2a: Economic growth: theory and data Growth: big questions, theoretical tools What does economic growth involve?  Factor accumulation & productivity growth  Changing structure of production, consumption & trade What makes economies richer? What sustains their growth?  Growth theory What determines the mix of goods produced, consumed and traded?  Trade theory models for small open economies Southeast Asian experience (1) East Asia and Pacific region: generally high and consistent growth since 1980s  Especially if we ignore the failures! (Gill & Kharas Table 1.2)  Progress of leading economies from low to middle income status Poverty alleviation record is strong (G&K Table 1.7) Inequality rising, but what does this signify?  From high or low base?  Changing structure of production, and urbanization  Relative scarcity of some productive factors – esp human capital and entrepreneurial abilities  Political economy, and development policy settings The “mechanics” of growth Why countries grow at different rates? Why rates of growth change over time? Is there anything that policy makers can to influence the rate of growth? Aggregate production functions: “parables” or “toys” for understanding aggregate economic growth Qty of output (Y) A: Linear production function B: Diminishing returns production function YB YA L0 Qty of Variable Input (L) A basic growth model Relate agg production (Y, measured in $) to capital stock (K), labor force (L), pop growth (n), savings (S), savings rate (s = S/Y), consumption (C), investment (I), and capital depreciation rate (d) Two-factor production function: Y = F(K, L) (Disposition of income) (Y = C + S) Savings out of income: S = s*Y (2) Savings = investment: S=I (3) Change (Δ) in K stock:) in K stock: Δ) in K stock:K = I – d*K Change in labor force: Δ) in K stock:L = n*L (1) (4) (5) Eq (1)-(6) can be solved for Y, K, L, I, S, C in terms of s, d and n Combining (3)-(5) gives: Δ) in K stock:K = s*Y – d*K (6) Using (5) and (6), aggregate output growth depends on net investment & growth of labor force • Expressed in intensive form (output per worker, y = Y/L, and capital per worker, k = K/L) • Diminishing returns to k y y = ƒ(k) k • From (6), growth of capital stock per worker : Δ) in K stock:k = sy – (n + d)k i.e Δ) in K stock:k rises with savings/worker, declines with pop growth & physical deprctn 10 y (n+d)k = depreciation y = ƒ(k) = output/worker yH y0 yL sy = savings/worker kL k0 kH k Δ) in K stock:k = sy – (n + d)k, so Δ) in K stock:k is vertical diffnce sy curve and (n+d)k • At kL, Δ) in K stock:k > and “capital deepening” Compare kH • At k0, Δ) in K stock:k = with “steady-state” output per worker y0 • “Steady state” implies constant per capita income • Convergence: poorer countries (lower k) will grow faster 11 y (n+d)k y = ƒ(k) y1 y0 (s+a)y sy k0 k1 k • Experiment: Increase savings per worker from sy to (s+a)y : At k0, Δ) in K stock:k now > New steady state income is y1 y (n+d)k y = ƒ(k) ((n–b)+d)k y1 y0 sy k0 k1 k • How we represent a reduction in population growth rate? What happens to capital accumulation and steady-state income per worker? More on Solow growth model  Solow: Empirically, technical progress accounts for most economic growth  Think about investments in human capital (education, training) as a form of technical progress that increases the effective labor endowment  What about natural resources?  Link between Δ) in K stock:k and the return on capital  Higher Δ) in K stock:k implies higher return on new investment (capital scarcity implies high returns)  Then capital should flow to poorest countries! Can Solow model explain comparative growth experiences? 14 Convergence • Standard Solow model: all countries share same technology, savings rates, etc • Diminishing returns implies lower growth rate of capital per worker at higher levels of k • Implication: absolute convergence  Poorer economies will grow more quickly than richer  Over time, per capita income levels among similar economies will become equal, regardless of initial differences  Formally:  GDP growth = a*(Base GDP) + b*(K/L growth); a < 0, b > 15 Southeast Asian experience (2) Sources of economic growth in SE Asia  What factors have contributed most to growth? Labor force growth (“demographic dividend”)  Capital investment (domestic and foreign)  Improvements in effective labor through education, nutrition, etc  Efficiency gains – from trade and specialization; domestic market activation, etc…  Productivity spillovers and externalities; increasing returns  World Bank: East Asian Miracle (1993), decomposes contribution of some of these to total GDP growth 16 Variable Indonesia Malaysia Singapore Thailand 1.1 1.64 1.69 0.87 Population growth 0.22 0.26 0.18 0.26 Primary enrollments 1.77 2.53 2.93 2.19 Secondary enrollments 0.16 0.5 0.84 0.31 Initial income -1.02 -1.47 -1.74 -1.12 Estimated growth rate 2.23 3.46 3.9 2.51 Actual growth rate 3.72 6.03 3.82 60 87 65 66 Investment Percentage explained Source: East Asian Miracle, 1993 What accounts for the unexplained 13-40%? 17 18 Divergent paths in countries 1954-58a 1978 1985 2005 Philippines 380 Rps 510 600 3170 Burma 300 150 186 1020 Thailand 400 490 752 6420 Ratio, Th/Ph 1.05 0.96 1.25 2.02 Ratio, Th/Bu 1.33 3.27 4.04 6.29 Sources: (1950s: Myrdal, Asian Drama; other years: World Bank Units: 1950s: Indian Rupees; 1978-85: current $US; 2005: PPP$ 19 What accounts for divergence within SE Asia? 20 ... produced, consumed and traded?  Trade theory models for small open economies Southeast Asian experience (1) ? ?East Asia and Pacific region: generally high and consistent growth since 1980s  Especially... Formally:  GDP growth = a*(Base GDP) + b*(K/L growth); a < 0, b > 15 Southeast Asian experience (2) Sources of economic growth in SE Asia  What factors have contributed most to growth? Labor force... activation, etc…  Productivity spillovers and externalities; increasing returns  World Bank: East Asian Miracle (1993), decomposes contribution of some of these to total GDP growth 16 Variable