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Unformatted text preview: Economic Growth
Week 1 Thursday GlobalizationEconomic Growth Link
Globalization has helped reduce poverty in a large number of developing countries but it must be harnessed better to help the world's poorest, most marginalized countries improve the lives of their citizens. But not all countries have integrated successfully. On average, their economies have contracted and poverty has risen. Important reasons for this exclusion are weak governance and policies in the nonintegrating countries, tariffs and other barriers that poor countries and poor people face in accessing rich country markets, and declining development assistance. 2 The Importance of Economic Growth
What are the gains from economic growth? Growing population Malthus(1798): the limited natural resources constrained the population size Higher income helps by enabling better nutrition and financing the production of medicine and medical research Average income per head is increased Next slides... Life expectancy Improving standards of living Poverty reduction 3 Economic Growth and Standard of Living 4 The Importance of Economic Growth
...for poor countries 5 Income growth reduces poverty. Estimated Effects of Economic Growth Example:
Growth and Poverty in Indonesia change in change in # of persons income per living below capita poverty line 1984-96 +76% -25%
1997-99 -12% +65%
6 Income and Poverty in the World 100 90 selected countries, 2000
India Nepal Bangladesh Madagascar % of population living on $2 per day or less 80 70 60 50 40 30 20 10 0 $0 Kenya Botswana China Peru Thailand Brazil Russian Chile Federation $10,000 Mexico S. Korea $15,000 $20,000 $5,000 Income per capita in dollars
7 The Importance of Economic Growth
...for poor countries ...for rich countries 8 Huge Effects from Tiny Differences
In rich countries like the U.S., if government policies or "shocks" have even a small impact on the longrun growth rate, they will have a huge impact on our standard of living in the long run...
9 Huge Effects from Tiny Differences Statistics
annual growth rate of income per capita 2.0% 2.5% percentage increase in standard of living after... ...25 years 64.0% 85.4% ...50 years 169.2% 243.7% ...100 years 624.5% 1,081.4% 10 11 12 Growth Questions What factors caused some countries to grow fast and others to grow slow over periods such as 1960 to 2000? In particular, why did the East Asian countries do so much better than the subSaharan African countries? How did countries such as the United States and other OECD members sustain growth rates of real GDP per person of around 2% per year for a century or more? What can policymakers do to increase growth rates of real GDP per person?
13 Key Concepts GDP Growth: Total output and output per capita Elements of Growth Diminishing Marginal Return Total Factor Productivity and Human Capital Convergence and Conditional Convergence CrossCountry Growth in the Long Run Geography, Institutions, and Growth Endogenous Growth?
14 Labor Capital Total Factor Productivity 1. GDP Growth An increase over time in the quantity of goods and services produced by an economy Rate of growth Real GDP: adjusts for inflation Real GDP per capita: adjusts for size of population 15 2. Analysis of Growth The Production Function
Capital (buildings, infrastructure and machines) Total Factor Productivity (technological knowledge and efficiency) Output (GDP) Labor (Hours worked, number of workers)
16 Analysis of Growth Capital: Total value of the machines and buildings used to produce output Labor productivity: the amount of goods and services produced by an average worker in one hour TFP everything else than capital and labor: education, skill, technology, efficiency 17 Growth in Output Increase in labor supply Increase in capital stock May have no impact on GDP per capita Not sustainable Increase in TFP Must increase at faster rate than labor No diminishing returns in this framework 18 Growth Accounting
The Production Function relation between the level of Y and the levels of A, K, and L Y = A * f(K,L) Growth accounting relation between the growth rate of Y and the growth rates of A, K, and L. DY/Y = DA/A + * DK/K + * DL/L Constant Returns to Scale: + = 1
19 Growth Accounting for Japan, Germany, the UK, and the United States, 19131950. 20 Growth Accounting for Japan, Germany, the UK, and the United States, 19501973. 21 Growth Accounting for Japan, Germany, the UK, and the United States, 19731992. 22 Growth Accounting Japan US Capital growth important through out Labor, TFP important '50 '73 TFP important until '73 Labor important after '73 UK and Germany rely less on labor 23 Growth Accounting in emerging markets, 19601994. 24 Growth Transitions
Labor Growth Capital Growth TFP Growth 25 Decreasing Marginal Product: Role of Inputs More inputs means more output Diminishing returns
1 worker = $10 in output 2 workers = $18 in output 3 workers = $24 in output Marginal return is $8 in output Marginal return is $6 in output 26 Decreasing Marginal Product
