What Makes Nations Grow?

Session 3

MSc EPS

Hilary term 2011Professor Dermot McAleese

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OUTLINE

1) Trends in economic growth

2) Growth theories

3) Human welfare and sustainable growth

4) Economic convergence

5) Policies for growth

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WHAT IS ECONOMIC GROWTH?

Gross Domestic Product (GDP) - measure of output of goods and services

GDP per capita - level of output per person

Production frontier

Food

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R3

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WHAT IS ECONOMIC GROWTH?

Food

R2

R3

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Trends in Economic Growth

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SIX STYLISED FACTS ON ECONOMIC GROWTH

Growth - the norm

Rich stayed rich Poor better off since 1950s Diversity in performance Acute poverty persists Natural resources economic

success

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1. Growth is the Norm

Growth Rates 1965-2008

Source: World Bank World Development Indicators 2001.

Real GDP

Real GDP per head (% p.a.)

Population 2000

(millions)

Low income ($760 or less) countries(63) 5.9 3.7 3722

Middle income countries 3.7 1.9 1433

High income ($9,361 or more) countries (35)3 2.3 903

Note difference in pop figures since 2000. Low income now 2495m and middle income 2738m. In 2002 China graduated from low income to the lower middle income bracket. Low incomehad changed by 2010 to $995 or less, high income $12,196 or more

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SourcIMF WEO Apr09

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Table 6. Real GNP per person

Source: Computed from Angus Maddison, The World Economy: A Millenium Perspective (Paris: OECD, 2001) and IMF, World Economic Outlook, May 1999. Purchasing power parities have been used for the developing countries.

1900 1950 2000

Belgium 5039 7382 25216Denmark 4912 11064 25391Finland 2774 7070 22305France 2689 4942 24205Germany 3718 5986 22391Italy 2947 5097 21650Japan 1993 3287 23640Netherlands 4825 7991 23401Sweden 3793 9977 21084UK 5184 7729 21883US 5336 12274 31942

China 540 444 3484India 659 626 1951South Korea 904 928 13500Argentina 2865 5162 10199

Table 2.1 GNP per pers on for s elec ted indus trial c ountries at c ons tant 2002 US $

1900 1950 2002

B elgium 5236 7670 26019Denm ark 5104 11495 34281Finland 2882 7346 26660France 2794 5135 25888Germ any 3941 6219 26493Italy 3062 5296 21622Japan 2071 3415 36492Netherlands 5013 8303 26596S weden 3941 10366 28993United K ingdom 5386 8030 26460United S tates 5544 12753 36680

S ourc e: Com puted from A ngus M addison, The W orld E c onom y: A Millenial P erspec tive (P aris : OE CD, 2001) and the International M onetary Fund, W orldE c onom ic Outlook , A pril 2002.

2. The Rich stayed rich

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Rich stayed rich: Real GNP per person (1900, 1950, 2002) $

Finland 2774 7070 22305France 2689 4942 24205Germany 3718 5986 22391Italy 2947 5097 21650Japan 1993 3287 23640Netherlands 4825 7991 23401Sweden 3793 9977 21084UK 5184 7729 21883US 5336 12274 31942Morocco 807 1455 2693China 540 444 3484India 659 626 1951South Korea 904 928 13500Argentina 2865 5162 10199Mexico 1116 2011 9021

Source: Computed from Angus Maddison, The World Economy: A Millenium Perspective (Paris: OECD, 2001)

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Rich families also stay rich – rich parents have rich children

If you are twice as rich as the average of your generation in…

The US and the UK : your children can expect to be 40% higher income than the average for their generation and your grandchildren 16% richer than average for their generation.

Denmark, your children can expect to be 15% better off than average for their generation. Similar results for Sweden and Canada

Miles Corak, University of Ottawa; Gary Solon University of Michigan

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Source: World Bank Global Economic Prospects 2008

Know-how keeps rich countries rich …

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3. Poor Countries are better off since the 1950s

• Life expectancy has roughly doubled(Gap between developed and developing countries’ life expectancy was 30 yrs in 1950, 10 years in 2000)

• Proportion of children attending school has risen from less than 50% to more than 75%

• Average GDP per person has doubled

• China and India two most populous countries in the world have been driving forces in this improvement

DMcA p. 15

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Growth Rates 1965-2008

Source: World Bank World Development Indicators 2001.

