Chapter 19. Introduction. Learning Objectives. Policies and Prospects for Global Economic Growth

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Chapter 19 Policies and Prospects for Global Economic Growth Introduction Builders in Brazil devote much time and expense to obtain legal permits from local and national government agencies.

In this chapter, you will learn why relatively complicated, slow-moving, and expensive legal systems are holding back economic growth in Brazil and other developing countries.

1 Chapter 19 Policies and Prospects for Global Economic Growth Introduction Builders in Brazil devote much time and expense to obtain legal permits from local and national government agencies. Construction costs can be driven up by as much as 400%. In this chapter, you will learn why relatively complicated, slow-moving, and expensive legal systems are holding back economic growth in Brazil and other developing countries. Copyright 2008 Pearson Addison Wesley. All rights reserved Learning Objectives Explain why population growth can have uncertain effects on economic growth Understand why the existence of dead capital retards investment and economic growth in much of the developing world Describe how government inefficiencies have contributed to the creation of relatively large quantities of dead capital in the world s developing nations Copyright 2008 Pearson Addison Wesley. All rights reserved

2 Learning Objectives (cont'd) Discuss the sources of international investment funds for developing nations and identify obstacles to international investment in these nations Identify the key functions of the World Bank and the International Monetary Fund Explain the basis for recent criticisms of policymaking at the World Bank and the International Monetary Fund Copyright 2008 Pearson Addison Wesley. All rights reserved Chapter Outline Labor Resources and Economic Growth Capital Goods and Economic Growth Private International Financial Flows as a Source of Global Growth International Institutions and Policies for Global Growth Copyright 2008 Pearson Addison Wesley. All rights reserved Did You Know That... In Haiti, registering a new company takes 203 days, which is at least 198 days longer than is required in the United States? In Sierra Leone, the cost of officially establishing a business is 1,200 times the average resident s annual income? In Nigeria, to record a sale of land, a business must complete 21 different procedures? Copyright 2008 Pearson Addison Wesley. All rights reserved

3 Labor Resources and Economic Growth Population growth does not necessarily translate into an increase in labor resources. In poor areas, many people do not join the labor force, or they may remain unemployed for long periods. Copyright 2008 Pearson Addison Wesley. All rights reserved Labor Resources We can express the growth rate of per capita real GDP in a nation as the difference between the rate of growth in real GDP and the population growth rate. Hence, if real GDP grows at a rate of 4% per year and population growth increases from 2 to 3%, then per capita real GDP will decline, from 2 to 1%. Copyright 2008 Pearson Addison Wesley. All rights reserved Labor Resources Population growth can contribute to economic growth. Whether population growth hinders or contributes to economic growth depends on where you live. Copyright 2008 Pearson Addison Wesley. All rights reserved

4 Table 19-1 Population Growth and Growth in Per Capita Real GDP in Selected Nations Since 1965 Copyright 2008 Pearson Addison Wesley. All rights reserved Labor Resources The role of economic freedom A crucial factor influencing economic growth is the relative freedom of a nation s residents. Only 17 nations, with 17% of the world s people, grant their residents high degrees of economic freedom. Copyright 2008 Pearson Addison Wesley. All rights reserved Labor Resources Economic Freedom The rights to own private property and to exchange goods, services, and financial assets with minimal government interference Copyright 2008 Pearson Addison Wesley. All rights reserved

5 Labor Resources The role of political freedom Political freedom: the right to openly support and democratically select national leaders Economic freedom tends to stimulate economic growth, which then leads to more political freedom. Copyright 2008 Pearson Addison Wesley. All rights reserved Labor Resources Question Why do you suppose that per capita real GDP appears to be related to the extent to which the rule of law prevails? Copyright 2008 Pearson Addison Wesley. All rights reserved International Example: The Rule of Law and Per Capita Real GDP Failure to abide by the rule of law makes the return on capital dependent more on the whims of individuals than on laws. Property rights become less secure, which discourages individuals and businesses from investing and using property for productive purposes. The growth-reducing effects of a breakdown in the rule of law should show up in the form of lower levels of per capital real GDP. Copyright 2008 Pearson Addison Wesley. All rights reserved

6 Figure 19-1 The Relationship Between Adherence to the Rule of Law and Per Capita Real GDP Copyright 2008 Pearson Addison Wesley. All rights reserved Capital Goods and Economic Growth A fundamental problem developing countries face is that a significant portion of their capital goods, or manufactured resources that may be used to produce other items in the future, is what economists call dead capital. Copyright 2008 Pearson Addison Wesley. All rights reserved Capital Goods Dead Capital Any capital resource that lacks clear title of ownership A resource that people cannot readily allocate to its most efficient use Is among the most significant impediments to growth in poor nations Copyright 2008 Pearson Addison Wesley. All rights reserved