Real GDP (billions of 1996 $) An increase in the quantity of labor increases Real GDP
15 12 6 500 1000 1500 But growth rate decreases as labor increases Labor Hours
27 Decreasing Marginal Product
Real GDP (billions of 1996 $) An increase in the quantity of capital increases Real But growth GDP rate decreases as capital increases 15 12 6 500 1000 1500 Quantity of Capital
28 3. Diminishing Marginal Return Growth will be fast when level of capital is low Growth slows down as capital accumulates Eventually, firms won't add new capital firms only replace depreciated capital Economy reaches a Steady State No new increase in capital will create economic growth The economy continues to grow ONLY by inventing new technology 29 The Asian Miracle Asian economies grow fast after 1950: Why? 1950 wealthiest Asian country Singapore 19732000 fast growth (per capita output increased in Singapore with almost fourfold) even if severe crisis occurred in 1997 Most of Asian countries similar increases in standard of living (OECD countries relatively little growth) 1960 South Korea similar standard living to Senegal or Ghana but output increased six or seven fold Huge investment rates capital accumulation Employment growth working age population growth So, substantial growth in capital and, to a lesser extent, in employment
30 The Asian Miracle The answer: They started with a very low output per capita, so they experienced a very high growth rate (7%). This a case study of capital accumulation. Can this experience be repeated elsewhere? Not in the case of mature industrialized countries They reached their steady state (they have achieved their growth through capital accumulation) so the important source of growth is TFP. 31 Growth Accounting
Asian Tigers, 1966 1990 32 Growth Questions What factors caused some countries to grow fast and others to grow slow over periods such as 1960 to 2000? In particular, why did the East Asian countries do so much better than the subSaharan African countries? How did countries such as the United States and other OECD members sustain growth rates of real GDP per person of around 2% per year for a century or more? What can policymakers do to increase growth rates of 33 4. Total Factor Productivity and Human Capital The influence of any factor that affects output other than capital accumulation and labor input An economy that increases its efficiency in producing output from a given level of capital increases its TFP Variations among countries variations in TFP A twist: human capital
34 Human Capital Skills and knowledge that accumulate over time, embodied in people 35 How to Increase Human capital? Educational attainment Expenditures on education
Allocation of resources Level of education Cost of education 36 Schooling Differences Across Countries
Average Years of Schooling 37 Review Crosscountry differentials in per capita output are substantial
Role of physical capital Role of human capital (hours worked + skills and knowledge) Significant fraction of differential is unexplained we call this "TFP" Other elements of TFP 38 TFP: Institutions Property Rights Regulatory Institutions Macroeconomic Stabilization Social Insurance Conflict Management Political Rights 39 Political Stability
Congo, Dem. Rep. (Zaire) LIBERIA AFGHANISTAN IVORY COAST BURUNDI SOMALIA SUDAN GEORGIA CENTRAL AFRICAN REPUBLIC COLOMBIA Top 10
NEW ZEALAND NETHERLANDS SWEDEN PORTUGAL NORWAY MALTA LUXEMBOURG ICELAND SWITZERLAND FINLAND
Congo, Dem. Rep. (Zaire) LIBERIA SOMALIA IRAQ MYANMAR CAMBODIA TURKMENISTAN TAJIKISTAN CAMEROON ANGOLA Top 10
ICELAND NORWAY NETHERLANDS CANADA SINGAPORE NEW ZEALAND SWEDEN FINLAND DENMARK SWITZERLAND
41 TFP: R & D Growth can be sustained through technological progress Role of Research and Development in promoting technological progress Example of South Korea 42 TFP: Foreign Direct Investment Investment by foreign firms in an economy Encourages capital accumulation and technology transfer Can facilitate convergence among countries 43 TFP: The New Economy Role of ICT How does IT produce growth?
Through capital accumulation TFP gains in adopting sectors TFP in sectors that produce IT Information and Communication Technology (sometimes just IT) 44 Why the different levels of performance?
Output per capita (1985 US $) Bangladesh Japan 724 617 531 1334 704 5307 15646 16584 22214 2000 1913 1820 US UK
0 1287 5032 1756
5000 10000 15000 20000 25000
45 5. CONVERGENCE
In 1900, U.S. income per capita was 3.5 times larger than Japan and 6.6 times larger than India In 2000, U.S. income per capita was only 1.3 times larger than Japan and 14.7 times larger than India Why did the first gap narrow and the second gap widen? 46 Explaining the differences Output per worker is a function of Capital, Labor, and Total Factor Productivity. Capital: building, machines, computers, etc. Labor: number of workers, hours worked, etc. TFP: education, skills, knowhow, etc. Mathematically: Y = f (K,L,A) where K is the capital stock, L is the labor supply and A is TFP.
