Rebalancing Economic Growth - Institute for International Economics
Growth Economics
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Transcript of Growth Economics
05:38:51 PM
Investment – Economic Growth and the Middle Income Trap
A2 Macro – Autumn 2013
05:38:51 PM
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05:38:51 PM
Sources of Economic Growth
Economic growth
Capital stock
Active labour supply
Natural resources
Factor productivity
Innovation
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China and UK GDP GrowthGrowth rate of GDP, annual % change at constant prices
China and the UK - Growth Compared
Source: Reuters EcoWin
04 05 06 07 08 09 10 11 12 13
-7.5
-5.0
-2.5
0.0
2.5
5.0
7.5
10.0
12.5
15.0
Pe
rce
nt
-7.5
-5.0
-2.5
0.0
2.5
5.0
7.5
10.0
12.5
15.0
China
United Kingdom
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Global GDP: A Changing World2005 2006 2007 2008 2009 2010 2011
Emerging markets 31.1 33.9 36.4 39.7 42.4 43.4 46.0
of whichChina 9.8 11.1 12.7 15.2 18.3 17.7 19.9
Other EM 21.3 22.8 23.7 24.5 24.1 25.7 26.1
Western world 68.9 66.1 63.6 60.3 57.6 56.6 54.0
of whichUS 23.8 22.9 21.2 18.9 19.8 19.2 18.0Japan 13.1 11.6 10.3 10.3 10.3 11.0 10.2
Rest of world 32.0 31.6 32.1 31.1 27.5 26.4 25.8
Source: private data made available by IHS Global Insight; UN statistical service; other data from charts in “The New Industrial Revolution: Consumers, Globalization and the End of Mass Production”, Peter Marsh, Yale University Press, 2012.
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Harrod-Domar Model
Increase national savings
Increase in net
investment
Larger capital stock
Rise in real GDP / GNI
Increased factor
incomes
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Harrod-Domar Growth Model
• Model stresses the importance of savings and investment• Rate of growth depends on:
– Level of national saving (S)– Productivity of capital investment (capital-output ratio)
• The Capital-Output Ratio (COR)– For example, if £100 worth of capital equipment
produces each £10 of annual output, a capital-output ratio of 10 to 1 exists.
– When the quality of capital resources is high, then the capital output ratio will be lower
• Rate of growth of GDP = Savings ratio / capital output ratio
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Importance of Investment as a Growth Driver
Injection of demand for capital goods industries
Multiplier effects through supply chains
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Importance of Investment as a Growth Driver
Lift rural productivity / incomes Economies of scale & competitiveness in fledgling sectors
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Importance of Investment as a Growth Driver
Investment to cope with rural-urban migration
Investment to sustain export-led growth
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Importance of Investment as a Growth Driver
Injection of demand for capital goods industries
Multiplier effects through supply chains
Bigger capital stock can lift rural productivity / incomes
Economies of scale & competitiveness in fledgling
sectors
Investment to cope with rural-urban migration
Investment to sustain export-led growth
05:38:52 PM
Investment and Saving as % of GDPGross capital formation Gross savings
% of GDP % of GDP2000 2011 2000 2011
Mongolia 29 63 23 31China 35 48 37 53Qatar 20 39India 24 35 25 31Vietnam 30 35 31 33Nepal 24 33 22 34South Korea 31 29 33 32Australia 26 27 21 25Sub-Saharan Africa 17 21 16 17Brazil 18 20 14 17Germany 22 18 20 24Greece 25 16 14 5United Kingdom 18 15 14 13United States 21 15 18 12Ireland 24 10 24 12
05:38:52 PM
China – Investment’s Contribution to GDP Growth
Overall, Total, Contribution share to GDP growth, Constant Prices, %
China - Gross Capital Investment
Source: Reuters EcoWin
98 99 00 01 02 03 04 05 06 07 08 09 10 11 12
20
30
40
50
60
70
80
90
Pe
rce
nt
20
30
40
50
60
70
80
90
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China’s Investment Driven Growth
“Economic commentators have often expressed concerns that economic growth in China is unbalanced, with an investment-driven model that is not sustainable in the future unless it is shifted toward a more consumption-driven model.” (FT, Sept 2013)
• As economies develop, they typically need higher capital investment• Is China over-investing? • An IMF report in 2012 argued that “investment in China may currently be around 10 per cent
of GDP higher than suggested by fundamentals.”
