Thorvaldur Gylfason

 Sources of economic growth around the world  Economic policy and institutions matter for growth  Democracy as an aspect of social capital  Democracy is good for growth  Cross-country patterns in data  164 countries, World Bank data  Including political data on aspects of democracy  Cross-country regressions social capitaldemocracy  Interactions of human, real, financial, natural, and social capital, including democracy

GDP per capita GDP per capita (US$ at 1990 prices)  Argentina and Sweden went hand in hand , and then grew apart free tradeliberal democracy income equality  Sweden pursued free trade, liberal democracy, and income equality, and avoided high inflation  Argentina did not Sweden 2.1% per year Argentina 1.0% per year = 3.1

GDP per capita GDP per capita (US$ at 2000 prices)  Botswana and Nigeria went hand in hand , and then grew apart democracy education,  Botswana practiced democracy, stressed education, and resisted corruption  Nigeria’s finance minister: “Oil has made us lazy” Botswana 7.1% per year Nigeria 0.6% per year = 11.7

Ghana Lesotho Namibia Botswana Korea Iceland was Ghana

Growth Real capital SavingSaving InvestmentInvestment Foreign investmentForeign investment Financial capital InflationInflation Human capital EducationEducation Health careHealth care FertilityFertility Social capital DemocracyCorruption Natural capital Dutch diseaseDutch disease Rent seekingRent seeking Resource curse

Natural capital EducationCorruptionDemocracyInvestment Interactions among determinants of growth

King Faisal Listen to King Faisal of Saudi Arabia ( ), as quoted by his Oil Minister, Sheik Yamani: “In one generation we went from riding camels to riding Cadillacs. The way we are wasting money, I fear the next generation will be riding camels again.”

Lee Kwan Yew Lee Kwan Yew, founding father of Singapore ( ), would not have been surprised either: natural resources people education “I thought then that wealth depended mainly on the possession of territory and natural resources, whether fertile land..., or valuable minerals, or oil and gas. It was only after I had been in office for some years that I recognized... that the decisive factors were the people, their natural abilities, education and training.”

efficiencydiversificationgood for growth  Democracy makes it easier to replace bad governments by better ones and for ideas to compete in the political arena, thus fostering efficiency and diversification, which is good for growth pressure groups bad for growth  Democracy plays into the hands of pressure groups that abuse their power by swaying public policies and institutions in their favor, which is bad for growth Empirical question

 Schumpeter (1942) “the democratic method is that institutional arrangement for arriving at political decisions in which individuals acquire the power to decide by means of a competitive struggle for the people’s vote.”  Source of data Polity IV (Marshall and Jaggers, 2001) 21-point scale, from -10 to 10, extensive coverage of countries

Democracy Oligocracy Autocracy 1946: 20 out of : 90 out of 170 Number of countries

0.51 Democracy is good for growth Rank correlation A rise in democracy index by 7 points goes along with an increase in per capita growth by one percentage point per year 164 countries

0.75 Corruption hurts growth

0.60 Different aspects of social capital go together

0.62 Human capital and social capital go together

-0.67 Natural capital crowds out social capital

-0.67 Natural capital share and growth are inversely related

0.69 Education is good for growth An increase in school life expectancy by 3 years goes along with an increase in per capita growth by one percentage point per year

-0.62 Social content of growth A decrease in fertility by 3 children per woman goes along with an increase in per capita growth by 2 percentage points per year

-0.82 Natural capital crowds out human capital

-0.74 Natural capital crowds out social capital

-0.46 Inflation impedes growth Stabilization increases efficiency by reducing production distortions, uncertainty, inflation tax, and overvaluation

-0.46 Inflation impedes growth sound policies support rapid growth High inflation is a sure sign of lax fiscal and monetary policies, so sound policies support rapid growth

Null hypothesis Democracy is good for growth, and so are investment, education, health care, usw. Alternative hypothesis Democracy is not good for growth, or worse Not trying to demolish other potential explanations of growth Rather, trying to find a complementary role for democracy: add, not subtract Institutions, economic policies, and natural resources side by side

Theoretical framework Neoclassical vs. endogenous growth False contrast Empirically indistinguishable Endogenous growth, endogenous democracy Long run vs. medium term Medium term: Policy-relevant choice Forty years of data, Long run is irrelevant except as a benchmark

Empirical strategy 1)Levels of income vs. rates of growth 2)Recursive modeling vs. instruments 3)Averages vs. initial values of independent variables Prefer averages when available so as not to discard data after the initial period 4)Cross sections vs. panels Begin with cross sections, will add panels

Conditional convergence requires b > 0  < 1 One-to-one correspondence between parameters

