Chapter One GROWING APART

Chapter 1 Introduces the subject and discusses why growth matters Tells stories about different growth performance in different countries around the world Main point: Economic policies and institutions matter for growth Outline

Growing Apart In other words: A view of the landscape Diverging growth paths Communism vs. capitalism Plan vs. market Main message: To grow or not to grow is in large measure a matter of choice

Growing Apart Great nations are never impoverished by private, though they sometimes are by publick prodigality and misconduct. ADAM SMITH There are many countries, not essentially different either in the degree of security which they afford to property, or in the moral and religious instruction received by the people, which yet, with nearly equal natural capabilities, make a very different progress in wealth. THOMAS MALTHUS Great nations are never impoverished by private, though they sometimes are by publick prodigality and misconduct. ADAM SMITH There are many countries, not essentially different either in the degree of security which they afford to property, or in the moral and religious instruction received by the people, which yet, with nearly equal natural capabilities, make a very different progress in wealth. THOMAS MALTHUS

The beginning Economic growth in the long run used to be considered immune to all but technological progress Which grew more rapidly: the United States or the Soviet Union? Economists did not fully acknowledge: destructive force of communism effects of gross economic mismanagement in many parts of the world Economic growth in the long run used to be considered immune to all but technological progress Which grew more rapidly: the United States or the Soviet Union? Economists did not fully acknowledge: destructive force of communism effects of gross economic mismanagement in many parts of the world They failed to build the experience of communist and developing countries into mainstream models of economic growth

Macroeconomic policy StabilizationRedistributionStabilizationRedistribution Inflation Inequality in the distribution of income and wealth Inflation Inequality in the distribution of income and wealth The main objectives of macroeconomic policy Inflation, inequality, and inefficiency were not considered harmful to growth Reallocation Inefficiency

Adam Smith Adam Smith Wealth of Nations Sources of wealth Division of labour enhances efficiency International trade  enlarges markets  increases efficiency  increases wealth and growth Nations tolerably well advanced as to skill, dexterity, and judgment, in the application of labour, have followed very different plans in the general conduct or direction of it; and those plans have not all been equally favourable to the greatness of its produce. ADAM SMITH private enterprise private property good governance free trade private enterprise private property good governance free trade

Determinants of long-term economic growth Economic systems Economic policies Economic institutions Economic systems Economic policies Economic institutions Communism: on the scrapheap of history Mixed market economy: the only game in town Explaining why growth rates differ

Questions If the economic systems adopted by two countries are not completely different, is it nonetheless possible to trace the differences in their economic performance to their different economic policies? Or does technology dictate growth differentials in such cases? Or perhaps geography? Or history? Or all of the above? If the economic systems adopted by two countries are not completely different, is it nonetheless possible to trace the differences in their economic performance to their different economic policies? Or does technology dictate growth differentials in such cases? Or perhaps geography? Or history? Or all of the above?

Examination of economic growth in theory and practice Growth performance of four pairs or clusters of countries since 1970 Low- and middle-income countries But most of the points to emerge apply to high-income countries as well Those economies have developed quite differently over the past years despite roughly comparable initial conditions

The four clusters Thailand and Burma Botswana, Nigeria, and Ghana Uruguay, Argentina, and Spain Madagascar and Mauritius Thailand and Burma Botswana, Nigeria, and Ghana Uruguay, Argentina, and Spain Madagascar and Mauritius

Burma and Thailand Burma 1962: General Ne Win came to power ‘victorious march towards socialism’ self-reliance but active client of IMF 1970s: respectable growth rising investment centrally planned  poor quality stagnant export 1980s: something had gone seriously wrong Burma 1962: General Ne Win came to power ‘victorious march towards socialism’ self-reliance but active client of IMF 1970s: respectable growth rising investment centrally planned  poor quality stagnant export 1980s: something had gone seriously wrong Thailand rising export ratio strong saving and investment performance banking system strongly influenced by politicians  quality of investment questionable strong education record : GNP per capita increased by more than 5% per year on average compared with 1% in Burma Thailand rising export ratio strong saving and investment performance banking system strongly influenced by politicians  quality of investment questionable strong education record : GNP per capita increased by more than 5% per year on average compared with 1% in Burma

Burma and Thailand: GNP per capita, (constant 1987 US$, 1960=100) Fig 1.1

Burma and Thailand Burma Burma spurts of rapid growth depressed investments of low quality plummeting exports deteriorating education evaporation of expertise political control of economic affairs Burma Burma spurts of rapid growth depressed investments of low quality plummeting exports deteriorating education evaporation of expertise political control of economic affairs Thailand the stock-market crash in not likely to dim long-run prospects Thailand’s growth prospects continue to look bright Thailand’s economy seems basically sound In 1990, Burma’s military junta refused to abide by the general election victory of the opposition, led by Aung San Suu Kyi In 1996, the universities were shut down Rapid growth over the long haul does not always have to be smooth Fix Yellow signs

Table 1.1 Selected countries: Overview

Botswana, Nigeria, and Ghana Botswana world record in growth GDP per capita has grown by 7.5% per year since 1966 dependent on natural resources - diamonds 80% of exports 40% of GDP democratic well-managed resources strong education stable economic development 11% average inflation rate Botswana world record in growth GDP per capita has grown by 7.5% per year since 1966 dependent on natural resources - diamonds 80% of exports 40% of GDP democratic well-managed resources strong education stable economic development 11% average inflation rate Nigeria oil price increase in world markets  income per capita rose fourfold  poor investment  unproductive capital  collapse of output low investment since 1980s oil exports crowded out non- oil exports (90% of total) natural resources: a mixed blessing? Nigeria oil price increase in world markets  income per capita rose fourfold  poor investment  unproductive capital  collapse of output low investment since 1980s oil exports crowded out non- oil exports (90% of total) natural resources: a mixed blessing?