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Linda Yueh – China’s Growth• Real GDP growth - 9.6% pa since 1979
• 60-70% has come from increasing capital and labour inputs (input accumulation)
• 30-40% has come from rising total factor productivity growth (increasing efficiency)
• Inputs: 50% of growth from adding capital, 10-20% from adding workers
• Increases in per capita output (productivity)
• 11-15% gains in human capital• 8-15% improving allocative efficiency
(moving from state-owned to private + rural to urban)
• 16-17% from the effects of innovation
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Harrod-Domar Model - Constraints
Persistent savings gap in some countries
Small scale financial institutions
Weaknesses in human capital to adapt to investment
Risks from unbalanced growth (C v I)
Investment and natural resource depletion
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Harrod-Domar Model - Constraints
Persistent savings gap in some countries
In many smaller low-income countries, high levels of extreme poverty make it almost impossible to generate sufficient savings to provide the funds needed to fund investment projects.
This increases reliance on tied aid
Some countries borrow heavily to fund capital investment projects – this can lead to a high level of external debt
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Harrod-Domar Model - Constraints
Small scale financial institutions
Financial markets help to channel domestic savings into funding for investment projects
Many of the least developed countries have limited financial markets such as banking, money and credit systems, insurance markets and stock markets
05:38:53 PM
Harrod-Domar Model - Constraints
Weaknesses in human capital to adapt to investment
Investment increases the size of the capital stock and helps to achieve “capital deepening” (capital per worker) but the skills and experience to make best use of new technology
In many countries there are acute shortages of human capital
Some countries lose some of its limited skilled workforce to other countries through a brain drain
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Harrod-Domar Model - Constraints
Risks from unbalanced growth (C v I)
1. High levels of capital investment might un-balance the economy
2. Depressing short-term living standards
3. Low quality investment projects given the go-ahead
4. Risks of investment bubbles e.g. in new house-building
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Unbalanced growth in ChinaBoth China and Japan have adopted the so-called “Asian growth model”. This involves generating breakneck economic growth with very high levels of investment and export expansion. Manufacturers are subsidised with cheap capital, while exports are boosted by an artificially depressed exchange rate. National savings are encouraged, at the expense of domestic consumption. Low interest rates reduce the return on household savings, while a cheap currency makes imports more expensive.
This set of mercantilist policies delivers economic miracles during the boom years, but it tends to culminate in excess investment, lacklustre domestic demand, credit and real estate bubbles, and the widespread misallocation of capital. The macroeconomic imbalances produced by China are on an epic scale. Household consumption, at an astonishingly low 35 per cent of GDP, is just over half the global average.
Source: Edward Chancellor, FT, August 2013
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Harrod-Domar Model - Constraints
Investment and natural resource depletion
• Natural resources provide a source of wealth for many lower-income countries
• When world prices are high, there is an incentive to increase investment and extraction rates to boost short-term export earnings
• This can damage growth potential
05:38:53 PM
Ideas, Institutions and Innovation
The growth that lifts a country from being lower-income to middle income is not necessarily the same type of growth needed to move from middle to higher income status.
Input driven growth can only take countries so far along development paths
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The Middle Income Trap
“The concept defines the fast-
growing economies that face a possible dilemma of being caught between
poverty and prosperity”
Source: World Bank Development Blog
05:38:53 PM
The Middle Income Trap
According to the OECD, only 17 countries have
joined ranks of rich nations in the post
war period by breaking out of the middle income trap
- this includes Greece and
Portugal!
