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Sources of Economic Growth Revisited

Sources of Economic Growth Revisited. Thorvaldur Gylfason. Growing Together, Growing Apart. One more: Chile vs. Zambia. West Germany vs. East Germany. Austria vs. Czechoslovakia. South Korea vs. North Korea. Rapid growth. Mauritius vs. Madagascar. Botswana vs. Nigeria.

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Sources of Economic Growth Revisited

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  1. Sources of Economic Growth Revisited Thorvaldur Gylfason

  2. Growing Together, Growing Apart One more: Chile vs. Zambia West Germany vs. East Germany Austria vs. Czechoslovakia South Korea vs. North Korea Rapid growth Mauritius vs. Madagascar Botswana vs. Nigeria Tunisia vs. Morocco National economic output Thailand vs. Burma Spain vs. Argentina Finland vs. Estonia Slow growth Taiwan vs. China Time

  3. Botswana, Ghana, and Nigeria: GNP per capita 1964-97 Case 1 Current US$, Atlas method

  4. Kenya, Tanzania, and Uganda: GNP per capita 1964-97 Case 2 Current US$, Atlas method

  5. Burma and Thailand: GNP per capita 1960-97 Case 3 Local currency, 1988 prices, 1960 = 100

  6. Barbados, Dominican Republic, and Haiti: GNP per capita 1964-97 Case 4 Current US$, Atlas method

  7. Egypt, Morocco, and Tunisia: GNP per capita 1964-97 Case 5 Current US$, Atlas method

  8. Argentina, Uruguay, and Spain: GNP per capita 1964-97 Case 6 Current US$, Atlas method

  9. Madagascar and Mauritius: GNP per capita 1964-97 Case 7 Current US$, Atlas method

  10. Chile and Zambia: GNP per capita 1964-98 Case 8 Current US$, Atlas method

  11. Eastern & Southern Africa: A Quick Glance* GNP per capita, ppp-adjusted, 1975-98 * MEFMI members only.

  12. Economic Growth: The Short Run vs. the Long Run Economic growth in the long run Potential output Actual output Upswing National economic output Business cycles in the short run The crisis of 1997-98 is irrelevant to Asia’s long-term growth potential. Downswing Time

  13. Economic Growth: The Short Run vs. the Long Run • To analyze the movements of actual output from year to year, viz., in the short run • Need short-run macroeconomic theory • Keynesian or neoclassical • To analyze the path of potential output over long periods • Need modern theory of economic growth • Neoclassical or endogenous

  14. The Neoclassical Theory of Exogenous Economic Growth Traces the rate of growth of output per capita to a single source: Technological 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

  15. The New Theory of Endogenous Economic Growth • Traces the rate of growth of output per capita to three main sources: • Saving • Efficiency • Depreciation “The proximate causes of economic growth are the effort to economize, the accumulation of knowledge, and the accumulation of capital.” W. ARTHUR LEWIS

  16. Exogenous vs. Endogenous Growth • The neoclassical view • that economic growth in the long run is merely a matter of technology does not throw much light on the spectacular growth performance of Asia since the 1960s. • The new view • that long-run growth depends on saving, efficiency, and depreciation is more illuminating. • Besides, it’s not really new, because Adam Smith knew this (1776).

  17. Sources of Endogenous Growth I • Saving • Fits real world experience quite well • No coincidence that, in East Asia, saving rates of 30-40% of GDP went along with rapid economic growth • No coincidence either that many African economies with saving rates around 10% of GDP have been stagnant • OECD countries: saving rates of about 20% of GDP • Important implication for economic policy: • Economic stability with low inflation and positive real interest rates spurs saving, which is good for growth.

  18. Sources of Endogenous Growth I Income per capita East Asia 400 High saving rates 300 200 OECD Medium saving rates Africa 100 Low saving rates 1965 1990

  19. Growth and Investment, 1975-98 Ten MEFMI countries Each ten percentage point increase in the investment ratio is associated with an increase in per capita growth by 1½% per year.

  20. 33 sub-Saharan African countries Growth and Investment, 1965-98 Each ten percentage point increase in the investment ratio is associated with an increase in per capita growth by 1½% per year.

  21. Sources of Endogenous Growth II • Depreciation • The effect of depreciation on growth is related to that of saving and investment on growth. • Unprofitable investment in the past reduces the quality of capital and makes it depreciate more rapidly, necessitating more replacement investment to make up for economic and physical wear and tear. • The more national saving has to be set aside for replacement investment, the less will be available for the buildup of new capital.

  22. Investment: Quantity and Quality • Compare Botswana and Tanzania: • In Botswana, the share of State-Owned Enterprises in total investment fell from 16% in 1985-90 to 12% in 1990-97. • In Tanzania, the SOE share of investment fell from 46% in 1985-90 to 23% in 1990-97. • This is probably a good sign. • Privatization helps improve investment.

  23. Investment: Quantity and Quality • Investment quality, however, is not only a question of public vs. private enterprise. • Sound banking is also important. • It takes sound commercial banks, usually privately owned banks motivated by profit rather than by political concerns, to channel household savings into high-quality investment.

  24. Sources of Endogenous Growth III • Efficiency • Also fits real world experience quite well • Technical progress is good for growth because it allows us to squeeze more output out of given inputs. • And that is exactly what increased efficiency is all about! • Thus, technology is best viewed as an aspect of general economic efficiency. • Important implication for economic policy: • Everything that increases economic efficiency, no matter what, is also good for growth.

