesia 4.7 31.7India 5.0 33.8Germany 5.8 …Denmark 7.1 …Philippines 7.4 40.7China 8.6 41.5Hong Kong 8.7 …United States 8.9 …Thailand 9.4 46.2Singapore 9.6 …United Kingdom 9.6 …Malaysia 11.7 48.4Mexico 13.5 50.3Russia 14.5 49.6Kenya 18.3 57.5Brazil 32.1 63.4

The 20/20 ratio and the Gini The 20/20 ratio and the Gini index of inequality in selected index of inequality in selected countriescountries

The economic damage wrought by governmentsThe economic damage wrought by governmentsThe economic damage wrought by governmentsThe economic damage wrought by governments

Pol Pot in CambodiaPol Pot in CambodiaPol Pot in CambodiaPol Pot in Cambodia Idi Amin in UgandaIdi Amin in UgandaIdi Amin in UgandaIdi Amin in Uganda

… … deliberate destruction of human capitaldeliberate destruction of human capital… … deliberate destruction of human capitaldeliberate destruction of human capital

The ultimate collapse of the Soviet UnionThe ultimate collapse of the Soviet UnionThe ultimate collapse of the Soviet UnionThe ultimate collapse of the Soviet Union

…inefficiencies created by a severe misallocation,

under-development, and outright destruction

of human capital

…inefficiencies created by a severe misallocation,

under-development, and outright destruction

of human capitalPolitical instabilityPolitical instability is a threat to is a threat to private property private property rightsrights, and reduces the incentives to save and , and reduces the incentives to save and investinvest

Political instabilityPolitical instability is a threat to is a threat to private property private property rightsrights, and reduces the incentives to save and , and reduces the incentives to save and investinvest


Figure 4.28Figure 4.28Income and Inequality (Gini Index)

1

10

100

1000

10000

100000

0 10 20 30 40 50 60 70

Gini index of inequality

GN

P p

er

cap

ita in

19

95

GN

P p

er

cap

ita in

19

95 Spain

India

Thailand

Russia BrazilCzech Republic

Nepal

Romania

Kenya

Slovenia

Slovakia

Tanzania

Chile

Figure 4.29 Income and Inequality (20/20 Ratio)

100

1000

10000

100000

0 5 10 15 20 25 30 35

20/20 ratio

GN

P p

er

cap

ita in

19

95

(U

SD

)G

NP p

er

cap

ita in

19

95

(U

SD

)

Brazil

Guinea-Bissau

Switzerland

Netherlands

Estonia

South Africa

Kenya

Slovakia

Lao PDRBangladesh

Norway

United Kingdom

Costa Rica

Panama

Sweden

Case 5: Natural resources and geography

Adam Smith:Adam Smith: ‘nature of its soil, climate, and situation’ ‘nature of its soil, climate, and situation’Adam Smith:Adam Smith: ‘nature of its soil, climate, and situation’ ‘nature of its soil, climate, and situation’

Jeffrey SachsJeffrey Sachs and associates: explored the and associates: explored the effects of geographic variables on economic effects of geographic variables on economic growth across countriesgrowth across countries

Jeffrey SachsJeffrey Sachs and associates: explored the and associates: explored the effects of geographic variables on economic effects of geographic variables on economic growth across countriesgrowth across countries

Natural resource abundanceNatural resource abundanceNatural resource abundanceNatural resource abundance

Ratio of coastline distance to land areaRatio of coastline distance to land areaRatio of coastline distance to land areaRatio of coastline distance to land area

Tropical or landlockedTropical or landlockedTropical or landlockedTropical or landlocked

Country’s distance from the equatorCountry’s distance from the equatorCountry’s distance from the equatorCountry’s distance from the equator

These variables make a differenceThese variables make a differenceThese variables make a differenceThese variables make a difference

The The geographical geographical variables variables increase the increase the explanatory explanatory power of the power of the growth growth regressionsregressions

The The geographical geographical variables variables increase the increase the explanatory explanatory power of the power of the growth growth regressionsregressions

Geography mattersGeography mattersGeography mattersGeography matters

Being situated in the Being situated in the tropicstropics tends to reduce tends to reduce a country’s annual rate of economic growth a country’s annual rate of economic growth per capita by more than 1 percentage point, per capita by more than 1 percentage point, other things being equalother things being equal

Being situated in the Being situated in the tropicstropics tends to reduce tends to reduce a country’s annual rate of economic growth a country’s annual rate of economic growth per capita by more than 1 percentage point, per capita by more than 1 percentage point, other things being equalother things being equal

Being Being landlockedlandlocked similarly tends to reduce similarly tends to reduce growth by more than half a percentage pointgrowth by more than half a percentage pointBeing Being landlockedlandlocked similarly tends to reduce similarly tends to reduce growth by more than half a percentage pointgrowth by more than half a percentage point

