The Analytics of Growth Dynamics

An Empirical Approach

December, 2011

Outline• A Forecasting Scenario for 2012-14

• Growth Facts

• Policy Questions

• The Centrality of economic growth

• The relationship between globalization and economic growth

• The Paradoxes of globalization

• From Correlates to Fundamental Causes

The Analytics of Growth Dynamics: GDP Forecast 2011

A Forecasting Scenario for 2012-14Real GDP Growth (PPPexchange rate)

Real GDP Growth (Market exchange rates)

A Forecasting Scenario for 2012-14Consumer price inflation(% av)

Main Policy Interest Rates(%; end-period)

Tremendous divergence in per-capita incomes since 1750

Small number of countries, mainly in East and Southeast Asia, have consistently caught up with growth leaders

Many countries have experienced growth spurts for a decade or two; but these have often fizzled out

Low growth over long term for a large number of countries

During the last two decades, China and (to a lesser extent) India have grown rapidly, while most other countries have experienced a growth slowdown.

Growth facts

The Policy Questions

• What determines the global growth rate of the leading countries in the last two centuries?

• To what extent is this growth rate sustainable? Can it be increased?

• What is the cause of the great differences between countries?

• Why are so many countries lagging behind? • How can we support their development?

Assume you care only about your own consumption Define rich and poor (within a country) as follows:

rich : having the same income level as people in the top decile (10%) of a country’s income distribution

poor: having the same income level as people in the bottom decile of a country’s income distribution

Define rich and poor country as follows rich country: a country that is in the top decile of all

countries ranked by per-capita GDP poor country: a country that is in the bottom decile of all

countries ranked by per-capita GDP

yj per-capita income (GDP) in country j;

dj income share of decile d in country j;

ydj average income level in decile d (=1,2,..,10) in country j.

 

ydj = 10 x dj x yj

 

Inequities in income: within and across countries

yj djRepresentative income of …

Poor country $868 Income share of top decile in poor countries = 0.35

Rich individual in poor country = $3,039

Rich country $34,767 Income share of bottom decile in rich countries

= 0.027

Poor individual in rich country = $9,387

(all figures in 2004 PPP-adjusted $)

Under-5 mortality rate (per 1000)

country average

bottom income quantile

top income quantile

ratio

representative poor country: Madagascar

123 142 49 2.9

representative rich country:

Denmark*6 7 2

ratio21

Source: WHO, World Bank.

* To be conservative, the distribution in Denmark is assumed to be same as in Madagascar.

Figure 1: World inequality has gone from almost exclusively a "within" country to mostly

an "across" country phenomena

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

1800 1820 1840 1860 1880 1900 1920 1940 1960 1980 2000

Years

Fra

cti

on

of

To

tal

Ine

qu

alit

y D

ue

to

A

cro

ss

Co

un

trie

s

Theil coefficient

Mean ln deviation

Source: Bourguignon and Morrison (2002), via Pritchett (2003)

Source: Maddison (2001), in 1990 international $

The Great DivergenceLong-term economic growth: the Great Divergence

100

1000

10000

100000

1500 1600 1700 1820 1870 1913 1950 1973 1998

19

90

PP

P $

Western Europe

Eastern Europe

Former USSR

United States

Other Western Offshoots

Latin America

Japan

China

India

Other Asia

Africa

Long-term economic growth: the Great Divergence

100

1000

10000

100000

1500 1600 1700 1820 1870 1913 1950 1973 1998

1990

PP

P $

Western Europe

Eastern Europe

Former USSR

United States

Other Western Offshoots

Latin America

Japan

China

India

Other Asia

Africa

Source: Maddison (2001)

Major landmarks in economic growth

Industrial revolution in Europe and the onset of “modern economic growth” (c.1750-1820)

Source: Maddison (2001). In 1990 PPP $.

450 400

774 8941024

1232

1974

34734594

11534

17921

400 400 400 400473

1201

2431

5257

9288

16172

26146

450 450572 575 571 575 543

640 635

1231

2936

425 416 400 400 400 418 444585

852

1365 1368

100

1000

10000

100000

0 1000 1500 1600 1700 1820 1870 1913 1950 1973 1998

year

Western Europe

Eastern Europe

Western off shoots

Latin America

J apan

Other Asia

Af rica

Per-capita GDP across various regions over the millennium

Long-term economic growth: the Great Divergence

100

1000

10000

100000

1500 1600 1700 1820 1870 1913 1950 1973 1998

1990

PP

P $

Western Europe

Eastern Europe

Former USSR

United States

Other Western Offshoots

Latin America

Japan

China

India

Other Asia

Africa

Source: Maddison (2001)

Major landmarks in economic growth

Absence of economic growth in Asia (except Japan) and Africa before 1950)

Long-term economic growth: the Great Divergence

100

1000

10000

100000

1500 1600 1700 1820 1870 1913 1950 1973 1998

1990

PP

P $

Western Europe

Eastern Europe

Former USSR

United States

Other Western Offshoots

Latin America

Japan

China

India

Other Asia

Africa

Source: Maddison (2001)

