Openness and Thorvaldur Gylfason Or why international trade is good for economic growth Growth

OpenneOpenness andss and

Thorvaldur Gylfason

Or why international trade is good for economic growth

GrowthGrowth

Growing ApartGrowing Apart

Different national economies have Different national economies have grown at grown at different ratesdifferent rates in the in the pastpast

Nations that started out in similar Nations that started out in similar circumstances a few decades circumstances a few decades ago can have vastly ago can have vastly different different standardsstandards of living today of living today

Reasons for differencesReasons for differencesDifferent economic Different economic systemssystemsDifferent economic Different economic policiespolicies

TimeTimeNati

on

al eco

nom

ic o

utp

ut

Nati

on

al eco

nom

ic o

utp

ut

Rapid growth

Slow growth

West-Germany : East-GermanyWest-Germany : East-GermanyAustria : Czech RepublicAustria : Czech RepublicFinland : EstoniaFinland : EstoniaTaiwan : ChinaTaiwan : ChinaSouth Korea : North KoreaSouth Korea : North Korea

Botswana : NigeriaBotswana : NigeriaKenya : TanzaniaKenya : TanzaniaThailand : BurmaThailand : BurmaTunisia : MoroccoTunisia : MoroccoSpain : ArgentinaSpain : ArgentinaMauritius : MadagascarMauritius : Madagascar

Economic system

Economic policy?

Growing Growing ApartApart

Botswana and Nigeria: GNP per capita 1964-2000

Case 1

Current US$,Atlas method

0

500

1000

1500

2000

2500

3000

3500

4000

1960

1964

1968

1972

1976

1980

1984

1988

1992

1996

2000

Botswana

Nigeria

Spain and Argentina: GNP per capita 1964-2000 Current US$,

Atlas method

Case 2

0

2000

4000

6000

8000

10000

12000

14000

16000

18000

1960

1964

1968

1972

1976

1980

1984

1988

1992

1996

2000

Argentina

Spain

Mauritius and Madagascar: GNP per capita 1964-2000

Current US$,Atlas method

Case 3

0

500

1000

1500

2000

2500

3000

3500

4000

4500

1960

1964

1968

1972

1976

1980

1984

1988

1992

1996

2000

Mauritius

Madagascar

Economic Systems and Policies

Economic systems and growthAs a rule, mixed market economy

grows more rapidly than centrally planned economy

Economic policies and growthPolicies that promote economic

efficiency are also good for growthLiberalization, stabilization,

privatizationEducation, diversification

Extensive and Intensive GrowthMain determinants of economic

growthSaving and high-quality investmentEconomic efficiency, including

technology

Extensive growth through accumulationSaving and investment

Intensive growth through better use of existing resourcesMore efficiency, better technologyEducation

Sources Sources of of growth: growth: Investment and Investment and educationeducation

In ves tm en t E d u ca tion

G row th

+ +

+denotes a positive effect in the direction shown

In ves tm en t E d u ca tion

G row th

+ +


Adam Smith knew this, and more, as did Arthur Lewis

Sources of Sources of growth: growth: Investment and Investment and educationeducation

Robert Solow Robert Solow raised doubts raised doubts on long-run on long-run linkageslinkages

Growth is Growth is

exogenousexogenous

More More sources sources of of growthgrowth

In ves tm en t x E d u ca tion

G row th+ +


+

Arthur Lewis: Arthur Lewis: xx is mainly trade, is mainly trade, stable politics, good weatherstable politics, good weather

Growth is Growth is

endogenouendogenou

ss

Sources of Endogenous Growth

100100

400400

300300

200200

19651965 19901990

East AsiaEast Asia

OECDOECD

AfricaAfrica

High saving rates

High saving rates

Medium saving rates

Low saving rates

IncomeIncomeper capitaper capita

Growth and Investment, 1965-98109

countrie

s

-6

-4

-2

0

2

4

6

8

10

0 10 20 30 40 50

Investment (% of GDP)

Gro

wth

pe

r c

ap

ita

(%

pe

r y

ea

r)

10%

1½%

BotswanaEach ten percentage point increase in the investment ratio is associated with an increase in per capita growth by 1½% per year.

Let’s Let’s be be more more specifispecificc

Growth and Investment, 1965-9885

countrie

s

-8

-6

-4

-2

0

2

4

6

0 5 10 15 20 25 30 35

Gross domestic investment 1965-1998 (% of GDP)

An

nu

al g

row

th o

f G

NP

pe

r ca

pit

a 19

65-9

8, a

dju

ste

d f

or

init

ial i

nco

me

(%

)

Nicaragua

Chad

Thailand

Jordan

Ireland

An increase in investment by 4% of GDP is associated with an increase in per capita growth by 1% per year.

r = 0.65

How How about about initial initial incomeincome??

Growth and Education, 1965-9886

countrie

s

-4

-2

0

2

4

6

8

10

0 20 40 60 80 100 120 140

Secondary-school enrolment 1980-97 (%)

Gro

wth

pe

r c

ap

ita

(%

pe

r y

ea

r)An increase in secondary-school enrolment by 40% of each cohort goes along with an increase in per capita growth by 1% per year.

