Sources of Economic Growth Revisited Thorvaldur Gylfason

Sources of Sources of Economic Economic Growth Growth RevisitedRevisited

Thorvaldur Gylfason

Growing Together, Growing Apart

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Spain vs. ArgentinaSpain vs. ArgentinaThailand vs. BurmaThailand vs. Burma

Finland vs. EstoniaFinland vs. Estonia

West Germany vs. East GermanyWest Germany vs. East Germany

South Korea vs. North KoreaSouth Korea vs. North Korea

Botswana vs. NigeriaBotswana vs. Nigeria

Tunisia vs. MoroccoTunisia vs. Morocco

Mauritius vs. MadagascarMauritius vs. Madagascar

Taiwan vs. ChinaTaiwan vs. China

Rapid growth

Slow growth

Austria vs. CzechoslovakiaAustria vs. Czechoslovakia

One more:One more:Chile vs. ZambiaChile vs. Zambia

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Botswana, Ghana, and Nigeria: GNP per capita 1964-97

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Kenya, Tanzania, and Uganda: GNP per capita 1964-97Case 2


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Burma and Thailand: GNP per capita 1960-97Case 3

Local currency, 1988 prices, 1960 = 100

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Barbados, Dominican Republic, and Haiti: GNP per capita 1964-97

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Egypt, Morocco, and Tunisia:GNP per capita 1964-97Case 5


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Argentina, Uruguay, and Spain:GNP per capita 1964-97Case 6


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Madagascar and Mauritius:GNP per capita 1964-97Case 7


Chile and Zambia:GNP per capita 1964-98Case 8

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Zambia


GNP per capita, ppp-adjusted, 1975-98

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urr

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Lesotho Malawi

Namibia Swaziland

Tanzania Uganda

Zambia Zimbabwe

Eastern & Eastern & Southern Southern Africa:Africa:A Quick A Quick Glance*Glance*

* MEFMI members only.* MEFMI members only.

Economic Growth: The Short Run vs. the Long Run

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Actual output

Potential output

Business cyclesin the short run

Economic growthin the long run

Downswing

Upswing

The crisis of 1997-98 is irrelevant to Asia’s long-term growth potential.

Economic Growth: The Short Run vs. the Long Run

To analyze the movements of To analyze the movements of actualactual output from year to year, viz., in the output from year to year, viz., in the shortshort run runNeed short-run macroeconomic theoryNeed short-run macroeconomic theory

Keynesian or neoclassicalKeynesian or neoclassical

To analyze the path of To analyze the path of potentialpotential output output over over longlong periods periodsNeed modern Need modern theory of economic growththeory of economic growth

Neoclassical or endogenousNeoclassical or endogenous

Traces the rate of growth of output per capita to a single source:

Technological progressTechnological progress

Hence, economic growth in the long run is immune to economic policy, good or bad.

“To change the rate of growth of real output per head you have to change the rate of technical progress.”

ROBERT M. SOLOW

The Neoclassical Theory of Exogenous Economic Growth

The New Theory of Endogenous Economic Growth

“The proximate causes of economic growth are the effort to economize, the accumulation of knowledge, and the accumulation of capital.”

W. ARTHUR LEWIS

Traces the rate of growth of output Traces the rate of growth of output per capita to three main sources:per capita to three main sources:

SavingSaving

EfficiencyEfficiency

DepreciationDepreciation

Exogenous vs. Endogenous Growth

The neoclassical viewThe neoclassical viewthat economic growth in the long run is that economic growth in the long run is

merely a matter of merely a matter of technologytechnology does not does not throw much light on the spectacular growth throw much light on the spectacular growth performance of Asia since the 1960s.performance of Asia since the 1960s.

The new viewThe new viewthat long-run growth depends on that long-run growth depends on savingsaving, ,

efficiencyefficiency, and , and depreciationdepreciation is more is more illuminating.illuminating.

Besides, it’s not really new, because Adam Besides, it’s not really new, because Adam Smith knew this (1776). Smith knew this (1776).

Sources of Endogenous Growth I

Saving Saving Fits real world Fits real world experienceexperience quite well quite well

No coincidence that, in East Asia, saving rates of No coincidence that, in East Asia, saving rates of 30-30-40%40% of GDP went along with rapid economic growth of GDP went along with rapid economic growth

No coincidence either that many African economies with No coincidence either that many African economies with saving rates around saving rates around 10%10% of GDP have been stagnant of GDP have been stagnant

OECD countries: saving rates of about OECD countries: saving rates of about 20%20% of GDP of GDP

Important implication for Important implication for economic policyeconomic policy::Economic stability with Economic stability with low inflationlow inflation and positive real and positive real

interest rates spurs saving, which is interest rates spurs saving, which is good for growth.good for growth.

