Economics: an introductionGrowth and Development GrowthEconomics Roberto Pasca di Magliano 2015/2016
Origins of Liberalism: Adam Smith • The father of liberalism is considered Adam Smith who published in 1776 “The Wealth of Nations”, the birth of modern economics • Smith’s theories designed the modern economic thought by discovering the superiority of the free market over any other structure • Among the many ideas put forward by Smith, one was particularly successful: that of the famous metaphor of the “invisible hand”
The « Invisible Hand » • The metaphor of the invisiblehandis the basis of the liberal view of the market economy • The market (asifitwereguided by an invisiblehand), ifleft free to operate according to itsownrationallogic, produces an unexpectedresultthatisalsodesirableat the same time: itmaximizes the wealth of the entire society • Such a resultisreachedwithoutanyoneexplicitelypursuing a collective goal. Rather, the collective goal isreachedthanks to the selfishness of individuals
Consequences of the free market • The consequence of such an assumption is all too obvious: the market works well only if it is left free (hence the famous expression “laissez faire”) • Therefore, the market, not only does not need any help, but if anything, just needs tobe freed of obstacles and regulations that might prevent its action • It is interesting to note that in this last consideration, one can find an argument that is often made in favour of the market, even nowadays: the market must be left free, it must not be caged
The role of the State in the economy • The founder of the theory of the role of the State in the market is John Maynard Keynes, who published in 1936 “General Theory of Employment, Interest and Money” • The innovative idea is that the role of the State is fundamental. Indeed, the market can, according to Keynes, produce results that are not optimal, and the State’s role is to help the market • The duty of the State is on the one hand to mitigate and control the economic cycles and on the other hand to bring the market to a better situation (especially in terms of unemployment) than the one that the market itself would have been able to realize if operating alone
Current Schools of Thought • Liberalism • monetarists • neo-classical school • State intervention • keynesian school • neo-keynesian school
Intermediate Positions (1) In reality, the contrastbetween market and State isplayedwithin the realmcomprisedbetween the twoextreme positions, most radical in their nature. Hereafter are a fewexamples: • Antonio Martinopure liberal and intellectuallyclose to the School of Chicago and to hismostnotableinspiration Milton Friedman, he trusts the free market as a source of economic and social progress • JagdishBagwaticonsiderseconomicintegrationas positive, providedthat the distortions be correctedwithoutintroducingduties • Anthony Giddensconsidersthat the growingliberalizationcreatesproblemsthatglobalizationmay, instead, contribute to solve • Lawrence Summersconsidersthat, within the market, the State must insure the reduction of inequalitiesthrough fiscal harmonization
Intermediate Positions (2) • Amartya Sen & Peter Singer viewrisksbutalso positive opportunities in the market dynamics, underlining the necessity for regulationthatbring businesses and individualstowards a virtuouspath • Joseph Stiglitzargues in favour of the importance of the role, notonly of the national State butalso of the internationalinstitutions in regulating the market • Edward Luttwak &Giulio Tremontiunderline the risksthat the global market, ifitisnotproperlyregulated, might impose uponthe workers of the developed world (lowsalaries, unemployment) and upon the environment • John Graydoesnotbelievethat the anglo-saxon model of economicliberalism can be applied to systemsthat are different from the western onehistoricallyspeaking and advocates for nationalsolutions • Paul Krugman(2008 Nobel Prize) underlines the need for global governance to makemarkets work, and thatit be entrusted to the IMF
The market in the face of crisisOrigins of the financialcrisis 2007/08 • Since the 1980s, liberal pressures and the dissemination of new and revolutionary communication technologies have produced an enormous expansion of the financiary activities at the international level • This has been, on the one hand, one of the cornerstones of globalization but on the other it has also brought about the huge expansion of a market that is less stable and less predictable than the real markets • From the 1970s to the 1990s, the volume of trade grew exponentially: suffice it to say that since the early 80s to the mid 90s, the trade volume produced by mutual funds, pension funds and institutional investors has increased tenfold • The conjunction between the expansion of financial wealth, the introduction of new derivative contracts and the growth of the debts of advanced countries has led to finance taking over the real economy. These phenomena are at the origin of the widespread crisis exploding in 2011, slowing down the global economic growth, causing recession and unemployment.
