eco paper 12pages

Development Economics Economic Growth:

Concepts and Patterns Reading: Chapter 3 in Perkins et al.

University of Miami

Professor: Salvador Ortigueira

Growth since 1960

● Large differences by countries: – Industrialized countries: ~2% per year – Negative growth: Some African countries and Venezuela – Slow/moderate growth (0-3%): Most developing

countries. India, Latin America – Rapid growth (3-6% yearly): (South-)East Asia,

Botswana

● → see table 3-1 in Perkins et al.

The case of Botswana ● Very poor after independence from UK (1965) ● Very fast growth since then ● Advantage: Rich in diamonds. But: Other countries

have such resources too, and failed! ● Likely reasons for success:

– Good institutions. Invested diamond profits into infrastructure; not much corruption.

– Good macroeconomic policies (low inflation, stable fiscal policy, open to trade).

– Property rights, legal system well developed

● Problems: HIV/AIDS, inequality.

Growth: Disappointments

● Argentina: Was supposed to have better prospects than the U.S. in 1900. Now at 30% of U.S. GDP.

● Sub-Saharan Africa: Negative growth since 1960 in Nigeria, Zambia, Chad, Senegal

● Central-Eastern economies after 1990: Negative growth after transition

Factor accumulation, productivity growth and economic growth

● Basic factors of production: labor (L), capital (K) and land. ● Output determined by

– Quantity of the factors used – How efficiently they are used, i.e. technology (A)

● Economic Growth depends on: – Factor accumulation, i.e. increasing the size of the capital

stock and/or the labor force. – Productivity growth: Gains in efficiency, technological

change – → Technological change most important

● Productivity growth often entails shifting resources from producing one good to another

● In low-income countries the process of growth almost always corresponds to a major structural shift from agriculture to industry

Production function Y=AF(K,A)

● Given K (capital) and L (labor), tells us how much is produced.

● Properties: Positive, but decreasing returns to factors

● Technological improvement shifts function upward ● → Need to understand what drives factor

accumulation and technological change to understand growth.

Solow growth model (sketch)

● Focuses on capital accumulation ● Investment increases capital stock ● Investment is financed by savings ● Savings comes from current income →

consumption-savings trade-off

● → Will come back to Solow in later chapter.

How important are factor accumulation and productivity gains in explaining growth? We now explain a framework that attributes recorded economic growth to: growth in the capital stock growth of the labor force changes in overall productivity

● This approach is called the Solow growth

accounting

Solow growth accounting (1) ●Measure contribution to growth g(y) in GDP from:

– Labor growth g(l) – Capital growth g(k) – Growth in total factor productivity (TFP) a: gains

from technology and more efficiency

● g(Y) = W(k)*g(k) + W(l)*g(l) + a ● W(k)~40% is income share from capital, ● W(l)=1-W(k)~60% is income share from labor

Solow growth accounting (2) g(Y) = W(k)*g(k) + W(l)*g(l) + a ● W(k)*g(k): contribution of capital to growth ● W(l)*g(l): contribution of labor to growth ● a: contribution of technology to growth

Growth accounting (3) ● All but a are observable in data → Can back a out

(Solow residual) ● Solow residual measures contribution of

technological progress ● Can calculate contributions to growth from 3 terms

in the sum and include education ● Results (see table 3-2 in Perkins et al.):

– g(k) important in poor countries – Fast-growing countries: Also a is important – Rich countries: g(k) and a

The Solow residual Be careful with the interpretation of a! → Solow residual may not capture technological

change in the following situations: ● Financial crises ● Factors are not fully used ● War ● Extreme weather events, especially for agricultural

economies

Underlying causes for capital accumulation and technological growth ● Barro growth regressions: Try to explain variation

in growth rates across countries by – Education – Health – Policies – Political system – Geography

● Somewhat controversial (what causes what?), but give us clues on what matters

Characteristics of fast-growing countries

● Macroeconomic and political stability ● Investment in health and education ● Effective governance and institutions ● Favorable environment for private enterprise ● Favorable geography

Macroeconomic and political stability

● Macroeconomic: – Low inflation – Low government budget deficits – Appropriate exchange rate – Functioning financial markets

● Political: – No cross-border/civil war – No coups

● → Figures 3-2 and 3-3 in Perkins et al.

Investment in health and education ● Better health → workers more productive, more

investments in capital and education ● Better education:

– Workers use machines more effectively – Better at inventing and adopting technological changes – Attracts foreign investment

● → Returns to investment in girls' education found to be especially high

● → Figure 3-4 in Perkins et al.

Effective governance and institutions

● Secure property rights: More investment by (home) entrepreneurs and foreigners

● Measuring quality of governance: – Surveys by world bank – Transparency International Corruption Index

● → Figure 3-5 in Perkins et al.

Favorable environment for private enterprise

● Important in poor countries: Agriculture. Too much market intervention reduces incentives for farmers. Exampe: China.

● Infrastructure: roads, electricity, water etc. ● Lack of large firms in poor countries → productivity

losses. ● Countries open to trade grow faster

– Cheaper inputs, more markets for output – But: more exposed to shocks from abroad

● See figure 3-6 in Perkins et al

Favorable geography ● Countries in tropics grew slower

– Diseases: malaria, HIV/AIDS – Volatile weather – Poor soil

● → Figure 3-7 in Perkins et al. ● Isolation hurts: landlocked or small islands

– High transportation cost for trade ● → Figure 3-8 in Perkins et al.

Convergence: Diminishing returns

● Diminishing marginal product of capital: More machines per worker lead to ever smaller increases in output.

● Poor countries have less capital (per worker) than rich countries. Implications: – Poor countries have potential to grow faster – Growth tends to slow as country accumulates capital

● → Income levels of rich and poor countries should converge

Is there convergence in the data?

● Has happened for some countries: Japan, Korea, maybe now China (?)

● But not for most countries. ● Do poor countries grow faster on average? No, if

we look at all countries at once. ● (see figure 3-10 in Perkins et al.) ● ● → No general convergence.

Conditional convergence

● Model of diminishing returns (Solow model) assumes that everything but capital is the same across countries (technology, savings rates, population growth).

● Look at similar countries (OECD, countries open to trade): there is convergence!

● → Have conditional convergence, but no general convergence!

● See figures 3-11 and 3-12 in Perkins.

Growth and structural change ● Share of output produced in agriculture decreases,

output from industry and services increases. ● Workers move away from agriculture to

industry/services. ● Urbanization ● More goods and services are sold on markets (less

home production) ● Engel's law: Share of food spending decreases

when income increases. ● → Figures 3-13 to 3-15 in Perkins et al.

Why does urbanization occur?

● Increasing returns to scale in production: Large plants more productive than small plants

● Need large work force concentrated in one area ● Close-by suppliers, good infrastructure in cities

Should governments force resources out of agriculture?

● Negative example: China's Great Leap Forward (1950s) → Famine

● Need increases in agricultural productivity to be able to shift away workers to other sectors!

● → Important not to neglect agriculture in growth policy