Thorvaldur Gylfason

Sources of economic growth around the worldEconomic policy and institutions matter for

growth Democracy as an aspect of social capital

Democracy is good for growth Cross-country patterns in data

164 countries, World Bank data 1960-2000 Including political data on aspects of democracy

Cross-country regressions Interactions of human, real, financial, natural,

and social capitalsocial capital, including democracydemocracy

GDP per capita 1900-2003 GDP per capita 1900-2003 (US$ at 1990 prices)

Argentina and Sweden went hand in hand 1900-1930, and then grew apart

Sweden pursued free tradefree trade, liberal liberal democracydemocracy, and income equalityincome equality, and avoided high inflation

Argentina did not

0

4,000

8,000

12,000

16,000

20,000

24,000

1900 1925 1950 1975 2000

ARGENTINASWEDEN

Sweden 2.1% per yearArgentina 1.0% per year

1.011103 = 3.1

GDP per capita 1965-2004 GDP per capita 1965-2004 (US$ at 2000 prices)

Botswana and Nigeria went hand in hand 1965-1970, and then grew apart

Botswana practiced democracydemocracy, stressed education,education, and resisted corruption

Nigeria’s finance minister: “Oil has made us lazy”

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

65 70 75 80 85 90 95 00

BOTSWANANIGERIA

Botswana 7.1% per yearNigeria 0.6% per year

1.06539 = 11.7

GhanaGhanaLesothoLesotho

NamibiaNamibia

BotswanaBotswana

KoreaKorea

Iceland was Ghana

Resource Resource

cursecurse

Interactions

among

determinants of

growth

Listen to King Faisal King Faisal of Saudi Arabia (1964-1975), as quoted by his Oil Minister, Sheik Yamani:“In one generation we went from riding camels to riding Cadillacs. The way we are wasting money, I fear the next generation will be riding camels again.”

Lee Kwan YewLee Kwan Yew, founding father of Singapore (1959-1991), would not have been surprised either:“I thought then that wealth depended mainly on the possession of territory and natural natural resourcesresources, whether fertile land ..., or valuable minerals, or oil and gas. It was only after I had been in office for some years that I recognized ... that the decisive factors were the peoplepeople, their natural abilities, educationeducation and training.”

Democracy makes it easier to replace bad governments by better ones and for ideas to compete in the political arena, thus fostering efficiencyefficiency and diversificationdiversification, which is good for growthgood for growth

Democracy plays into the hands of pressure groups pressure groups that abuse their power by swaying public policies and institutions in their favor, which is bad for bad for growthgrowth

Empirical question

Schumpeter (1942)“the democratic method is that institutional arrangement for arriving at political decisions in which individuals acquire the power to decide by means of a competitive struggle for the people’s vote.”

Source of dataPolity IV (Marshall and Jaggers, 2001)21-point scale, from -10 to 10, extensive coverage of countries

Democracy

Oligocracy

Autocracy

1946: 20 out of 701946: 20 out of 70

2000: 90 out of 1702000: 90 out of 170

Nu

mb

er

of

cou

ntr

ies

0.51

Democracy is good for growth

Rank correlation

A rise in democracy index by

7 points goes along with an

increase in per capita growth

by one percentage point per

year

164 countries

0.75Corruption hurts growth

0.60Different aspects of social capital go together

0.62Human capital and social capital go together

-0.67Natural capital crowds out social capital

-0.67

Natural capital share and growth are inversely related

0.69Education is good for growth

An increase in school life

expectancy by 3 years

goes along with an

increase in per capita

growth by one

percentage point per

year

-0.62

Social content of growth

A decrease in fertility by 3

children per woman goes along

with an increase in per capita

growth by 2 percentage points

per year

-0.82Natural capital crowds out human capital

-0.74

Natural capital crowds out social capital

-0.46

Inflation impedes growth

Stabilization increases efficiency by reducing

production distortions, uncertainty, inflation tax,

and overvaluation

-0.46

Inflation impedes growth

High inflation is a sure sign of lax fiscal and

monetary policies, so sound policies support rapid sound policies support rapid

growthgrowth

High inflation is a sure sign of lax fiscal and

monetary policies, so sound policies support rapid sound policies support rapid

growthgrowth

Null hypothesisDemocracy is good for growth, and so are investment, education, health care, usw.

Alternative hypothesisDemocracy is not good for growth, or worse

Not trying to demolish other potential explanations of growth

• Rather, trying to find a complementary role for democracy: add, not subtract

Institutions,

economic policies,

and natural

resources side by

side

Theoretical frameworkNeoclassical vs. endogenous growth

False contrastEmpirically indistinguishableEndogenous growth, endogenous democracy

Long run vs. medium termMedium term: Policy-relevant choiceForty years of data, 1960-2000Long run is irrelevant except as a benchmark

Empirical strategy1) Levels of income vs. rates of growth2) Recursive modeling vs. instruments3) Averages vs. initial values of independent

variablesPrefer averages when available so as not to discard data after the initial period

4) Cross sections vs. panelsBegin with cross sections, will add panels

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Conditional

convergence requires

b > 0 < 1

One-to-one

correspondence

between parameters

Economic growth depends on the accumulation of capital and the efficiency with which it is used

Five, or rather six, kinds of capital

1)1) SocialSocial capital: democracy, corruption

2)2) HumanHuman capital: education, fertility3)3) RealReal capital: investment4)4) FinancialFinancial capital: low inflation5)5) ForeignForeign capital: openness -- ignore

6) 6) NaturalNatural capital

Model 1

Initial income

-0.74(5.2)