A heavy A heavy dependence on natural resourcesdependence on natural resourcesseems to be harmful to growthseems to be harmful to growthA heavy A heavy dependence on natural resourcesdependence on natural resourcesseems to be harmful to growthseems to be harmful to growth


More Primary Exports Go Along with less Income

100

1000

10000

100000

0,00 0,10 0,20 0,30 0,40 0,50 0,60 0,70 0,80 0,90 1,00

Share of primary exports in total exports in 1995

GN

P p

er

cap

ita in

19

95

(U

SD

)G

NP p

er

cap

ita in

19

95

(U

SD

)

Saudi Arabia

Venezuela

Nigeria

Norway Sweden

Mexico

Finland

Denmark Iceland

New Zealand

Cote d'Ivoire

Rwanda

Seychelles

EcuadorCongo


At least At least threethree possible possible reasonsreasonsAt least At least threethree possible possible reasonsreasons

Natural resources haveNatural resources havelong had a tendency tolong had a tendency tobe be poorly managedpoorly managed

Natural resources haveNatural resources havelong had a tendency tolong had a tendency tobe be poorly managedpoorly managed

The The Dutch diseaseDutch disease: A : A natural resource boom natural resource boom tendstendsto drive up the value of theto drive up the value of thedomestic currency in real domestic currency in real termsterms

The The Dutch diseaseDutch disease: A : A natural resource boom natural resource boom tendstendsto drive up the value of theto drive up the value of thedomestic currency in real domestic currency in real termsterms

NetherlanNetherlandsdsNetherlanNetherlandsds

NorwayNorwayNorwayNorway

IcelandIcelandIcelandIceland

OverfishingOverfishingOverfishingOverfishing

State interventionState interventionState interventionState intervention

Excessive rent-seekingExcessive rent-seekingExcessive rent-seekingExcessive rent-seeking


Natural resources vs. human resources: Natural resources vs. human resources: tendency to neglect tendency to neglect educationeducation

But this does not diminish the importance But this does not diminish the importance ofofeconomic policyeconomic policy in promoting growth in promoting growth

But this does not diminish the importance But this does not diminish the importance ofofeconomic policyeconomic policy in promoting growth in promoting growth

The importance of environmental protectionThe importance of environmental protectionThe importance of environmental protectionThe importance of environmental protection

Former Soviet UnionFormer Soviet UnionFormer Soviet UnionFormer Soviet Union

Economic growth and Economic growth and environmental protectionenvironmental protection are complementary to one another. A clean are complementary to one another. A clean environment does not preclude rapid growth. On environment does not preclude rapid growth. On the contrary, economic growth is necessary for the contrary, economic growth is necessary for countries to be able to afford a cleaner countries to be able to afford a cleaner environment.environment.

Economic growth and Economic growth and environmental protectionenvironmental protection are complementary to one another. A clean are complementary to one another. A clean environment does not preclude rapid growth. On environment does not preclude rapid growth. On the contrary, economic growth is necessary for the contrary, economic growth is necessary for countries to be able to afford a cleaner countries to be able to afford a cleaner environment.environment.


The need for a new measure of national income which The need for a new measure of national income which is consistent with sustainable management of natural is consistent with sustainable management of natural resourcesresources

The need for a new measure of national income which The need for a new measure of national income which is consistent with sustainable management of natural is consistent with sustainable management of natural resourcesresources

This is what This is what green national income accountinggreen national income accounting is all about is all aboutThis is what This is what green national income accountinggreen national income accounting is all about is all about

Attempt to correct current measures of national Attempt to correct current measures of national income flows for changes in the stock of natural income flows for changes in the stock of natural resourcesresources

Attempt to correct current measures of national Attempt to correct current measures of national income flows for changes in the stock of natural income flows for changes in the stock of natural resourcesresources

Economic growth, as it is measured by traditional methods Economic growth, as it is measured by traditional methods in the national income accounts, isn’t everything. Some in the national income accounts, isn’t everything. Some countries may register artificially inflated economic growth countries may register artificially inflated economic growth over extended periods by running down their resources and over extended periods by running down their resources and by running up debts.by running up debts.

Economic growth, as it is measured by traditional methods Economic growth, as it is measured by traditional methods in the national income accounts, isn’t everything. Some in the national income accounts, isn’t everything. Some countries may register artificially inflated economic growth countries may register artificially inflated economic growth over extended periods by running down their resources and over extended periods by running down their resources and by running up debts.by running up debts.

