“Economic growth in the global economy”

• This module is the first half of a course (“Economic Growth and History of the global economy”) on long run trends in the world economy

• The part I teach is module 1: “Economic Growth in the Global Economy”

• My colleague Giovanni Ceccarelli will teach module 2: “Economic History of the Global Economy”

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Who I am

Francesco Daveri, M.Sc. Oxford (UK); PhD Pavia (Italy)

Research topics: labor markets, growth and productivity issues

Formerly a consultant to Italy’s Ministry of the Economy, the European Commission (DG INFSO and ECFIN) and the World Bank (Research Department)

A coauthor of the top-selling book Centomila punture di spillo (2008), written with Carlo De Benedetti and Federico Rampini.

My latest book is Crescere si può (il Mulino, 2012)

Also a columnist of Il Corriere della Sera and a member of the Editorial Board of the website LaVoce.info.

Fb page: http://it-it.facebook.com/fdaveri

Twitter: twitter.com/fdaveri 1-2

Readings

• David Weil, “Economic growth”, 2012 (3rd edition; 2007 2nd edition)

• Specific chapters indicated on the course website together with the lecture slides and the course syllabus

Office hours: Wednesdays 11-13 and Thu 11-13

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What this course is about

Two mysteries to investigate

Mystery 1: Why are there rich and poor countries in the world economy?

Mystery 2: Why do some countries become richer and others stay poor?

Solving these mysteries is important

• Will Africans be as rich as we are today in the – near or distant - future?

• Or will Italians be as poor as today’s Africans?

Today:

we only document these mysteries and give some introductory definitions to be made crystal clear in what follows

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Copyright © 2009 Pearson Education, Inc. Publishing as Pearson Addison-Wesley

THE FACTS TO BE EXPLAINED

Chapter 1

A world of rich and poor

World population = 6.7 billion, of which

At one extreme, very poor people:

• 866 million with not enough food to eat

• 1 billion with no safe drinking water

• 2.7 billion with no access to health

At the other extreme, very rich people:

• abundant food and good health.

• At times, associated with worrisome rise in obesity (USA, Michelle Obama campaigning against it)

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Per-capita income differences, this is our MYSTERY #1

Economists sum up differences in many social indicators through single indicator: Per-capita income

• Some 20% of the world population earns 60% of total income

• 80% of world pop survives with < 8630 $, less than 700$ monthly

• One billion people barely survive with <1$ per day1-7

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Is there a relationship between GDP and the UN Human Development Indicator (HDI)? Yes, a very close one

• The correlation between GDP rank and HDI rank=0.95• GDP per capita is on the average a very good measure ofWelfare!

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0 50 100 150

HDI rank

GD

P p

er c

ap

ita

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Concept revision: Income ≈ GDP

GDP (Gross Domestic Product) is

• A measure of the value of all the goods and services produced in a country in a given year

May be seen as

• The value of total output at market prices, or

• The value of total income (wages, rents, interest and profits) earned in a country.

This is why we often interchangeably speak of Gdp as “output” or “national income”

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• “GDP is the market value . . .”

– Output is valued at market prices

• “. . . of all final . . .”

– It records only the value of final goods, not intermediate goods (the value is counted only once)

• “. . . goods and services . . .”

– It includes both tangible goods (food, clothing, cars) and intangible services (haircuts, house-cleaning, doctor visits)

• “. . . produced within a country . . .”

– It includes goods and services currently produced, not transactions involving goods produced in the past. It measures the value of production within the geographic confines of a country

• “. . . in a given period of time”

– It measures the value of production that takes place within a specific interval of time, usually a year or a quarter (three months)

GDP: definition

Gdp, Income and Expenditure

GDP, a measure of a nation’s income. It is also – for us economists – the most reliable measure of welfare

• As we do with individuals, to understand whether an economy is doing well or poorly, we usually look at the total income that everyone in the economy is earning

• For the economy as a whole, though, income equals expenditure because:

• Every transaction has a buyer and a seller

• Hence, every euro of spending by some buyer is a euro of income for some seller

• This equivalence between income and expenditure gives us a variety of ways in which GDP can be calculated

Spending (= GDP)

Goods andservices

bought

Revenue (= GDP)

Goods andservicessold

Labor, land,and capital

Income (= GDP)

Inputs forproduction

Wages, rent, and profit (= GDP)