Sources of Endogenous Growth I

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19651965 19901990

East AsiaEast Asia

OECDOECD

AfricaAfrica

High saving rates

High saving rates

Medium saving rates

Low saving rates

IncomeIncomeper capitaper capita

Growth and Investment, 1975-98

Botswana

Uganda

Swaziland

Lesotho

ZambiaTanzania

Angola

ZimbabweNamibia

Malawi

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Investment (% of GDP)

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(%

pe

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r)Each ten percentage point increase in the investment ratio is associated with an increase in per capita growth by 1½% per year.

Ten MEFMI countries

Growth and Investment, 1965-98

33 sub-33 sub-Saharan Saharan African African countriecountriess

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Investment (% of GDP)

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r)Each ten percentage point increase in the investment ratio is associated with an increase in per capita growth by 1½% per year.

Sources of Endogenous Growth II

Depreciation Depreciation The effect of depreciation on growth is related The effect of depreciation on growth is related

to that of saving and investment on growth.to that of saving and investment on growth.Unprofitable investment in the past reduces Unprofitable investment in the past reduces

the the quality of capitalquality of capital and makes it depreciate and makes it depreciate more rapidly, necessitating more replacement more rapidly, necessitating more replacement investment to make up for economic and investment to make up for economic and physical wear and tear.physical wear and tear.

The more national saving has to be set aside The more national saving has to be set aside for replacement investment, the less will be for replacement investment, the less will be available for the available for the buildup of new capitalbuildup of new capital. .

Investment: Quantity and Quality

Compare Botswana and Tanzania:Compare Botswana and Tanzania:In In BotswanaBotswana, the share of State-Owned , the share of State-Owned

Enterprises in total investment fell Enterprises in total investment fell from 16% in 1985-90 to 12% in 1990-from 16% in 1985-90 to 12% in 1990-97. 97.

In In TanzaniaTanzania, the SOE share of , the SOE share of investment fell from 46% in 1985-90 investment fell from 46% in 1985-90 to 23% in 1990-97. to 23% in 1990-97.

This is probably a good sign.This is probably a good sign.Privatization helpsPrivatization helps improve investment. improve investment.

Investment: Quantity and Quality

Investment quality, however, is Investment quality, however, is not only a question of public vs. not only a question of public vs. private enterprise. private enterprise.

Sound bankingSound banking is also important. is also important.It takes sound commercial banks, It takes sound commercial banks,

usually usually privately ownedprivately owned banks banks motivated by profit rather than by motivated by profit rather than by political concerns, to channel political concerns, to channel household savings into household savings into high-high-quality investmentquality investment. .

Sources of Endogenous Growth III

EfficiencyEfficiencyAlso fits real world experience quite wellAlso fits real world experience quite well

Technical progress is good for growth because it allows Technical progress is good for growth because it allows us to us to squeeze more output out of given inputssqueeze more output out of given inputs..

And that is exactly what increased And that is exactly what increased efficiencyefficiency is all is all about! about!

Thus, technology is best viewed as an aspect of general Thus, technology is best viewed as an aspect of general economic efficiency. economic efficiency.

Important implication for Important implication for economic policyeconomic policy::Everything that increases economic efficiency, no matter Everything that increases economic efficiency, no matter

what, is also what, is also good for growthgood for growth..


Five sources of increased efficiencyFive sources of increased efficiency1.1. LiberalizationLiberalization of prices and trade increases of prices and trade increases

efficiency, which is efficiency, which is good for growthgood for growth..

2.2. StabilizationStabilization reduces the inefficiency associated with reduces the inefficiency associated with inflation, which is inflation, which is good for growthgood for growth..

3.3. PrivatizationPrivatization reduces the inefficiency associated with reduces the inefficiency associated with state-owned enterprises, which …state-owned enterprises, which …

4.4. EducationEducation makes the labor force more efficient. makes the labor force more efficient.

5.5. Technological progressTechnological progress also enhances efficiency. also enhances efficiency.

The possibilities are virtually endless!The possibilities are virtually endless!


This is This is good newsgood news..If growth were merely a matter of technology, we If growth were merely a matter of technology, we

would not be able to do much about it …would not be able to do much about it …… … except to follow technology-friendly policies by except to follow technology-friendly policies by

supporting supporting R&DR&D and such. and such.

