Macro Chapter 17 Institutions, Policies, and Cross- Country Differences in Income and Growth

2 Learning Goals 1) 1)Explain how economic freedom and growth are related 2) 2)Identify the benefits of economic freedom

How Large Are the Income Differences Across Countries?

Copyright ©2015 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 15 th edition Gwartney-Stroup Sobel-Macpherson Cross-Country Differences in Income The 2011 Per Person Income Levels for high-, Middle-, and Low-Income Countries (measured in 2005 PPP U.S. dollars) Hungary Chile Russia Botswana Mexico Venezuela Brazil South Africa $17,938 17,294 15,251 14,714 14,174 13,021 12,814 11,258 10,279 9,678 China$7,418 Ukraine6,365 5,547Egypt 4,503 Philippines 4,094 India 3,638 3,223 Nigeria2,237 Bangladesh1,569 Uganda1,188 Singapore$53,591 Norway46,971 Hong Kong44,640 Ireland 42,486 Netherlands 39,385 United States 37,118 Australia 35,715 Germany 35,439 Switzerland 34,853 Canada 34,573 High-Income CountriesMiddle-Income CountriesLow-Income Countries Malaysia Poland Indonesia Bolivia Peru Thailand 9,037 7,635 Malawi789 Niger642 United Kingdom Japan 32,809 30,660

Why?

How Do Growth Rates Vary across Countries?

Copyright ©2015 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 15 th edition Gwartney-Stroup Sobel-Macpherson Economic Growth: The Average Annual Growth Rate Per-Person GDP for High-Growth, High-Income Industrial, and Low-Growth Countries (1990–2011) Norway The Netherlands United Kingdom United States Canada France Japan Italy 1.8% 1.7% 1.6% 1.4% 1.0% 0.7% 0.6% Kyrgyz Repulic-0.8% Central African Republic-0.8% -0.9%Cote d’Ivoire -0.9% Georgia -1.1% Burundi -1.1% -1.2% Tajikistan-1.7% Moldova-2.0% Congo, Dem. Rep.-3.0% China9.5% Vietnam5.9% India4.8% Dominican Republic 4.4% Korea, Rep. 4.3% Taiwan 4.3% Chile 4.0% Poland 4.0% Sri Lanka 3.8% Panama 3.8% High-GrowthHigh-Income IndustrialLow-Growth Germany Australia Ukraine Madagascar

Why? 2 major reasons: 1)Institutions (see Chapter 16) 2)Economic Freedom

Economic Freedom as a Measure of Sound Institutions

Institutions, Policies, and Economic Performance

Economic Freedom Method of organizing economy with the following characteristics: 1)Personal choice 2)Market-based voluntary exchange 3)Competitive entry into markets 4)Private property

Class Activity: What conclusion can you draw from the following exhibit?

Main point: the government’s policies and involvement in the economy are important, but too much government intervention can harm growth Analogy: Your mom’s involvement in your education Transmitter question next

Q17.1 Economic theory indicates that the size of government will be 1.unrelated to economic growth. 2.negatively related to economic growth at all possible sizes of government. 3.positively related to economic growth at all possible sizes of government. 4.positively related to economic growth at small levels of government but is negatively related to economic growth at large levels of government. 60

Major Conclusion: The more free the economy is, the higher the growth rate will be

Two Transmitter Questions next

Q17.2 According to the EFW rankings, the U.S. is more free than Canada, Finland, and Chile. 1.True 2.False 30

Q17.3 According to the EFW rankings, the U.S. is ranked in the top True 2.False 30

The 2012 EFW report reveals the US is now in 18 th place with a rating of 7.69 “The United States, long considered the standard bearer for economic freedom among large industrial nations, has experienced a substantial decline in economic freedom during the past decade. From 1980 to 2000, the United States was generally rated the third freest economy in the world, ranking behind only Hong Kong and Singapore. After increasing steadily during the period from 1980 to 2000, the chainlinked EFW rating of the United States fell from 8.65 in 2000 to 8.21 in 2005 and 7.70 in The chain-linked ranking of the United States has fallen precipitously from second in 2000 to eighth in 2005 and 18th in 2010.”

Economic Freedom of the World Good News! The US is now in 12 th place.

Copyright ©2015 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 15 th edition Gwartney-Stroup Sobel-Macpherson

Economic Freedom of the World EFW

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Copyright ©2015 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 15 th edition Gwartney-Stroup Sobel-Macpherson Economic Freedom and Income The real per-person income (using a PPP adjustment) for countries ordered by economic freedom rating is shown here by quartiles. Note the strong positive linkage. Income per person in the freest quartile of countries was about seven times the figure for the least free. Least-Free Quartile Second Quartile Most-Free Quartile $5,188 $16,957 $37, GDP Per Capita, PPP (in constant 2005 dollars) Third Quartile $6,596