FIRMS HOUSEHOLDS

MARKETS FORFACTORS OFPRODUCTION

Flow of goodsand services

Flow of dollars

MARKETS FORGOODS AND

SERVICES

Graphics of Income = ExpenditureGdp measures both flows of dollars and flows of goods & services in a simplified market economy

Concept revision: levels and growth rates

1. Growth rate of level of X from t to t+1

• g = (Xt+1-Xt) / Xt

2. Compounded average growth rate (average g, from t to t+n)

CAGR = g = (Xt+n/Xt)1/n-1

This is from the following: if g is the same between period t and t+n, then:

Xt+n=Xt(1+g)n

From which the formula above of CAGR is obtained

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A method to measure how much growth matters

The rule of 72: Doubling time of X = 72 / g (where g is growth rate of X in % points). Very handy rule.

Example 1: If China’s income keeps growing by 9% per year, an average Chinese will see its income doubled in 8 years.

Example 2: The five stages of market capitalism (so far)1950-1973: ‘Golden age’, per-capita Gdp up by +3% per year1973-2005: ‘neo-liberal order’, +1.7% per year1870-1913: ‘liberal order’, +1.3% per year1913-1950: ‘wars + interwar period’, +1% per year1820-1870: ‘early capitalism’, +0.5% per yearRemark: in the “golden age” of mkt capitalism, the doubling time

was 24 years; during early capitalism it was 144 years - quite a difference!

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Average growth = some 2% per year. US per capita Gdp doubling every 36 year.

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Gdp growth, a natural state of affairs (the US economy, 1870–2009)

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Club convergence: Faster Gdp growth in the UK and Japan than in the US has led their Gdp to converge towards US levels

.. While some others did not grow at all. Positive growth is unfortunately NOT the rule around the world. This is MYSTERY #2 1-17

Convergence does not hold for all countriesDistribution of 1975–2009 growth rates indicates that some poor countries grew fast ..

More recently: the rise of the rest has been ongoing The poorest countries in the world have caught up a

little bit

Countries Gdp pc 2000 $ Avg Growth 2000-09 %

Gdp pc 2009 $

Oecd (high per capita Gdp)

30528 +0.9 32568

Low and middle per capita Gdp

3287

(gap with Oecd: 9:1)

+4.7 4974

(gap with Oecd: 6:1)

Low per capita Gdp

773

(gap with Oecd: 40:1)

+3.5 1055

(gap with Oecd: 31:1 )

A summary of geographical growth

differencesSouth-East Asia did well or very well (growth often

in excess of 5%)Sub-Saharan Africa did poorly (decline rather than

growth)Middle-East countries benefited from oil shocks,

but short-lived effect on living standards (Oil as a mixed blessing)

Latin America went from hell to heaven, back and forth a few times (early 1980s, mid 1990s, early 2000s, what next?)

Appendix: GDP as a measure of welfare

To understand whether the average Italian citizen is richer than the average Chinese we have to compare the two countries’ Gdp

Problem: How do we compare, if Italy’s gdp is in euros and China’s gdp is in yuans? It’s like comparing apples and oranges -- it can’t be done

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How to compare Gdp in the US and India? Two methods

Method 1: use market exchange rates to convert Rupees into US $ (e.g. on Sep 10, 2009: 1$=49 rupees; US Gdp=37.000, India Gdp=600; so the income differential is 62:1)

Two problems

1. Exchange rates are asset prices and are thus extremely volatile on a daily basis. This is unreasonable: wealth and poverty do not fluctuate that much

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How to compare Gdp in the US and India

Method 2Starting point: the prices of non-traded goods (haircuts) are usually

much lower in poorer countries. This means that 1$ has different purchasing power in different countries (higher in poorer countries)

Method 2: exploit info on lower price of non-traded goods to construct PPP (purchasing power parity) exchange rates and use this - and not the market exchange rate - to compare GDPs across countries

If we do this, the US Gdp is still 37,000 but the Indian Gdp goes up to 3,000. And the income differential between an average American citizen and an average Indian citizen goes down to 12.3:1.

Still there, but much much lower !!!

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Does it make a difference in practice? Yes, a lot for poor countries. Poor countries are “less poor” with PPP than with market exchange rates

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The Effect of Using PPP or market exchange rates on Gdp comparisons

Gdp, an imperfect measure of welfare?Yes, but money buys a bit of happiness

What we learn from this Appendix

Comparing welfare and living standards is important

Not easy to do it in a sensible way

Gdp comparisons based on PPP exchange rates are more sensible than those based on market exchange rates

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