The facts of growth
# 7
14 March 2016
Measuring
output or living standard?
Growth can be measured as output (production) or as living standard
(consumption) as PPP model shows
So, can we always assume that a decline in output per person depends on a slump in productivity?
Or can it be the result of a trade-off between income and leisure?
as it could be in some cases when GDP per capita overcome a certain threshold
Matching production
and consumption sides
A sloppy economic growth could be explained as the result of a reduction in the number of hours worked or the ratio of the number of workers (or hours) to population more than a fall in the output per worker or per hour worked (productivity)
typically, in rich countries (Europe vs USA)
So a fraction of a higher income (production) could depend on a higher number of hours worked
typically in emerging economies Europe vs USA: productivity
was still growing in Europe in 2000 whilst hours per person were decreasing leisure vs income [Blanchard,
2004]
Growth: an overview
Looking at output levels and growth rate in the last decades one can yield two main conclusions:
there has been a large increase in output per capita there has been convergence of output per person
across countries
Yearly growth output rate pc
Real output per person (US2000 dollars)
1950-2004 1950 2004 2004/1950
France 3.3 5,920 26,186 4.4
Japan 4.6 2,187 24,661 11.2
UK 2.7 8,091 26,762 3.3
USA 2.6 11,233 36,098 3.2
Average 3.5 6,875 28,422 3.9
Convergence: what is it?
Convergence means getting closer,
reducing differences in level of output by growing faster, catching up with the gap between the richer and the poorer
the force of compounding: a small difference becomes a significant amount over time
The post-war convergence between the
four-country sample is not specific, it
extends to a larger set of countries
(OECD, 1948)
OECD countries (the club of winners):
the output convergence, 1950-1992
Convergence: a general rule?
A large set of countries steadily
converged after 1950 catching up with the richest (USA) as a result of an
asymmetrical variation in growth rates But is enough to take it as a general rule?
to be accepted in the club success is a prerequisite
hence, a huge bias: actually, the sample is a biased selection of “economic winners”!
The world economies, 1960-1992
Does every country converge?
By constructing a larger sample of economies (almost all the economies) convergence
does not appear the general rule, although is not a solely OECD phenomenon:
Which regional areas converged or are still converging?
Europe as a whole
North and South America, with exceptions Asia (four tigers)
But it is not the rule for African countries
OECD countries, Africa and Asia
Capital accumulation,
technology and institutions
# 8
15 March 2016
How can we explain growth?
A starting model could be Solow’s based on the aggregate production function [Cobb-Douglas, 1928]
Y = F/(K,N)
where inputs are K (aggregate capital stock) and N (aggregate employment)
The actual output depends on the state of technology given a certain amount of factors K and N
What does define technology?
Two definitions of the state of technology:
a narrow one: the range of products and the techniques available to produce them
a broader one: the first definition + the way the economy is organised from firms’
organisation to legal and political systems
How does the aggregate production function work?
Increasing quantities of inputs (both K and N) produce positive effects on aggregate output according to constant returns to scale (no
scale effects!)
Yet, if just one input increases
additional quantities of inputs will lead to a smaller and smaller
increase in output:
decreasing returns to capital/labour Hence, the upward-sloping curve,
but a change in the state of technology can modify the aggregate production function
F(K/N)1
Technology and the aggregate
production function
Capital accumulation or technological
progress? The US evidence
The sources of growth
Thus, growth comes from capital accumulation (K(N) and technological progress (innovation) But capital accumulation in itself does not sustain
growth in the long term (that’s why there is an upward slopping curve!)
Hence, (higher) saving rates cannot contribute but partially and temporarily
In the long term growth depends on technological progress, but what exactly produces
innovation? What is the ultimate cause?
Institutions: a definition
Technology is the proximate cause of growth.
But what - the ultimate cause - does make a country more innovative than others?
The idea that institutions could shape
economic behaviour and choice is a long lasting one (since Locke and Smith)
Institutions: the “rules of the game”, explicit and implicit/tacit rules within an
economy/society [North, 1990]
Institutions are a set/structure of incentives
A competing explanation
Institutions matter for economic growth because they shape the incentives of key actors
[Acemoglu, Johnson, Robinson, 2005]
in particular, they influence investments in physical and human capital (K + H), in technology and the organisation of production
Other competing factors:
Geography [Montesquieu, 1748; Marshall, 1890;
Sachs, 2001]
Culture [Weber, 1905; Huntington, 1993 and 1996]
Chance and Randomness [Wrigley, 1988]
A dynamic perspective
The economic institutions affect not only the current aggregate economic growth
potential of the economy, but also
determine future outcomes by influencing the distribution of resources
wealth, capital, human capital
They determine the size of the economy and the income distribution amongst groups
and individuals, now and in the future
Hence, a conflict of interestA hierarchy of institutions
political power t → economic institutions t
economic institutions t → economic performance t distribution of resources t1
There are conflicting groups and interests over current and future distribution of resources, i.e.
