1 Chapter 3 Economic Growth: Concepts and Patterns Norton Media Library Dwight H. Perkins Steven Radelet David L. Lindauer

2 Why some countries rich and others poor? Why some countries grow while others grow slowly or not at all? How did some East Asian countries advance from poverty to relative prosperity in just 30 years? Why many African countries remain in deep poverty? Sustained development and poverty reduction cannot occur in the absence of economic growth Why some countries rich and others poor? Why some countries grow while others grow slowly or not at all? How did some East Asian countries advance from poverty to relative prosperity in just 30 years? Why many African countries remain in deep poverty? Sustained development and poverty reduction cannot occur in the absence of economic growth 2

3 Divergent Patterns of Economic Growth since 1960 After 1960s LDCs begin to diverge For example per capital income in Thailand was $1100 and that of Zambia was $1200 Thailand now has per capita income of $9500*, but Zambia is about $1600*? What happened? Growth difference: Thailand grew over 4.5% and Zambia growth was - 0.6% (negative) * : 2011 After 1960s LDCs begin to diverge For example per capital income in Thailand was $1100 and that of Zambia was $1200 Thailand now has per capita income of $9500*, but Zambia is about $1600*? What happened? Growth difference: Thailand grew over 4.5% and Zambia growth was - 0.6% (negative) * : 2011

4 Qatar19 Mongolia17 Turkmenistan 15 Chana14 Iraq10 China9 Kuwait8 Sudan-4 Puerto Rico -6 Greece-7 Yemen-11

5 See table 3.1 for Average Growth Rates across countries : Negative Growth (Nigeria, Zambia,Chad, etc) <0 Slow Growth (Kenya, Ghana, Rwanda, Argentina) 0.12<G<1.3 Moderate growth (Lesotho, Egypt, Brazil, India)2.1<G< 2.75 Rapid Growth (Botswana, Malaysia, South Korea, Singapore 3.32<G< 6.3 Industrial Countries (Japan USA, Canada, UK) Japan= 4.11, USA= 2.43 Negative Growth (Nigeria, Zambia,Chad, etc) <0 Slow Growth (Kenya, Ghana, Rwanda, Argentina) 0.12<G<1.3 Moderate growth (Lesotho, Egypt, Brazil, India)2.1<G< 2.75 Rapid Growth (Botswana, Malaysia, South Korea, Singapore 3.32<G< 6.3 Industrial Countries (Japan USA, Canada, UK) Japan= 4.11, USA=

6 Why is Botswana Successful (Read Box 3.1) Between , Botswana was the fastest growing country in the world at about 8% per year. But at independence in 1965, it was poor it had 100 high school graduates and 22 college graduates. What is the main source of success: Good policies and strong institution and democratic government Protection of property rights and minimal corruption including civil service base on merit not on patronage These has led to highest per capital income and best HDI Recent challenge: High HIV/AIDS infection rate has reversed this. Between , Botswana was the fastest growing country in the world at about 8% per year. But at independence in 1965, it was poor it had 100 high school graduates and 22 college graduates. What is the main source of success: Good policies and strong institution and democratic government Protection of property rights and minimal corruption including civil service base on merit not on patronage These has led to highest per capital income and best HDI Recent challenge: High HIV/AIDS infection rate has reversed this.

7 Factor Accumulation, Productivity Growth, Econ. Growth Factor Accumulation: increase in the size of capital stock and labor force. More machines, factories, buildings, roads, electricity, computers and tools along with better trained workers Productivity Growth: Amount of output per unit of machine or worker: increases in 2 ways by greater efficiency-specialization, and technological change. This can be explained using production function Q= f (Labor, Capital, etc…) Factor Accumulation: increase in the size of capital stock and labor force. More machines, factories, buildings, roads, electricity, computers and tools along with better trained workers Productivity Growth: Amount of output per unit of machine or worker: increases in 2 ways by greater efficiency-specialization, and technological change. This can be explained using production function Q= f (Labor, Capital, etc…)

8 Fig. 3.1 Basic Sources of Growth: Production function Q=f(K)-capital accumulation ) 7

9 Fig. 3.1 bottom: Productivity Gains 8

10 Saving, Investment & Capital Accumulation Key Elements of Economic Growth New investment increases the capital stock Investment (I) is financed through savings (S) I=f(S) Savings comes from income of GDP S= f(GDP) These decisions are made by consumers, firms corporations, & governments Sustaining Growth requires both generating new investment and making sure it is productive & employment creating. Key Elements of Economic Growth New investment increases the capital stock Investment (I) is financed through savings (S) I=f(S) Savings comes from income of GDP S= f(GDP) These decisions are made by consumers, firms corporations, & governments Sustaining Growth requires both generating new investment and making sure it is productive & employment creating.