Major landmarks in economic growth

Japanese catchup post-1950

Long-term economic growth: the Great Divergence

100

1000

10000

100000

1500 1600 1700 1820 1870 1913 1950 1973 1998

1990

PP

P $

Western Europe

Eastern Europe

Former USSR

United States

Other Western Offshoots

Latin America

Japan

China

India

Other Asia

Africa

Source: Maddison (2001)

Major landmarks in economic growth

A world divided between rich and poor countries

(percent below $1.25 per day poverty line, in 2005 PPP $)(percent below $1.25 per day poverty line, in 2005 PPP $)

Source: Thomas (2007)

Source: Thomas (2007)

Trade opportunities, capital flows, access to technology increase potential for catch-up

On the other hand, policies of free trade and free capital mobility do not necessarily provide the most conducive environment for domestic entrepreneurship, investment, and structural change. Cf. relationships between tariffs and growth in late 19th

century; downside of recent experience with financial globalization

What does the overall empirical record show?

Historical experience with growth

0

1

2

3

4

5

6

7

8

9

1000-1500 1500-1820 1820-1870 1870-1913 1913-1950 1950-73 1973-90 1990-2005

Western Europe United States Other Westernoffshoots

Mexico Norway Japan South Korea China

GDP per capita growth rate of fastest growingcountry/region (annual average, %)World GDP per capita growth rate (annual

average, %)

Foreign economic policies in the World Bank’s star “globalizers” of the 1990s growth rate average

tariffs (early to mid-

‘90s)

NTBs? WTO member? (early to mid-

‘90s)

Open capital

account?

China 7.1 31.2 yes no no Vietnam 5.6 30-50 yes no no India 3.3 50.5 yes yes no Uganda 3.0 14.4 yes yes no Note: List of star globalizers taken from World Bank, Globalization, Growth, and Poverty: Building an Inclusive World Economy, 2001.

Economic growth

3.3%

5.6%

6.4%

1.2%

3.3% 3.3%

2.8%

-0.8%

1.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

1960-1980 1980-90 1990-2003

East Asia & Pacif ic

South Asia

Latin America & Caribbean

Heritage Foundation Index of "Economic Freedom"*

5

5.5

6

6.5

7

7.5

8

China India Vietnam Argentina Bolivia Brazil Chile El Salvador Mexico Uruguay

World Bank's star economic globalizers

*The index is a composite quantitative measure of “the 10 key ingredients of economic freedom such as low tax rates, tariffs, regulation, and government intervention, as well as strong property rights, open capital markets, and monetary stability.”

Source: Jeanne and Ranciere (2005)

Foreign reserves (excluding gold) in months of importsindustrial and non-oil developing countries

0

1

2

3

4

5

6

7

8

9

1950

1952

1954

1956

1958

1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

Industrial Countries

Developing Countries (excl. oil-exportingcountries)

Source: Prasad, Rajan and Subramanian (2006)

A parable of two countriesCountry A

… has preferential, free access to the US market for its exports… can send several millions of its citizens to the US as workers… receives huge volumes of direct investment… is totally plugged in to US production chains… for which the US Treasury stands ready to as lender of last resort… has effective security guarantee from the US military

Does globalization get better than this? Whereas B is a country for which

… the US maintains a trade embargo, and does not have diplomatic relations

… which receives neither aid nor any other kind of assistance… and which is kept outside international organizations like the WTO… which is prevented from borrowing from the IMF and WB.

Which country did better?

Four models of growth:

1. Foreign borrowing-led growth• countries in the periphery of EU in 1990s, LA in 1970s, …

2. Commodity booms• 19th century, many African countries in the last decade

3. Growth based on deep integration• Goods and factor market integration + institutions +

transfers (convergence within EU)4. Structural transformation-led growth

• From low-productivity traditional products to modern, mostly manufacturing activities (and lately increasingly into tradable services)

• Based not on (static) comparative advantage, but on producing what richer countries produce

• Japan, S. Korea, ChinaOnly the last is a realistic possibility for most countries

EU versus NAFTA models One is hard because it entails legal, institutional,

political integration Labor mobility, in addition to capital and product-market

integration Embedded within EU-wide institutions

Acquis communautaire (>100,000 pages) European Court of Justice European Central Bank and a common currency (for most) Significant inter-regional transfers

Growing pains of a quasi-federal political system The other is comparatively easy But only the first has the potential to foster economic

convergence The EU model not in the cards for most developing

countries

High-growth countries are those that are able to undertake rapid structural transformation from low-productivity (“traditional”) to high-productivity

(“modern”) activities to tradables in particular and to industrial activities within tradables and also in more recent times, tradable services

Economic rationale: modern tradables are under-produced in laissez-faire because they suffer disproportionately from the market and institutional failures that are rampant in poor nations (Rodrik 2009)

