I. 20th Century EconomicsI. 20th Century Economics

Selected data, theory, norms and policiesSelected data, theory, norms and policies

(overview(overview)

I.1 Some 20th Century Data

I.1.1 Long term growth trends

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1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000

USA Canada Australia Japan

Real GDP p.c., 1870 – 2001: USA, CND, AUS, J1990 International Geary – Khamis dollars

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1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000

USA Canada Australia Japan

Real GDP p.c., 1870 – 2001: USA, CND, AUS, J1990 International Geary – Khamis dollars

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Real GDP p.c., 1870 – 2001: F,D,I,UK1990 International Geary – Khamis dollars

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1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000

France Germany Italy UK

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1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000

Austria Belgium Netherlands Switzerland

Real GDP p.c., 1870 – 2001: A, B, NL, CH1990 International Geary – Khamis dollars

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Real GDP p.c., 1870 – 2001: DK, FIN, N, S1990 International Geary – Khamis dollars

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1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000

Denmark Finland Norway Sweden

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1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000

Argentina Sweden

Real GDP p.c., 1870 – 2001: ARG, S1990 International Geary – Khamis dollars

logarithmic scale

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Argentina Sweden

Real GDP p.c., 1870 – 2001: ARG, S1990 International Geary – Khamis dollars

GDP p.c. in 1900 and 2001 and average growth rate

1990 International Geary-Khamis dollars

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What are the factors of long term growth?

Evidence for most of the developed countries:• Remarkable GDP growth in 20th century• Striking difference with other parts of the

worldFactors of growth:• Labour supply and productivity• Capital available (conditioned by national

savings)• Capital/labour ratio• Technological progress and innovation

Remark on inflation: USA, 1900-1998

Source: Blanchard

Growth and inflation in 20th century• Growth: since 1870 a substantial increase,

especially since 1950• Price levels: until the outbreak of WWI, the

price level stable and average inflation close to zero; between WWI and WWII much lower stability, but average still zero

• After WWII: permanent growth of price level• Hypothesis: strong long-term growth must be

accompanied by always positive inflation?

I.1.2 Short term fluctuations

GDP growth USA, 1951-2003

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51 53 55 57 59 61 63 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03

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USA US averages

GDP growth EU15, 1956-2003

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EU growth EU averages US averages

Unemployment EU15 a USA

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EU USA

Growth and public deficit, USA 1951-2003

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General G. Balance - %GDP Growth in %

Growth and current account deficit“Asian tigers”

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Growth, inflation, CAD - Czech Republic

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1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

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I.2 Economic Theory and Economic Policies

I.2.1 Descriptive Theory and Models

Microeconomics (1)

• On the level of individual agents and markets• Assumptions about behaviour (people

maximize utility, firms maximize profit)• Walrasian general equilibrium:

– People maximize utility given the income constraints, consumption on the utility possibilities frontier

– Firms maximize profits given their technology constraints, output on the production possibility frontier

– Perfectly competitive markets, agents behave according fully flexible prices

Microeconomics (2)

– Full information about the markets and prices, that are known before transactions take place

– Firms and workers have stable expectations

– Simultaneous equilibrium on all markets (D=S)

– Production factors are paid their share: rent for land, wage for labour and interest for capital

– Pareto optimality

Macroeconomics• Describes the economy on the highest level of

aggregation • Focus on macroeconomic aggregates,

namely GDP (GNP), consumption, savings, investment, money, inflation, unemployment, public finance deficit, current account deficit, public debt, exchange rate, interest rate and others

• Confines the analyses to following five sectors

Sectors on macroeconomic level (1)

• Households: all population, own and provide factors of production (labour, land, capital) to the firms, receive payments (income) from them and generate expenditures for goods and services (for final consumption)

• Firms: “own” technology, employ factors, produce goods and services for final consumption (households, government, export) or for intermediate use (other firms, incl. foreign)

Sectors on macroeconomic level (2)

• Government:– Collects taxes– Manages activities that society expects from it:

• spends on goods and services for public purpose (e.g. defence), on employees in state administration, even owns some firms (that produce goods and services) – “produces” public services

• finances transfers and social benefits• Financial sector: provides transmission services that

channel money from savers to borrowers (incl. government)

• Foreign sector: purchases goods and services (exports), sells goods and services (imports), generates flows of capital out and into the domestic country (FDI in or out, debt financing, equity capital)

Theory and models

• Formalized relationship among economic variables (linked to statistical indicators)– Forms: verbal, graphical, mathematical

• Building blocks:– Markets and agents – Focus of the model: endogenous variables– External environment: exogenous variables

Structure• Structure of the model (based on theory):

system of equations• Solution of the system: equilibrium

values of endogenous variables• Concept of equilibrium: state of the rest,

does not have to be equality between supply and demand– Disturbance: either change in exogenous

variables or a random shock

Time, static and dynamic models• Static model

– Equilibrium: given exogenous variables, the model determines endogenous variables in a specific time moment

– Comparative statics: given the change in exogenous variable(s), the endogenous variables adjust between two specific time moments, multipliers

– Time length between the two moments: short, medium or long term model

• Dynamic (growth) model – determines the development of endogenous variables in time (growth trajectory)

– Initial conditions

– Assumptions about the time development of exogenous variables

• Most of our course: static model

I.2.2 Normative theory and policies

Towards “the norms” (1)

• Theory seen as a provider of the policy tools for the state to steer the economic performance in the “desired” direction

• What is “desired”? – according social, political and other norms in the society, different policy goals are determined and can be classified into three groups:– General: growth of GDP (GDP per capita),

full employment, low inflation, low debt, balanced budget, stable exchange rate, proper distribution of the welfare, etc.