11 Sources of Growth Analysis Solow Model: Explores the contribution of each factor to increase to output: Q(K, L, Productivity gains) Growth Accounting or Source of Growth Analysis Yg= (Wk x Kg) + (Wn x Lg+ A Yg= growth of income Kg, Lg= growth of capital and labor Wk, Wn= share of capital and labor A= rate of productivity of inputs= residual Solow Model: Explores the contribution of each factor to increase to output: Q(K, L, Productivity gains) Growth Accounting or Source of Growth Analysis Yg= (Wk x Kg) + (Wn x Lg+ A Yg= growth of income Kg, Lg= growth of capital and labor Wk, Wn= share of capital and labor A= rate of productivity of inputs= residual

12 Example of Growth Accounting Assume the following: Yg=0.05 (GDP) Kg=0.07 (7 percent),KL=.02 (labor growth) WL=0.06 share of labor in income (6%) Wk= 0.04 (share of capital in income (4%) Substitute in Yg= WkKg + LwLg +A 0.05= (0.4 x 0.07) +( 0.6 x0.02) +A A= 0.01 or 1 percent Assume the following: Yg=0.05 (GDP) Kg=0.07 (7 percent),KL=.02 (labor growth) WL=0.06 share of labor in income (6%) Wk= 0.04 (share of capital in income (4%) Substitute in Yg= WkKg + LwLg +A 0.05= (0.4 x 0.07) +( 0.6 x0.02) +A A= 0.01 or 1 percent

13 Economic Growth Across Countries : table 3.1 Negative Growth (Nigeria, Chad, Senegal) Slow Growth (Kenya, Ghana, South Africa) Moderate Growth (Lesotho, Egypt, Brazil) Rapid Growth (Botswana, Malaysia, S.Korea, Thailand) Industrial Countries (Japan, US, Canada) Negative Growth (Nigeria, Chad, Senegal) Slow Growth (Kenya, Ghana, South Africa) Moderate Growth (Lesotho, Egypt, Brazil) Rapid Growth (Botswana, Malaysia, S.Korea, Thailand) Industrial Countries (Japan, US, Canada)

14 Sources of Growth Across Countries (1980s) based on table 3.2 Country/Region: Output(Q) K Education TFP Brazil Ethiopia Ghana o Africa East Asia Latin America Middle East South Asia Country/Region: Output(Q) K Education TFP Brazil Ethiopia Ghana o Africa East Asia Latin America Middle East South Asia

15 Characteristics of Rapidly Growing Countries 1. Macroeconomic stability 2. Investment in Health and Education 3. Effective Governance and Institutions 4. Favorable Environment to Private Enterprise 5. Favorable Geography or location? 1. Macroeconomic stability 2. Investment in Health and Education 3. Effective Governance and Institutions 4. Favorable Environment to Private Enterprise 5. Favorable Geography or location?

16 Macroeconomic stability Macroeconomic implies avoiding inflation and recession. An extreme case of high inflation: Zaire/Congo=2800%, more recently Zimbabwe 4000%! Primarily by printing too much money to pay for deficeit Political instability in the form of civil war, military coups, cross-border wars are rampant in Africa 2/3 of African states suffer from conflict See figures 3.2, 3.3 Macroeconomic implies avoiding inflation and recession. An extreme case of high inflation: Zaire/Congo=2800%, more recently Zimbabwe 4000%! Primarily by printing too much money to pay for deficeit Political instability in the form of civil war, military coups, cross-border wars are rampant in Africa 2/3 of African states suffer from conflict See figures 3.2, 3.3

17 Fig. 3.2: Inflation and Growth in 1990s 16

18 Fig. 3.3: GDP per capita before and After Civil War 17

19 Investment in Education and Health ( Human Capital) Investment on Human capital is a key as it translates to longer life, healthier and productive population. Health and Education are both input or means and outcome (goal) of development. Increase in the level and quality of Education and health is crucial Investment on Human capital is a key as it translates to longer life, healthier and productive population. Health and Education are both input or means and outcome (goal) of development. Increase in the level and quality of Education and health is crucial

20 Fig. 3.4: Growth and Life Expectancy Relations 19

21 Effective Governance and Institutions Douglas North study shows relationship between economic growth, the rule of law, extent of corruption, property rights and quality of government bureaucracy, and other measures of institutional quality Economic Growth = F( Institutions..) Other factors: effective private sector, civil society groups, and free press, political competition, etc.. Douglas North study shows relationship between economic growth, the rule of law, extent of corruption, property rights and quality of government bureaucracy, and other measures of institutional quality Economic Growth = F( Institutions..) Other factors: effective private sector, civil society groups, and free press, political competition, etc..

