Why are some countries richer than others? Part 2

Transcription

1 Understanding the World Economy Why are some countries richer than others? Part 2 Lecture 2 Nicolas Coeurdacier nicolas.coeurdacier@sciencespo.fr

2 Lecture 2 : Why are some countries richer than others? Part 2 1. Do countries catch up with economic leaders? 2. Institutions and growth 3. Innovation and growth

3 Reminder Output per workergrowth ( )dynamicsin the Solow model Countries starting further away from their steadystate capital stock are growing at a faster pace. Zero growth fromcapital accumulation

4 Do countries converge? According to the Solow growth model, poorer countries (in terms of capital stock per worker) should grow faster. Doesithold in thedata? Investigate link between future growth and initial income per capita.

5 Do economies converge? Round I: Advanced economies

6 Do economies converge? Round II: The U.S. states

7 Do economies converge? Round III: European Regions

8 Do economies converge? Round IV: Japanese Prefectures

9 Do countries converge? Round V: The World If economies converge then expect negative correlation : countries with high GDP in 1960 shouldgrow more slowly ascapital earnsalow return. Source: PWT

10 The convergence puzzle According to theory, poorercountries should catch-up with advanced economies. In the data, prediction holds when looking at similar regions/countries But doesnot hold whenlooking at the wholesample of countries. Convergence puzzle?

11 Capital Flows and the Lucas Puzzle With decreasing returns, a country with a low level of capital stock should have a higher marginal product of capital. Investing in poor countries countries should bring higher returns. In theory, capital should massively flow towards poorer countries. In the data, low level of capital flows to poorer countries = Lucas Puzzle. Many developing markets lending to rich countries.

12 Countries with low levels of capital should have higher returns on capital. Marginal Product of Capital Capital

13 Reconciling the evidence When we look at all economies no evidence of convergence. When we examine very similar countries strong evidence of convergence. How can we explain this mixed evidence concerning convergence? - take into account that steady states can differ across countries!

14 Output, TFP and capital per worker Output per workerin a country such that : Output per worker = = = Differences in output per worker across countries should reflect - differences in capital stock per worker - differences in technology = Total Factor Productivity TFP

15 China with U.S. capital China ispoorerthanthe U.S. becauseof a lowertfp and because of a lower capital stock.

16 Development accounting withu.s TFP Differences in TFP are crucial to understand differences in income per capita. Differences in capital stock matters but to a smaller extent.

17 ImpliedTFP A relative to U.S. Differences in TFP crucial to understand differences in income per capita.

18 Conditional convergence The Solow model does not predict convergence unconditionally. Everything else equal, countries with lower capital stock should grow faster. Countries with same steady-state should converge = conditional convergence Countries with lower TFP should not catch-up. Importance for growth is distance from steady-state which can be different across countries.

19 Conditional convergence: an illustration Which country should grow faster? Steadystate investment per worker =! = Initial conditions: < = < < Capital per worker

20 Conditional convergence Only when countries share the same steady state should we see convergence. Explains why only see evidence for convergence amongst similar countries. Explains why many African countries do not catch up with Europe/U.S. Suggests that wealthier economies will persistently stay wealthier, but within wealthier economies should see evidence ofcatchup. The big question is what determines countries steady states and more specifically countries TFP?

21 An answer to the Lucas Puzzle? The marginal productivity of capital of a country depends on the level of capital but also on the efficiency at which the capital is used. If countries with low levels of capital have also lower technology (lower TFP), marginal product of capital can be equalized across countries. Contrary to Lucas intuition, data show small differences in the marginal product of capital across countries (Caselli and Feyrer (2007)).

22 If countries with low levels of capital have also lower TFP, marginal product of capital can be equalized across countries. Marginal Product of Capital High TFP low TFP Capital

23 Production function Output produced Buildings and machinery Labour input Technical knowledge and efficiency Rest of the lecture focuses on third input TFP

24 What is behind TFP? Two main aspects to TFP I) Efficiency A country may use its factors of production inefficiently and produce below the possibility frontier e.g, bureaucratic obstacles, poor institutions, etc. II) Technology A country may produce at the production possibility frontier but improvements in technology push the frontier out and enable more output to be produced for given factors of production.