over the set of economic institutions
Even political power is endogenous → political institutions → incentives and constraints
State variables and shocks
State variables (distribution of resources and political power) determine the other
variables in the system affecting the ultimate economic performance
They tend to be persistent over time so that
“lock in” phenomena could occur even on a very negative equilibrium
Shocks can hit both of them:
changes in technologies and the international environment (e.g., the Atlantic trade)
The ultimate causes of economic growth:
models and evidence
# 9
16 March 2016
Proximate and ultimate causes of prosperity
If technology and capital accumulation (both K and H) are proximate causes of wealth, that is productivity, yet they are not necessarily the fundamental causes of prosperity for societies
Three hypotheses compete for explaining why some countries are richer than others and why some countries might remain poor
The geography hypothesis
This approach claims that differences in
geography, climate and ecology ultimately determine the large differences in wealth across the world
Such circumstances are out of their control and such conditions make it impossible or unlikely to accumulate or effectively use the factors of production
The climate [Montesquieu, 1748; Marshall, 1980]
or disease (malaria, dengue fever) in tropical areas [Sachs, 2001] affect human capital
How to escape
from the “geography trap”?
A great geographical divide:
temperate zones vs tropical zones
These countries are permanently
disadvantaged and they should not be expected to catch up with the rest of the world
although some large-scale investments
in transport technology and disease
eradication may, at least, partially
redress such disadvantages
But was Montesquieu right?
The culture hypothesis
Societies are different because they
respond differently because of specific shared experiences, different values, cultural and religious beliefs, family ties and tacit social norms
some societies encourage hard work,
saving and investment, adoption of new technologies
whilst other nurture superstition and mistrust technologies
Weber and Huntington
Max Weber recognised in Protestantism the ultimate cause of the European
industrialisation as it encouraged hard work (education), thrift and investment
i.e., a market economy and economic growth a variant: Anglo-Saxon culture vs Iberian
culture
Samuel Huntington contrasts the West and the Islamic world (the “clash of
civilisations”) or North and South Korea
The institutions hypothesis
The institutions are the “rule of the game”
they are determined by individuals as member of a society
they place constraints on behaviour
they shape behaviour determining incentives
Institutions are humanly-devised, man-made
factors, vs geography (out of control) and culture (a very slowly changing variable)
They do not come out of the blue but are a complex product of choices and conditions
Efficient and inefficient institutions
Societies may chose different economic institutions. The efficient ones:
protection and enforcement of property rights partial or impartial judicial systems
financial arrangements (how much efficient is borrowing money for businesses?)
business and labour regulation (how much open and free is entering into a new line of business or occupations?)
education and training opportunities
Extractive vs inclusive institutions
Inclusive economic institutions are those
institutions that encourage the participation of the great/vast majority of the population in economic activities by best allocating talents and skills
Extractive economic institutions are those institutions shaped by those who control
political power to extract resources from the rest of the society
typically, a dictatorship, an absolute monarchy
A natural experiment of history:
North and South Korea
South Korea has a legal system in which private contracts are recognised (property rights) and enforced, a market economy allocating K and H, whilst North Korea has a dictatorship, the opposite of the rule of law
A second experiment:
Austria and her neighbours
A more reliable experiment?
“The West” and “the Rest”
A long-term growth process with diverging areas depending on sets of different
institutions is represented by how “the West” expanded after 1500
A larger number of observations
(countries), a longer term process (i.e., a larger sample over a longer time period) This experiment is a good test for the
institutions hypotheses
The reversal of fortune
When considering
“the Rest” a
reversal of fortune between differently colonised zones emerges
The poorer areas in 1500, proxied by urbanisation rates, are today the
richest areas across the world Why?
Understanding
the reversal of fortune 1/2
The geography hypothesis could argue that
poorer countries today are so because of less productive semitropical soils in comparison to temperate soils (North America)
But the opposite is true: in 1500 North America was poorer and other areas such India and North Africa were comparatively more
prosperous!
Europeans established more extractive
institutions in places that were more populated to funnel gold and agricultural surplus
Understanding
the reversal of fortune 2/2
On the contrary, Europeans set up more
inclusive institutions in areas that were less populated and developed
Such a simple strategy was conceived in order to extract wealth and income by controlling former empires (Aztec and Inca in America, Mogul in India): labour, riches, income flows whilst setting up inclusive institutions where
Europeans themselves were settlers, like in North America or Australia and New
Zealand
Urbanisation rate in 1500 and institutions in 1995
Population density in 1500 and institutions in 1995