Causes of the Middle-Income TrapRising wages / unit labour costs
Productivity slowdown
Challenges of moving up the product value chain
Institutional Weaknesses
Challenge of maintaining macro-economic stability
2:32:17 PM
Causes of the Middle-Income TrapRising wages / unit labour costs
Productivity slowdown
Challenges of moving up the product value chain
Institutional Weaknesses
Challenge of maintaining macro-economic stability
2:32:17 PM
Rapid wage inflation in China
Causes of the Middle-Income TrapRising wages / unit labour costs
Productivity slowdown
Challenges of moving up the product value chain
Institutional Weaknesses
Challenge of maintaining macro-economic stability
2:32:17 PM
Rapid wage inflation in China
Requires better capital and more innovation
Causes of the Middle-Income TrapRising wages / unit labour costs
Productivity slowdown
Challenges of moving up the product value chain
Institutional Weaknesses
Challenge of maintaining macro-economic stability
2:32:17 PM
Rapid wage inflation in China
Requires better capital and more innovation
Moving away from low value manufacturing
Causes of the Middle-Income TrapRising wages / unit labour costs
Productivity slowdown
Challenges of moving up the product value chain
Institutional Weaknesses
Challenge of maintaining macro-economic stability
2:32:17 PM
Rapid wage inflation in China
Requires better capital and more innovation
Moving away from low value manufacturing
Underdeveloped finance & legal markets
Causes of the Middle-Income TrapRising wages / unit labour costs
Productivity slowdown
Challenges of moving up the product value chain
Institutional Weaknesses
Challenge of maintaining macro-economic stability
2:32:17 PM
Rapid wage inflation in China
Requires better capital and more innovation
Moving away from low value manufacturing
Underdeveloped finance & legal markets
Threat of high inflation and trade deficits
Avoiding a Middle Income Trap Rising domestic consumption
Human capital investment
Investment in critical infrastructure
Regional Trade Integration and New Trade Routes
Diversification of industrial base and export industries
Encouraging private sector development
Measures to support inclusive growth
2:32:17 PM
Avoiding a Middle Income Trap Rising domestic consumption
Human capital investment
Investment in critical infrastructure
Regional Trade Integration and New Trade Routes
Diversification of industrial base and export industries
Encouraging private sector development
Measures to support inclusive growth
2:32:17 PM
Avoiding a Middle Income Trap Rising domestic consumption
Human capital investment
Investment in critical infrastructure
Regional Trade Integration and New Trade Routes
Diversification of industrial base and export industries
Encouraging private sector development
Measures to support inclusive growth
2:32:17 PM
Avoiding a Middle Income Trap Rising domestic consumption
Human capital investment
Investment in critical infrastructure
Regional Trade Integration and New Trade Routes
Diversification of industrial base and export industries
Encouraging private sector development
Measures to support inclusive growth
2:32:17 PM
Avoiding a Middle Income Trap Rising domestic consumption
Human capital investment
Investment in critical infrastructure
Regional Trade Integration and New Trade Routes
Diversification of industrial base and export industries
Encouraging private sector development
Measures to support inclusive growth
2:32:17 PM
Avoiding a Middle Income Trap Rising domestic consumption
Human capital investment
Investment in critical infrastructure
Regional Trade Integration and New Trade Routes
Diversification of industrial base and export industries
Encouraging private sector development
Measures to support inclusive growth
2:32:17 PM
Avoiding a Middle Income Trap Rising domestic consumption
Human capital investment
Investment in critical infrastructure
Regional Trade Integration and New Trade Routes
Diversification of industrial base and export industries
Encouraging private sector development
Measures to support inclusive growth
2:32:17 PM
05:38:55 PM
Middle Income Trap
Danny Quah
The proposition that fast-growing economies will slow eventually is called “neoclassical convergence” — when capital-deepening has run its course and any further advance in prosperity can come only from technological progress, whether through indigenous innovation or through importing techniques from any economies still running on ahead. But neoclassical convergence is an old idea.
05:38:55 PM
What else matters for growth?
Trust Trade Institutions
Dynamic Private Sector Sound Macro Policies Equity / Fairness
05:38:55 PM
What else matters for growth?
Trust Trade Institutions
Dynamic Private Sector Sound Macro Policies Equity / Fairness
05:38:55 PM
What else matters for growth?
Trust Trade Institutions
Dynamic Private Sector Sound Macro Policies Equity / Fairness
05:38:55 PM
What else matters for growth?
Trust Trade Institutions
Dynamic Private Sector Sound Macro Policies Equity / Fairness
05:38:55 PM
What else matters for growth?
Trust Trade Institutions
Dynamic Private Sector Sound Macro Policies Equity / Fairness
05:38:55 PM
What else matters for growth?
Trust Trade Institutions
Dynamic Private Sector Sound Macro Policies Equity / Fairness
05:38:55 PM
Upgrading an economyPolicies to support diversification and productive upgrading can help a country escape the middle-income trap. For example, South Korea has grown it’s capacity to benefit from trade-led growth in high connectivity and higher value-added sectors
05:38:55 PM
Upgrading an economyPolicies to support diversification and productive upgrading can help a country escape the middle-income trap. For example, South Korea has grown it’s capacity to benefit from trade-led growth in high connectivity and higher value-added sectors
Threats to Growth
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Many factors can throw a country off their projected long run growth path. Many of the world’s least developed countries are highly vulnerable
Changes in the real exchange rate affecting competitiveness
Financial instability e.g. unsustainable credit boom and fall in savings
Volatility in world prices for essential imports and key exports
Political instability / military conflicts
Natural disasters and other external supply shocks
Disruptive technologies that threaten existing trade advantages
05:38:56 PM
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