22 Fig. 3.5: Governance and Growth 21

23 Institutions, Governance & Growth read box 3.2 on page institutions are necessary according to Rodrik and Sumbramanian (2003-Finance & Development) 1. market institutions that protect property rights 2. Market regulating institutions that deal with market failure 3. Market stabilizing institutions to control inflation 4. Market legitimizing institutions such as social protection and insurance 5.Political institutions determine how a country is governed: level of democracy, transparency, free press, participatory politics, and competitive parties. See Figure 3.5 Governance and Growth 5 institutions are necessary according to Rodrik and Sumbramanian (2003-Finance & Development) 1. market institutions that protect property rights 2. Market regulating institutions that deal with market failure 3. Market stabilizing institutions to control inflation 4. Market legitimizing institutions such as social protection and insurance 5.Political institutions determine how a country is governed: level of democracy, transparency, free press, participatory politics, and competitive parties. See Figure 3.5 Governance and Growth

24 Favorable Environment for Private Enterprise Growth depends on millions of private citizens making decision to save, invest, work, educate, etc Agricultural policies are central in Africa since 70-80% of the population lives from agriculture Hernando de Soto: The Mystery of Capital Heavy business regulation and weak property rights under mine or kill businesses The degree of openness to international trade and influence matters see Figure 3.6 Growth depends on millions of private citizens making decision to save, invest, work, educate, etc Agricultural policies are central in Africa since 70-80% of the population lives from agriculture Hernando de Soto: The Mystery of Capital Heavy business regulation and weak property rights under mine or kill businesses The degree of openness to international trade and influence matters see Figure 3.6

25 Fig. 3.6: Degree of Openness 24

26 Does Geography Matter? Most economically developed states are in Temperate climate Zone. Most developing countries are in the tropics. “The effect of climate”: Andrew Kamrack argument. Does being land locked matter? (no coast line). Yes and no Botswana is land locked but it is most successful African Economy Switzerland and Austria are land locked yet they are wealthy countries. Most economically developed states are in Temperate climate Zone. Most developing countries are in the tropics. “The effect of climate”: Andrew Kamrack argument. Does being land locked matter? (no coast line). Yes and no Botswana is land locked but it is most successful African Economy Switzerland and Austria are land locked yet they are wealthy countries.

27 Fig. 3.7: The Destiny of Geography? 26

28 Fig. 3.8: Growth and Geography 27

29 Production Function & Diminishing Returns The Concept of Production function Q= Output= f( Labor, Capital, Land, etc) Principle of Diminishing Marginal Product (See Figure 3.9) Implications of diminishing returns of capital for developing & African countries The Concept of Production function Q= Output= f( Labor, Capital, Land, etc) Principle of Diminishing Marginal Product (See Figure 3.9) Implications of diminishing returns of capital for developing & African countries

30 Implications of Diminishing marginal product of Capital Poor countries have a potential to grow more rapidly since they face capital scarcity Richer countries with capital abundant grow slowly Since poor countries have more potential to grow faster they can catch up with rich countries Examples: China, India, etc..This has not happened in Africa except in Botswana. Why? Poor countries have a potential to grow more rapidly since they face capital scarcity Richer countries with capital abundant grow slowly Since poor countries have more potential to grow faster they can catch up with rich countries Examples: China, India, etc..This has not happened in Africa except in Botswana. Why?