Such growth is not sustainableSuch growth is not sustainableSuch growth is not sustainableSuch growth is not sustainable


Other variables:Other variables:Other variables:Other variables:

Social and cultural environmentSocial and cultural environmentSocial and cultural environmentSocial and cultural environment

LanguageLanguageLanguageLanguage

Infrastructure and the quality ofInfrastructure and the quality ofgovernment institutionsgovernment institutionsInfrastructure and the quality ofInfrastructure and the quality ofgovernment institutionsgovernment institutions

The absenceThe absenceofof corruption corruptionThe absenceThe absenceofof corruption corruption

Flexible labour market institutionsFlexible labour market institutionsFlexible labour market institutionsFlexible labour market institutions

Bottom line:Bottom line:If it increases efficiency, it is good for If it increases efficiency, it is good for growthgrowth

Bottom line:Bottom line:If it increases efficiency, it is good for If it increases efficiency, it is good for growthgrowth


Summary

The question of The question of catch-upcatch-up and and convergenceconvergence

Economic growth depends on many factorsEconomic growth depends on many factors

Poverty traps:Poverty traps: Some countries seem stuckSome countries seem stuck

Even so,Even so, economic policy economic policy can foster can foster economic growth by promoting economic growth by promoting efficiencyefficiency

LiberalizationLiberalization

StabilizationStabilization

PrivatizationPrivatization

EducationEducation

Natural resourcesNatural resources

Questions for review

1.1. Do poor countries generally grow more or less Do poor countries generally grow more or less rapidly than affluent ones? Do small countries generally rapidly than affluent ones? Do small countries generally grow more or less rapidly than large ones? Does grow more or less rapidly than large ones? Does economic growth theory suggest answers to these economic growth theory suggest answers to these questions? What is the empirical evidence?questions? What is the empirical evidence?

1.1. Do poor countries generally grow more or less Do poor countries generally grow more or less rapidly than affluent ones? Do small countries generally rapidly than affluent ones? Do small countries generally grow more or less rapidly than large ones? Does grow more or less rapidly than large ones? Does economic growth theory suggest answers to these economic growth theory suggest answers to these questions? What is the empirical evidence?questions? What is the empirical evidence?

2.2. The prime minister asks you to draw up a list of policy The prime minister asks you to draw up a list of policymeasures designed to stimulate economic growth. Does itmeasures designed to stimulate economic growth. Does itmatter much whether the country in question is Jamaica,matter much whether the country in question is Jamaica,Japan, or Jordan? If so, how? What information about theJapan, or Jordan? If so, how? What information about thecountry in question do you request before you offer your country in question do you request before you offer your advice? advice?

2.2. The prime minister asks you to draw up a list of policy The prime minister asks you to draw up a list of policymeasures designed to stimulate economic growth. Does itmeasures designed to stimulate economic growth. Does itmatter much whether the country in question is Jamaica,matter much whether the country in question is Jamaica,Japan, or Jordan? If so, how? What information about theJapan, or Jordan? If so, how? What information about thecountry in question do you request before you offer your country in question do you request before you offer your advice? advice?

3.3. Suppose international capital flows are severely Suppose international capital flows are severely restricted by law in an attempt to stabilize exchange restricted by law in an attempt to stabilize exchange rates. Would you expect such legislation to affect rates. Would you expect such legislation to affect economic growth? Where? How?economic growth? Where? How?

3.3. Suppose international capital flows are severely Suppose international capital flows are severely restricted by law in an attempt to stabilize exchange restricted by law in an attempt to stabilize exchange rates. Would you expect such legislation to affect rates. Would you expect such legislation to affect economic growth? Where? How?economic growth? Where? How?

Questions for review

4.4. Suppose the government decides to Suppose the government decides to lowerlower taxes. taxes.What other information do you need in order to beWhat other information do you need in order to beable to determine whether the tax cut is likely toable to determine whether the tax cut is likely tostimulate economic growth or not? stimulate economic growth or not?

4.4. Suppose the government decides to Suppose the government decides to lowerlower taxes. taxes.What other information do you need in order to beWhat other information do you need in order to beable to determine whether the tax cut is likely toable to determine whether the tax cut is likely tostimulate economic growth or not? stimulate economic growth or not?

5.5. “An increased deficit in the government budget “An increased deficit in the government budget may raise national income in the short run, but it may may raise national income in the short run, but it may also retard economic growth in the long run.” Evaluate also retard economic growth in the long run.” Evaluate this statement. this statement.

5.5. “An increased deficit in the government budget “An increased deficit in the government budget may raise national income in the short run, but it may may raise national income in the short run, but it may also retard economic growth in the long run.” Evaluate also retard economic growth in the long run.” Evaluate this statement. this statement.

6.6. “Natural resource abundance generally tends to “Natural resource abundance generally tends to increase national income per capita in the resource-rich increase national income per capita in the resource-rich country, but it may also retard its economic growth.” country, but it may also retard its economic growth.” Does this statement involve a contradiction? Discuss. Does this statement involve a contradiction? Discuss.

6.6. “Natural resource abundance generally tends to “Natural resource abundance generally tends to increase national income per capita in the resource-rich increase national income per capita in the resource-rich country, but it may also retard its economic growth.” country, but it may also retard its economic growth.” Does this statement involve a contradiction? Discuss. Does this statement involve a contradiction? Discuss.

Classroom discussionClassroom discussion

chapter four the importance of being efficient chapter 4 asks whether the poor countries are...

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