1. The Analytics of Growth Dynamics
An Empirical Analysis With Application
September, 2010
December 2010

2. Outline
A Forecasting Scenario for
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

3. The Analytics of Growth Dynamics: GDP Forecast 2011

4. A Forecasting Scenario for 2012-14
Real GDP Growth (PPPexchange rate)
Real GDP Growth (Market exchange rates)

5. A Forecasting Scenario for 2012-14
Consumer price inflation(% av)
Main Policy Interest Rates(%; end-period)

6. Tremendous divergence in per-capita incomes since 1750
Growth facts
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

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

8. Accounting for global income disparities: within versus between countries
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

9. Inequities in income: within and across countries
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 yj
dj
Representative 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 $)

10. Inequities in health: within and across countries
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 21
Source: WHO, World Bank.
* To be conservative, the distribution in Denmark is assumed to be same as in Madagascar.

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

12. The Great Divergence
Source: Maddison (2001), in 1990 international $

13. Major landmarks in economic growth
Industrial revolution in Europe and the onset of “modern economic growth” (c )
Source: Maddison (2001)

14. Per-capita GDP across various regions over the millennium
Source: Maddison (2001). In 1990 PPP $.

15. Major landmarks in economic growth
Absence of economic growth in Asia (except Japan) and Africa before 1950)
Source: Maddison (2001)

16. Major landmarks in economic growth
Japanese catchup post-1950
Source: Maddison (2001)

17. Major landmarks in economic growth
A world divided between rich and poor countries
Source: Maddison (2001)

18. How growth matters to poverty: back to poverty incidence
(percent below $1.25 per day poverty line, in 2005 PPP $)

19. Source: Thomas (2007)

20. Source: Thomas (2007)

21. How does globalization contribute to economic growth?
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?

22. Economic performance over time: is more globalization always better?
Historical experience with growth 1 2 3 4 5 6 7 8 9
Western Europe
United States
Other Western
offshoots
Mexico
Norway
Japan
South Korea
China
GDP per capita growth rate of fastest growing
country/region (annual average, %)
World GDP per capita growth rate (annual
average, %)

23. Paradoxes of globalization (I) Countries that have benefited most from globalization are those that have not played by the rules …

24. Paradoxes of globalization (I)
Paradoxes of globalization (I) ... while those that have, have performed worse

25. Paradoxes of globalization (I) Countries that have benefited the most from integration in the world economy are countries with non-standard policies
*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.”

26. Paradoxes of globalization (II) Financial globalization has produced frequent and painful crises…
Source: Jeanne and Ranciere (2005)

27. Paradoxes of globalization (II) … and has forced countries to engage in costly strategies of self-insurance

28. Paradoxes of globalization (II) … with the result that capital now flows in the “wrong” direction
Source: Prasad, Rajan and Subramanian (2006)

29. Which country did better?
Paradoxes of globalization (III) For the vast majority of countries, domestic policies trump (nearly) everything else when it comes to economic growth
A parable of two countries Country 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?

30. What drives growth in developing countries?
Four models of growth:
Foreign borrowing-led growth
countries in the periphery of EU in 1990s, LA in 1970s, …
Commodity booms
19th century, many African countries in the last decade
Growth based on deep integration
Goods and factor market integration + institutions + transfers (convergence within EU)
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, China
Only the last is a realistic possibility for most countries

31. Deep vs. shallow integration as drivers of convergence
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

32. Where did real growth come from?
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)

33. What has worked: “productivist” policies
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

34. … combined with an enabling external environment
Permissive of industrial policies
At least under GATT and
Until recently
No pressure to liberalize finance and capital accounts
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

35. From this perspective, existing global rules leave lots to be desired…
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

36. Growth Economics: Rethinking The Links
income
endogenous
endowments
productivity
trade
institutions
partly
endogenous
geography
exogenous

37. (Jared Diamond, Jeffrey Sachs)
Growth Economics: Rethinking The Links
income
endowments
productivity 4
trade
institutions
1, 2 3
geography
(Jared Diamond, Jeffrey Sachs)

38. 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.

39. The Analytics Of Growth Dynamics: From Correlates to Fundamental Causes

40. The Analytics of Growth Dynamics: The Role of Finance
Elements 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 evidence.
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 frontiers
What 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.

41. Growth Economics: The Washington Consensus
“Augmented” Washington Consensus
the previous 10 items, plus:
Original Washington Consensus
1. Fiscal discipline
2. Reorientation of public expenditures
3. Tax reform
4. Financial liberalization
5. Unified and competitive exchange rates
6. Trade liberalization
7. Openness to DFI
8. Privatization
9. Deregulation
10.Secure Property Rights
11. Corporate governance
12. Anti-corruption
13. Flexible labor markets
14. WTO agreements
15. Financial codes and standards
16. “Prudent” capital-account opening
17. Non-intermediate exchange rate regimes
18. Independent central banks/inflation targeting
19. Social safety nets
20. Targeted poverty reduction

42. Disappointments of the Washington Consensus
Latin America: Only 3 countries have grown faster during the 1990s than in the 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.

43. Feasibility Priorites Relevance Uniformity
Questions about the augmented WC
Feasibility
Can all of it be done together?
Priorites
Which reforms first?
Relevance
Does the recipe correspond to actual experience of successful cases?
Uniformity
Is there really one way?
Economic principles do not map into
a unique set of institutional arrangements

44. Hence the chief shortcoming with global economic 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