Economic growth depends on the accumulation of capital and the efficiency with which it is used Five, or rather six, kinds of capital 1)Social 1)Social capital: democracy, corruption 2)Human 2)Human capital: education, fertility 3)Real 3)Real capital: investment 4)Financial 4)Financial capital: low inflation 5)Foreign 5)Foreign capital: openness -- ignore 6) Natural 6) Natural capital

Model 1 Initial income (5.2) Natural capital Democracy School life expectancy (log) Fertility Investment rate (log) Inflation distortion Countries 164 Adjusted R

Model 1Model 2 Initial income (5.2) (3.1) Natural capital (5.3) Democracy School life expectancy (log) Fertility Investment rate (log) Inflation distortion Countries Adjusted R

Model 1Model 2Model 3 Initial income (5.2) (3.1) (3.8) Natural capital (5.3) (3.1) Democracy 0.10 (3.0) School life expectancy (log) Fertility Investment rate (log) Inflation distortion Countries Adjusted R

Model 1Model 2Model 3Model 4 Initial income (5.2) (3.1) (3.8) (9.5) Natural capital (5.3) (3.1) (2.8) Democracy 0.10 (3.0) 0.09 (3.6) School life expectancy (log) 3.86 (8.8) Fertility Investment rate (log) Inflation distortion Countries Adjusted R

Model 1Model 2Model 3Model 4Model 5 Initial income (5.2) (3.1) (3.8) (9.5) (10.5) Natural capital (5.3) (3.1) (2.8) (1.6) Democracy 0.10 (3.0) 0.09 (3.6) 0.07 (2.7) School life expectancy (log) 3.86 (8.8) 2.91 (5.7) Fertility (3.3) Investment rate (log) Inflation distortion Countries Adjusted R

Model 1Model 2Model 3Model 4Model 5Model 6 Initial income (5.2) (3.1) (3.8) (9.5) (10.5) (10.2) Natural capital (5.3) (3.1) (2.8) (1.6) (2.0) Democracy 0.10 (3.0) 0.09 (3.6) 0.07 (2.7) 0.08 (3.0) School life expectancy (log) 3.86 (8.8) 2.91 (5.7) 2.69 (5.3) Fertility (3.3) (2.4) Investment rate (log) 0.97 (2.0) Inflation distortion Countries Adjusted R

Model 1Model 2Model 3Model 4Model 5Model 6Model 7 Initial income (5.2) (3.1) (3.8) (9.5) (10.5) (10.2) (11.5) Natural capital (5.3) (3.1) (2.8) (1.6) (2.0) (1.4) Democracy 0.10 (3.0) 0.09 (3.6) 0.07 (2.7) 0.08 (3.0) 0.04 (2.1) School life expectancy (log) 3.86 (8.8) 2.91 (5.7) 2.69 (5.3) 2.83 (6.5) Fertility (3.3) (2.4) (3.8) Investment rate (log) 0.97 (2.0) 0.61 (1.4) Inflation distortion (6.2) Countries Adjusted R

Model 1Model 2Model 3Model 4Model 5Model 6Model 7 Initial income (5.2) (3.1) (3.8) (9.5) (10.5) (10.2) (11.5) Natural capital (5.3) (3.1) (2.8) (1.6) (3.2) (1.4) Democracy 0.10 (3.0) 0.09 (3.6) 0.07 (2.7) 0.04 (2.2) 0.04 (2.1) School life expectancy (log) 3.86 (8.8) 2.91 (5.7) 0.08 (3.2) 2.83 (6.5) Fertility (3.3) 1.39 (3.0) (3.8) Investment rate (log) 3.01 (6.4) 0.61 (1.4) Inflation distortion (6.2) Countries Adjusted R

with adequate natural resources Since the second world war it has become quite clear that rapid economic growth is available to those countries with adequate natural resources which make the effort to achieve it. W. Arthur Lewis (Accra, 1968)

with sound democratic institutions Since the second world war it has become quite clear that rapid economic growth is available to those countries with sound democratic institutions which make the effort to achieve it. W. Arthur Lewis (Accra, 1968)

 Diversification is good for growth  Economic diversification  Economic diversification away from excessive reliance on natural resources  Political diversification  Political diversification away from narrowly based political elites toward full-fledged democracy  Social and human capital are good for growth  Democracy seems to make a difference  Social insurance also makes a difference, as well as education and health care  Judicious use of natural resources requires good institutions, including democracy  Key to Norway’s successful oil management

 The development effort required around the world includes a double diversification  Economic diversification  Away from agriculture and other natural- resource intensive activity into manufacturing (as in China) and services (as in India)  P olitical diversification  From dictatorship to democracy (as in Korea and Taiwan) These slides – and more! – can be viewed on my website: