Economic Growth in the Global Economy

Francesco Daveri

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“Economic growth in the global economy”

• This module is the first half of a course

“Economic Growth and History of the Global Economy”

on long run trends in the world economy

• I teach module 1: “Economic Growth in the Global Economy”

• My colleague Giovanni Ceccarelli will teach module 2: “Economic History of the Global Economy”

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Who I am

Francesco Daveri, M.Sc. Oxford (UK); PhD Pavia (Italy)

Research topics: labor markets, growth and productivity issues

Formerly a consultant to Italy’s Ministry of the Economy, the European Commission (DG INFSO and ECFIN) and the World Bank (Research Department)

One top-selling book: Centomila punture di spillo (2008), with Carlo De Benedetti and Federico Rampini

My latest book: Crescere si può (il Mulino, 2012)

Now I write shorter pieces. Columns in Il Corriere della Sera and slightly more technical stuff in the website LaVoce.info

Fb page: http://it-it.facebook.com/fdaveri

Twitter: @fdaveri1-3

Facts about the world economy

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Gdp growth, a natural state of affairs. Example: the US economy, 1870–2009

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Highlights of world Gdp growth: 1) 1978-2013: +3.5% on average & never<0 before 2009; 2) 2003-07: +4.5% 3) 2010-14: strong bouncing back in 2010, then loss of steam through 2014. Back to long-run average of 3.5%

Over shorter spells: growth still rules. Yet thru alternating slowdowns and recoveries

IMF World Economic Outlook Database (October 2014) 1-6

The crisis, across countries & over time1. Across countries: the rise of the rest2. Over time: a “world with a W”

IMF, World Econ Outlook, October 2014

GDP growth, % 2007 2008 2009 2010 2011 2012 2013 2014p

World +4.9 +3.9 -0.5 +5.2 +3.9 +3.2 +3.3 +3.3

Usa +1.9 +0.0 -2.6 +3.0 +1.8 +2.8 +2.2 +2.2

Euro Zone +2.8 +0.3 -4.1 +1.9 +1.6 -0.6 -0.4 +0.8

Japan +2.4 -1.2 -6.3 +4.4 -0.6 +2.0 +1.5 +0.9

China +14.2 +9.6 +9.2 +10.4 +9.3 +7.7 +7.7 +7.4

India +9.9 +6.2 +7.2 +9.9 +6.3 +3.2 +5.0 +5.6

Brazil +6.1 +5.2 -0.7 +7.5 +2.7 +1.0 +2.5 +0.3

Russia +8.5 +5.2 -7.8 +4.0 +4.3 +3.4 +1.3 +0.2

Mid East & N. Afr. +5.6 +4.6 +2.7 +4.9 +3.9 +4.6 +2.5 +2.7

SubSahara Africa +7.1 +5.6 +2.8 +5.3 +5.5 +4.9 +5.1 +5.1

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What this course shall deliver

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Two mysteries explained

Two mysteries to investigate

Mystery 1: Why are there rich and poor countries in the world economy?

Mystery 2: Why do some countries become richer and others stay poor?

Solving these intertwined mysteries is important

• Will Africans be as rich as we are today in the – near or distant - future?

• Or will Italians be as poor as today’s Africans?

We first document these mysteries and give some introductory definitions to be made clear in what follows.

Then we will see potential explanations of such mysteries.1-9

Starting from scratch

(so as to keep everybody on board)

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Concepts: Income ≈ GDP

GDP (Gross Domestic Product) is

• A measure of the value of all the goods and services produced in a country in a given year

May be seen as

• The value of total output at market prices, or

• The value of total income (wages, rents, interest and profits) earned in a country.

This is why we often interchangeably speak of Gdp as “output” or “national income”

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• “GDP is the market value . . .”

– Output is valued at market prices

• “. . . of all final . . .”

– It records only the value of final goods, not intermediate goods (the value is counted only once)

• “. . . goods and services . . .”

– It includes both tangible goods (food, clothing, cars) and intangible services (haircuts, house-cleaning, doctor visits)

• “. . . produced within a country . . .”

– It includes goods and services currently produced, not transactions involving goods produced in the past. It measures the value of production within the geographic confines of a country

• “. . . in a given period of time”

– It measures the value of production that takes place within a specific interval of time, usually a year or a quarter (three months)

GDP: definition

Gdp, Income and Expenditure

GDP, a measure of a nation’s income. It is also – for us economists – the most reliable measure of welfare

• As we do with individuals, to understand whether an economy is doing well or poorly, we usually look at the total income that everyone in the economy is earning

• For the economy as a whole, though, income equals expenditure because:

• Every transaction has a buyer and a seller

• Hence, every euro of spending by some buyer is a euro of income for some seller

• This equivalence between income and expenditure gives us a variety of ways in which GDP can be calculated

Spending (= GDP)

Goods andservices

bought

Revenue (= GDP)

Goods andservicessold

Labor, land,and capital

Income (= GDP)

Inputs forproduction

Wages, rent, and profit (= GDP)

FIRMS HOUSEHOLDS

MARKETS FORFACTORS OFPRODUCTION

Flow of goodsand services

Flow of dollars

MARKETS FORGOODS AND

SERVICES

Graphics of Income = ExpenditureGdp measures both flows of dollars and flows of goods & services in a simplified market economy

Dictionary: Nominal & Real GDP

Nominal GDP:The production of goods and services valued at current prices

Real GDP:The production of goods and services valued at constant prices

From Nominal GDP to Real GDP

The GDP deflator measures the rise in nominal GDP that is attributable to a rise in prices rather than a rise in the quantities produced