7 Capital Goods Dead capital and inefficient production Nontransferable physical structures are valued at more than $9 trillion in developing nations. Dead capital and economic growth Disincentives to invest in new capital goods can greatly hinder economic growth. Copyright 2008 Pearson Addison Wesley. All rights reserved Capital Goods Government inefficiencies, investment, and growth Governments in many of the world s poorest nations place tremendous obstacles in the way of entrepreneurs. These entrepreneurs are interested in owning capital goods and directing them to profitable opportunities. Copyright 2008 Pearson Addison Wesley. All rights reserved Capital Goods Government inefficiencies, investment, and growth In a nation with a stifling government bureaucracy regulating the uses of capital goods, newly created capital will all too likely become dead capital. Thus, government inefficiency can be a major barrier to economic growth. Copyright 2008 Pearson Addison Wesley. All rights reserved

8 Figure 19-2 Bureaucratic Inefficiency and Economic Growth Copyright 2008 Pearson Addison Wesley. All rights reserved Private International Financial Flows as a Source of Global Growth Question Given the large volume of inefficiently employed capital goods in developing nations, what can be done to promote greater global growth? Copyright 2008 Pearson Addison Wesley. All rights reserved Private International Financial Flows as a Source of Global Growth (cont'd) Answers One approach is to rely on private markets Another is to entrust the world s governments Copyright 2008 Pearson Addison Wesley. All rights reserved

9 Private International Financial Flows as a Source of Global Growth (cont'd) Private investment in developing nations Each year since 1995, at least $150 billion in private funds have flowed to developing nations in the form of purchases of bonds or stock. Nearly all funds that flow into developing countries due so to finance investment projects in those nations. Copyright 2008 Pearson Addison Wesley. All rights reserved Private International Financial Flows as a Source of Global Growth (cont'd) Economists group international flows of investment funds into three categories. 1. Loans from banks and other sources 2. Portfolio investment 3. Foreign direct investment Copyright 2008 Pearson Addison Wesley. All rights reserved Private International Financial Flows as a Source of Global Growth (cont'd) Portfolio Investment The purchase of less than 10% of the shares of ownership in a company in another nation Foreign Direct Investment The acquisition of more than 10% of the shares of ownership in a company in another nation Copyright 2008 Pearson Addison Wesley. All rights reserved

countries susceptible to problems relating to asymmetric information Copyright 2008 Pearson Addison Wesley. All rights reserved.

10 Figure 19-3 Sources of International Investment Funds Copyright 2008 Pearson Addison Wesley. All rights reserved Private International Financial Flows as a Source of Global Growth (cont'd) Obstacles to international investment Markets for loans, bonds, and stocks in developing countries susceptible to problems relating to asymmetric information Copyright 2008 Pearson Addison Wesley. All rights reserved Private International Financial Flows as a Source of Global Growth (cont'd) Asymmetric information as a barrier to financing global growth Adverse selection problems arise Moral hazard another problem Copyright 2008 Pearson Addison Wesley. All rights reserved

11 Private International Financial Flows as a Source of Global Growth (cont'd) Question To what countries do most residents of developing nations allocate the majority of their own foreign direct investment? Copyright 2008 Pearson Addison Wesley. All rights reserved International Example: Investing in the Usual Places Residents of developing nations have increased their FDI in highly developed nations by 250% since Over two-thirds of the funds residents of developing nations allocate go to the United States, Japan, and nations of the European Monetary Union. Copyright 2008 Pearson Addison Wesley. All rights reserved Private International Financial Flows as a Source of Global Growth (cont'd) International Financial Crisis The rapid withdrawal of foreign investments and loans from a nation Copyright 2008 Pearson Addison Wesley. All rights reserved

International Institutions and Policies for Global Growth Since 1945, the world s governments have taken an active role in supplementing private markets.

19-34 International Institutions and Policies for Global Growth (cont'd) The World Bank A multinational agency that specializes in making loans to about 100 developing nations in an effort to promote

12 International Institutions and Policies for Global Growth Since 1945, the world s governments have taken an active role in supplementing private markets. Two international institutions, the World Bank and the International Monetary Fund, have been at the center of government-directed efforts. Copyright 2008 Pearson Addison Wesley. All rights reserved International Institutions and Policies for Global Growth (cont'd) The World Bank A multinational agency that specializes in making loans to about 100 developing nations in an effort to promote their longterm development and growth Loans are made to finance improved irrigation systems, roads, and better hospitals. Copyright 2008 Pearson Addison Wesley. All rights reserved Figure 19-4 The Distribution of World Bank Lending Since 1990 Copyright 2008 Pearson Addison Wesley. All rights reserved

13 International Institutions and Policies for Global Growth (cont'd) The International Monetary Fund A multinational organization that aims to promote world economic growth through more financial stability The IMF assists developing countries primarily by making loans to their governments. Copyright 2008 Pearson Addison Wesley. All rights reserved International Institutions and Policies for Global Growth (cont'd) When a country joins the IMF, it deposits funds into an account called a quota subscription. These funds are measured in terms of an international unit of accounting called special drawing rights (SDRs). Copyright 2008 Pearson Addison Wesley. All rights reserved International Institutions and Policies for Global Growth (cont'd) SDRs have a value based on a weighted average of four key currencies The euro, the pound sterling, the yen, and the dollar At present, one SDR is equal to just under $1.50. Copyright 2008 Pearson Addison Wesley. All rights reserved

