Overcoming Barriers to Riches

Edward C. PrescottArizona State University

andFederal Reserve Bank of Minneapolis

Key Development Facts

Prior to 1700, constant living standard varied little across countries and over time.

After 1700, living standards began to increase in some countries.

After 1850, they doubled every 35 years – modern economic growth.

Explosive Growth Post-1800

Leader's Per Capita GDPRelative to Pre-1800 Level

0

10

20

30

40

2000 bc 1000 bc 0 1000 2000

1

U.S. GDP per Capita

1880 1900 1920 1940 1960 1980 2000

Source: Maddison

1990

U.S

. $

2,000

32,000

16,000

8,000

4,000

Trend Growth2% per year

England entered modern growth first, U.S. and Western Europe a little later.

Many countries entered much later (post-1950).

As a result, income disparities widened to their current huge levels.

Some late starters have caught up; some have not.

Per Capita GDP Trends (1990 U.S. $)

1800 1850 1900 1950 2000Source: Maddison

Japan

Leader

500

1,0002,0004,000

8,000

16,00032,000

Different Countries Start at Different Times

China

Taiwan

Regional Growth Patterns

Income: Fraction of the Leader, 1800-2004

1800 1850 1900 1950 2000

Western Europe

Latin America

Eastern Asia

China

1

1/2

1/4

1/8

1/16

Land crucial to production. Trade-off between living standards and population size.

Increases in stock of usable knowledge led to increase in output. But, population increases led to no increase in living standards.

Why: Groups maximized living standards subject to constraint that they could defend their land.

Theory of Pre-1700 Period

No trade-off between increases in living standards and population size.

Increases in stock of usable knowledge lead directly to increases in living standards.

Key feature is the use of fossil fuels for energy rather than land.

Theory of Post-1850 Period

Problem with Theory

Why didn’t all countries start modern economic growth at the same time?

Parente and Prescott’s theory: A society’s productivity depends on the set of constraints society imposes as well as the stock of usable knowledge.

A country loses ground relative to leader prior to entry into modern economic growth.

Catch-up occurs only if production efficiency E increases.

Large increase in E leads to growth miracle with doubling of living standards in 12 years.

Constraints That Reduce Productivity

Constraint 1: How a technology must be operated– Examples: Work rules, inspections and bribes. In Brazil:

Full-service gas stations; elevator operators; public transportation. In Australia: “One-in-all-in,” patmen, one man one forklift rule; H.R. Nichols Society, vol 3.

Constraint 2: Which technologies can be operated – Examples: Regulation, laws, bribes. See DeSoto for

problems in opening a small Peruvian business.

Why Constraints Exist

Typically constraints exist to protect industry insiders with vested interest in current production processes.

Adoption sometimes leads to loss of employment and/or earnings either because factor is specialized with respect to current production process, or because industry faces inelastic demand for its product.

A Recent Example

The Segezhabumpron Paper Mill, Karelia, Russia. (Fox and Heller 2000)

Early 1990s, Assidoman of Sweden acquired majority stake

$100 million planned modernization expenditure

Fear of job loss

Campaign to force out Swedes– Judicial challenge on the legality of purchase– Threats of violence– Refusal of regional government to co-fund working capital

Why Country Barriers Differ

Question: What type of arrangements lead to result that it is not in best interest for industry groups to block adoption of better technology (either by threats and protests or by lobbying government for protection)?

Answer: Being a member of a free trade club.

Definition of Free Trade Club

A set of states constitutes a free trade club if

– Members cannot impose tariffs and restrict imports from other members.

– Members have a considerable degree of economic sovereignty from collective entity.

– Property rights of member states are protected.

USA’s Golden Economic Era1865-1929

Per capita income went from two-thirds of U.K.’s in 1865 to 100% in 1900.

Surged past U.K. and in 1928 was 1.3 times U.K.’s.

Why: USA became a free trade club.

EU Labor Productivities Relative to U.S.

Year Original EU

1870 62

1913 53

1929 52

1959 53

1973 78

1983 84

1993 102

2002 101

Why Did the Original EU Countries Catch Up?

Answer: Original EU countries became a free trade club like U.S. in 1957.

Why Being in a Free Club Fosters Higher E

No centralized mechanism to block adoption of better production processes in all member states.

Export industries in state face elastic demand; implies employment increases when efficiency increases; thus, no vested interests in inefficiency.

Exporters have vested interest in continual membership in club.

Another Reason

States without groups that will not be adversely affected by introduction of some technology and with groups that will benefit want the better technology adopted there.

Example: Toyota in 1985 located automobile plant in Kentucky introducing just-in-time production in U.S. A powerful construction industry wanted construction project. Kentuckians wanted high paying jobs in auto plant. The same thing happened in Wales.

Why Didn’t Latin America Catch Up?

Latin America is not a free trade club.

If it became one, it would catch up.

What about the Asian Tigers and other Asian economies?

South Korea and Taiwan were forced by U.S. and defense needs to permit efficiency.

Japan did virtually all its catching up after World War II after occupation forces imposed new institutions.

Singapore followed policy of openness.

In Hong Kong colonial authority did not permit constraints that lead to large inefficiencies.

A European-like trading club has developed in Asia.

What about China? It was decentralized in late 1970s, a step in the direction of a trading club.

India has huge diversity and could evolve into a trading club and become rich.

Conclusion

Openness good; trade volumes not critical.

Some reason for hope? – Last election Americans voted for openness.– European Union was expanded by 10 in 2004.– A number of Asian countries are becoming

open countries that are integrated with the advanced industrial countries.

Taiwan and four other Asian economies have become rich.