Divergence Big Time: Economic Growth Since 1870

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Divergence Big Time Economic Growth Since 1870

• Nick Crafts

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Modern Economic Growth

• Post industrial revolution era
• Driven by technological progress that has
  substantial impact on productivity growth
• Need appropriate institutions and policies to
  take advantage of the opportunity
• Penalty for getting it wrong gets much bigger
  income divergence is not new but increases
  dramatically

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World GDP Growth ( per year)

• 1500-1820 0.32
• 1820-1870 0.93
• 1870-1913 2.11
• 1913-1950 1.82

• 1950-1973 4.90
• 1973-2001 3.05
• 1820-2001 2.22

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GDP/Person Growth ( per year)
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Levels of GDP/Person (1990,ppp)
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• 20th CENTURY DIVERGENCE
• BUT
• 21st CENTURY CONVERGENCE
• (Lucas, 2000)
• The restoration of inter-society income equality
  will be one of the major economic events of the
  century to come

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The Lucas Model

• Countries that start growing later have faster
  initial growth and then experience growth
  proportional to income gap with leader
• Dy/y a bx
• where x is the number of 50 year periods since
  1800. Hazard rate for beginning modern economic
  growth (l) evolves from 0.001 to 0.03

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World Growth Rate and Income Variability
Parameter Values a .02 b .025 ? min
.001 ? max .03 ? .5
Annual Growth Rate
Log Standard Deviation
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Underlying Argument

• Obstacles to growth removed through imitation of
  institutions, policies, technologies
• Capital mobility and financial liberalization
  relax the savings constraint
• Capital will increasingly flow from rich to poor
  (high K/L to low K/L) countries as the pure
  neoclassical model predicts

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The Solow Model in a Globalized World

• Y/L A(K/L)a
• Diminishing returns to capital accumulation
• Technology universal
• Factors mobile, K/L equalized across countries
• SO
• Beta and sigma convergence

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Why Might the Solow Model Be Wrong ?

• TFP is not the same across all countries
• Obstacles to factor mobility prevent equalization
  of K/L
• Geography, institutions or economic policies
  differ

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Why Do Some Countries Produce So Much More Output
per Worker Than Others?

• Hall Jones (1999) account for international
  differences in Y/L levels using a neoclassical
  production function
• Their results show massive differences in TFP
  contrary to the assumptions of the Solow model
• Labour productivity and TFP are inversely
  correlated with institutional quality

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Sources of Labour Productivity Growth ( per
year) (Bosworth Collins, 2003)
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TFP Growth

• In the textbook Solow model equates to
  technological progress
• In practice reflects both technological progress
  and changes in the efficiency with which factors
  of production are used
• Very rapid TFP growth typically has both these
  components
• Negative TFP growth unlikely to mean technology
  has gone backwards

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Growth Accounting Results

• TFP growth and capital deepening both much
  stronger in East Asia than in Africa
• Investment and innovation contribute more to
  growth in East Asia than in Africa
• Yet scope for catch-up was much greater in Africa
  in 1970s

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Catch-Up Growth

• Not automatic requires social capability
• Persistence of bad institutions may preclude
  catch-up (North)
• Generally speaking, conditionality has not worked
• Occasionally big reforms happen (e.g., Dengs
  China)

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Social Capability

• Incentive structures that inform investment and
  innovation
• Formal and informal institutions matter
• Rule of law, contract enforcement and property
  rights are key
• Institutional reform is often difficult

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Investment and Innovation

• Capital accumulation and technological progress
  are key sources of growth
• Institutions affect incentives to invest and to
  innovate and the quality of investment
• Can you appropriate the benefits?
• How much external finance will there be?

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Rule of Law (Kaufmann et al., 2005)

• the extent to which agents have confidence in
  and abide by the rules of society based on
  aggregations of components which include the
  effectiveness and predictability of the judiciary
  and the enforceability of contracts
• Should be positively related to investment and
  innovation
• Captures Norths central concept of institutional
  quality

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Rule of Law Kaufmann et al. (2006)
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Social Capital

• Features of social organization such as trust,
  norms and networks that can improve the
  efficiency of society (Putnam)
• Informal institutions in Norths terminology
• Not amenable to top-down reform
• Hard to quantify

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International Differences in TrustKnack Keefer
(1997)
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Trust and GrowthKnack Keefer (1997)

• Trust reduces transactions costs, increases
  incentives to invest and innovate
• TRUST is positively correlated with growth 10
  percentage point increase raises growth by 0.8
  percentage points
• Associational activity does not raise growth

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Institutional Diversity

• Is it a one size fits all world?
• Substitutes for prerequisites
• Addressing co-ordination problems
• Does the developmental state fit well with the
  belief that property rights institutions dominate
  outcomes?

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The Chinese Economic Miracle

• Gradualism not big bang
• Context-specific reforms
• No private property seriously flawed capital
  market
• BUT
• Fully reflects importance of incentive
  structures decollectivization of agriculture,
  competition in industry (TVEs) etc.

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Divergence Big Time

• Persistent and widening income gaps characterize
  modern economic growth era
• Institutional/policy failures matter much more
  when growth opportunities increase BUT there is a
  strong geographic correlation of development
  outcomes
• Does this mean that geography undermines the
  mainstream assumption of a level playing field
  for development?

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(No Transcript)
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Geography and Income

• Geography may preclude full convergence
• Natural resources and market access
• Direct and indirect effects

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Economic Geography and International Inequality
(Redding and Venables, 2004)

• Most (60-70) cross-country income variation
  accounted for simply by location relative to
  other countries
• market access (export demand)
• supplier access (import supply)
• Move 50 closer to trading partners would raise
  income by about 25

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World Market Access
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More Results from Redding Venables

• Moving Sri Lanka and Zimbabwe to Central Europe
  would raise income by 67 and 80 respectively
• Making Sri Lanka and Zimbabwe open economies
  would raise income by 21 and 28 respectively
• Other variables do affect income levels including
  institutions

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Natural Resource Curse?

