Vicious and Virtuous Circles

Vicious and Virtuous Circles Vicious circle of debt Debt  Child Labor  Low Education  Poverty Note Bernanke’s warning … Budget deficit  Debt  Interest rates Virtuous circle of development Per capita real GDP  Health  Productivity

W.W. Rostow: Best & the Brightest?Stages of Economic Growth Traditional Society Transition: Preconditions to Take Off Emergence of Capitalist/Commercial Sector Finance/Transport Infrastructure Take Off Political change  Protection of private property Accumulation  Compound Growth Maturity Diversification / Import Substitution Mass Consumption Society / Welfare State

Penn World Table: Heston, Summers, Aten Want Real GDP in comparable units ($2000) • Define global output basket • Price the basket in each country • Basket costs …………….. ZL 220 in Poland • Basket costs ………………$ 100 in U.S. • PPP Exchange Rate …….. ZL 2.2/$1 (as opposed to market exchange rate of ~ ZL 4/ $1

Penn World Table:Heston, Summers, Aten • Polish 2004 gdp per capita ………. ZL 22,560 • Translated to $s @ ZL 2.19/$ ………$ 10,484 • This was Polish PPP per capita gdp in 2004 $s • It was 26.5% as great as US gdp per capita in 2004 • If Polish gdp had been translated into dollars at the 2004 market exchange rate of ZL 3.66/$, Polish gdp would have measured only $6,273 per capita • only 15.9% of US per capita gdp of $39,535 • 2004 dollars don’t go as far as 2000 dollars • Adjusting for dollar inflation, 2004 Polish Real GDP Per Capita in 2000 dollars is $9,705 in PPP dollars • This compares with 2003 real gdp per capita of $9,216 • Poles enjoyed a 5.3% growth in real per capita gdp

Growth and Development in Picturesy = f(Factors & Productivity)Productivity  Technology & Efficiency

Latin American Countries Argentina 7.1 Brazil 11.6 Chile 6.2 Mexico 13.4 Venezuela 16.2 Colombia 6.5 Peru 10.5 Ecuador 9.1 Costa Rica 10.5 El Salvador 6.8 Honduras 3.5 Nicaragua 8.3 Other Countries USA 27.5 Hong Kong 38.5 South Korea 10.0 Japan 21.6 India 2.0 Germany 18.3 United Kingdom 23.8 Italy 16.2 Israel 17.0 Ivory Coast 4.7 Kenya 2.0 Somalia 1.0 Estimated Country Effects, (Ai Relative to Lowest)Yit = Kitα (Ai Lit )(1-α)Source: Nazrui Islam, Growth Empirics, QJE 11/95

Adam Smith’s Glorious Vision Accumulation + Division of Labor = Cumulative Progress

Adam Smith • Accumulation: • “capitals are increased by parsimony and diminished by prodigality and misconduct.” • Division of labor: • “… natural propensity among men to truck, barter, and exchange one thing for another.”

Adam Smith: • The division of labor is limited by the extent of the market. • Free Trade  Extended Market

Adam Smith:Limit to Growth • Accumulation | • Competition Up | • Profit Down • Steady State: “that full complement of riches which the nature of [a nation’s] soil and climate, and its situation with respect to other countries, allow it to acquire.”

Getting to Take-Off: Foreign Aid? Harrod – Domar Model  Financing Gap Y = k K • Labor doesn’t matter  there’s surplus labor Sir W. Arthur Lewis • Constant marginal productivity of capital ΔY = kΔ K = k I g = ΔY/Y = k (I/Y) • Investment share of gdp limited to national saving … unless you get injections from abroad • With k = output:capital ratio ≈.25, need saving rate of 20% to achieve growth of 5%  Poor country needs grants and loans … foreign aid Rostow: Once growth takes off, national saving up Easterly: But it doesn’t – incentive is to consume

Vicious and Virtuous Circles