25 The double-dividend of TFP Output per worker Higher = Capital per worker

26 Lecture 2 : Why are some countries richer than others? Part 2 1. Do countries catch up with economic leaders? 2. Institutions and growth 3. Innovation and growth

27 What is behind TFP? Two main aspects to TFP I) Efficiency A country may use its factors of production inefficiently and produce below the possibility frontier e.g, bureaucratic obstacles, poor institutions, corruption, etc. II) Technology A country may produce at the production possibility frontier but improvements in technology push the frontier out and enable more output to be produced for given factors of production.

28 What are institutions? Wide ranging concept rules of the game formal and informal constraints on political, economic and social interactions. Particular organisational entities, procedural devices, regulatory frameworks. Good institutions establish incentives to encourage efficiency and reduce uncertainty.

29 What are institutions? Institutional factors have many dimensions. Just as for firms the internal organisation of countries matter. Legal system -Rule of law Protection of Property Rights Political Institutions Educational Institutions and Allocation of Talent Financial Institutions Regulatory Institutions Institutions for Macroeconomic Stabilization Institutions for Social Insurance

30 Measuring institutions Various indicators available. Most commonly used, World Bank Indicator of Governance 6 dimensions on a -2.5, +2.5 scale. Rule of law Control of Corruption Political Stability and Absence of Violence Government Effectiveness Regulatory Quality Voice and Accountability Highly correlated with each other.

31 2,5 0-2,5 Bottom Ten and Top Ten (Rule of Law) Somalia Venezuela, RB Syrian Arab Rep. Libya Central African Rep. Iraq South Sudan North Korea Afghanistan Congo, Dem. Rep. Austria Singapore Canada Netherlands Denmark New Zealand Switzerland Finland Norway Sweden World Bank, 2016 data

32 Institutions and Level of Development World Bank, 2016 data Do betterinstitutions lead to highergdp per capita?

33 Institutions and Level of Development World Bank, 2016 data

34 Institutions and level of development Does better institutions increase output per capita or the other way around? Institutions endogenous to the process of development. Correlation is not causality. How can we identify the sense of the causality? Find exogenous changes in institutions in a given country (or a set of countries) and then look at growth outcomes. Natural experiment. Instrumental variables. Acemoglu, Johnson, Robinson (2001).

35 Do institutions matter North and South Korea GDP per capita South Korea North Korea

36 Do institutions matter North and South Korea

37 The colonial origins of comparative development Source: Acemoglu, Johnson and Robinson (2001)

38 Institutions and rent seeking Economies flourish when institutions provide the right incentives. Effort and investment in order to create value should be rewarded. Poor institutions encourage rent seeking. do not reward value creation do reward value extraction Direct effect: waste of talent Indirect effect Rentseekingislike atax Positive NPV projects may not be undertaken. Misallocation of resources Dominated projects are selected. Negative NPV projects are undertaken.

39 Institutions and rent seeking Case study. Coltan Shock in Eastern Congo. Context: in 2000, innovations in the video-games industry led the demand for coltan to skyrocket. In response to the large increase in the price of coltan, armed groups emerged in Eastern Congo where coltan mines are present. Start taxing where coltan is produced. But also provide protection. EmergenceofaState?

40 Coltan Shock, Conflict and Taxation in Eastern Congo Sanchez de la Sierra 2017

41 The Curse of Raw Materials More broadly, often find that countries rich in raw materials have disappointing growth. Different potential channels Voracity effect raw materials subverts institutions and leads to rent seeking(including civil conflict) Dutch disease Due to high level of exports see sharp increase in real exchange rate which crowds out other sectors exports. Wastageandinefficiency lowlevelsoftfp.