Copyright ©2015 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 15 th edition Gwartney-Stroup Sobel-Macpherson Economic Freedom and Growth The relationship between the economic freedom of a country and its growth rate (of GDP per capita) during the period is shown here. Countries in the most free quartile grew at an annual rate of 3.6% compared to the 1.6% growth for the least-free quartile. Least-Free Quartile Second Quartile Most-Free Quartile 1.6% 2.8% 3.6% Growth of GDP Per Capita (Annual %) Third Quartile 2.4%

Copyright ©2015 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 15 th edition Gwartney-Stroup Sobel-Macpherson Economic Freedom and Poverty The extreme poverty rate in the most free quartile of countries was 2.7% compared to 41.5% in the least free quartile. The pattern in the data for the moderate poverty rate is the same. Clearly the countries with more economic freedom have lower poverty rates. Least-Free Quartile Second Quartile Most-Free Quartile 41.5% 7.8% 2.7% Extreme Poverty Rate ( ) Third Quartile 21.3% Least-Free Quartile Second Quartile Most-Free Quartile 3.6% 36.3% 57.4% Third Quartile 14.0% Moderate Poverty Rate ( )

Copyright ©2015 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 15 th edition Gwartney-Stroup Sobel-Macpherson Economic Freedom and Private Investment Here countries are divided into 3 groups, based upon their average EFW rating during Investment is positively linked to economic freedom. Private investment was 18.7% of GDP in the freest group, while only 11.2% of GDP for the least free group. < 5.0> 7.0 Economic Freedom & Private Investment as a Share of GDP (Groups are Average EFW Ratings for ). 5.0 – % 18.7% 15.6%

Copyright ©2015 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 15 th edition Gwartney-Stroup Sobel-Macpherson Economic Freedom and the Productivity of Private Investment The estimated impact of a 1 percentage point increase in investment as a share of GDP on annual growth rate during is shown. In the most free group, a 1 percentage point increase in private investment enhanced long-term growth by 0.25%, compared to 0.07% for the least free group. EFW < 5 EFW > % 0.25% Change in Growth Rate Per Percentage-Point Change in Investment (1980 – 2005) EFW %

Copyright ©2015 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 15 th edition Gwartney-Stroup Sobel-Macpherson Economic Freedom and Life Expectancy People in the most economically free countries had almost 20 additional years of life compared to those in the least free economies of the world. Least-Free Quartile Second Quartile Most-Free Quartile Years of Life Expectancy (at birth) 2007 Third Quartile 66.7

Copyright ©2015 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 15 th edition Gwartney-Stroup Sobel-Macpherson The infant mortality rate in the least economically free countries was nearly 12 times greater than that of the most free economies. Economic Freedom and Infant Mortality Rate Least-Free Quartile Second Quartile Most-Free Quartile Infant Mortality Rate (per 1000 live births) 2007 Third Quartile 39.1

Copyright ©2015 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 15 th edition Gwartney-Stroup Sobel-Macpherson Access to sanitary water increased with economic freedom. Economic Freedom and Access to Sanitary Water 16.A3 Table in word file Should fit in this space Least-Free Quartile Second Quartile Most-Free Quartile 74.2% 89.5% 99.2% Share of Population with Access to Improved Water Source, 2006 Third Quartile 83.5%

Copyright ©2015 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 15 th edition Gwartney-Stroup Sobel-Macpherson Studies have shown that the quality of the environment is strongly linked to income. Economic Freedom and Environmental Quality 16.A3 Table in word file Should fit in this space Least-Free Quartile Second Quartile Most-Free Quartile Environmental Performance Index (2007/2008) Third Quartile 71.6

Copyright ©2015 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 15 th edition Gwartney-Stroup Sobel-Macpherson In the nations of the top quartile, the average income of the poorest 10% was more than eight times that of the poorest 10% from countries in the bottom quartile. Economic Freedom Income of Lowest 10% of Earners 16.A3 Table in word file Should fit in this space Least-Free Quartile Second Quartile Most-Free Quartile $896 $3,269 $9,105 Average Income of Poorest 10%, 2007 Third Quartile $1,744

Copyright ©2015 Cengage Learning. All rights reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible web site, in whole or in part. First page 15 th edition Gwartney-Stroup Sobel-Macpherson The incidence of political corruption was lower in the more free economies of the world. These numbers are a reflection of the higher quality legal systems of the freer economies. Economic Freedom and Political Corruption 16.A3 Table in word file Should fit in this space Least-Free Quartile Second Quartile Most-Free Quartile Corruption Perceptions Index, 2007 Third Quartile 3.2

With few exceptions, when an economy is more free the country will achieve: A higher growth rate A more equal distribution of income Better environmental quality Better health outcomes Higher standards of living

Video:

Transmitter question next

Q17.4 On average, countries that have a larger degree of economic freedom tend to have 1.higher per capita income levels but slower rates of economic growth than countries with less economic freedom. 2.lower per capita income levels but more rapid rates of economic growth than countries with less economic freedom. 3.both higher per capita income levels and more rapid growth rates than countries with less economic freedom. 4.both lower income levels and slower growth rates than countries with less economic freedom. 60

2 Learning Goals 1) 1)Explain how economic freedom and growth are related 2) 2)Identify the benefits of economic freedom