Ownership and Growth Thorvaldur Gylfason

Presentation in Two Parts 1. General discussion of economic growth and the analytical background of the paper 2. Specific discussion of the topic at hand: public vs. private ownership and the difference it makes for growth nJoint work with Tryggvi Thor Herbertsson and Gylfi Zoega

Economic Growth As old as economics itself Adam Smith, John Stuart Mill, Alfred Marshall, Joseph Schumpeter were all growth theorists Then Harrod and Domar came along, summarizing the old literature by g = sE -  where E = Y/K. This means, inter alia, that saving is good for growth.

Economic Growth: The Short Run vs. the Long Run Time National economic output Actual output Potential output Business cycles in the short run Economic growth in the long run Downswing Upswing Thus, increased saving may reduce actual output, while increasing potential output.

Economic Growth: The Short Run vs. the Long Run To analyze the movements of actual output from year to year, viz., in the short run Need short-run macroeconomic theory Keynesian or neoclassical To analyze the path of potential output over long periods Need modern theory of economic growth Neoclassical or endogenous

Economic Growth: Solow’s Rebellion Solow rebelled against Harrod and Domar by pointing out that economic growth in the long run must be exogenous. In the long run, growth depends solely on population growth and technological progress: g = n + q To show this, Solow made E = Y/K endogenous. Hence, saving cannot affect long-run growth.

Why not? Take another look at g = sE -  When s increases, E begins to decrease, according to Solow, and continues to do so until g is restored to its intial, exogenously determined value. This occurs essentially because an increase in s increases K, so that E = Y/K goes down.

Economic Growth: The Solow Model But this approach distracted attention from two key questions: 1.How long is the long run? – Is it possible that the long run is so long as to be almost irrelevant from the point of view of economic policy? 2.What determines output per head? – Is is possible that the level of output per head is endogenous in the long run even if its rate of growth is not?

Economic Growth: The Solow Model k = K/L y = Y/L E A In long-run steady-state equilibrium at A, growth is exogenous: g = n + q

Economic Growth: The Solow Model efficiency The parameter A represents technology and efficiency.

Traces the rate of growth of output per capita to a single source: Technological progress Hence, economic growth in the long run is immune to economic policy, good or bad “To change the rate of growth of real output per head you have to change the rate of technical progress.” ROBERT SOLOW The Neoclassical Theory of Exogenous Economic Growth

The New Theory of Endogenous Economic Growth Meanwhile, on the ranch... Traces the rate of growth of output per capita to three main sources: SavingEfficiencyDepreciation “The proximate causes of economic growth are the effort to economize, the accumulation of knowledge, and the accumulation of capital.” ARTHUR LEWIS

A Simple Model of Endogenous Growth Four building blocks: n S = I Saving equals investment in equilibrium. Saving equals investment in equilibrium. n S = sY Saving is proportional to income. Saving is proportional to income. n I =  K +  K Investment involves addition to capital stock. Investment involves addition to capital stock. n Y = EK Output depends on quality and quantity of capital. Output depends on quality and quantity of capital.

Endogenous Growth in the Harrod-Domar Model This version of the endogenous growth model is simply a restatement of the Harrod- Domar model where growth depends on: A. the saving rate B. the capital/output ratio C. the depreciation rate This version of the endogenous growth model is simply a restatement of the Harrod- Domar model where growth depends on: A. the saving rate B. the capital/output ratio C. the depreciation rate

If it increases economic efficiency, it is also good for growth. This idea seems to go a long way towards explaining per capita income differentials of 30 or 60 across countries. And even if long-run growth is exogenous, the level of income is endogenous. This is why endogenous growth theory is perhaps best viewed as an extension of the Solow model of exogenous growth. The Main Point about Endogenous Growth

Specific Model learning by doing Now, assume learning by doing: It follows that and that Two equations in two unknowns

A Picture of the Model g q 45° n sE -  A

Properties of the Model sEn g++-0 q++--

Saving Fits real world experience quite well. No coincidence that, in East Asia, saving rates of % of GDP went along with rapid economic growth. No coincidence either that many African economies with saving rates around 10% of GDP have been stagnant. OECD countries: saving rates of about 20% of GDP Important implication for economic policy: Economic stability with low inflation and positive real interest rates encourages saving, and thus is good for growth. Sources of Endogenous Growth

East Asia OECD Africa High saving rates Medium saving rates Low saving rates Income per capita