But if growth depends on saving and efficiency, But if growth depends on saving and efficiency, there are things that we there are things that we can docan do, in the private , in the private sector as well as through the public sector, to sector as well as through the public sector, to foster rapid economic growth.foster rapid economic growth.

Because Because everything that is good for saving and everything that is good for saving and efficiency is also efficiency is also good for growthgood for growth..

What to Do to Encourage Economic Growth

Recap

Maintain strong incentives to Maintain strong incentives to savesaveKeep Keep inflationinflation low and low and real interest ratesreal interest rates positive positive

Maintain Maintain financial systemfinancial system in good health in good healthso as to channel saving into high-quality investmentso as to channel saving into high-quality investment

Foster Foster efficiencyefficiency1.1. Liberal price and trade regimes Liberal price and trade regimes

2.2. Low inflation Low inflation

3.3. Strong private sector Strong private sector

4.4. More and better education More and better education

5.5. Limited, or well managed, natural resources Limited, or well managed, natural resources

Liberalization and Economic Growth

Liberalization of pricesLiberalization of prices means that markets, means that markets, not bureaucrats, are allowed to set prices. not bureaucrats, are allowed to set prices. Mixed market economy is Mixed market economy is more efficientmore efficient than than

central planning.central planning. Compare former Soviet Union with the US and Compare former Soviet Union with the US and

EuropeEurope

Liberalization of tradeLiberalization of trade allows specialization allows specialization according to comparative advantage.according to comparative advantage.Free trade is Free trade is more efficientmore efficient than self-sufficiency. than self-sufficiency.

North Korea and Cuba vs. Hong Kong and SingaporeNorth Korea and Cuba vs. Hong Kong and Singapore

Applies to trade in goods, services, capital.Applies to trade in goods, services, capital.

Growth and Trade, 1975-98

Botswana

Swaziland

Lesotho

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Angola

Tanzania

Uganda

Zimbabwe

Malawi

Namibia

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Each ten percentage point increase in the trade ratio is associated with an increase in per capita growth by almost 1% per year.

Ten MEFMI countries

Growth and Trade, 1965-98


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Trade (% of ppp-adjusted GDP)

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Growth and FDI, 1975-98

Botswana

Swaziland

LesothoUganda

Namibia

ZambiaTanzania

Zimbabwe

Malawi

Angola

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Foreign direct investment (% of GDP)

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r)Each one percentage point increase in the FDI ratio is associated with an increase in per capita growth by 1% per year.

Ten MEFMI countries

Relationship depends on the inclusion of Botswana.

Growth and FDI, 1965-98

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Each one percentage point increase in the FDI ratio is associated with an increase in per capita growth by almost 1% per year.


Relationship depends on the inclusion of Botswana.

Stabilization and Economic Growth

Stabilization of pricesStabilization of prices means that distortions means that distortions associated with inflation are reduced.associated with inflation are reduced. InflationInflation distorts the choice between real and financial distorts the choice between real and financial

capital by punishing money holdings, and thus capital by punishing money holdings, and thus creates creates inefficiency inefficiency in production.in production.

Inflation thus involves a tax, the Inflation thus involves a tax, the inflation taxinflation tax.. An An inefficient taxinefficient tax compared with most other taxes. compared with most other taxes.

Inflation also creates Inflation also creates uncertainlyuncertainly which tends to which tends to discourage trade and investment. discourage trade and investment.

Inflation also tends to result in Inflation also tends to result in overvaluationovervaluation of of currency, thus hurting exports and growth.currency, thus hurting exports and growth.

Privatization and Economic Growth

PrivatizationPrivatization means that profit-oriented means that profit-oriented owners and able managers are allowed to owners and able managers are allowed to direct enterprises.direct enterprises.Profit motiveProfit motive replaces political considerations as replaces political considerations as

the guiding principle of business operations.the guiding principle of business operations.Profit-maximizing owners generally want to appoint Profit-maximizing owners generally want to appoint

managers and staff on merit rather than on the managers and staff on merit rather than on the basis of political connections, for example.basis of political connections, for example.

Private enterprise is generally Private enterprise is generally more efficientmore efficient than state-owned enterprises.than state-owned enterprises.

Education and Economic Growth

EducationEducation means a better trained and hence means a better trained and hence more efficientmore efficient work force. work force. Need to provide primary and secondary education Need to provide primary and secondary education

to all, especially femalesto all, especially females Need to provide tertiary education to a greatly Need to provide tertiary education to a greatly

increased number of peopleincreased number of people Need increased public commitment to educationNeed increased public commitment to education This requires both increased This requires both increased public expenditurepublic expenditure on on

education and probably also increased scope for education and probably also increased scope for private sector involvementprivate sector involvement in education. in education.

