1. Macroeconomics ECON 2301 Fall 2009 Marilyn Spencer, Ph.D. Professor of Economics Chapter 19

2. Announcement: Bonus Extra Credit Opportunity 4 Attend the SEA economic forum Nov. 23, 7 p.m., in the UC Lonestar Ballrooms A&B. 4 Sign in with me. 4 To earn up to 4 points of extra credit: Email me your summary, in 50-100 words, before the start of class on Mon., Nov. 30.

3. Announcement: Students Who Completed the JA Option 4 You must sign up, in class by Nov. 18, for your presentation. 4 I am circulating sign-up sheets now through Nov. 18. 4 If you fail to sign up in class by Nov. 18, you will not be allowed to present, so you will forfeit presentation credit.

4. Chapter 19: Policies and Prospects for Global Economic Growth

5. Introduction ÜIn 2008, a contagion swept around the globe. The source of the contagion was a sharp decline in U.S. housing prices that generated a collapse in the values of numerous housing- related financial assets. Many investors responded by removing their funds from U.S. and European banks. ÜDoes this event send a signal to developing nations that they should not copy industrialized nations by relying on private financing? ÜTo answer this question, we will need to examine how international flows of private investment funds influence economic growth, which is a key topic in this chapter.

6. Learning Objectives: After you’ve studied this chapter, you should be able to… 1.Explain why population growth can have uncertain effects on economic growth 2.Understand why the existence of dead capital retards investment and economic growth in much of the developing world 3.Describe how government inefficiencies have contributed to the creation of relatively large quantities of dead capital in the world’s developing nations 4.Discuss the sources of international investment funds for developing nations and identify obstacles to international investment in these nations 5.Identify the key functions of the World Bank and the International Monetary Fund 6.Explain the basis for recent criticisms of policymaking at the World Bank and the International Monetary Fund

7. Chapter Outline 4 Labor Resources and Economic Growth 4 Capital Goods and Economic Growth 4 Private International Financial Flows as a Source of Global Growth 4 International Institutions and Policies for Global Growth

8. Did You Know That... 4 When the president of the Republic of the Congo recently visited New York City for a few days, his office paid for 44 rooms at the Waldorf-Astoria Hotel and ran up a bill of $252,000? 4 The government of the Republic of the Congo paid these expenses just a few months after receiving aid packages from the IMF and the World bank totaling $2.9 billion. 4 The Republic of Congo already had $9 billion in existing debts. More than 3 million people (>70% of the citizens) earn incomes of less than $3/day. 4 Evaluating the activities of the World Bank and the IMF is one key topic of this chapter.

9. Labor Resources and Economic Growth 4 Population growth does not necessarily translate into an increase in labor resources. 4 In poor areas, many people do not join the labor force, or they may remain unemployed for long periods. 4 We can express the growth rate of per capita real GDP in a nation as the difference between the rate of growth in real GDP and the population growth rate. ÜHence, if real GDP grows at a rate of 4% per year and population growth increases from 2 to 3%, then per capita real GDP will decline, from 2%to 1%.

10. Labor Resources and Economic Growth (cont'd) 4 Population growth can contribute to economic growth. 4 Whether population growth hinders or contributes to economic growth depends on where you live: ÜHow that population growth occurs in your country/region. ÜPolicies and procedures in your country/region

11. Table 19-1 Population Growth and Growth in Per Capita Real GDP in Selected Nations Since 1970

12. Labor Resources and Economic Growth (cont'd) 4 The role of economic freedom ÜA crucial factor influencing economic growth is the relative freedom of a nation’s residents. ÜOnly 17 nations, with 17% of the world’s people, grant their residents high degrees of economic freedom.

13. Labor Resources and Economic Growth (cont'd) 4 Economic Freedom: The rights to own private property and to exchange goods, services, and financial assets with minimal government interference 4 The role of political freedom ÜPolitical freedom: the right to openly support and democratically select national leaders ÜEconomic freedom tends to stimulate economic growth, which then leads to more political freedom.

14. Labor Resources and Economic Growth (cont'd) 4 Question ÜWhy do you suppose that per capita real GDP appears to be related to the extent to which the rule of law prevails?

15. Capital Goods and Economic Growth (cont'd) 4 Dead Capital: Any capital resource that lacks clear title of ownership ÜA resource that people cannot readily allocate to its most efficient use ÜIs among the most significant impediments to growth in poor nations

16. Capital Goods and Economic Growth (cont'd) 4 Dead capital and inefficient production ÜNontransferable physical structures are valued at more than $9 trillion in developing nations. 4 Dead capital and economic growth ÜDisincentives to invest in new capital goods can greatly hinder economic growth.