Financial Markets • Theymovevolumes of wealthbuilt on the trade of derivatives and otherproductsthat are detached from economicactivities, wherebyeveryturbulencegeneratespsychologicalrepercussionsnotonly on the stock marketsbutalso on the loans to businesses • They are maneuvered by investmentbanks and big investors, but are a cause of growingconcern for the small savers • They are particularlyvolatile, and aboveall, moody: perceptions of the market compared to hypotheticalscenariosmaygive rise to chainreactions • Theyinfluencerealactivitiesthroughbanks and otherfinancialintermediaries
Reasons of the actualcrisis • Manyhavedenounced the end of a financialsystemexempt of rulesof supervision and surveillance • On the otherhand, the same liberal view, whileitencourages private activity, alsoplacesit in a balancedinteractionbetween market and institutions • The presentcrisisoriginates in a guiltylack of governance, representative of the liberal culture thatwasindulged in during the times in which the strong economicgrowthfacilitatedfinancialactivities (Fed, Grennspan) • Butinvestmentbanks, and notonly, havetakenadvantage of this, thrusting on muchhigherleverageratiosthanthose of the commercial banks, eventuallybringingabout the creation of high-riskfinancialproducts
The actualcrisis: potentialsolutions • Public participation in the capitals of banks in crisis, provided it goes to fuel the loan supplies (EU’s approach) • Government guarantee both on deposits and interbank loans • Lighten the regulatory capital requirements of Basel 2 • Appeal to FDI by promoting cooperation agreements with Sovereign Funds • Greater flexibility in the budgetary constraints imposed by the Maastricht Treaty, revising a view that is only concerned with budgetary discipline and inflation • Boost the demand, by reducing the tax burden on families, in order to send a strong signal to the recovery of purchasing power • Review the rules regulating the financial and stock markets in order to fight the speculative designs that preceed the speculation in real terms over the economic and patrimonial consistency of businesses • Lower the minimum requirement for OPA in businesses to avoid hostile participations • Intervention of the European Stability Mechanism (ESM)
The differencesbetweenDEVELOPMENT & GROWTH Development: • newly-bornbackwardcountriesafter World War II • developmentis a four-legchairwhereinstitutional, social, civil and economicaspects are stabilised • interdisciplinarystudies Growth: • dominance of the economy over the behavior of institutions and individuals Mainaspects: • explainingwhygrowthisconcentrated in a fewcountries, whilemanyothers are stillwaitingalong the road • explaininghow some developingcountries are redeemed and crowding the group of the emergingcountries • Explaining the dynamicsthatmove the transitioncountries
Course-outline • Elements of development as part of classic economic litterature • Notes on the newly-born specialized litterature on the basis of the success-experience of developing countries, distinct from the traditional litterature that has been denominated “growth theory” , by reviewing the most famous authors (Rostow, Myrdal, Lewis, Streeten, Sen, ..) • Growth acceleration as theengineof national wealth and of the well-being of populations: Theories and models, both neoclassic and keynesian • Endogenous growth theories, based on human capital valorization
Course-outline in details • From theories to models • Classicaltheories of development • The Keynesiangrowth model of Harrod-Domar • Neo-classicalmodels of growth: Solowapproach • Analysis of growthbasedon the production function • The new endogenousgrowththeory (NTC) and macrodeterminants of growth
Incomeinequalitiesthroughthe world The Gini coefficient is a number between 0 and 1, where 0 corresponds with perfect equality (where everyone has the same income) and 1 corresponds with perfect inequality (where one person has all the income—and everyone else has zero income). Income distribution can vary greatly from wealth distribution in a country.