NS4053 Winter Term 2014 Growth, Convergence and Income Distribution

Introduction I Kemal Dervis and Homi Kharas, Growth, Convergence and Income Distribution: An Introduction (Brookings, November 2014 Introduces several of the main themes in the course – growth, convergence and income distribution I. With differential recoveries from the global economic crisis a number of new debates on growth Some economies argue an era of secular stagnation lies ahead unless vigorous policy actions are taken Other economists argue that ongoing and pending technological change is likely to lead to an acceleration in growth Stagnation thesis usually applied to the advanced countries, but sometimes to the global economy as a whole – can emerging economies decouple and sustain growth on their own? 2

Introduction II II. Second debate is on the convergence between average incomes in the lower- and middle-income emerging economies and that in the advanced economies Until post-WWII period no doubt considerable divergence In 1776 per capita income in Netherlands about four times that in poorer countries Two centuries later the Netherlands was 40 times richer than China, 24 times richer than India and 10 times richer than Thailand In the aggregate, this divergence slowed markedly in the 1950s with average incomes in all EMDEVs (emerging and developing economies) picked up pace Then starting in the late 1980s a processes of convergence seems to have taken hold – average income in EMDEVs growing much faster over

Introduction III Today, the Netherlands is only five times richer than China and Thailand and 11 times richer than India Major question – Is this convergence going to last? or Was rapid convergence a temporary phenomenon? III. The third debate centers on income distribution – intense, contemporary debate over capitalism Is growth relevant if increases in income largely accrue to the top 10 or even 1% of the population? Seems to be happening in the U.S. and the U.K Is there an inherent long-run tendency towards greater inequality in a market economy? Is there a possible link between possible secular stagnation and income distribution? How does inequality in the world relate to inequality in particular countries? 4

Overview: Three Interlinked Debates I Secular stagnation debate confusing: Does it refer to slower potential output growth? or Slower growth of actual output? Potential growth may be slowing because of trends in: technological change, educational advancement, aging, and debt-induced underinvestment in public goods and infrastructure Slowdown in observed output growth can also be due to gaps between actual and potential output. Hansen/Summers view that this form of stagnation may threaten the U.S. economy or advanced economies as a whole. Reason: Desired aggregate savings has increased compared to desired aggregate investment Real interest rate needed to restore macroeconomic equilibrium may be negative 5

Overview: Three Interlinked Debates II Less clear is whether this form of secular stagnation applies to the global economy Has global investment demand and the global supply of saving shifted so that there is a global savings glut? Requiring a global real interest rate that is negative? Is it desirable therefore to link the secular stagnation debate to the convergence debate? If secular stagnation affects all countries, then convergence may disappear. If it is more of a phenomenon affecting rich countries, then convergence could continue. In this case, it may be that growth in the emerging world might actually provide the demand impulse needed for the advanced economies 6

Overview: Three Interlinked Debates III The income distribution debate is itself linked to both the growth and convergence debate. If take population of the world as a whole and focus on an inequality indicator for that population, increasing inequality within countries will lead to increases in the global inequality index. But convergence – catch up by the developing countries – will lead to a decrease in world inequality index. Has an important bearing on global demand While we see stress on the struggling middle class in advanced countries resulting from wage stagnation and growing within- countries inequalities – Also see emergence of a global middle class in the rest of the world – especially Asia Clearly one has to clearly define what one means by inequality. 7

Overview: Three Interlinked Debates IV Whether inequality is good or bad for growth has been debated over the years Classical economists felt savings were needed to finance investment and therefore inequality good because higher income groups do most of the savings These theories focus on changes in potential output as the real determinant on growth. Recent research suggests the opposite view IMF research suggests there have been more episodes of sustained rapid growth in societies that are relatively more equal More stable socially, politically and financially – factors that seem to outweigh the classical link to savings. Keynesian link diametrically opposed to classical link – problem of excess savings and increased income inequality makes the problem worse – here focus is on actual rather than potential output 8

The Tree Debates The rest of the paper contains some technical terms that we will have to discuss before delving into the arguments – we should return to these debates after developing the neoclassical model with its emphasis on the sources of growth. 9