Solow's growth model production function: Y/L = F(K/L,1,A) y = A F(k) We assume that all countries have the same production function and access to technology. Also the economy is a close economy (S = I). If low level of capital per worker and low level of income per worker, then poor country If high level of capital per worker and high level of income per worker, then rich country 48 1. CONVERGENCE 49 CONVERGENCE transition for capital per worker, k, as it rises from its initial value, k(0), to its steadystate value, k* k* works like a target or magnet for k during the transition. k* depends on the saving rate, s, the technology level, A, the population growth rate, n, the depreciation rate, , and the initial level of labor input, L(0). We can summarize these results in the form of a function for k*: 50 Economy 1 starts at capital per worker k(0)1 and economy 2 starts at k(0)2. The two economies have the same steadystate capital per worker, k*, shown by the dashed blue line. In each economy, k rises over time toward k*. However, k grows faster in economy 1 because k(0)1 is less than k(0)2. Therefore, k1 converges over time toward k2. 51 One of the outcomes of the Solow model is that if you have two countries that have the same steadystate, the poorer country should grow more quickly than the richer country. CONVERGENCE This idea of economic catchup is also know as convergence. As is, the countries are converging to the same steadystate. Poor countries are further away from the steadystate and thus add more to capital per capita in the next time period. Remember...higher levels of capital per worker means a higher level of output. This result comes about because of diminishing marginal returns to capital. 52 The Convergence Hypothesis
Hypothesis: Growth rate of Y/L should be negatively related to the initial level of Y/L. Countries with initial low levels of Y/L should have subsequent higher growth rates.
Therefore there is a negative relationship between the growth rate of GDP per capita and the initial level of GDP per capita.
Question: How well does this hypothesis hold? It seems to hold for the U.S. and Japan. Does it hold for other countries? 54 Just the facts: What does the data say about convergence? What does convergence mean empirically? Levels of income should coincide in the long run Low income countries grow faster than high income countries Higher MPK for low income countries Also: one can test the hypothesis using statistical methods (regressions)!
55 6. Cross Country Growth in the Long Run : Testing the Convergence Hypothesis Strong evidence of convergence among industrial countries since 1960 The evidence for convergence since 1960 does not extend to the world as a whole Next two figures illustrate this fact: 56 57 58 Growth Rate Versus Level of Income per Person for U.S. States, 18802000 59 So? Little evidence of convergence across all countries divergence Some evidence of convergence for select, similar countries Countries may have different steady states Conditional convergence 60 Two Steady States
Output Real GDP Depreciation SS 1 SS 2 Capital Stock 61 So what do we know now: Steady State diminishing returns of capital Solow poor countries will grow faster and catch up with poor countries Reality: mostly divergence or conditional convergence Why?
62 Cross Country Growth Some variables that can cause differences in growth rates of income per capita or levels of income per capita among countries : Saving rates Population growth Measures of human capital Political variables Openness to trade Market distortions The fractions of primary products in total exports Geographic variables
63 7. Geography, Institutions and Growth Distance from the equator is highly correlated to income per capita. Countries far from the equator are relatively rich, and countries close to the equator are relatively poor. What causes the relation between geography and income? Does geography affect growth directly, or does the effect operate through social institutions?
64 65 Geography
The geography hypothesis: most of the differences in income per capita across countries can be explained by geographic, climatic, and ecological differences. Tropical regions (centered near the equator) have grown at a slower rate than temperate regions (north or south of the tropics). 66 Differences in social infrastructure can explain much of the variation of levels of income per capita across countries beyond what can be accounted for by physical capital and human capital Distance from the equator is a proxy for the influence of Western Europe, the first region to implement a social infrastructure favorable to production, on the rest of the world Social Infrastructure 67 68 8. Endogenous growth theory Paul Romer focus on investments in research and development , or R&D . Successful R&D projects lead to the discovery of new products, better products, or superior methods of production. In the Solow growth model, we can think of these research successes as increases in the technology level, A. Endogenous growth models: the growth rate of A is explained within the model. Therefore, we can use endogenous growth models to understand how government policies and other variables influence R&D investment and, thereby, the rate of technological progress and the longrun growth rate of real GDP per person.
69 Is diminishing returns theory apply to R&D investment? If A represents an idea, all producers can use the idea simultaneously. If producer 1 uses the idea to create goods and services, producer 2 can use the same idea at the same time to create other goods and services. In a physical sense, an idea is a nonrival good any number of producers can use the idea simultaneously without reducing the amount of the idea available to others. Examples of nonrival ideas are mathematical formulas in calculus, chemical formulas for drugs, codes for computer software....
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- Spring '09