Thorvaldur Gylfason

Overview of general theme of conference: economic governance and sustained growth economic governance and sustained growth

Picture to be presented will be painted with a broad brush, covering Main determinants of efficiency and growth Main determinants of efficiency and growth Empirical cross-country growth patterns Empirical cross-country growth patterns

observedobserved Main task: Set stage, without explicit Balkan

content, for local as well as regional analyses to follow

Like politics, all growth economics focusing on economic policy and institutions economic policy and institutions is local

Our standard of living today depends on one thing only, by definition: economic economic growth growth

Rich countries are rich because they grew rapidly over long periods

Poor countries are poor because they did not grow rapidly enough

So why do some countries grow more rapidly than others?

Why, e.g., did Thailand leave Zambia so far behind in one generation?

Hard to think of anything else (Lucas)

Thailand and Zambia started out in a similar position and grew apart

Thailand pursued growth-friendly growth-friendly policiespolicies, stressing liberal trade, stability, private enterprise, and education

0

400

800

1200

1600

2000

2400

60 65 70 75 80 85 90 95 00

THAILAND ZAMBIA

GDP per capita 1960-2003 GDP per capita 1960-2003 (US$ at 2000 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

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

0

4000

8000

12000

16000

20000

24000

1900 1925 1950 1975 2000

ARGENTINA SWEDEN

What makes countries grow Economic efficiencyefficiency and growth Economic policiespolicies and institutionsinstitutions

Education and health careBusiness governanceMonetary and financial policies and

institutionsExternal governance

Empirical evidence Empirical evidence of cross-country linkages between governance and growth as we go along

First things first: Output is produced by labor, capital, and other inputs

Output per capita can grow through accumulation of capital through savingsaving and investmentinvestment

Output per capita, however, cannot grow through population growth, on the contrary

But, output per capita can grow through improvementsimprovements in labor, via investments in human capital: Education Education and health carehealth care Investment and education: Key drivers of

growth

Why do education and health care matter? Because they increase labor productivitylabor productivity This is also why technological progress technological progress is

good for growth Technological progress enables firms to

squeeze more output from given inputssqueeze more output from given inputs But so does increased efficiency!

Latin American story about air fares Increased efficiency Increased efficiency is tantamount to

technological progress, which helps growthhelps growth

In sum, output per capita depends on the quantityquantity and qualityquality of inputs

Quantity of inputs can be increased through accumulationaccumulation, esp. capital accumulation

QualityQuality of inputs – their productivity! – can be increased through increased efficiencyincreased efficiency Education and healthEducation and health LiberalizationLiberalization StabilizationStabilization PrivatizationPrivatization Aspects of institutionsAspects of institutions

Check them

out one by one

Policies

Education lifts Education lifts labor productivitylabor productivity, thereby increasing overall economic efficiency and growth of output

From unskilled to skilled labor

Data for 131 countries, 1960-2000

-6

-4

-2

0

2

4

6

0 20 40 60 80 100

Secondary school-enrolment rate (%)

Pe

r ca

pita

gro

wth

ad

just

ed

for

initi

al i

nco

me

(%

)

r = 0.50

POLICIES

r = rank correlation

There is another way to provide more and better education to children

Produce fewer fewer children children to increase their average “quality”

163 countries, 1960-2000

-8

-6

-4

-2

0

2

4

6

1 2 3 4 5 6 7 8

Fertility (number of children)Pe

fr c

ap

ita g

row

th a

dju

ste

d fo

r in

itia

l in

com

e (

%)

POLICIES

r = -0.54

Good public health, reflected in longevitylongevity, is also conducive to increased labor productivity and economic growth

156 countries,1960-2000

-8

-6

-4

-2

0

2

4

6

30 40 50 60 70 80

Life expectancy 1960 (years)

Pe

r ca

pita

gro

wth

ad

just

ed

for

initi

al i

nco

me

(%

)

POLICIES

r = 0.54

Increased spending on health health care care also spurs economic growth

Close connection between public health and health care, i.e., between output and input

162 countries,1960-2000

-8

-6

-4

-2

0

2

4

6

0 2 4 6 8 10 12 14

Health expenditure (% of GDP)

Pe

r ca

pita

gro

wth

ad

just

ed

for

initi

al i

nco

me

(%

)

POLICIES

r = 0.40

Liberalization of pricesprices increases efficiency in resource resource allocationallocation

Liberalization of tradetrade increases efficiency in division of labordivision of labor

163 countries,1960-2000

-8

-6

-4

-2

0

2

4

6

0 40 80 120 160 200

Exports (% of GDP)

Pe

r ca

pita

gro

wth

ad

just

ed

for

initi

al i

nco

me

(%

)

POLICIES

r = 0.26

Exports are not a good indicator of openness because size matterssize matters

So look at import import duties duties as well

Higher duties hurt hurt growthgrowth, but connection is weak

147 countries,1960-2000

r = 0.20

-8

-6

-4

-2

0

2

4

6

0 10 20 30 40 50 60 70

Share of import duties in tax revenues (%)

Pe

r ca

pita

gro

wth

ad

just

ed

for

initi

al i

nco

me

(%

)

POLICIES

r = -0.23

Economic theory is clear, from Adam Smith (1776) on: external as well as internal trade is trade is good for growthgood for growth