17. Capital Goods and Economic Growth (cont'd) 4 Government inefficiencies, investment, and growth ÜGovernments in many of the world’s poorest nations place tremendous obstacles in the way of entrepreneurs. ÜThese entrepreneurs are interested in owning capital goods and directing them to profitable opportunities.

18. Capital Goods and Economic Growth (cont'd) 4 Government inefficiencies, investment, and growth ÜIn a nation with a stifling government bureaucracy regulating the uses of capital goods, newly created capital will all too likely become dead capital. ÜThus, government inefficiency can be a major barrier to economic growth.

19. Figure 19-1 Bureaucratic Inefficiency and Economic Growth Sources: International Monetary Fund; World Bank.

20. Capital Goods and Economic Growth (cont’d) 4 Access to credit matters Ü2006 Nobel Peace Prize winner Muhammad Yunus of Bangladesh contends that access to private credit is vital for promoting economic growth in poverty-stricken countries. ÜMicrolenders are banking institutions that specialize in making very small loans to entrepreneurs trying to lift themselves from poverty.

21. Figure 19-2 The Ratio of Private Credit to GDP in Selected Nations ÜSource: Federal Reserve Bank of St. Louis.

22. Private International Financial Flows as a Source of Global Growth 4 Question ÜGiven the large volume of inefficiently employed capital goods in developing nations, what can be done to promote greater global growth? 4 Answers ÜOne approach is to rely on private markets. ÜAnother is to entrust the world’s governments.

23. Private International Financial Flows as a Source of Global Growth (cont'd) 4 Private investment in developing nations ÜEach year since 1995, at least $150 billion in private funds have flowed to developing nations in the form of purchases of bonds or stock. ÜNearly all funds that flow into developing countries due so to finance investment projects in those nations.

24. Private International Financial Flows as a Source of Global Growth (cont'd) Economists group international flows of investment funds into three categories. 1.Loans from banks and other sources 2.Portfolio investment: The purchase of less than 10% of the shares of ownership in a company in another nation 3.Foreign direct investment: The acquisition of more than 10% of the shares of ownership in a company in another nation

25. Figure 19-3 Sources of International Investment Funds Source: International Monetary Fund (including estimates)

26. Private International Financial Flows as a Source of Global Growth (cont'd) 4 Obstacles to international investment ÜMarkets for loans, bonds, and stocks in developing countries susceptible to problems relating to Asymmetric information Adverse selection Moral hazard

27. International Institutions and Policies for Global Growth 4 Since 1945, the world’s governments have taken an active role in supplementing private markets. 4 Two international institutions, the World Bank and the International Monetary Fund, have been at the center of government- directed efforts.

28. International Institutions and Policies for Global Growth (cont'd) 4 The World Bank: A multinational agency that specializes in making loans to about 100 developing nations in an effort to promote their long-term development and growth ÜLoans are made to finance improved irrigation systems, roads, and better hospitals.

29. Figure 19-4 The Distribution of World Bank Lending Since 1990 ÜSource: World Bank.

30. International Institutions and Policies for Global Growth (cont'd) 4 The International Monetary Fund: A multinational organization that aims to promote world economic growth through more financial stability ÜThe IMF assists developing countries primarily by making loans to their governments.

31. International Institutions and Policies for Global Growth (cont'd) 4 When a country joins the IMF, it deposits funds into an account called a quota subscription: A nation’s account with the International Monetary Fund, denominated in special drawing rights

32. International Institutions and Policies for Global Growth (cont'd) 4 These funds are measured in terms of an international unit of accounting called special drawing rights (SDRs). 4 SDRs have a value based on a weighted average of four key currencies ÜThe euro, the pound sterling, the yen, and the dollar ÜAt present, one SDR is equal to just under $1.50.

33. International Example: The IMF Rethinks Nations’ Voting Shares 4 A nation’s IMF quota subscription determines how much the country can borrow from the IMF under the organization’s standard credit arrangements. 4 It also determines the nation’s voting power within the IMF. 4 Nevertheless, many nations’ shares of quota subscriptions do not correspond to their relative importance in the world economy.