Growth and Education, 1975-98

Botswana

Swaziland

NamibiaZimbabwe

Angola

ZambiaTanzania

MalawiUganda

Lesotho

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Each two percentage point increase in the education expenditure ratio is associated with an increase in per capita growth by almost 1% per year.

Ten MEFMI countries

Growth and Education, 1965-98

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Natural ResourcesNatural Resources and and Economic GrowthEconomic Growth

Natural resources, if not well Natural resources, if not well managed, may turn out to be, managed, may turn out to be, at best, a at best, a mixed blessingmixed blessing..

Three possible channelsThree possible channels EducationEducation Dutch diseaseDutch disease Rent seekingRent seeking

What is the evidence?What is the evidence?

Natural Resources and Economic Growth 1965-98

Abundant natural resources, if not well Abundant natural resources, if not well managed, appear managed, appear harmful to growthharmful to growth..

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86 countries

A ten percentage point increase in the natural capital share goes along with a decrease in per capita growth by nearly 1% per year.

Natural Resources and Education

90 countries

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Abundant Abundant natural natural resources resources appear to appear to crowd out crowd out human human resourcesresources..

Natural Resources and Corruption

Abundant Abundant natural natural resources resources appear to appear to go along go along withwith corruptiocorruptionn..

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What Is the Upshot?What Is the Upshot?

Economic growth responds to Economic growth responds to public policypublic policy..

In particular, by encouragingIn particular, by encouragingsaving and saving and investmentinvestment of high of high

qualityqualityforeign foreign tradetrade and investment and investmenteducationeducation

... the government can help foster ... the government can help foster rapid rapid economic growtheconomic growth. .

Sir Arthur Lewis Got It Sir Arthur Lewis Got It RightRight

Since the second Since the second world war it has world war it has become quite clear become quite clear that rapid economic that rapid economic growth is available growth is available to those countries to those countries with adequate with adequate natural resources natural resources which which make the make the effort to achieve iteffort to achieve it..

W. ARTHUR LEWISW. ARTHUR LEWIS(1968)(1968)

What Else?What Else?These lessons are borne out by These lessons are borne out by

experience from around the world.experience from around the world.Additional lessons:Additional lessons:

Too much Too much inflationinflation hurts saving, investment, hurts saving, investment, and trade and trade — and thereby also growth. and thereby also growth.

Too much Too much SOESOE activity hurts the quality of activity hurts the quality of investment and education investment and education — and growth. and growth.

Too much Too much agricultureagriculture and, more generally, and, more generally, natural resource dependencenatural resource dependence, if not well , if not well managed, hurts education and trade managed, hurts education and trade — and and thereby also growth. thereby also growth.

Too rapid Too rapid population growthpopulation growth also also tends to tends to impede economic growth.impede economic growth.

ReservationsReservationsEven so, the question of rapid growth is, Even so, the question of rapid growth is,

of course, a bit more complicated.of course, a bit more complicated.We also need to address a host of We also need to address a host of

politicalpolitical, , socialsocial,, and and culturalcultural questions questions as well as questions of as well as questions of naturalnatural conditions, climate, and public health conditions, climate, and public health — which would take us too far afield..

But the main point remains:But the main point remains:To grow or not to growTo grow or not to grow is in large measure a is in large measure a

matter of choicematter of choice..Many of the constraints on growth are Many of the constraints on growth are man-man-

mademade, and can be removed., and can be removed.

In Conclusion: In Conclusion: It Can Be It Can Be DoneDone These slides can be viewed on my

website: www.hi.is/~gylfason/malta.ppt

The

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The

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So, the legacy of inadequate policies So, the legacy of inadequate policies that tends to be regarded as a sign that tends to be regarded as a sign of weakness may be turned into of weakness may be turned into strength.strength.

There is, thus, a sense in which we can There is, thus, a sense in which we can say:say:The worse, the better! The worse, the better!

Remember the main point of Gunnar Remember the main point of Gunnar Myrdal’s Myrdal’s Asian DramaAsian Drama (1968)? (1968)? It was that the Asian economies were It was that the Asian economies were

incapable of rapid economic growth!incapable of rapid economic growth!

I believe that those who make similar I believe that those who make similar claims about Africa will also be claims about Africa will also be proven wrong.proven wrong.

Documents

Sources of Economic Growth Revisited Thorvaldur Gylfason