To grow or not to grow: Why institutions must make a difference Thorvaldur Gylfason

Why growth rates differ If technology matters for economic growth, as it must, then … General economic efficiency must also make a difference for growth Economic policy Institutions Institutions or geography? False contrast There is room for both, side by side

Why growth rates differ Resource depletion drag Dutch disease Rent seeking + + + – + Political and economic diversification

Growth and political liberties, 1965-98 r = rank correlation Brazil Democracy is good for growth: No visible sign that democracy stands in the way of economic growth Botswana China Korea Venezuela Central African Republic Niger r = -0.62 85 countries

Growth and political liberties, 1965-98 Brazil Political liberty is good for growth because oppression breeds inefficiency, and so does corruption Botswana China Korea Venezuela Central African Republic Niger r = -0.62

Growth and natural capital, 1965-98 An increase in the natural capital share by 8% goes along with a decrease in per capita growth by 1% per year. Australia Venezuela r = -0.64 85 countries

Recent literature Six main linkages: Resource depletion drag Natural capital tends to crowd out Recent literature But Norway is, so far at least, an exception Six main linkages: Resource depletion drag Dutch disease Hurts level, composition, or volatility of exports Rent seeking Protectionism, corruption, oppression False sense of security Poor quality of policies and institutions Education 6. Investment Foreign capital Social capital Human capital Real capital

Natural resource abundance and economic structure Hypothesis: Dependence hurts growth, even if abundance may help Resource poor, resource dependent (Chad, Mali) Resource rich, resource dependent (OPEC) Resource dependence Resource poor, resource free (Jordan, Panama) Resource rich, resource free (Canada, USA) Resource abundance

Empirical research strategy Study 85 industrial and developing countries from 1965 to 1998 Look for cross-country patterns in data from the World Bank Dig deeper through regression analysis Recognize interconnections among several key determinants of growth by estimating a system of simultaneous equations by Seemingly Unrelated Regression method

Regression results Recursive system -0.08 (5.8) 0.05 (2.7) -1.89 (9.2) Dependent variable Natural capital share Natural capital per person Initial income Popu-lation growth Civil liberties index Enrol-ment rate Gross invest-ment R2 Economic growth -0.08 (5.8) 0.05 (2.7) -1.89 (9.2) -0.56 (3.0) -0.27 (2.5) 0.02 0.08 (3.7) 0.77 Enrolment rate -0.77 (4.1) 0.54 (2.2) 13.00 (5.2) -3.82 Gross investment -0.26 (4.0) 0.16 (1.8) -1.92 -0.73 (1.4) 0.24 Civil liberties 0.04 -0.05 (2.9) -0.95 (6.5) 0.65 Recursive system Note: 85 observations. Method of estimation is SUR. t-statistics are shown within parentheses.

Regression results Investment is good for growth -0.08 (5.8) 0.05 Dependent variable Natural capital share Natural capital per person Initial income Popu-lation growth Civil liberties index Enrol-ment rate Gross invest-ment R2 Economic growth -0.08 (5.8) 0.05 (2.7) -1.89 (9.2) -0.56 (3.0) -0.27 (2.5) 0.02 0.08 (3.7) 0.77 Enrolment rate -0.77 (4.1) 0.54 (2.2) 13.00 (5.2) -3.82 Gross investment -0.26 (4.0) 0.16 (1.8) -1.92 -0.73 (1.4) 0.24 Civil liberties 0.04 -0.05 (2.9) -0.95 (6.5) 0.65 Note: 85 observations. Method of estimation is SUR. t-statistics are shown within parentheses.

Regression results Education is good for growth -0.08 (5.8) 0.05 (2.7) Dependent variable Natural capital share Natural capital per person Initial income Popu-lation growth Civil liberties index Enrol-ment rate Gross invest-ment R2 Economic growth -0.08 (5.8) 0.05 (2.7) -1.89 (9.2) -0.56 (3.0) -0.27 (2.5) 0.02 0.08 (3.7) 0.77 Enrolment rate -0.77 (4.1) 0.54 (2.2) 13.00 (5.2) -3.82 Gross investment -0.26 (4.0) 0.16 (1.8) -1.92 -0.73 (1.4) 0.24 Civil liberties 0.04 -0.05 (2.9) -0.95 (6.5) 0.65 Note: 85 observations. Method of estimation is SUR. t-statistics are shown within parentheses.