34. International Example: The IMF Rethinks Nations’ Voting Shares (cont’d) 4 The IMF is in the process of developing a plan to reconfigure nations’ voting power within the organization. 4 One factor complicating this endeavor is that countries with relative voting power exceeding their economies’ shares of world GDP do not wish to give up any of their voting rights. 4 Ultimately, the IMF may address the issue simply by creating additional voting rights and granting these “extra” voting rights to underrepresented countries.

35. International Institutions and Policies for Global Growth (cont'd) 4 The World Bank’s Mission ÜTo make loans to developing nations that fund projects incapable of attracting private financing from investors at home or abroad. However, the World Bank makes many loans to countries that have no trouble attracting financing. Some observers contend that a number of countries that receive funds are inappropriate recipients of development assistance (i.e. China)

36. International Institutions and Policies for Global Growth (cont'd) 4 Asymmetric information & the World Bank and the IMF: ÜConditions on loans exist to reduce adverse selection and moral hazard problems but are often imprecise ÜHave the World Bank and the IMF contributed to international financial crises?

37. International Institutions and Policies for Global Growth (cont'd) 4 Rethinking long-term development lending: A main theme of development economics has been market reforms. ÜMarkets work better when a developing nation has more effective institutions: Basic property rights Well-run legal systems Uncorrupt government agencies

38. International Institutions and Policies for Global Growth (cont'd) 4 Alternative institutional structures for limiting financial crises ÜMany proposals for change diverge sharply. ÜEconomists recommend improvements in standards. 4 Question ÜIs it time to replace the World Bank and the IMF?

39. Issues and Applications: Private International Investment - Source of Instability or Engine of Economic Growth? 4 As shown in Figure 19-3, in recent years there has been a gradual decrease in bank loans as a source of private funding in developing nations. 4 As this source of funds has declined, private international investment has increased. 4 Figure 19-5 indicates that portfolio investment has been much more volatile than direct foreign investment. This tends to be associated with lower economic growth.

40. Figure 19-5 Worldwide Flows of Portfolio Stock Investment, Portfolio Bond Investment & Foreign Direct Investment Since 1990 Source: World Bank

41. Issues and Applications: Private International Investment - Source of Instability or Engine of Economic Growth? (cont'd) 4 Argentina, Venezuela, and South Africa have experienced more volatile flows of international investment because these low-growth nations have received much more portfolio investment than foreign direct investment. 4 In contrast, Indonesia, Pakistan, and China are recipients of larger shares of global foreign direct investment and have experience much faster rates of economic growth.

42. Summary of Learning Objectives 1. Effects of population growth and personal freedoms on economic growth ÜIncreased population growth has contradictory effects on economic growth. ÜThere is evidence of a positive relationship between economic freedom and growth.

43. Summary of Learning Objectives (cont'd) 2. Why dead capital deters investment and slows economic growth: ÜFew people in less developed countries establish legal ownership of capital. ÜUnofficially owned resources are known as dead capital. ÜIn many developing nations, there is a disincentive to accumulate capital, which limits growth prospects.

44. Summary of Learning Objectives (cont'd) 3. Government inefficiencies and dead capital in developing nations ÜA negative relationship between government inefficiency and economic growth 4. Sources of international investment funds and obstacles to investing in developing nations: ÜSources include bank loans, portfolio investment, and foreign direct investment ÜObstacles include problems relating to asymmetric information such as adverse selection and moral hazard

45. Summary of Learning Objectives (cont'd) 5. The functions of the World Bank and the International Monetary Fund ÜThe World Bank’s function is to finance capital investment. ÜA fundamental duty of the IMF is to stabilize international financial flows.

46. Summary of Learning Objectives (cont'd) 6. The basis for recent criticisms of the World Bank and IMF policymaking: ÜThe World Bank has extended credit to companies and governments that could have obtained private funds. ÜThe World Bank and IMF have failed to effectively deal with adverse selection and moral hazard, suggesting more stringent conditions on credit access are needed.

47. Wednesday, November 25 4 We will not hold class that day. 4 I will hold extended office hours that afternoon, 1-5 p.m. 4 Use your class time for one or more of these activities: ÜWrite your summary of the Monday evening panel. ÜStudy for exam 3. ÜPrepare for your JA presentation. ÜConsult with me.

48. Exam 3 4 Wednesday, December 2 4 Chapters 15, 16 & 19 4 Same format as earlier exams 4 Review in class on Mon., Nov. 23, and possibly Mon., Nov. 30