Sound “fundamentals” Market-friendly policies Macro stability

But also: Industrial policies in support of new economic

activities Undervalued currencies to promote tradables A certain degree of repression of finance, to

enable: Development banking Subsidized credit Undervaluation

Permissive of industrial policies At least under GATT and Until recently

No pressure to liberalize finance and capital accounts Until recently

Willing to absorb excess supply of tradables U.S. attitude of benign neglect towards current account

deficits BW I and II

Unconcerned with undervaluation in developing countries

Again, until recently

Trade regime Agreements on subsidies, TRIMs, TRIPs, and other

negotiations on services narrowing room for “industrial policies”

International capital markets Financial codes and standards no roles for

development banking and credit market interventions Monetary rules

CB independence and “free floating” no role for exchange rate as developmental policy instrument

income

institutionstrade

geographyexogenous

partlyendogenous

endogenous

Growth Economics: Rethinking The Links

endowments productivity

income

institutionstrade

geography(Jared Diamond, Jeffrey Sachs)

endowments productivity

1, 2

4

3

Growth Economics: Rethinking The Links

The Analytics Of Growth Dynamics: From Correlates to Fundamental Causes • The Correlates of economic growth are physical capital, human capital and technology. •But these are only proximate causes of economic growth and economic success: why do certain societies fail to improve their technologies, invest more in physical capital, and accumulate more human capital? • To illustrate this point further: how did South Korea and Singapore manage to grow, while Nigeria failed to take advantage of the growth opportunities? If physical capital accumulation is so important, why did Nigeria not invest more in physical capital? If education is so important, why our education levels in Nigeria still so low and why is existing human capital not being used more effectively? •The answer to these questions is related to the fundamental causes of economic growth. •We can think of the following list of potential fundamental causes: luck (or multiple equilibria) ;geographic differences; institutional differences ; cultural differences •An important caveat should be noted: discussions of geography, institutions and culture can sometimes be carried out without explicit reference to growth models or even to growth empirics. But it is only by formulating parsimonious models of economic growth and confronting them with data that we can gain a better understanding of both the proximate and the fundamental causes of economic•growth.

The Analytics Of Growth Dynamics: From Correlates to Fundamental Causes

The Analytics of Growth Dynamics: The Role of FinanceElements of Rapid Growth:• What are the reasonably robust empirical correlates of economic growth: Macroeconomic stability Stable, predictable “property rights” (institutional quality) Financial sector Something about external policies

Government’s role in finance:• Governments need to do More and better in some areas Less in others• And to recognize how finance without frontiers is changing what they can

do, and can achieve• Because finance matters for growth and poverty reduction, and we have

the evidenceidence

What has been empirically prooved:

• Strength of relationship between finance and growth Importance of legal and information base

• Importance of private sector monitoring for development and stability Cautions on deposit insurance

• The cost of state ownership• The benefits of foreign banking • How technology is leading to finance without frontiersWhat should not be done:

• To ‘leave finance to the market.’ • To privatize banks all at once• Open up to entry to foreign financial firms and leave it to them.• Open to capital flows without robust regulatory system.

   

“Augmented” Washington Consensus the previous 10 items, plus:

1. Fiscal discipline2. Reorientation of public expenditures3. Tax reform4. Financial liberalization5. Unified and competitive exchange rates6. Trade liberalization7. Openness to DFI8. Privatization9. Deregulation10.Secure Property Rights 

11. Corporate governance 12. Anti-corruption13. Flexible labor markets14. WTO agreements15. Financial codes and standards16. “Prudent” capital-account opening 17. Non-intermediate exchange rate regimes18. Independent central banks/inflation targeting19. Social safety nets20. Targeted poverty reduction 

Original Washington Consensus

Growth Economics: The Washington Consensus

Latin America: Only 3 countries have grown faster during the 1990s than in the 1950-80 period (and one of those 3 is [was] Argentina!)

Countries in transition from socialism: Real output below 1990 levels in all but four former socialist economies; poverty rates remain higher 1990 even in the most successful countries (e.g., Poland)

Sub-Saharan Africa: Results remain very disappointing, and far worse than those obtained prior to the late 1970s

Widening income gaps: Income inequalities have worsened in most of the countries that have adopted the WC agenda

Frequent and painful financial crises: East Asia, Brazil, Russia, Argentina, Turkey.

Questions about the augmented WCFeasibility

Can all of it be done together?Priorites

Which reforms first?Relevance

Does the recipe correspond to actual experience of successful cases?

UniformityIs there really one way?

Economic principles do not map into

a unique set of institutional arrangements

is not that they present inadequate levels of market access for developing nations

Doha round and agriculture a sideshow No developing country’s growth potential is significantly constrained at

present due to inadequate market access but that they are premised on the notion that removing

remaining impediments to trade in goods, services and capital are the primary lever with which to achieve convergence

thus forcing developing nations to trade valuable “policy space” in exchange for ephemeral gains in market access