Towards “the norms” (2)

– For the business: macroeconomic stability and implied social and political stability, strong demand for products, export promoting exchange rate, protection against imports, low interest rates, etc.

– microeconomic: fulfil the assumptions that ensure competition, free movement of prices, minimal distortion of markets, private ownership of productive resources

Norms, policies and the state (1)

Consequently, the role of state:• Efficient allocation of the resources ⇒ cultivating

the markets• Control of inflation and unemployment ⇒

stabilization policies • Ensuring economic growth ⇒ long term growth

policies• Attempting to achieve a fair distribution of wealth

across the society welfare policies⇒• Ensuring the society’s needs (police, defence, legal

system, coping with the externalities, etc.) other ⇒policies, primarily not economic ones

Norms, policies and the state (2)

In modern history – 3 approaches how to meet the norms• Capitalism, free market and political democracy:

laissez faire, price as basic signal for production decisions (what, how, for whom), private ownership, minimal government and governmental policies. Efficient allocation of the resources. Minimal role for the state. (Alleged) deficiency: production gaps (unemployment) and unjust distribution of the wealth.

• Central planning (socialism). Consumption decided and resources allocated through the planning system, not according price signals. State ownership. Equal distribution of the wealth. Deficiency: inefficient allocations, gaps in productivity, political dictatorship.

Norms, policies and the state (3)

• Mixed capitalist economy. Prevailing private ownership, cohabitating with the state ownership of certain assets. An attempt to complement free market with governmental policies to cope with the deficiencies of the free market. Inclinations towards welfare state policies.

Examples for government interventions …

• Provision of essential services (e.g. basic education, defence)

• Transfer payments (e.g.unemployment benefits)

• The existence of natural monopolies• External social costs (e.g.drugs) and benefits

(e.g. free vaccination) of the society• Support to industry and commerce• Aggregate demand management

… as translated into policies

• Fiscal policy

• Monetary policy

• Exchange rate policy

• International trade policy

• Supply-side policy

• Price and income policies

• Employment policy

Policies in this course• For mixed capitalist economy and mainly

stabilization policies– but some overlapping of the policies, e.g. supply side

policies are strongly relevant for the long term economic growth (i.e. dynamic model)

– exception: chapter on socialism and transformation

• However, “non”- economic policies directly linked to macroeconomic limits (budget deficits, indebtedness, etc.)– and provide feedback to economic policies (education ⇒

long term growth

• Historical approach – trip through 20th century

I.3 Too much or too little of Government?

Policies: The Easy Definition

• To create appropriate conditions for sustainable economic growth and the improvement of the well-being of the population in the long run.

• To understand, preview and soften the fluctuations around the trend (to soften the business cycle) in the short- and medium run.

• Basis: market economy, the government intervenes to remedy market deficiencies

• The crucial question: how much governmental intervention is needed to achieve the goals above?

Some examples (1)

Best illustrated by following examples:• Was the growth difference between 0-1800 and 1801-

2000 result of some organized „governmental“ activities?– The power of markets?– Adam Smith, invisible hand

• Was the Great Depression a result of the market failure?– Many believe yes (but not all).

• Was an extraordinary growth after WWII a result of a careful economic policy of the governments?– Many macroeconomists 40 years ago convinced that yes

(but in reality, it was not)

Some examples (2)

• Was the state intervention responsible for the high US inflation in 60‘s, EU high unemployment till today or Japanese problems in the 90‘s?– Very probably yes.

• Was the lack of market coordination responsible for Asian crises in 1997 or for burst of telecom bubble and subsequent US economy slowdown in 2000?– Maybe yes.

Adam Smith

• 1723 – 1790

• Political economist and philosopher

• 1751 – professor of logic at Glasgow University

• 1759 – Theory of Moral Sentiments

• 1776 - An Inquiry in the Nature and Causes of the Wealth of Nations

No clear answer

• The existence of the state is a fact, the degree of state intervention into economic affairs is matter of discussion

• The dividing line among the economists and the politicians as well.

• Markets have power and do not fail, only people do fail.

Concluding remark

• Policy definition above is more pragmatic than theoretical

• Theoretical approach: the criteria and intervention defined over more profound discussion of:– Market failures– Social preference function

• Problems with the link to individual preferences

• We do not discuss these issues in this course, with some exceptions

Literature to Lecture IMicroeconomics:• Any text from VSE or IES FSV UK• Varian, H.R.: Microeconomic Analysis.W.W.Norton&Company,

New York, 1984 (2nd and subsequent editions plus Czech translation).

• Henderson, J.M., Quandt, R.E.: Microeconomic Theory. McGraw Hill, 1958 (and subsequent editions).

Macroeconomics:• Any text from VSE or IES FSV UK.• Mankiw, G.N.: Macroeconomics, Worth Publishers, New York,

1992 (and subsequent editions).• Blanchard, O.: Macroeconomics, Prentice Hall, 1997 (and

subsequent editions).Long-term data:• Maddison, A.: The World Economy, A Millennial Perspective,

OECD, 2001.Economic Policy• Acocella, N.: The Foundations of Economic Policy, CUP, 1998 (this

goes beyond our course, but Chapter 1 provides a good theoretical summary, see also references to Frisch, Tinbergen and Theil).