Natural capital

Democracy

School life expectancy (log)Fertility

Investment rate (log) Inflation distortionCountries 164

Adjusted R2 0.14

Model 1 Model 2

Initial income

-0.74(5.2)

-0.49(3.1)

Natural capital

-0.04(5.3)

Democracy

School life expectancy (log)Fertility

Investment rate (log) Inflation distortionCountries 164 125

Adjusted R2 0.14 0.18

Model 1 Model 2 Model 3

Initial income

-0.74(5.2)

-0.49(3.1)

-0.77(3.8)

Natural capital

-0.04(5.3)

-0.03(3.1)

Democracy 0.10(3.0)

School life expectancy (log)Fertility

Investment rate (log) Inflation distortionCountries 164 125 113

Adjusted R2 0.14 0.18 0.18

Model 1 Model 2 Model 3 Model 4

Initial income

-0.74(5.2)

-0.49(3.1)

-0.77(3.8)

-1.66(9.5)

Natural capital

-0.04(5.3)

-0.03(3.1)

-0.01(2.8)

Democracy 0.10(3.0)

0.09(3.6)

School life expectancy (log)

3.86(8.8)

Fertility

Investment rate (log) Inflation distortionCountries 164 125 113 99

Adjusted R2 0.14 0.18 0.18 0.56

Model 1 Model 2 Model 3 Model 4 Model 5

Initial income

-0.74(5.2)

-0.49(3.1)

-0.77(3.8)

-1.66(9.5)

-1.85(10.5)

Natural capital

-0.04(5.3)

-0.03(3.1)

-0.01(2.8)

-0.01(1.6)

Democracy 0.10(3.0)

0.09(3.6)

0.07(2.7)

School life expectancy (log)

3.86(8.8)

2.91(5.7)

Fertility -0.40(3.3)

Investment rate (log) Inflation distortionCountries 164 125 113 99 99

Adjusted R2 0.14 0.18 0.18 0.56 0.61

Model 1 Model 2 Model 3 Model 4 Model 5 Model 6

Initial income

-0.74(5.2)

-0.49(3.1)

-0.77(3.8)

-1.66(9.5)

-1.85(10.5)

-1.79(10.2)

Natural capital

-0.04(5.3)

-0.03(3.1)

-0.01(2.8)

-0.01(1.6)

-0.01(2.0)

Democracy 0.10(3.0)

0.09(3.6)

0.07(2.7)

0.08(3.0)

School life expectancy (log)

3.86(8.8)

2.91(5.7)

2.69(5.3)

Fertility -0.40(3.3)

-0.30(2.4)

Investment rate (log)

0.97(2.0)

Inflation distortionCountries 164 125 113 99 99 99

Adjusted R2 0.14 0.18 0.18 0.56 0.61 0.62

Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 Model 7

Initial income

-0.74(5.2)

-0.49(3.1)

-0.77(3.8)

-1.66(9.5)

-1.85(10.5)

-1.79(10.2)

-1.71(11.5)

Natural capital

-0.04(5.3)

-0.03(3.1)

-0.01(2.8)

-0.01(1.6)

-0.01(2.0)

-0.01(1.4)

Democracy 0.10(3.0)

0.09(3.6)

0.07(2.7)

0.08(3.0)

0.04(2.1)

School life expectancy (log)

3.86(8.8)

2.91(5.7)

2.69(5.3)

2.83(6.5)

Fertility -0.40(3.3)

-0.30(2.4)

-0.42(3.8)

Investment rate (log)

0.97(2.0)

0.61(1.4)

Inflation distortion

-2.71(6.2)

Countries 164 125 113 99 99 99 99

Adjusted R2 0.14 0.18 0.18 0.56 0.61 0.62 0.73

Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 Model 7

Initial income

-0.74(5.2)

-0.49(3.1)

-0.77(3.8)

-1.66(9.5)

-1.85(10.5)

-1.72(10.2)

-1.71(11.5)

Natural capital

-0.04(5.3)

-0.03(3.1)

-0.01(2.8)

-0.01(1.6)

-0.02(3.2)

-0.01(1.4)

Democracy 0.10(3.0)

0.09(3.6)

0.07(2.7)

0.04(2.2)

0.04(2.1)

School life expectancy (log)

3.86(8.8)

2.91(5.7)

0.08(3.2)

2.83(6.5)

Fertility -0.40(3.3)

1.39(3.0)

-0.42(3.8)

Investment rate (log)

3.01(6.4)

0.61(1.4)

Inflation distortion

-2.71(6.2)

Countries 164 125 113 99 99 99 99

Adjusted R2 0.14 0.18 0.18 0.56 0.61 0.61 0.73

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

(Accra, 1968)

Since the second world war it has become quite clear that rapid economic growth is available to those countries with sound with sound democratic institutions democratic institutions which make the effort to achieve it. W. Arthur Lewis

(Accra, 1968)

Diversification is good for growth Economic diversification Economic diversification away from excessive

reliance on natural resources Political diversification Political diversification away from narrowly based

political elites toward full-fledged democracy Social and human capital are good for growth

Democracy seems to make a difference Social insurance also makes a difference, as well

as education and health care Judicious use of natural resources requires

good institutions, including democracyKey to Norway’s successful oil management

The development effort required around the world includes a double diversification

Economic diversification Economic diversification Away from agriculture and other natural-

resource intensive activity into manufacturing (as in China) and services (as in India)

PPolitical diversification olitical diversification From dictatorship to democracy (as in

Korea and Taiwan)

These slides – and more! – can be

viewed on my website:

www.hi.is/~gylfason