42 The Curse of Raw Materials Countries with plentiful supply of raw materials growing at a slower pace? Sachs and Warner 2001

43 Lecture 2 : Why are some countries richer than others? Part 2 1. Do countries catch up with economic leaders? 2. Institutions and growth 3. Innovation and growth

44 What is behind TFP? Two main aspects to TFP I) Efficiency A country may use its factors of production inefficiently and produce below the possibility frontier e.g, bureaucratic obstacles, poor institutions, etc. II) Technology A country may produce at the production possibility frontier but improvements in technology push the frontier out and enable more output to be produced for given factors of production.

45 Innovation and growth In Solow, at the steady state, economy can no longer grow through capital accumulation alone. But output per capita has been increasing since Industrial Revolution. Need to understand how to beat the law of diminishing returns = endogenous growth theory. Output can always expand through technological progress and innovation. In Solow, technological progress comes from the sky. In reality, the outcome of R&D and not a free lunch. Need to think of the forces shaping incentives across time and countries to improve technology. 45

46 Theory. From Malthus to Endogenous Growth Production(abstract from capital for simplicity) " = # $% = Stock of ideas/knowledge(= technology) # =Population Outputperworker = "/# = # % Decreasing returns: higher population means fewer resources per person. Higher population growth reduces output per capita growth. Unless A increases, people starve(= Malthusian Trap). 46

47 The production of ideas How ideas are produced? Simple case Eachpersonhasagivennumberofideas = ' A = '# ' =productivityofr&d Production of new ideas Δ A = ' ) ) =populationgrowthrate Innovation increases with population growth. 47

48 Endogenous growth Outputperworker = = '# $% Outputgrowthperworker = Δ = (1.) * ) More people means more innovation which benefits everyone(ideas are non-rivalrous). The nonrivarly of ideas sustains growth in the long-run = Endogenous Growth A larger economy is more productive = Increasing Returns to Scale. Malthus(or later Solow). Goods are rivalrous: more people means fewer resources per person. Decreasing returns to scale. 48

49 Scale effects and technology diffusion Scale effects. A larger population, implies more ideas. Countries with larger populations should have higher levels of technology and be richer. Counterfactual. Another interpretation of the theory is that a country's level of technology depends on ideas produced around the world. Reasonable assumption if some international technology diffusion(keller(2002, 2004), IMF World Econ. Outlook(2018)). In this case, countries with large R&D sectors should be ahead but do not grow permanently faster. Poor countries do not need to carry out R&D and can adopt the technology of the rich countries. 49

50 Combining Growth Theories Endogenous Growth Theory(Romer) Explains the long term trend growth of the world frontier (e.g. advanced economies). The world frontier grows through the discovery of new ideas. Solow Growth Theory Countries grow around the world technological trend. Transition explain why countries grow at different rates for long periods of time. Eachcountryhasasteadystaterelativetotheworldfrontier. Steady state is determined by its own TFP, institutions, openness to ideas/technological transfer, etc. 50

51 Combining Growth Theories In Solow, if a country is far away from its steady-state, it can still grow through capital accumulation only. If a country is close to its steady state, needs to push technological frontier. As a country gets close to its steady state, the incentives to encourage R&D rise strongly. Should expect rich countries to push the technology frontier and conduct most of R&D. R&D less important for poor countries that can rely on capital accumulation and copy technologies of the advanced countries. More important once they have caught up.

52 R&D Expenditures across the world Composition of US R&D

53 % 5 R&D in South Korea (% of GDP) As Korea matures it invests more heavily in R&D Source : OECD 2009 (MSTI)

54 Source : World Bank R&D Expenditures (% of GDP) United States France China China is catching up. Good or bad news?

55 What is driving R&D? R&D intensity varies across countries. Depends on incentives to create new goods and ideas. institutions and property rights industrial structure and competition among firms size of the market education of workforce public intervention

56 Summary TFP differences are essential to understand cross country income differences. Also explains why many countries do not catch up with respect to the most advanced nations. Changes in TFP over time are due to changes in institutions & policies, and technological progress. Differences in institutions across countries can have very long-lasting effects on development. As countries get richer they shift their source of growth from capital accumulation towards technological progress. Endogenous growth models explain how growth can be sustained in the long-run, beating the law of diminishing returns.