14 International Institutions and Policies for Global Growth (cont'd) Quota Subscription A nation s account with the International Monetary Fund, denominated in special drawing rights Copyright 2008 Pearson Addison Wesley. All rights reserved Figure 19-5 IMF Quota Subscriptions Copyright 2008 Pearson Addison Wesley. All rights reserved International Institutions and Policies for Global Growth (cont'd) Questions Are the World Bank and the IMF part of the solution or part of the problem? Does the World Bank really have a mission anymore? Copyright 2008 Pearson Addison Wesley. All rights reserved

15 International Institutions and Policies for Global Growth (cont'd) Rethinking long-term development lending: a main theme of development economics has been market reforms. Markets work better when a developing nation has more effective institutions. Basic property rights Well-run legal systems Uncorrupt government agencies Copyright 2008 Pearson Addison Wesley. All rights reserved International Policy Example: Using Catastrophe Bonds to Aid Drought-Stricken Nations The World Food Program is poised to implement a program that will rely on catastrophe bonds to help when droughts take place. Could catastrophe bonds replace other forms of aid and lending, such as World Bank and other assistance programs? Copyright 2008 Pearson Addison Wesley. All rights reserved International Institutions and Policies for Global Growth (cont'd) Alternative institutional structures for limiting financial crises Many proposals for change diverge sharply. Economists recommend improvements in standards. Copyright 2008 Pearson Addison Wesley. All rights reserved

16 International Institutions and Policies for Global Growth (cont'd) Question Is it time to replace the World Bank and the IMF? Copyright 2008 Pearson Addison Wesley. All rights reserved Issues and Applications: Bogging Down Business in Brazil Brazil s legal system, which is based on a 245-article constitution that is among the world s lengthiest, and includes a labor law containing 922 articles, is perhaps the most complicated in the Western Hemisphere. This helps explain why the average time required for a firm to resolve a legal dispute is 81 weeks, which is 36 weeks longer than in the United States. Laying off a worker requires a Brazilian business to incur an expense equivalent to paying the worker for 165 weeks, whereas a U.S. firm normally faces a layoff expense no greater than 8 weeks worth of wage payments to the employee. Copyright 2008 Pearson Addison Wesley. All rights reserved Issues and Applications: Bogging Down Business in Brazil (cont'd) Since 2000, international investors have been more hesitant to allocate funds to Brazilian business projects. The World Bank committed to providing the Brazilian government $500 million in so-called competitiveness loans. Copyright 2008 Pearson Addison Wesley. All rights reserved

17 Issues and Applications: Bogging Down Business in Brazil (cont'd) Critics of these loans worry the willingness of the World Bank to step in reduces the incentive for legal reform. The end result of World Bank credits and IMF bailouts, they worry, may perpetuate Brazil s legal labyrinth. Copyright 2008 Pearson Addison Wesley. All rights reserved Summary Discussion of Learning Objectives Effects of population growth and personal freedoms on economic growth Increased population growth has contradictory effects on economic growth. There is evidence of a positive relationship between economic freedom and growth. Copyright 2008 Pearson Addison Wesley. All rights reserved Summary Discussion of Learning Objectives (cont'd) Why dead capital deters investment and slows economic growth Few people in less developed countries establish legal ownership of capital. Unofficially owned resources are known as dead capital. In many developing nations, there is a disincentive to accumulate capital, which limits growth prospects. Copyright 2008 Pearson Addison Wesley. All rights reserved

18 Summary Discussion of Learning Objectives (cont'd) Government inefficiencies and dead capital in developing nations A negative relation between government inefficiency and economic growth Copyright 2008 Pearson Addison Wesley. All rights reserved Summary Discussion of Learning Objectives (cont'd) Sources of international investment funds and obstacles to investing in developing nations Sources include bank loans, portfolio investment, and foreign direct investment Obstacles include problems relating to asymmetric information such as adverse selection and moral hazard Copyright 2008 Pearson Addison Wesley. All rights reserved Summary Discussion of Learning Objectives (cont'd) The functions of the World Bank and the International Monetary Fund The World Bank s function is to finance capital investment. A fundamental duty of the IMF is to stabilize international financial flows. Copyright 2008 Pearson Addison Wesley. All rights reserved

19 Summary Discussion of Learning Objectives (cont'd) The basis for recent criticisms of the World Bank and IMF policymaking The World Bank has extended credit to companies and governments that could have obtained private funds. The World Bank and IMF have failed to effectively deal with adverse selection and moral hazard, suggesting more stringent conditions on credit access are needed. Copyright 2008 Pearson Addison Wesley. All rights reserved End of Chapter 19 Policies and Prospects for Global Economic Growth 19

Chapter 14. Introduction. Learning Objectives. Deficit Spending and The Public Debt. Explain how federal government budget deficits occur

Chapter 14. Introduction. Learning Objectives. Deficit Spending and The Public Debt. Explain how federal government budget deficits occur Chapter 14 Deficit Spending and The Public Debt Introduction In adopting the euro, European nations agreed to abide by the Stability and Growth Pact. The pact called for limitations on government spending