Real GDP

Real GDP per head (% p.a.)

Population 2000

(millions)

Low income ($755 or less) countries(60) 5.9 3.7 3722

Middle income countries 3.7 1.9 1433

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4. DIVERSITY IN PERFORMANCE

China, India, South East Asia

Latin America

North Africa/ Middle East

Sub-Saharan Africa

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GDP per capita growth 1971-2010

1971-80 1981-90 1991-2003

2001-10

Asia 3.2 4.9 5.3 6.9

Latin America

3.3 -0.9 1.6 2.0

Middle East/N. Africa

4.0 -0.6 1.2 2.8

Sub-Saharan Africa

0.7 -1.1 -0.2 3.5

High Income Countries

2.6 2.5 1.8 1.7

World Bank Washington DC

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REAL GROWTH IN GDP PER PERSON 2001-2010

Source: World Bank Global Economic Prospects 2009

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5. Acute Poverty Persists

% living below $1 (PPP) a day

0 20 40 60

Middle East and North Africa

Eastern Europe and Central Asia

East Asia and Pacif ic

Latin America and the Caribbean

South Asia

Sub-Saharan Africa

2005 1987

S Chen and M Ravallion “The Developing World is Poorer than we Thought ..”Policy Research Paper 4703 World Bank August 2008

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Decline in income poverty 1981-2005

Share of people living on less than $1 (PPP US$) a day (%)

Region 1981 1990 2005

East Asia 68.7 40.6 9.5

Europe & Central Asia 0.7 0.8 3.4

Latin America 7.4 7.1 5.0

MENA 3.6 2.3 2

South Asia 41.9 33.6 24.3

Subsaharan Africa 39.2 45.9 39.2

World 41.7 29.8 16.1

Source Chen and Ravallion World Bank August 2008 Table 7

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The Bottom Billion

The Third World has shrunk.

For forty years the development challenge has been a rich world of one billion people facing a poor world of five billion people. …

By 2015 however it will be apparent that this way of conceptualising development has become outdated. Most of the five billion are developing often at an amazing speed.

The real challenge of development is there is a group of countries at the bottom that are falling behind and often falling apart.

Paul Collier The Bottom Billion: Why the Poorest Countries are failing and what can be done about it?Oxford University Press 2008

“Seeing the world differently” The Economist June 12th 2010.

Since 2008 developing countries have contributed almost all

global economic growth. Their share of world GDP at PPP has risen from 34% in the 1980s

to 43% in 2010. Trade between developing countries is growing twice as fast as

world trade. Emerging markets are donors of capital. China recently agreed to

finance oil refineries in Nigeria worth over $23 billion – nearly twice the overall aid to Africa over 5 years in one deal.

Yield on 10-year govt bonds is the same in Thailand as in America. The largest single foreign investment in Afghanistan is a Chinese-

owned copper mine in Aynak, 20 miles east of Kabul. Over next 25 yrs it plans to produce 11m tons copper, build a power station and construct a road to Kabul. (The International Independent 15 June 2010).

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6. Natural resources economic success

Major oil producers and economic growth

Saudi Arabia 263 73 -2.0 15,711

Iran, Islamic Rep. 127 93 -0.2 7,968

Iraq 118 100+ na na

United Arab Emirates 100 100+ -2.6 25,514

Kuwait 96 100+ -0.5 26,321

Venezuela 77 72 -1.0 6,632

Russian Federation 73 22 -0.7 10,845

Libya 32 66 2.5 6,621

Nigeria 30 43 -0.1 1,128

Source: World Bank, Economist July 17th 2004, UNDP Human Dev Report 2007/8

GDP per capita grow th 1975-2005

GDP per capita $2005(PPP)

Oil reserves (end-03, barrels bn)

Years of remaining reserves

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The Natural Resources (NR) trap

• Voracity effect: NR revenues leads to big government and often bad investment decisions

• Pressures generated by electoral competition reinforce the above effect (Nigeria)

• NR attracts FDI (good!) but often this bolsters unsavoury regimes (China’s investment in Angola, Chad has been criticised on these grounds)

• NR trap is a probabilistic tendency, not a immutable rule ...... Some countries use NR effectively (Norway, Botswana)

See Collier ch 3

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Growth Theories

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WHERE ECONOMICS BEGAN Adam Smith, Wealth of Nations, 1776

Productivity the key to wealth of nations (not gold, not balance of trade surplus)

Productivity enhanced by specialisation Dexterity Saving of time Machinery invented by workmen

Specialisation increased by enlarging the extent of the market Extent of market limited by Trade barriers

Monopoly ‘Invisible hand’ will even look after the poor!

