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Chapter 3Chapter 3Chapter 3Chapter 3

Chapter 3

EconomicGrowth:

Concepts andPatterns

Norton Media Library

Dwight H. PerkinsSteven Radelet

David L. Lindauer

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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

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Divergent Patterns of Economic Growth Divergent Patterns of Economic Growth since 1960 since 1960

Divergent Patterns of Economic Growth Divergent Patterns of Economic Growth since 1960 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

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Qatar 19

Mongolia 17Turkmenistan 15

Chana 14

Iraq 10

China 9

Kuwait 8

Sudan -4Puerto Rico -6

Greece -7

Yemen -11

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See table 3.1 for Average See table 3.1 for Average Growth Rates across countries Growth Rates across countries

1960-2003: 1960-2003:

See table 3.1 for Average See table 3.1 for Average Growth Rates across countries Growth Rates across countries

1960-2003: 1960-2003: 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= 2.434

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Why is Botswana Successful (Read Box Why is Botswana Successful (Read Box 3.1)3.1)

Why is Botswana Successful (Read Box Why is Botswana Successful (Read Box 3.1)3.1)

Between 1970-90, 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 1970-90, 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.

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Factor Accumulation, Factor Accumulation, Productivity Growth, Econ. Productivity Growth, Econ.

Growth Growth

Factor Accumulation, Factor Accumulation, Productivity Growth, Econ. Productivity Growth, Econ.

Growth 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…)

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Saving, Investment & Capital Saving, Investment & Capital

AccumulationAccumulation Saving, Investment & Capital Saving, Investment & Capital

AccumulationAccumulation

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.

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Sources of Growth AnalysisSources of Growth AnalysisSources of Growth AnalysisSources of Growth AnalysisSolow 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

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Example of Growth Example of Growth Accounting Accounting

Example of Growth Example of Growth Accounting 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

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Economic Growth Across Economic Growth Across Countries 1960-2003: table 3.1Countries 1960-2003: table 3.1

Economic Growth Across Economic Growth Across Countries 1960-2003: table 3.1Countries 1960-2003: 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)

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Sources of Growth Across Countries Sources of Growth Across Countries 1960-2000 (1980s) based on table 3.21960-2000 (1980s) based on table 3.2

Sources of Growth Across Countries Sources of Growth Across Countries 1960-2000 (1980s) based on table 3.21960-2000 (1980s) based on table 3.2

Country/Region: Output(Q) K Education TFP

Brazil -1.63 0.16 0.68 -2.47

Ethiopia -1.74 1.11 0.27 -3.12

Ghana -1.14 -1.23 o.15 0.07

Africa -1.06 -0.07 0.42 -1.41

East Asia 4.36 2.45 0.66 1.25

Latin America -1.77 0.04 0.47 -2.28

Middle East 1.15 0.55 0.53 0.07

South Asia 0.68 1.02 0.42 2.25

Country/Region: Output(Q) K Education TFP

Brazil -1.63 0.16 0.68 -2.47

Ethiopia -1.74 1.11 0.27 -3.12

Ghana -1.14 -1.23 o.15 0.07

Africa -1.06 -0.07 0.42 -1.41

East Asia 4.36 2.45 0.66 1.25

Latin America -1.77 0.04 0.47 -2.28

Middle East 1.15 0.55 0.53 0.07

South Asia 0.68 1.02 0.42 2.25

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Characteristics of Rapidly Characteristics of Rapidly Growing CountriesGrowing Countries

Characteristics of Rapidly Characteristics of Rapidly Growing CountriesGrowing 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?

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Macroeconomic stabilityMacroeconomic stabilityMacroeconomic stabilityMacroeconomic 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

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Investment in Education and Investment in Education and Health ( Human Capital)Health ( Human Capital)

Investment in Education and Investment in Education and Health ( Human Capital)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

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Effective Governance and Effective Governance and InstitutionsInstitutions

Effective Governance and Effective Governance and InstitutionsInstitutions

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..

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Institutions, Governance & Institutions, Governance & GrowthGrowth

read box 3.2 on page 82-83read box 3.2 on page 82-83

Institutions, Governance & Institutions, Governance & GrowthGrowth

read box 3.2 on page 82-83read box 3.2 on page 82-835 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

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Favorable Environment for Favorable Environment for Private EnterprisePrivate Enterprise

Favorable Environment for Favorable Environment for Private EnterprisePrivate 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

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Does Geography Matter?Does Geography Matter?Does Geography Matter?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.

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Production Function & Production Function & Diminishing ReturnsDiminishing Returns

Production Function & Production Function & Diminishing ReturnsDiminishing 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

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Implications of Diminishing Implications of Diminishing marginal product of Capitalmarginal product of CapitalImplications of Diminishing Implications of Diminishing marginal product of Capitalmarginal product of CapitalPoor 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?

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The Convergence Debate: Is The Convergence Debate: Is there convergence?there convergence?

The Convergence Debate: Is The Convergence Debate: Is there convergence?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)

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Economic Growth & Structural Economic Growth & Structural ChangeChange

Economic Growth & Structural Economic Growth & Structural ChangeChange

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

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Reasons for the Decline of Reasons for the Decline of Share of Agriculture Share of Agriculture

Reasons for the Decline of Reasons for the Decline of Share of Agriculture 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 18th & 19th 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 18th & 19th century the majority of Americans were in agriculture, now only 3% of US population is engaged in agriculture and 97% in industry and services.

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Chapter 3: Economic Growth Chapter 3: Economic Growth SummarySummary

Chapter 3: Economic Growth Chapter 3: Economic Growth SummarySummary

• 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

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End Chapter 3End Chapter 3End Chapter 3End Chapter 3

This concludes the Norton Media LibrarySlide Set for Chapter 3

W. W. Norton & CompanyIndependent and Employee-Owned

Economics ofDevelopment

SIXTH EDITION

ByDwight H. Perkins Steven Radelet

David L. Lindauer