Regression results Civil liberties are good for growth -0.08 (5.8) Dependent variable Natural capital share Natural capital per person Initial income Popu-lation growth Civil liberties index Enrol-ment rate Gross invest-ment R2 Economic growth -0.08 (5.8) 0.05 (2.7) -1.89 (9.2) -0.56 (3.0) -0.27 (2.5) 0.02 0.08 (3.7) 0.77 Enrolment rate -0.77 (4.1) 0.54 (2.2) 13.00 (5.2) -3.82 Gross investment -0.26 (4.0) 0.16 (1.8) -1.92 -0.73 (1.4) 0.24 Civil liberties 0.04 -0.05 (2.9) -0.95 (6.5) 0.65 Index goes from 1 (full civil liberties) to 7 (negligible civil liberties) Note: 85 observations. Method of estimation is SUR. t-statistics are shown within parentheses.

Regression results Population growth hurts growth -0.08 (5.8) 0.05 Dependent variable Natural capital share Natural capital per person Initial income Popu-lation growth Civil liberties index Enrol-ment rate Gross invest-ment R2 Economic growth -0.08 (5.8) 0.05 (2.7) -1.89 (9.2) -0.56 (3.0) -0.27 (2.5) 0.02 0.08 (3.7) 0.77 Enrolment rate -0.77 (4.1) 0.54 (2.2) 13.00 (5.2) -3.82 Gross investment -0.26 (4.0) 0.16 (1.8) -1.92 -0.73 (1.4) 0.24 Civil liberties 0.04 -0.05 (2.9) -0.95 (6.5) 0.65 Note: 85 observations. Method of estimation is SUR. t-statistics are shown within parentheses.

Regression results Conditional convergence: 2% per year -0.08 (5.8) Dependent variable Natural capital share Natural capital per person Initial income Popu-lation growth Civil liberties index Enrol-ment rate Gross invest-ment R2 Economic growth -0.08 (5.8) 0.05 (2.7) -1.89 (9.2) -0.56 (3.0) -0.27 (2.5) 0.02 0.08 (3.7) 0.77 Enrolment rate -0.77 (4.1) 0.54 (2.2) 13.00 (5.2) -3.82 Gross investment -0.26 (4.0) 0.16 (1.8) -1.92 -0.73 (1.4) 0.24 Civil liberties 0.04 -0.05 (2.9) -0.95 (6.5) 0.65 Note: 85 observations. Method of estimation is SUR. t-statistics are shown within parentheses.

Regression results Abundance is good for growth -0.08 (5.8) 0.05 (2.7) Dependent variable Natural capital share Natural capital per person Initial income Popu-lation growth Civil liberties index Enrol-ment rate Gross invest-ment R2 Economic growth -0.08 (5.8) 0.05 (2.7) -1.89 (9.2) -0.56 (3.0) -0.27 (2.5) 0.02 0.08 (3.7) 0.77 Enrolment rate -0.77 (4.1) 0.54 (2.2) 13.00 (5.2) -3.82 Gross investment -0.26 (4.0) 0.16 (1.8) -1.92 -0.73 (1.4) 0.24 Civil liberties 0.04 -0.05 (2.9) -0.95 (6.5) 0.65 Note: 85 observations. Method of estimation is SUR. t-statistics are shown within parentheses.

Regression results Dependence is bad for growth -0.08 (5.8) 0.05 (2.7) Dependent variable Natural capital share Natural capital per person Initial income Popu-lation growth Civil liberties index Enrol-ment rate Gross invest-ment R2 Economic growth -0.08 (5.8) 0.05 (2.7) -1.89 (9.2) -0.56 (3.0) -0.27 (2.5) 0.02 0.08 (3.7) 0.77 Enrolment rate -0.77 (4.1) 0.54 (2.2) 13.00 (5.2) -3.82 Gross investment -0.26 (4.0) 0.16 (1.8) -1.92 -0.73 (1.4) 0.24 Civil liberties 0.04 -0.05 (2.9) -0.95 (6.5) 0.65 Note: 85 observations. Method of estimation is SUR. t-statistics are shown within parentheses.

Regression results Dependence is bad for growth -0.08 (5.8) 0.05 (2.7) Dependent variable Natural capital share Natural capital per person Initial income Popu-lation growth Civil liberties index Enrol-ment rate Gross invest-ment R2 Economic growth -0.08 (5.8) 0.05 (2.7) -1.89 (9.2) -0.56 (3.0) -0.27 (2.5) 0.02 0.08 (3.7) 0.77 Enrolment rate -0.77 (4.1) 0.54 (2.2) 13.00 (5.2) -3.82 Gross investment -0.26 (4.0) 0.16 (1.8) -1.92 -0.73 (1.4) 0.24 Civil liberties 0.04 -0.05 (2.9) -0.95 (6.5) 0.65 Note: 85 observations. Method of estimation is SUR. t-statistics are shown within parentheses.

Regression results Dependence is bad for education -0.08 (5.8) 0.05 Dependent variable Natural capital share Natural capital per person Initial income Popu-lation growth Civil liberties index Enrol-ment rate Gross invest-ment R2 Economic growth -0.08 (5.8) 0.05 (2.7) -1.89 (9.2) -0.56 (3.0) -0.27 (2.5) 0.02 0.08 (3.7) 0.77 Enrolment rate -0.77 (4.1) 0.54 (2.2) 13.00 (5.2) -3.82 Gross investment -0.26 (4.0) 0.16 (1.8) -1.92 -0.73 (1.4) 0.24 Civil liberties 0.04 -0.05 (2.9) -0.95 (6.5) 0.65 Note: 85 observations. Method of estimation is SUR. t-statistics are shown within parentheses.

Regression results Indirect effect through education is -0.77·0.02  -0.02 Dependent variable Natural capital share Natural capital per person Initial income Popu-lation growth Civil liberties index Enrol-ment rate Gross invest-ment R2 Economic growth -0.08 (5.8) 0.05 (2.7) -1.89 (9.2) -0.56 (3.0) -0.27 (2.5) 0.02 0.08 (3.7) 0.77 Enrolment rate -0.77 (4.1) 0.54 (2.2) 13.00 (5.2) -3.82 Gross investment -0.26 (4.0) 0.16 (1.8) -1.92 -0.73 (1.4) 0.24 Civil liberties 0.04 -0.05 (2.9) -0.95 (6.5) 0.65 Note: 85 observations. Method of estimation is SUR. t-statistics are shown within parentheses.

Regression results Dependence is bad for investment -0.08 (5.8) 0.05 Dependent variable Natural capital share Natural capital per person Initial income Popu-lation growth Civil liberties index Enrol-ment rate Gross invest-ment R2 Economic growth -0.08 (5.8) 0.05 (2.7) -1.89 (9.2) -0.56 (3.0) -0.27 (2.5) 0.02 0.08 (3.7) 0.77 Enrolment rate -0.77 (4.1) 0.54 (2.2) 13.00 (5.2) -3.82 Gross investment -0.26 (4.0) 0.16 (1.8) -1.92 -0.73 (1.4) 0.24 Civil liberties 0.04 -0.05 (2.9) -0.95 (6.5) 0.65 Note: 85 observations. Method of estimation is SUR. t-statistics are shown within parentheses.

Regression results Indirect effect through investment is -0.26·0.08  -0.02 Dependent variable Natural capital share Natural capital per person Initial income Popu-lation growth Civil liberties index Enrol-ment rate Gross invest-ment R2 Economic growth -0.08 (5.8) 0.05 (2.7) -1.89 (9.2) -0.56 (3.0) -0.27 (2.5) 0.02 0.08 (3.7) 0.77 Enrolment rate -0.77 (4.1) 0.54 (2.2) 13.00 (5.2) -3.82 Gross investment -0.26 (4.0) 0.16 (1.8) -1.92 -0.73 (1.4) 0.24 Civil liberties 0.04 -0.05 (2.9) -0.95 (6.5) 0.65 Note: 85 observations. Method of estimation is SUR. t-statistics are shown within parentheses.

Regression results Dependence is bad for liberty -0.08 (5.8) 0.05 Dependent variable Natural capital share Natural capital per person Initial income Popu-lation growth Civil liberties index Enrol-ment rate Gross invest-ment R2 Economic growth -0.08 (5.8) 0.05 (2.7) -1.89 (9.2) -0.56 (3.0) -0.27 (2.5) 0.02 0.08 (3.7) 0.77 Enrolment rate -0.77 (4.1) 0.54 (2.2) 13.00 (5.2) -3.82 Gross investment -0.26 (4.0) 0.16 (1.8) -1.92 -0.73 (1.4) 0.24 Civil liberties 0.04 -0.05 (2.9) -0.95 (6.5) 0.65 Note: 85 observations. Method of estimation is SUR. t-statistics are shown within parentheses.

Regression results Indirect effect through civil liberties is 0.04·(-0.27)  -0.01 Dependent variable Natural capital share Natural capital per person Initial income Popu-lation growth Civil liberties index Enrol-ment rate Gross invest-ment R2 Economic growth -0.08 (5.8) 0.05 (2.7) -1.89 (9.2) -0.56 (3.0) -0.27 (2.5) 0.02 0.08 (3.7) 0.77 Enrolment rate -0.77 (4.1) 0.54 (2.2) 13.00 (5.2) -3.82 Gross investment -0.26 (4.0) 0.16 (1.8) -1.92 -0.73 (1.4) 0.24 Civil liberties 0.04 -0.05 (2.9) -0.95 (6.5) 0.65 Note: 85 observations. Method of estimation is SUR. t-statistics are shown within parentheses.

Regression results Liberties and resources both matter for growth Total effect is -0.08 + (-0.77)·0.02 + (-0.26)·0.08 + 0.04·(-0.27)  -0.13 Dependent variable Natural capital share Natural capital per person Initial income Popu-lation growth Civil liberties index Enrol-ment rate Gross invest-ment R2 Economic growth -0.08 (5.8) 0.05 (2.7) -1.89 (9.2) -0.56 (3.0) -0.27 (2.5) 0.02 0.08 (3.7) 0.77 Enrolment rate -0.77 (4.1) 0.54 (2.2) 13.00 (5.2) -3.82 Gross investment -0.26 (4.0) 0.16 (1.8) -1.92 -0.73 (1.4) 0.24 Civil liberties 0.04 -0.05 (2.9) -0.95 (6.5) 0.65 Liberties and resources both matter for growth Note: 85 observations. Method of estimation is SUR. t-statistics are shown within parentheses.

What is the upshot? Growth differentials across countries can be explained by several different interconnected factors Private initiatives (investment, fertility) Public policies (education) Institutions (democracy) Geography (natural resources) In particular, institutions survive the presence of geography, and vice versa

Case in point: Norway The problem is not the existence of natural wealth as such ... but rather the failure to avert the dangers that accompany the gifts of nature Norway is, so far, a success story Government takes in 80% of oil rent and invests it mostly in foreign securities No signs of damage to growth potential, at least not yet

Why Norway has succeeded where OPEC and others failed Long tradition of democracy and market economy in Norway since before the advent of oil Large-scale rent seeking was averted as oil was defined as a common- property resource from the beginning Adequate investment performance Excellent education record

Why Norway has succeeded where OPEC and others failed Even so, Norway faces challenges Some (weak) signs of Dutch disease Stagnant exports, sluggish FDI Limited interest in EU and EMU Some signs also of unwillingness to undertake difficult reforms Health care provision Pensions Management of oil fund transferred from Ministry of Finance to Central Bank 1999

These slides can be viewed on my website: www.hi.is/~gylfason Bottom line Growth requires accumulation and efficient use of capital Physical capital through strong incentives to save and invest Human capital via education, training, & less fertility in LDCs Social capital through democracy, etc. Fin Financial and foreign capital: Same story