100GDP Real

GDP Nominal=Deflator GDP

Nominal GDP Real GDPDeflator

Nominal and real GDP in practice – numerical example

Goods

Quantity 2013 (2013 =base year)

Base- year

prices (€/kg)

Quantity 2014

(2014 = current year)

Current prices (€/kg)

Oranges 50 kg €1.00 55 kg €1.00

Apples 50 kg €1.00 50 kg €1.10

• 2013 (Base year)– Nominal GDP = €100– Real GDP = €100

• The two are the same in the base year• 2014 (Current year)

– Nominal GDP = €110 (+10%)– Real GDP = €105 (+5%)

• The two are not the same in other years than the base year– GDP deflator = 105.0 (+5%)

• Remarks– The nominal (current price) Gdp increase in 2014 is due for one

half to a rise in quantities and for the other half to a rise in the average price (Gdp deflator)

Nominal and real GDP: solution of the example

A method to measure how much Gdp growth matters

The rule of 72: Doubling time of X = 72 / g (where g is growth rate of X in % points). Very handy rule.

Example 1: If China’s income keeps growing by 9% per year, an average Chinese will see its income doubled in 8 years.

Example 2: The five stages of market capitalism (so far)

1950-1973: ‘Golden age’, per-capita Gdp up by +3% per year

So in the “golden age” of mkt capitalism, the doubling time was 24 years; during early capitalism it was 144 years - quite a difference!

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Concept revision: levels and growth rates

1. Growth rate of level of X from t to t+1

• g = (Xt+1-Xt) / Xt

2. Compounded average growth rate (average g, from t to t+n)

CAGR = g = (Xt+n/Xt)1/n-1

This is from the following: if g is the same between period t and t+n, then:

Xt+n=Xt(1+g)n

From which the formula above of CAGR is obtained

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Per-capita income differences, this is our MYSTERY #1

Economists sum up differences in many social indicators through single indicator: Per-capita income

• Some 20% of the world population earns 60% of total income

• 80% of world pop survives with < 8630 $, less than 700$ monthly

• 1% of the top earners earn as much as the bottom 3.5 billions 1-21

The Mother of All Questionswhen it comes to Emerging Markets

Are all countries bound to become equally rich?

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Evidence of “club convergence”: countries similar enough do converge (Faster growth in UK & Japan than in US has led Uk & Jap Gdp to converge towards US levels) …

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… as well as for very similar “regions” such as the 50 U.S. states in the last 100 years …

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.. While convergence does NOT hold for the entire world. Data below show that some poor countries grew fast and some others didn’t grow at all, both in 1975-2009 …

... And throughout a longer time period (1960-2000) …

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A summary of geographical growth differences

South-East Asia did well or very well (growth often in excess of 5%)

Sub-Saharan Africa did poorly (decline rather than growth)

Middle-East countries benefited from oil shocks, but short-lived effect on living standards (Oil as a mixed blessing)

Latin America went from hell to heaven, back and forth a few times (early 1980s, mid 1990s, early 2000s, what next?)

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Summing up so far

Big differences in GDP growth rates across countries

No evidence in favor of strict convergence hypothesis (“income of the the poor guys grows faster than the rich guys”)

Instead: evidence of convergence within clubs. “Similar enough” countries show tendency to converge

Hence: need theory of growth consistent with: Worldwide divergence and Club convergence

We will develop this theory next

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Appendix: GDP as a measure of welfare

To understand whether the average Italian citizen is richer than the average Chinese we have to compare the two countries’ Gdp

Problem: How do we compare, if Italy’s gdp is in euros and China’s gdp is in yuans? It’s like comparing apples and oranges -- it can’t be done

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How to compare Gdp in the US and India? Two methods

Method 1: use market exchange rates to convert Rupees into US $ (e.g. on Sep 10, 2009: 1$=49 rupees; US Gdp=37.000, India Gdp=600; so the income differential is 62:1)

Two problems

1. Exchange rates are asset prices and are thus extremely volatile on a daily basis. This is unreasonable: wealth and poverty do not fluctuate that much

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How to compare Gdp in the US and India? Two methods

Method 2Starting point: the prices of non-traded goods (haircuts) are usually

much lower in poorer countries. This means that 1$ has different purchasing power in different countries (higher in poorer countries)

Method 2: exploit info on lower price of non-traded goods to construct PPP (purchasing power parity) exchange rates and use this - and not the market exchange rate - to compare GDPs across countries

If we do this, the US Gdp is still 37,000 but the Indian Gdp goes up to 3,000. And the income differential between an average American citizen and an average Indian citizen goes down to 12.3:1.

Still there, but much lower !!!

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Does it make a difference in practice? Yes, a lot for poor countries. Poor countries are “less poor” with PPP than with market exchange rates

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The Effect of Using PPP or market exchange rates on Gdp comparisons

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Gdp, an imperfect measure of welfare? Well, the relationship between GDP and the UN Human Development Indicator (HDI) is a very close one!

• The correlation between GDP rank and HDI rank=0.95• GDP per capita is on the average a very good measure ofWelfare!

0

20

40

60

80

100

120

140

160

0 50 100 150

HDI rank

GD

P p

er c

ap

ita

ra

nk

Gdp, an imperfect measure of welfare?Yes, but money buys a bit of happiness

What this Appendix teaches us

Comparing welfare and living standards is important

Not easy to do it in a sensible way

Gdp comparisons based on PPP exchange rates are more sensible than those based on market exchange rates

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