Economic growth, economic development, well-being

Should we increase it at all cost? – a question of national planning

Basic Concepts

What is Economic Growth?

• An increase in Gross National Product (GNP) or GDP

GNP: Measures the dollar value of all goods and services that an economy produces during a specified timeperiod - the throughput of stuff flowing through an economy

GNP in the big picture

• Throughput – a flow based concept

• Relies on input from natural capital

Economic Growth

• Is a quantity based concept - not quality based

• A direct measure of changes in the size of the economy– Is it a measure of welfare?– Development?– Sustainable development?

Importance of Economic Growth (via GNP)

• Political Importance– Domestic (4 year planning)– International (Must be better to have higher

GNP/Cap., than lower); IMF Policies• Humanitarian Importance• As an indicator of welfare?• As an indicator of development?• As an indicator of sustainable development?

What can we really use it for?

Basic Concepts

• GDP vs GNP

• Nominal or current GNP– Not accounting for inflation

• Constant or real GNP– Accounting for inflation

Basic Concepts

• Constant GNP– Future values lower, past values higher

((Current GNP)/GNP deflator)*100

Deflators based on:• Consumer prices (400 goods)• Producer prices (2800 items)

Basic Concepts

• Deflators Example

Consumer price index

CPI = ∑((Pit/Pib)*(Pit/∑Pt))

Basic Concepts

• PPP; Purchasing power parity

• Law of one price: in an efficient market, identical goods must have only one price

• A purchasing power parity exchange rate equalizes the purchasing power of different currencies in their home countries for a given basket of goods.

• Often used to compare standard of living• Big Mac Index, Tall Latte index

Big Mac Index

Standard National Accounts

• How to measure GNP?

• 3 methods:– Expenditures– Value added of production– Income

Standard National Accounts

Expenditures• GNP = C + I + G + (X - M)• Where:

– C: Personal consumption expenditures– I: Gross private investment– G: Government expenditures– X: Exports– M: imports

Standard National Accounts

• Production side

• The sum of value added: the difference between revenue and cost.

• Accounted for all sectors of the economy e.g.– Agriculture, construction, manufacturing,

trade, finance, services, government

Standard National Accounts

• Income side:– Income earned by all factors of production

• Employee compensation• Rents (return to housing)• Interest payments (return to lenders of capital)• Payment to owners (return to capital)• Indirect business taxes (return to government)

Standard National Accounts

Net National Product• NNP = GNP - DepreciationDepreciation: reduction in capital stock due to

use causing wear and tear.

National Income• NI = NNP - indirect taxesAvailable for spending

Standard National Accounts

• Personal Income:

PI = NI - Corporate profits - contribution to social insurance + transfer payments + interest income + dividend income

• Disposable personal income:

DPI = PI - personal tax payments

What does GNP measure?

• Total value of goods and services produced within an economy in a given year

• Measure of welfare, development, sustainable anything?

Definitions

• Welfare: measures quality of life• Development: Quality based concept

• Economic income:Value of goods and services

• Sustainable income:How much we can spend without running down capital stocks - can maintain same level of spending in perpetuity

Definitions

• Hicksian income: Income a man can consume during a week and be as well off at the end of the week as he was in the beginning - living of the interests of both man made and natural capital

• Economic Welfare: GNP corrected for expenditures on various regrettable necessities

• Human Welfare: Separation of means from ends - a direct measure of well-being

But can GDP be an indicator of human development or

human welfare?

Longevityand GDPpercapita

• Increases rapidly up to ca 4000$ per capita

• Small returns after that

Infant Mortalityand GDPpercapita

• Declines rapidly up to ca 4000$ per capita

• Small returns after that

Literacy and GDP per Capita

• Increases rapidly up to ca 4000$ per capita

• Small returns after that

Happiness and GDP per Capita

• Increases rapidly up to ca 4000$ per capita

• Small returns after that

• What does this mean?

• What influences happiness?

Do changes in GDP correlate to changes in environmental

quality?

The Environmetnal Kuznets Curve

• Kuznets curve (KC) is the graphical representation of Kuznet’s theory from the 1940’s that economic inequality increases over time, then at a critical point begins to decrease.

• Environmental KC (EKC) shows a hypothesized relationship between various indicators of environmental degradation and income per capita.

ECK

• In the early stages of economic growth degradation and pollution increase,

• Beyond some level of income per capita (which varies for different indicators) the trend reverses, so that at high-income levels economic growth leads to environmental improvement.

• This implies that the environmental impact indicator is an inverted U-shaped function of income per capita.

ECK

• Various functional form found: EKC does not always apply

– Logistic Increase – e.g. carbon dioxide emissions

– Constant Decrease – e.g. bacteria in drinking water

– Inverted U – sulfur dioxide concentration

ECK

• Scale effect: Economic growth increases environmental pollution if there is no change in other factors

• Other factors explain the shape e.g.:– Change in output mix– Change in input mix– State of technology– Production efficiency– Demand for “improved environment”

The Model

ln(ED) = a + b1*ln(GDP/P) - b2 *(ln(GDP/P))**2 + error term

What to look for?• Coefficents• T-stats• R - squared

Evidence for the EKC

• Jury still out• Lots of bad stats, theory statistically weak• What about trade effects?• Turning points vary

– Low for local pollutants (3000-4000 USD per cap)– Others no relationship (deforestation, biodiversity– River quality, carbon, waste increases with

increasing income

Results – Turning points

Implications of EKC

• If exists do we not need to worry about the environment?

• Tunneling through• Possible increase

later on – statistical evidence?

Per Capita GDP

Increase GDP at all cost?

Should we always aim to increase GDP?

What is the ultimate gain?

Happiness?

What is the cost?

Environmental degradation?– Remember Kuznets curve and IPAT

Stress?

Depends on what GDP really measures – is it an indicator of wealth?

What is (not) included in GNP?

1. Ignores income distribution• Can be fixed using Gini coefficient

2. Rough measure of employment

3. Must use real or constant values• Always use deflators

4. Does not capture well quality of products

What is (not) included in GNP?

5. Excludes some non-market and non-productive transactions - but not all– Excluded– Things produced at home

• If women only counted• Childcare• Subsistence production

– Things that are resold or reused• Increased durability reduces growth

What is (not) included in GNP?

5. Excludes some non-market and non-productive transactions - but not all– Included

• Consumption/production at farms of food and fuel

• Rental income of all houses

What is (not) included in GNP?

6. Depreciation of the capital stock– Neither man-made (Included in NNP) -

increased depreciation increases growth– Nor natural capital

What is (not) included in GNP?

7. Treats some expenditures as final use - even if some are intermediate factors of production:

a) defensive expenditures• Households (included)• Firms (excluded)• Government (included)

b) Army expenditures (included)

What is (not) included in GNP?

8. No measure for leasure;• Increased work increases GNP

9. Urbanization increases GNP

10. Includes various expenditures such as:1. Commuting

2. National defense

3. Police

4. Sanitation etc.

What does GNP measure?

• Wealth?

• Sustainable income?

• Hicksian income?

• Economic development?

• Sustainable development?

• Economic welfare?

• Human welfare?