Growth Economics

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Updated presentation on aspects of factors affecting economic growth including the middle income trap. Designed as a resource for A2 macro - unit 4 Development Economics

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Growth Economics

  1. 1. Investment – Economic Growth and the Middle Income Trap A2 Macro – Autumn 2013 3:10:23 PM
  2. 2. Get help from fellow students, teachers and tutor2u on Twitter: #econ4 @tutor2u_econ 3:10:23 PM
  3. 3. Sources of Economic Growth Economic growth Capital stock Active labour supply Natural resources Factor productivity Innovation 3:10:24 PM
  4. 4. China and UK GDP Growth 3:10:24 PM
  5. 5. Global GDP: A Changing World 3:10:24 PM 2005 2006 2007 2008 2009 2010 2011 Emerging markets 31.1 33.9 36.4 39.7 42.4 43.4 46.0 of which China 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 which US 23.8 22.9 21.2 18.9 19.8 19.2 18.0 Japan 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.
  6. 6. Harrod-Domar Model Increase national savings Increase in net investment Larger capital stock Rise in real GDP / GNI Increased factor incomes 3:10:24 PM
  7. 7. 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 3:10:24 PM
  8. 8. 3:10:24 PM
  9. 9. Importance of Investment as a Growth Driver Injection of demand for capital goods industries Multiplier effects through supply chains 3:10:24 PM
  10. 10. Importance of Investment as a Growth Driver Lift rural productivity / incomes Economies of scale & competitiveness in fledgling sectors 3:10:24 PM
  11. 11. Importance of Investment as a Growth Driver Investment to cope with rural-urban migration Investment to sustain export-led growth 3:10:24 PM
  12. 12. 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 3:10:24 PM
  13. 13. Investment and Saving as % of GDP Gross capital formation Gross savings % of GDP % of GDP 2000 2011 2000 2011 Mongolia 29 63 23 31 China 35 48 37 53 Qatar 20 39 India 24 35 25 31 Vietnam 30 35 31 33 Nepal 24 33 22 34 South Korea 31 29 33 32 Australia 26 27 21 25 Sub-Saharan Africa 17 21 16 17 Brazil 18 20 14 17 Germany 22 18 20 24 Greece 25 16 14 5 United Kingdom 18 15 14 13 United States 21 15 18 12 Ireland 24 10 24 12 3:10:24 PM
  14. 14. China – Investment’s Contribution to GDP Growth 3:10:24 PM
  15. 15. 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.” 3:10:24 PM
  16. 16. 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 3:10:24 PM
  17. 17. 3:10:24 PM
  18. 18. 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 3:10:24 PM
  19. 19. 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 3:10:24 PM
  20. 20. 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 3:10:24 PM
  21. 21. 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 3:10:24 PM
  22. 22. 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 3:10:24 PM
  23. 23. Unbalanced growth in China Both 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 3:10:24 PM
  24. 24. 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 3:10:24 PM
  25. 25. 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 3:10:24 PM
  26. 26. 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 3:10:24 PM
  27. 27. 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! 3:10:24 PM
  28. 28. Causes of the Middle-Income Trap Rising 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
  29. 29. Causes of the Middle-Income Trap Rising 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
  30. 30. Causes of the Middle-Income Trap Rising 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
  31. 31. Causes of the Middle-Income Trap Rising 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
  32. 32. Causes of the Middle-Income Trap Rising 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
  33. 33. Causes of the Middle-Income Trap Rising 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
  34. 34. 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
  35. 35. 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
  36. 36. 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
  37. 37. 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
  38. 38. 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
  39. 39. 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
  40. 40. 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
  41. 41. Middle Income Trap 3:10:24 PM 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.
  42. 42. What else matters for growth? 3:10:25 PM Trust Trade Institutions Dynamic Private Sector Sound Macro Policies Equity / Fairness
  43. 43. What else matters for growth? 3:10:25 PM Trust Trade Institutions Dynamic Private Sector Sound Macro Policies Equity / Fairness
  44. 44. What else matters for growth? 3:10:25 PM Trust Trade Institutions Dynamic Private Sector Sound Macro Policies Equity / Fairness
  45. 45. What else matters for growth? 3:10:25 PM Trust Trade Institutions Dynamic Private Sector Sound Macro Policies Equity / Fairness
  46. 46. What else matters for growth? 3:10:25 PM Trust Trade Institutions Dynamic Private Sector Sound Macro Policies Equity / Fairness
  47. 47. What else matters for growth? 3:10:25 PM Trust Trade Institutions Dynamic Private Sector Sound Macro Policies Equity / Fairness
  48. 48. Upgrading an economy 3:10:25 PM Policies 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
  49. 49. Upgrading an economy 3:10:25 PM Policies 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
  50. 50. Threats to Growth 3:10:25 PM 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
  51. 51. Get help from fellow students, teachers and tutor2u on Twitter: #econ4 @tutor2u_econ 3:10:25 PM

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