Thorvaldur Gylfason

economic governance and sustained growth  Overview of general theme of conference: economic governance and sustained growth  Picture to be presented will be painted with a broad brush, covering  Main determinants of efficiency and growth  Empirical cross-country growth patterns observed  Main task: Set stage, without explicit Balkan content, for local as well as regional analyses to follow economic policy and institutions  Like politics, all growth economics focusing on economic policy and institutions is local

economic growth  Our standard of living today depends on one thing only, by definition: economic growth  Rich countries are rich because they grew rapidly over long periods  Poor countries are poor because they did not grow rapidly enough  So why do some countries grow more rapidly than others?  Why, e.g., did Thailand leave Zambia so far behind in one generation?  Hard to think of anything else (Lucas)

 Thailand and Zambia started out in a similar position and grew apart growth-friendly policies  Thailand pursued growth-friendly policies, stressing liberal trade, stability, private enterprise, and education GDP per capita GDP per capita (US$ at 2000 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 GDP per capita GDP per capita (US$ at 1990 prices)

 What makes countries grow efficiency  Economic efficiency and growth policiesinstitutions  Economic policies and institutions  Education and health care  Business governance  Monetary and financial policies and institutions  External governance  Empirical evidence  Empirical evidence of cross-country linkages between governance and growth as we go along

 First things first: Output is produced by labor, capital, and other inputs saving investment  Output per capita can grow through accumulation of capital through saving and investment  Output per capita, however, cannot grow through population growth, on the contrary improvements Education health care  But, output per capita can grow through improvements in labor, via investments in human capital: Education and health care  Investment and education: Key drivers of growth

 Why do education and health care matter? labor productivity  Because they increase labor productivity technological progress  This is also why technological progress is good for growth squeeze more output from given inputs  Technological progress enables firms to squeeze more output from given inputs  But so does increased efficiency!  Latin American story about air fares  Increased efficiency helps growth  Increased efficiency is tantamount to technological progress, which helps growth

quantityquality  In sum, output per capita depends on the quantity and quality of inputs accumulation  Quantity of inputs can be increased through accumulation, esp. capital accumulation  Quality increased efficiency  Quality of inputs – their productivity! – can be increased through increased efficiency  Education and health  Liberalization  Stabilization  Privatization  Aspects of institutions Check them out one by one Policies

 Education lifts labor productivity  Education lifts labor productivity, thereby increasing overall economic efficiency and growth of output  From unskilled to skilled labor  Data for 131 countries, r = 0.50 POLICIES r = rank correlation

 There is another way to provide more and better education to children fewer children  Produce fewer children to increase their average “quality”  163 countries, POLICIES r =

longevity  Good public health, reflected in longevity, is also conducive to increased labor productivity and economic growth  156 countries, POLICIES r = 0.54

health care  Increased spending on health care also spurs economic growth  Close connection between public health and health care, i.e., between output and input  162 countries, POLICIES r = 0.40

prices resource allocation  Liberalization of prices increases efficiency in resource allocation trade division of labor  Liberalization of trade increases efficiency in division of labor  163 countries, POLICIES r = 0.26

size matters  Exports are not a good indicator of openness because size matters import duties  So look at import duties as well hurt growth  Higher duties hurt growth, but connection is weak  147 countries, r = 0.20 POLICIES r =

trade is good for growth  Economic theory is clear, from Adam Smith (1776) on: external as well as internal trade is good for growth  Good external governance  Good external governance is good for growth  Autarky spells disaster  Autarky spells disaster, always and everywhere Darkness in North-Korea POLICIES

 Stabilization increases efficiency  Stabilization increases efficiency by reducing production distortions, uncertainty, inflation tax, and overvaluation  164 countries, r = POLICIES r =

sound policies support rapid growth  High inflation is a sure sign of lax fiscal and monetary policies, so sound policies support rapid growth independent central banks  Sound financial institutions, incl. independent central banks, also support rapid growth r = POLICIES r =

profit motive  Privatization replaces political motives by profit motive in business  Private enterprise  Private enterprise is usually more efficient than state- owned enterprises  38 countries, POLICIES r =

 Growth differentials across countries can be traced to several different interconnected factors  Private initiatives Investment Fertility  Public policies Education Health care Liberalization Stabilization Privatization Overlaps between private and public spheres

 This is not all, however  Institutions and geography  Institutions (Aspects of social capital) Corruption Inequality Liberal democracy  Geography Primary production (Agriculture, mining, etc.) Natural resource dependence  Institutions or geography?  False contrast  There is room for both, side by side

 Two views  Corruption greases wheels  Corruption greases wheels of production and exchange and thus helps growth  Corruption breeds inefficiency  Corruption breeds inefficiency and hurts growth  88 countries, More corruption INSTITUTIONS r = 0.69

good business governance is good for growth  So, good business governance is good for growth secure property rights effective bankruptcy laws  Argument can be extended to other aspects, such as secure property rights and effective bankruptcy laws  Same story More corruption INSTITUTIONS r = 0.69

 Two views  Inequality sharpens incentives  Inequality sharpens incentives and thus helps growth  Inequality endangers social cohesion  Inequality endangers social cohesion and hurts growth  117 countries, INSTITUTIONS r =

 Two views  Political oppression restrains special interest groups  Political oppression restrains special interest groups and thus helps growth  Political oppression breeds inefficiency  Political oppression breeds inefficiency and hurts growth  117 countries, INSTITUTIONS r =

 Again, two views  Democracy plays into hands of special interest groups  Democracy plays into hands of special interest groups that hurt growth  Democracy facilitates change of government  Democracy facilitates change of government and helps growth  143 countries, r = 0.48 INSTITUTIONS r = 0.50

technological innovation and progress  Manufacturing is an important source of technological innovation and progress and thereby also of economic growth  156 countries, INSTITUTIONS r = 0.48

few spillover benefits  Agriculture and mining are low-skill labor intensive and offer few spillover benefits to other industries Mixed blessing  Natural resources: Mixed blessing if not well managed  156 countries, r = 0.48 INSTITUTIONS r =

 Economic growth is available to all who make the effort to achieve it (Lewis) economic efficiency good governancepolicy institutions  High-quality growth requires accumulation of capital as well as economic efficiency through good governance: judicious policy undertakings and sound institutions  Education, family planning, health care  Free trade, stable prices, private enterprise  Honesty, equality, liberty, democracy  Not too much dependence on agriculture and natural resources THE END