31 Fig. 3.9: The effect of Diminishing Marginal Product of Capital 30

32 Fig. 3.10: Growth & Initial Per capital level 31

33 The Convergence Debate: Is there convergence? There may be convergence among open economies that share the same features For example East Asian Economies since 1965 (Sachs and Warner, 1195) Other studies show there no evidence of absolute convergence but there may be conditional convergence. (See figure 3.2) There may be convergence among open economies that share the same features For example East Asian Economies since 1965 (Sachs and Warner, 1195) Other studies show there no evidence of absolute convergence but there may be conditional convergence. (See figure 3.2)

34 Fig. 3.11: Conditional Convergence Among OECD Countries 33

35 Fig

36 Economic Growth & Structural Change Growth involves more than increases in per capita income and rise in factor productivity Structural change must take place in 4 ways 1.Proportion of output from agriculture declines, share of manufacturing & services rise 2.Proportion of Labor engaged in agriculture declines and labor force in industry rises 3.Population becomes more urbanized & cities and towns grow over time 4. Greater share of output is sold in markets. 5. Ignoring agriculture in early stage is a mistake Growth involves more than increases in per capita income and rise in factor productivity Structural change must take place in 4 ways 1.Proportion of output from agriculture declines, share of manufacturing & services rise 2.Proportion of Labor engaged in agriculture declines and labor force in industry rises 3.Population becomes more urbanized & cities and towns grow over time 4. Greater share of output is sold in markets. 5. Ignoring agriculture in early stage is a mistake

37 Reasons for the Decline of Share of Agriculture 1. Engel’s Law: as income the share of expenditure on food declines and expenditure on non-food such as recreation, clothing, housing, etc rises. 2. Productivity gains in agriculture frees labor for non- agricultural goods or manufacturing and service production. Technology (improved seeds, fertilizer, machinery,etc) allows less labor to produce food Example in 18 th & 19 th century the majority of Americans were in agriculture, now only 3% of US population is engaged in agriculture and 97% in industry and services. 1. Engel’s Law: as income the share of expenditure on food declines and expenditure on non-food such as recreation, clothing, housing, etc rises. 2. Productivity gains in agriculture frees labor for non- agricultural goods or manufacturing and service production. Technology (improved seeds, fertilizer, machinery,etc) allows less labor to produce food Example in 18 th & 19 th century the majority of Americans were in agriculture, now only 3% of US population is engaged in agriculture and 97% in industry and services.

38 Fig. 3.13: Structural transformation among four developing countries 37

39 Fig

40 Fig. 3.15: Decreasing Share of Rural Population with income rise 39

41 Chapter 3: Economic Growth Summary 1. A nontechnical overview of economic growth. The main questions posed are Why are some countries rich and others poor, and why do some countries grow quickly and others grow slowly? The chapter broadly observes the performance of groups of countries and divides their growth into the following categories: negative, slow, moderate, and rapid. 2. Basic mechanisms of economic growth and break them down into factor accumulation and productivity growth. Basic features of the production function and the concept of diminishing returns. The key ideas and implications of the Solow model are presented in a nontechnical manner. Followed by the idea of diminishing returns to convergence and explores the convergence debate. 3. The analysis of the sources of growth decomposition is shown, and the idea of total factor productivity is introduced. The authors then trace the results of the empirical work on sources of growth from Solow to Collins and Bosworth (who find that developing countries rely more on capital accumulation). 4.The five main characteristics of rapidly developing countries: macroeconomic and political stability, investment in health and education, effective governance and institutions, favorable business environment, and favorable geography. Using new data, the text explains the idea of structural change. 5Boxed Examples: There are two boxed examples. 1,The economic success of Botswana. 2.Summary of the recent research on institutions and economic growth s 1. A nontechnical overview of economic growth. The main questions posed are Why are some countries rich and others poor, and why do some countries grow quickly and others grow slowly? The chapter broadly observes the performance of groups of countries and divides their growth into the following categories: negative, slow, moderate, and rapid. 2. Basic mechanisms of economic growth and break them down into factor accumulation and productivity growth. Basic features of the production function and the concept of diminishing returns. The key ideas and implications of the Solow model are presented in a nontechnical manner. Followed by the idea of diminishing returns to convergence and explores the convergence debate. 3. The analysis of the sources of growth decomposition is shown, and the idea of total factor productivity is introduced. The authors then trace the results of the empirical work on sources of growth from Solow to Collins and Bosworth (who find that developing countries rely more on capital accumulation). 4.The five main characteristics of rapidly developing countries: macroeconomic and political stability, investment in health and education, effective governance and institutions, favorable business environment, and favorable geography. Using new data, the text explains the idea of structural change. 5Boxed Examples: There are two boxed examples. 1,The economic success of Botswana. 2.Summary of the recent research on institutions and economic growth s

42 End Chapter 3 This concludes the Norton Media Library Slide Set for Chapter 3 W. W. Norton & Company Independent and Employee-Owned Economics of Development SIXTH EDITION By Dwight H. Perkins Steven Radelet David L. Lindauer