‘in a well-governed society, opulence extends itself to the lowest ranks of the people’

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The Model

Y = A Kα L

1-α

• L = Labour

• K = Capital Stock minus 4% depreciation plus investment rate (% of GDP)

• A = Total factor productivity (TFP)

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GROWTH THEORIES

Quantity of inputsLabour --- population growth,

participation rates, hours worked per worker, unemployment rate

Capital --- physical (I/GDP ratio) --- human (education)

Total factor productivity Y = A.f(L, K). dA/A = dY/Y – a.dL/L – b. dK/K where a = wL/y and b = rK/y. This is the growth accounting approach. Y = g + h.L +j. K + f. A etc prod function approach. Total factor productivity (A) is unobservable. Also called multi-factor productivity

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SOURCES OF REAL GDP GROWTH (1999-2005)

Capital Labor TFP

China 3.3 0.7 5.1 9.1

East Asia 1.7 1.5 2.0 5.2

South East Europe 1.1 0.2 2.0 3.3

Latin America 0.9 1.7 -- 2.6

Source World Bank Unleashing Prosperity 2008

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OECD Economic Surveys: China, Feb 2010

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Total Factor Productivity (TFP)

A growing body of evidence suggests that, even after physical and human capital accumulation are accounted for, something else accounts for the bulk of cross country differences in the level and growth rate of GDP per head. Economists typically refer to the something else as total factor productivity

Easterly and Levine What have we learned from a decade of empirical research on growth? The World Bank Economic Review No 2 2001Baking a cake with exactly same set of ingredients. Some do it very well and produce splendid and varied cakes.

Others make a mess of it. How to explain. TFP differs across industries and across firms within industries.

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Easterly and Levine’s Stylised Facts (World Bank Economic Review Summer 2001)

• TFP a more crucial factor than factor accumulation (human and capital)

• TFP growth accounts for more than half of total growth in output per worker

• But we don’t know enough about which specific components of TFP matter most.

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TOTAL FACTOR PRODUCTIVITY (TFP/MFP)

advances in technologyredistribution of resources to higher

productivity sectorsterms of tradeinstitutional and political stabilityquality of the labour force

(human skills and motivation）economic policy

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Population and economic growth

• High population growth adversely linked with standard of living

• Stabilisation of population growth leads to transitional gain as dependency rate falls

• Zero or negative population growth also has adverse implications for living standards. High elderly dependency becomes the next “problem”

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China’s population

TOTAL (thousands)

1,100,000

1,150,0001,200,000

1,250,0001,300,000

1,350,0001,400,000

1,450,0001,500,000

1,550,000

2000 2010 2020 2030 2040 2050

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Age dependency rates for selected countries 1960-1999

Note: age dependency = (pop 0-14 + pop 65+)/pop 15-64

Source: World Bank WDI

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China’s age dependency ratio 2000-2045

30.0

35.0

40.0

45.0

50.0

55.0

60.0

65.0

2000 2005 2010 2015 2020 2025 2030 2035 2040 2045

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2000 2010 2030 2045Japan 46.6 55.3 71.7 91.0France 53.6 52.8 67.9 73.7Germany 46.0 49.4 69.9 83.6China 48.0 40.3 50.5 62.5

AGE DEPENDENCY RATE

Source: World Bank 2005ADR = Pop (0-14 + 65+) % pop (15-64)

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ELDERLY DEPENDENCY RATIOS 2000

Elderly pop (m) Active Pop (m)

China

Japan

United States

Elderly dependency

20

25

ratio (%)1288

22

36

853

87

186

China’s elderly ratios: 2000 - 12 elderly per 100 workers

2010 – 16 elderly per 100 workers 2025 - 32 elderly per 100 workers 2050 - 61 elderly per 100 workers