  25. Sources of Endogenous Growth III • Five sources of increased efficiency • Liberalization of prices and trade increases efficiency, which is good for growth. • Stabilization reduces the inefficiency associated with inflation, which is good for growth. • Privatization reduces the inefficiency associated with state-owned enterprises, which … • Education makes the labor force more efficient. • Technological progress also enhances efficiency. • The possibilities are virtually endless!

  26. Sources of Endogenous Growth III • This is good news. • If growth were merely a matter of technology, we would not be able to do much about it … • … except to follow technology-friendly policies by supporting R&D and such. • But if growth depends on saving and efficiency, there are things that we can do, in the private sector as well as through the public sector, to foster rapid economic growth. • Because everything that is good for saving and efficiency is also good for growth.

  27. What to Do to Encourage Economic Growth • Maintain strong incentives to save • Keep inflation low and real interest rates positive • Maintain financial system in good health • so as to channel saving into high-quality investment • Foster efficiency 1. Liberal price and trade regimes 2. Low inflation 3. Strong private sector 4. More and better education 5. Limited, or well managed, natural resources Recap

  28. Liberalization and Economic Growth • Liberalization of prices means that markets, not bureaucrats, are allowed to set prices. • Mixed market economy is more efficient than central planning. • Compare former Soviet Union with the US and Europe • Liberalization of trade allows specialization according to comparative advantage. • Free trade is more efficient than self-sufficiency. • North Korea and Cuba vs. Hong Kong and Singapore • Applies to trade in goods, services, capital.

  29. Growth and Trade, 1975-98 Ten MEFMI countries Each ten percentage point increase in the trade ratio is associated with an increase in per capita growth by almost 1% per year.

  30. 32 sub-Saharan African countries Growth and Trade, 1965-98 Each 20 percentage point increase in the trade ratio is associated with an increase in per capita growth by 1% per year.

  31. Growth and FDI, 1975-98 Ten MEFMI countries Each one percentage point increase in the FDI ratio is associated with an increase in per capita growth by 1% per year. Relationship depends on the inclusion of Botswana.

  32. 31 sub-Saharan African countries Growth and FDI, 1965-98 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.

  33. Stabilization and Economic Growth • Stabilization of prices means that distortions associated with inflation are reduced. • Inflation distorts the choice between real and financial capital by punishing money holdings, and thus creates inefficiency in production. • Inflation thus involves a tax, the inflation tax. • An inefficient tax compared with most other taxes. • Inflation also creates uncertainly which tends to discourage trade and investment. • Inflation also tends to result in overvaluation of currency, thus hurting exports and growth.

  34. Privatization and Economic Growth • Privatization means that profit-oriented owners and able managers are allowed to direct enterprises. • Profit motive replaces political considerations as the guiding principle of business operations. • Profit-maximizing owners generally want to appoint managers and staff on merit rather than on the basis of political connections, for example. • Private enterprise is generally more efficient than state-owned enterprises.

  35. Education and Economic Growth • Education means a better trained and hence more efficient work force. • Need to provide primary and secondary education to all, especially females • Need to provide tertiary education to a greatly increased number of people • Need increased public commitment to education • This requires both increased public expenditure on education and probably also increased scope for private sector involvement in education.

  36. Growth and Education, 1975-98 Ten MEFMI countries Each two percentage point increase in the education expenditure ratio is associated with an increase in per capita growth by almost 1% per year.

  37. 33 sub-Saharan African countries Growth and Education, 1965-98 Each two percentage point increase in the education expenditure ratio is associated with an increase in per capita growth by about 1% per year.

  38. Natural Resources and Economic Growth • Natural resources, if not well managed, may turn out to be, at best, a mixed blessing. • Three possible channels • Education • Dutch disease • Rent seeking What is the evidence?

  39. Natural Resources and Economic Growth 1965-98 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. Abundant natural resources, if not well managed, appear harmful to growth.

  40. Natural Resources and Education 90 countries An 18 percentage point increase in the natural capital share is associated with a decrease in public expenditure on education by 1% of GNP. Abundant natural resources appear to crowd out human resources.

  41. Natural Resources and Corruption Abundant natural resources appear to go along with corruption.

  42. What Is the Upshot? • Economic growth responds to public policy. • In particular, by encouraging • saving and investment of high quality • foreign trade and investment • education • ... the government can help foster rapid economic growth.

  43. Sir Arthur Lewis Got It Right Since the second world war it has become quite clear that rapid economic growth is available to those countries with adequate natural resources which make the effort to achieve it. W. ARTHUR LEWIS (1968)

  44. What Else? • These lessons are borne out by experience from around the world. • Additional lessons: • Too much inflation hurts saving, investment, and trade — and thereby also growth. • Too much SOE activity hurts the quality of investment and education — and growth. • Too much agriculture and, more generally, natural resource dependence, if not well managed, hurts education and trade — and thereby also growth. • Too rapid population growth also tends to impede economic growth.

  45. Reservations • Even so, the question of rapid growth is, of course, a bit more complicated. • We also need to address a host of political, social,and cultural questions as well as questions of natural conditions, climate, and public health — which would take us too far afield. • But the main point remains: • To grow or not to grow is in large measure a matter of choice. • Many of the constraints on growth are man-made, and can be removed.

  46. In Conclusion: It Can Be Done These slides can be viewed on my website: www.hi.is/~gylfason/malta.ppt So, the legacy of inadequate policies that tends to be regarded as a sign of weakness may be turned into strength. There is, thus, a sense in which we can say: • The worse, the better! Remember the main point of Gunnar Myrdal’s Asian Drama (1968)? • It was that the Asian economies were incapable of rapid economic growth! I believe that those who make similar claims about Africa will also be proven wrong. The End

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