• How might it work?
• Dutch disease
• Exposure to external shocks
• Detrimental to institutional quality
• Makes civil conflict much more likely

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Natural Resource Curse Revisited (Sala-I-Martin
Subramanian, 2003)

• Much more careful econometrics says effect of oil
  and minerals exports on growth is
• negative
• non-linear
• robust
• Works only through institutions
• Natural resource share in exports 55 compared
  with zero reduces expected growth by about 1
  percentage point through predicted impact on
  institutional quality
• BUT natural resources not per se bad news ......
  if Nigeria were Norway ....

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Growth Regressions

• Explore correlations in cross-country growth
  experience

Gyp a b(y/p)o c policy d Institutions
e geography

• Results highlight importance of good institutions
  but also point to role of good policy (openness,
  education) and growth penalty from unfavourable
  geography (transport costs, climate)

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Explaining Differences in per capita Income
Growth between East Asia and Africa, 1965-1990
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The Future of World Growth

• NICK CRAFTS
• University of Warwick

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Questions

• What will future world growth be?
• What will happen to regional shares of world GDP?
• What are the key parameters?
• What are the main risks?

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Context

• Demographics
• US productivity performance
• Catch-up growth experiences
• The BRICs Hypothesis
• Past surprises

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BRICs Hypothesis

• Goldman-Sachs (2003) highlighted change in world
  economic structure consequent on rapid growth of
  big developing economies
• Brazil Russia India China BRICs
• GS story based on catch-up and convergence in
  real GDP per head in these economies (TFP
  converges at 1.5 per year)
• Balassa-Samuelson hypothesis means BRICs share
  of world GDP rises faster measured at market
  exchange rates rather than PPP

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Purchasing Power Parity (ppp)

• PPP theory E/ PUS/PE
• where PUS is the dollar price of a reference
  basket of goods in the US and PE is the euro
  price of the same basket in Europe
• Equivalently PUS E/ x PE such that if PPP
  holds both countries price levels are equal when
  measured in terms of the same currency
• NB the real exchange rate q/ (E/ x PE)/
  PUS is constant in PPP always obtains

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The Balassa-Samuelson Hypothesis
W PT PT W AT
AT
PN W PN W PN gt PN
AN AN

• Relative prices of non-tradables lower in poor
  countries since labour productivity gap lower in
  non-tradables
• Price level is lower in poor countries PPP is
  systematically violated
• Empirically log relative price level 0.4 log
  relative real income per person

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Price Levels and Real Incomes, 2000




















































50,000
40,000
30,000
20,000
10,000
Real per-capita income (in 1996 US dollars)
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GNP/PERSON, 2004
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Implications of Balassa-Samuelson

• Income levels in China relative to US higher
  measured at PPP than at current exchange rates
• Chinese real exchange rate will rise if catch-up
  growth countries
• Chinese growth in constant US will be faster
  than growth measured in constant renmimbi
• 2005-30 according to BRICs 8.8 vs 5.2

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Rules of Thumb

• 3 growth is as good as it gets in a mature
  economy
• Catch-Up growth rates can be 2 or 3 times faster
• Catch-up depends on social capability and is
  often incomplete
• Emerging markets are exciting but risky

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GDP Growth, 1995-2004( per year annual average)

• OECDOld EU 2.2New EU 3.7USA 3.4Japan
  1.2

• EmergingChina 8.7India 6.1Russia 2.9

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Labour Productivity Growth, 1995-2004 per year
annual average

• OECDOld EU 1.5New EU 4.3USA 2.5Japan
  2.3

• EmergingChina 6.3India 3.8Russia 3.3

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World GDP Growth ( per year)
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Rise of China and India
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Naïve Extrapolation

• After the Golden Age of OECD growth world growth
  slowed until Asia took off
• World growth has been increasing as weights of
  China and India rise
• Naïve extrapolation builds this in to the future
  but is implausible

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Naïve Extrapolation
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Components of Growth

• Rate of growth of output Rate of growth of
  labour force Rate of growth of labour
  productivity
• DY/Y DL/L D (Y/L)/(Y/L)
• DL/L demographics matter
• D(Y/L)/(Y/L) scope for catch-up, social
  capability, technological advance are key

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Business as Usual with Demographics

• Use UN population projections
• Age-structure effects important
• Labour force growth in Asia will slow down
• Overall, demographics have a strong retarding
  effect on future growth

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Business as Usual with Demographics
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Demographics and Convergence in China India
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Demographics BRICs
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BRICs Growth Rates
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Projected GDP at Market Exchange Rate (2003 US
bn)
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Brazil and Russia

• Not central to the BRICs hypothesis
• By no means guaranteed to succeed in long-term
  catch-up growth
• Does either have the required social capability?
• Will Russia succumb to the Natural Resource Curse?

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Rule of Law in the BRICs
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Chinese Productivity Growth

• Can be expected to slow down as scope for
  catch-up is reduced in any case
• Requires further reforms to be sustained at a
  very rapid rate and is vulnerable to reform
  failures
• Exerts a very strong impact on future world GDP
  growth

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Growth of total factor productivity in China
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Chinese Productivity Growth Falls to 3
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Wildcards

• AIDS epidemics
• Globalization backlash
• Back to the 1970s
• Latin America takes off

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Latin America Takes Off
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Summary

• World growth is very likely to slow down in the
  next 25 years
• Negative surprises easier to imagine than
  positives
• Chinese productivity growth has central role in
  outcomes