Botswana, Nigeria, and Ghana Nigeriaoil 80% of government revenue 20% of GDP ruled by military on and off 19% inflation on average Nigeriaoil 80% of government revenue 20% of GDP ruled by military on and off 19% inflation on average Ghana model client of IMF and World Bank since 1980s increasing foreign trade increasing investment a turning point exports of goods and services rising net foreign direct investment flowing into Ghana 3.6% of GDP in 1995 compared with 2.4% in Nigeria 36% inflation on average Ghana model client of IMF and World Bank since 1980s increasing foreign trade increasing investment a turning point exports of goods and services rising net foreign direct investment flowing into Ghana 3.6% of GDP in 1995 compared with 2.4% in Nigeria 36% inflation on average Abundant natural resource wealth can turn out to be, at best, a mixed blessing

Botswana, Ghana, and Nigeria: GNP per capita, (current US$, Atlas method) Fig 1.2

Uruguay, Argentina, and Spain Uruguay abundant resources dedication to social security and social services South American welfare state active role of government protectionism declining GNP per capita today: quite closed economy rampant inflation Uruguay abundant resources dedication to social security and social services South American welfare state active role of government protectionism declining GNP per capita today: quite closed economy rampant inflation Argentina gradual relative decline political development lagged behind economic progress landowners ruled the country blocking decentralization, democratization, and diversification away from agriculture hardening conflict between landowners and emerging urban classes gradual deterioration of living standards Argentina gradual relative decline political development lagged behind economic progress landowners ruled the country blocking decentralization, democratization, and diversification away from agriculture hardening conflict between landowners and emerging urban classes gradual deterioration of living standards Economic growth is relative

Uruguay, Argentina, and Spain Argentina Perón president in 1946 high inflation rapid escalation of debt flawed economic policies import substitution overvaluation of the currency insufficient competition reduced foreign trade and dragged down living standards civil disorder, inflation, corruption, and brain-drain  slow and uneven growth strikingly closed economy history of high inflation Argentina Perón president in 1946 high inflation rapid escalation of debt flawed economic policies import substitution overvaluation of the currency insufficient competition reduced foreign trade and dragged down living standards civil disorder, inflation, corruption, and brain-drain  slow and uneven growth strikingly closed economy history of high inflation Spain joined the European Union in 1986 opened up its economy expanded exports Spain joined the European Union in 1986 opened up its economy expanded exports History matters for economic growth, as does politics and so does inflation

Argentina, Uruguay, And Spain: GNP per capita, (current US$, Atlas method) Fig 1.3 and

Madagascar and Mauritius Mauritius mixed market economy since 1980: income per head has increased fast diversified economy more open to foreign trade and investment invests more farther along on its way from agriculture to industry, trade, and services sends more girls go to school Mauritius mixed market economy since 1980: income per head has increased fast diversified economy more open to foreign trade and investment invests more farther along on its way from agriculture to industry, trade, and services sends more girls go to school Madagascar centrally planned economy since 1980: income per head has fallen growth differential between the two countries has been even larger since mid-1980s more inflation more dependent on exports of raw materials more indebted abroad Madagascar centrally planned economy since 1980: income per head has fallen growth differential between the two countries has been even larger since mid-1980s more inflation more dependent on exports of raw materials more indebted abroad

Madagascar and Mauritius: GNP per capita, (current US$, Atlas method) Fig 1.4

Conclusion Country comparisons are not to be taken literally intended to highlight some aspects of economic growth What do the examples have in common? All point to economic factors rather than exogenous technology economic system institutions orientation of economic policy Key distinction: Endogenous growth vs. exogenous growth This is the fundamental message of the theory of endogenous growth

Aims of the book A. By interpreting the theory of economic growth, old and new, in nontechnical language in order to identify the main sources of growth B. By emphasizing the economic policy implications of the theory of growth and its empirical relevance C. By demonstrating how, in theory and practice, economic growth depends crucially on choices that people make, individually and collectively A. By interpreting the theory of economic growth, old and new, in nontechnical language in order to identify the main sources of growth B. By emphasizing the economic policy implications of the theory of growth and its empirical relevance C. By demonstrating how, in theory and practice, economic growth depends crucially on choices that people make, individually and collectively 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. ARTHUR LEWIS Illuminate and simplify the subject and make it accessible to laymen and students

Questions for review 1. Does economic growth matter? To whom? Why? 2. Consider two countries, A and B, with the same national income per capita in the year Suppose that in country A national income grows at 4% a year on average and the population remains unchanged, whereas in country B national income grows by 2% per year and the population increases by 1% a year. If these growth rates continue indefinitely, what will the ratio of income per head in country B to that in country A be in 2025? What will it be in 2050? 3. In 1970, per capita GNP in the United Kingdom was about twice as high as that of Hong Kong. From 1970 to 1995, the annual average rate of growth of per capita GNP was 1.8% in the United Kingdom compared with 5.8% in Hong Kong. In 1995, the number of mobile phones per 1,000 people was 98 and 129 in the two countries. Do you want to guess which of the two countries had more mobile phones per capita?

Classroom discussion