Good external Good external governance governance is good for growth

Autarky spells Autarky spells disasterdisaster, always and everywhere

Darkness in North-Korea

POLICIES

Stabilization Stabilization increases increases efficiency efficiency by reducing production distortions, uncertainty, inflation tax, andovervaluation

164 countries,1960-2000

r = -0.46

-8

-6

-4

-2

0

2

4

6

0.0 0.2 0.4 0.6 0.8 1.0

Inflation distortion

Pe

r ca

pita

gro

wth

ad

just

ed

for

initi

al i

nco

me

(%

)

POLICIES

r = -0.46

High inflation is a sure sign of lax fiscal and monetary policies, so sound sound policies support policies support rapid growthrapid growth

Sound financial institutions, incl. independent independent central bankscentral banks, also support rapid growth

r = -0.46

-8

-6

-4

-2

0

2

4

6

0.0 0.2 0.4 0.6 0.8 1.0

Inflation distortion

Pe

r ca

pita

gro

wth

ad

just

ed

for

initi

al i

nco

me

(%

)

POLICIES

r = -0.46

Privatization replaces political motives by profit profit motivemotive in business

Private enterprise Private enterprise is usually more efficient than state-owned enterprises

38 countries, 1978-92

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-4

-2

0

2

4

6

8

.0 .1 .2 .3 .4

Share of SOEs in employment (%)

Pe

r ca

pita

gro

wth

(%

pe

r ye

ar)

POLICIES

r = -0.35

Growth differentials across countries can be traced to several different interconnected factors Private initiativesPrivate initiatives

Investment Fertility

Public policiesPublic policies Education Health care Liberalization Stabilization Privatization

Overlaps between

private and public

spheres

This is not all, however Institutions and geography

Institutions (Institutions (Aspects of social capitalAspects of social capital)) Corruption Inequality Liberal democracy

GeographyGeography Primary production (Agriculture, mining, etc.) Natural resource dependence

Institutions or geography? False contrast There is room for both, side by side

Two views Corruption Corruption

greases wheels greases wheels of production and exchange and thus helps growth

Corruption breeds Corruption breeds inefficiency inefficiency and hurts growth

88 countries,1960-2000

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-4

-2

0

2

4

6

0 2 4 6 8 10 12

Corruption perceptions index

Pe

r ca

pita

gro

wth

ad

just

ed

for

initi

al i

nco

me

(%

)

More corruption

INSTITUTION

S

r = 0.69

So, good business good business governance is governance is good for growthgood for growth

Argument can be extended to other aspects, such as secure property secure property rights rights and effective effective bankruptcy lawsbankruptcy laws

Same story

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-4

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0

2

4

6

0 2 4 6 8 10 12

Corruption perceptions index

Pe

r ca

pita

gro

wth

ad

just

ed

for

initi

al i

nco

me

(%

)

More corruption

INSTITUTION

S

r = 0.69

Two views Inequality Inequality

sharpens sharpens incentives incentives and thus helps growth

Inequality Inequality endangers social endangers social cohesion cohesion and hurts growth

117 countries,1960-2000

-8

-6

-4

-2

0

2

4

6

10 20 30 40 50 60 70

Gini index of inequality

Pe

r ca

pita

gro

wth

ad

just

ed

for

intia

l in

com

e (

%)

INSTITUTION

S

r = -0.27

Two views Political oppression Political oppression

restrains special restrains special interest groups interest groups and thus helps growth

Political oppression Political oppression breeds inefficiency breeds inefficiency and hurts growth

117 countries,1960-2000

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-4

-2

0

2

4

6

0 1 2 3 4 5 6 7 8

Political oppression

Pe

r ca

pita

gro

wth

ad

just

ed

for

initi

al i

nco

me

(%

)

INSTITUTION

S

r = -0.64

Again, two views Democracy plays Democracy plays

into hands of into hands of special interest special interest groups groups that hurt growth

Democracy Democracy facilitates change of facilitates change of government government and helps growth

143 countries, 1960-2000

r = 0.48

-8

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-4

-2

0

2

4

6

-12 -8 -4 0 4 8 12

Democracy

Pe

r ca

pita

gro

wth

ad

just

ed

for

initi

al i

nco

me

(%

)

INSTITUTION

S

r = 0.50

Manufacturing is an important source of technological technological innovation and innovation and progress progress and thereby also of economic growth

156 countries,1960-2000

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-4

-2

0

2

4

6

8

0 20 40 60 80 100

Share of manufactures in exports (%)

Pe

r ca

pita

gro

wth

ad

just

ed

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initi

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nco

me

(%

)

INSTITUTION

S

r = 0.48

Agriculture and mining are low-skill labor intensive and offer few spillover few spillover benefits benefits to other industries

Natural resources: Mixed blessing Mixed blessing if not well managed

156 countries,1960-2000

r = 0.48

-8

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-2

0

2

4

6

0 10 20 30 40 50 60 70

Primary production (% of GDP)

Pe

r ca

pita

gro

wth

ad

just

ed

for

initi

al i

nco

me

(%

)

INSTITUTION

S

r = -0.59

Economic growth is available to all who make the effort to achieve it (Lewis)

High-quality growth requires accumulation of capital as well as economic efficiency economic efficiency through good good governancegovernance: judicious policypolicy undertakings and sound institutionsinstitutions Education, family planning, health careFree trade, stable prices, private enterpriseHonesty, equality, liberty, democracyNot too much dependence on agriculture

and natural resources THE END