Sources of Endogenous Growth Depreciation The effect of depreciation on growth is related to that of saving on growth. The effect of depreciation on growth is related to that of saving on growth. Unprofitable investment in the past reduces the quality of capital and thus makes it depreciate more rapidly, necessitating more replacement investment to make up for wear and tear. Unprofitable investment in the past reduces the quality of capital and thus makes it depreciate more rapidly, necessitating more replacement investment to make up for wear and tear. The more national saving has to be set aside for replacement investment, the less will be available for the buildup of new capital. The more national saving has to be set aside for replacement investment, the less will be available for the buildup of new capital. Examples: 1.Oil shocks 2.Soviet collapse

Sources of Endogenous Growth Efficiency Also fits real world experience quite well Technical progress good for growth because it allows us to squeeze more output from given inputs. But that is exactly what increased efficiency is all about! Thus, technology is best viewed as an aspect of general economic efficiency. Important implication for economic policy: Everything that increases economic efficiency, no matter what, is also good for growth.

Sources of Endogenous Growth Five sources of increased efficiency Five sources of increased efficiency 1.Liberalization of prices and trade increases efficiency, and thus is good for growth. 2.Stabilization reduces the inefficiency associated with inflation, and thus is good for growth. 3.Privatization reduces the inefficiency associated with state-owned enterprises, and thus … 4.Education makes the labor force more efficient. 5.Technological progress also enhances efficiency. The possibilities are virtually endless!

Sources of Endogenous Growth This is good news! If growth were merely a matter of technology, we would not be able to do much about it … … except to follow technology-friendly policies by supporting R&D and such. But if growth depends on saving and efficiency, there are things that we can do, in the private sector as well as through the public sector, to foster rapid economic growth. Because everything that is good for saving and efficiency is also good for growth.

What to Do to Encourage Economic Growth Recap Maintain strong incentives to save Keep inflation low and real interest rates positive Maintain financial system in good health so as to channel saving into high-quality investment Place strong emphasis on efficiency 1. Liberal price and trade regimes 2. Low inflation 3. Strong private sector 4. More and better education

The Bottom Line Whatever increases efficiency also increases economic growth. Solow: Output per head increases, and growth also increases for a while. Romer: Economic growth increases (and thereby also output per head). This idea has triggered a large empirical literature since the early 1990s.

My Work in this Area: Three Main Channels High inflation hurts growth. Follows directly from Inflation may reduce both saving and efficiency. Excessive dependence on natural resources impedes growth. Has to do with The Dutch disease The Dutch disease Rent seeking Rent seeking Education Education Public vs. private ownership

Privatization and Economic Growth Privatization means that profit-oriented owners and able managers are allowed to direct enterprises. Profit motive replaces political considerations as the guiding principle of business operations. Profit-maximizing owners generally want to appoint managers and staff on merit rather than on the basis of political connections, for example. Hypothesis: Private enterprise is generally more efficient than state-owned enterprises. Which brings me, at last, to the point of this paper...

The Model Start with optimal growth à la Ramsey: Then assume with SOEs may be inefficient, and may thus depend on low interest and little growth. SOEs produce low-quality output, so that privatization increases quality (i.e., efficiency) and growth. Why? We derive r = r(v) by applying Romer’s model of expanding product variety.

What is the evidence?

Empirical Results Correlation analysis To explore the relationship between SOEs and relative productivity, investment, and education Regression analysis To attempt to provide a fuller picture of the interrelations among these variables

Sample of Countries

Correlation = -0.40

Correlation = -0.50

Correlation = -0.58

Correlation = -0.35

Interpretation An increase in the SOEs’ employment share by 10 percentage points is associated with a decrease in annual economic growth by almost 1%. A large SOE sector generally goes hand in hand with slow growth. No country with an SOE sector accounting for more than 10% of employment had economic growth of 2% per year or more. Sole exception: Côte d’Ivoire. Sole exception: Côte d’Ivoire.

Regression Results

Summary of Results 1.An increase in SOE employment reduces investment and education and thereby also economic growth indirectly. An increase in SOE labor share by 10% reduces growth by 1% (t = 2.1). An increase in SOE labor share by 10% reduces growth by 1% (t = 2.1). 2.An increase in SOE output reduces economic growth directly. An increase in SOE output share by 10% reduces growth by 0.3% (t = 2.1). An increase in SOE output share by 10% reduces growth by 0.3% (t = 2.1). 3.An increase in SOE debt reduces growth.

Conclusion Across countries, SOE activity is inversely related to Relative productivity of labor in SOE sector Relative productivity of labor in SOE sector Investment Investment Education Education Economic growth varies inversely with the size of the SOE sector. An increase in SOE labor share by 10% reduces growth by 0.5% to 1% across countries, cet. par. An increase in SOE labor share by 10% reduces growth by 0.5% to 1% across countries, cet. par. So, privatization may be good for growth. But it needs to be implemented with care. But it needs to be implemented with care.