Increase from 88m in 2000 to 438m in 2050Source: World Bank, Center for Strategic and International Studies Wash DC

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World’s largest countries by population (million)

2007 2050

China 1329 India 1658

India 1169 China 1409

Unites States 306 United States 402

Indonesia 232 Indonesia 297

Brazil 192 Pakistan 292

Pakistan 164 Nigeria 289

Bangladesh 159 Brazil 254

Nigeria 148 Bangladesh 254

Russian Federation 142 Congo 187

Japan 128 Ethiopia 183

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Population growth: Uganda case study

Despite HIV rate that peaked at 30% in the 1990s Uganda now has one of the world’s fastest growing populations (3.3% pa 2005-2010).

17m 1990, 31m 2007, 60m 2030, 103m 2050. President Museveni thought this was desirable, and that higher population should be a target for Uganda’s policy!

56% of population is under the age of 18Fertility rate: 6.4 children per woman

Total GDP growth 1990-2007 7%, GDP per head 3.5%.Increase in population means that growth has to be spread over larger

numbers of people.

Economists have attributed 40% of east Asia’s per capita growth between 1965-1990 to its beneficial population structure – and to the decline in its dependency ratio.

Source: HDR Report 2009 Tables L and M

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CLASS EXERCISE: RECENT GROWTH EXPERIENCE

1. How many countries have experienced annual average growth in real GDP per head <1% during the period 1990-2008? How do you explain their poor performance? Do these countries have any special economic or geographic characteristics that separate them from other countries?

2. What countries experienced rapid GDP per head growth

(>3% p.a.)? How do you explain their strong performance? Do they have any common characteristics? What lessons do they have to offer to the slow-growth countries?

3. Taking a general view, is the global trend one of

convergence of living standards between poor and rich countries, or is the process one of “the rich getting richer and the poor getting poorer”?

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Class Exercise

Explain how an increase in each of these variables would be expected to affect growth

of GDP per capita :

• Initial income level • Initial level of schooling• Population growth • Investment/GDP ratio• Terms of trade• Degree of openness/globalisation• Government consumption/GDP• Democracy

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Class exercises (2)

• Q for D 4, p. 39 (Asia vs Africa)

• Q for D 5, p. 39 (growth of firm vs growth of economy)

• E4, p. 39

• E 6, p. 40 (India and China case)

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Exercise 6 p.40

a) India's per capita GDP was $2675 in 2002 (PPP basis).

Assuming a growth rate of 3 per cent per person was sustained,

how many years will it take India to reach the average per capita

GDP level in developed countries of about $28,744? b) Suppose

industrial countries continue to grow at 2 per cent per year, how

long before India catches up with the industrial countries?

Comment on the plausibility of these projections? c) Do same

exercise for China. Assume China’s GDP per capita is $5003

(PPP) in 2003, take $30,300 as figure for developed countries and

assume China’s per capita GDP grows at 7% p.a.

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Question for Discussion

With appropriate economic policies and institutions, rapid economic growth is achievable almost anywhere

Thorvaldur Gylfason Principles of Economic Growth 1999

Do you agree?

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Human Welfare and Economic Growth

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GDP AS MEASURE OF WELFARE

Household economy

Voluntary activities

Shadow economy (positive aspects)

Leisure

Inputs classified as output (police, defence spending)

Environmental degradation

Exhaustion of natural resources

ADD:

SUBTRACT:

TO IMPROVE GDP AS MEASURE OF WELFARE ….

Leisure

Household contribution

Voluntary activities

Shadow economy (positive aspects)

Environmental damage

Depletion of natural resources

Inputs classified as output (defence, cost of pollution control)

Add:

Subtract:

Take account of:Income distribution

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When there are large changes in inequality (more generally a change in income distribution) gross domestic product (GDP) or any other aggregate computed per capita may not provide an accurate assessment of the situation in which most people find themselves.

If inequality increases enough relative to the increase in average per capita GDP, most people can be worse off even though average income is increasing

Report by the Commission on the Measurement of Economic Performance and Social Progress, J Stiglitz, A Sen and J Fitoussi Paris 2009 . Report presented to the President of France.

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The commonly used statistics may not be capturing some phenomena, which have an increasing impact on the well-being of citizens.

For example, traffic jams may increase GDP as a result of the increased use of gasoline, but obviously not the quality of life.

Moreover, if citizens are concerned about the quality of air, and air pollution is increasing, then statistical measures which ignore air pollution will provide an inaccurate estimate of what is happening to citizens’ well-being.

Or a tendency to measure gradual change may be inadequate to capture risks of abrupt alterations in the environment such as climate change.

Report by the Commission on the Measurement of Economic Performance and Social Progress, J Stiglitz, A Sen and J Fitoussi Paris 2009

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Environmental damage

Depletion of natural resources

Inputs classified as output (defence, cost of pollution control)

World Bank estimates that the total annual cost of air and water pollutionIn China amounts to 5% of China’s GDP.

This measure is contested. It relies on estimates of the effect ofpollution on health.

Report finds that China’s poor are disproportionately affected by pollution.

Source: World Bank web page. This World Bank study was referred to in James Fallows Postcards from Tomorrow Square: Reports From China Vintage 2009

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CHINA (OECD 2010)

Source: www.oecd.org

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GDP and Human Development Index

HDI is a weighted average of data on: GDP per head Life expectancy at birth Years of schooling and adult literacy

HDI and GDP per head ranking is very similar (see next table)

High income, better health and more education tend to proceed in tandem

Research continues on direction of causality.

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The basic purpose of development is to enlarge people’s choices. ..

People often value achievements that do not show up at all, or not immediately, in income or growth figures: greaterassess to knowledge, better nutrition and health services, more secure livelihoods, security against crime and physical violence, satisfying leisure hours, political and cultural freedoms and sense of participation in community activities.

The objective of development is to create an enabling environment for people to enjoy long, healthy and creative lives.

Mahbub ul HaqFounder the the Human Development Report

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Developing countries: HDI GDP per capSouth Korea 26 35Chile 44 59Mexico 53 58Saudi Arabia 59 40Brazil 75 79Philippines 105 124Turkey 79 63China 92 86Algeria 104 88South Africa 129 78Indonesia 111 121Egypt 123 103Morocco 130 118India 134 114Botswana 125 60Zambia 164 176S Leone 180 175Note: Blue denotes a better HDI ranking, Red denotes a better GDP per capita ranking.

Source: HDR 2009 table H

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1) Does GDP per capita growth = Happiness?

2) Does high level of GDP per capita = Happiness?

1) Weak correlation between economic growth and happiness index (‘Are you feeling satisfied with your life’)

Sources: Andrew Oswald, University of Warwick

Robert Frankel, Yale University

2) Weak correlation between income level and happiness up to a certain threshold.

3) Beyond that threshold, income distribution matters more. More unequal societies have more unhappiness

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Happiness and income: the weakest link

59Peter Sanfey “Does Transition make you happy?” EBRD working paper no 91, April 2005

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Layard (continued)

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Why do GDP and Happiness differ?

• Many goods are ‘Positional goods’ – status symbols

• Externalities – e.g. if everyone has a car, congestion costs increase

• Relative poverty creates major feelings of unhappiness

• Longevity is good, but leads to high medical bills and rise in dependency ratio

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Policy Implications

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POLICY PRESCRIPTION FOR GROWTH Give priority to economic efficiency

Government to complement rather than replace market forces

Stable, transparent institutional framework Competition policyLabour market policy InfrastructureEducation system for new tech activities

Poor macro management significantly impairs growth

Outward orientated policies help growth

Economic environment should encourage and mobilise individual effort in a socially productive way

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Conclusions• Growth a complex process, no easy

blueprint• New economic consensus helps most

countries and some more than others, but it is not sufficient

• Economic growth will not occur when there is political instability and absence of property rights. Hence emphasis on TFP, institutions, governance and stability

• We still have big gaps in knowledge about key binding constraints on growth. They differ from country to country

• Climate change and sustainable growth are pushing up the agenda

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Question for Discussion

The growth of global trade has been wonderful for Asia. But don’t count on trade to help the bottom billion. Based on present trends, it seems more likely to lock yet more of the bottom-billion countries into the natural resource trap than to save them through export diversification

Paul Collier The Bottom Billion p. 87