Growth and Education, 1965-9887

countrie

s

-8

-6

-4

-2

0

2

4

6

0 20 40 60 80 100 120

Gross secondary-school enrolment 1980-97 (%)

An

nu

al g

row

th o

f G

NP

pe

r ca

pit

a 19

65-9

8, a

dju

ste

d

for

init

ial i

nco

me

(%

) Thailand Japan

Finland

JamaicaGhana

How How about about initial initial incomeincome??

Positive but diminishing returns to education

Efficiency is Key

Need economic policies that increase efficiencyProduce more output from given

inputs Takes fewer inputs to produce given

outputMore efficiency, better technology are

two ways of increasing output per unit of input

So is more and better education

Trade increases efficiency and thereby also economic growth

A Simple Model of Endogenous Growth

Four building blocks:Four building blocks:

S = IS = ISaving equals investment in equilibrium Saving equals investment in equilibrium

S = sYS = sYSaving is proportional to incomeSaving is proportional to income

I = I = K + K + KKInvestment means addition to capital stockInvestment means addition to capital stock

Y = EKY = EKOutput depends on Output depends on qualityquality and and quantityquantity of of

capital capital


Let´s do the arithmetic:Let´s do the arithmetic:

S = sY = I = S = sY = I = K + K + K K

= = Y/E + Y/E + Y/E Y/E

Rearranging terms we find Rearranging terms we find

Y/E = sY - Y/E = sY - Y/E Y/E

Multiplying by Multiplying by EE and dividing by and dividing by YY gives gives Y/Y = sE - Y/Y = sE -


Growth equation:Growth equation:

g = sE - g = sE -

Rate of economic growth equalsRate of economic growth equals Saving rateSaving rate

timestimes

EfficiencyEfficiencyminusminus

DepreciationDepreciation


This is This is good newsgood newsIf growth were merely a matter of technology, we If growth were merely a matter of technology, we

would not be able to do much about it …would not be able to do much about it …… … except to follow technology-friendly policies by except to follow technology-friendly policies by

supporting supporting R&DR&D and such and such

But if growth depends on saving and efficiency, But if growth depends on saving and efficiency, there are things that we there are things that we can docan do, in the private , in the private sector as well as through the public sector, to sector as well as through the public sector, to foster rapid economic growthfoster rapid economic growth

Because Because everything that is good for saving and everything that is good for saving and efficiency is also efficiency is also good for growthgood for growth


Five mainFive main sources of increased efficiencysources of increased efficiency1.1. LiberalizationLiberalization of prices and trade increases of prices and trade increases

efficiency, and thus is efficiency, and thus is good for growthgood for growth

2.2. StabilizationStabilization reduces the inefficiency associated with reduces the inefficiency associated with inflation, and thus is inflation, and thus is good for growthgood for growth

3.3. PrivatizationPrivatization reduces the inefficiency associated with reduces the inefficiency associated with state-owned enterprises, and thus …state-owned enterprises, and thus …

4.4. EducationEducation makes the labor force more efficient makes the labor force more efficient

5.5. Technological progressTechnological progress also enhances efficiency also enhances efficiency

The possibilities are virtually endless!The possibilities are virtually endless!

So What to Do to Encourage Economic GrowthMaintain strong incentives to Maintain strong incentives to savesave

Keep Keep inflationinflation low and low and real interest ratesreal interest rates positive positive

Maintain Maintain financial systemfinancial system in good health in good healthso as to channel saving into high-quality investmentso as to channel saving into high-quality investment

Place strong emphasis on Place strong emphasis on efficiencyefficiency1.1. Liberal price and trade regimes Liberal price and trade regimes

2.2. Low inflation Low inflation

3.3. Strong private sector Strong private sector

4.4. More and better education More and better education

5.5. Limited natural resources Limited natural resources

Liberalization and Economic Growth

Liberalization of pricesLiberalization of prices means that markets, means that markets, not bureaucrats, are allowed to set prices. not bureaucrats, are allowed to set prices. Mixed market economy is Mixed market economy is more efficientmore efficient than than

central planning.central planning. Compare former Soviet Union with the US and EuropeCompare former Soviet Union with the US and Europe

Liberalization of tradeLiberalization of trade allows specialization allows specialization according to comparative advantage.according to comparative advantage.Free trade is Free trade is more efficientmore efficient than self-sufficiency. than self-sufficiency.

Compare North Korea with Hong Kong and SingaporeCompare North Korea with Hong Kong and Singapore

More efficiency is More efficiency is good for growthgood for growth..

Market Equilibrium and Economic Welfare

SupplySupply

DemandDemand

EE

ProducerProducersurplussurplus

ConsumeConsumerrsurplussurplus

Quantity

Price

AA

BB

CC

Total Total welfare gainwelfare gain associated associatedwith market equilibrium equalswith market equilibrium equalsproducer surplus (= ABE) plusproducer surplus (= ABE) plusconsumer surplus (= BCE)consumer surplus (= BCE)

SupplySupply

DemandDemand

Price ceilingPrice ceiling

EE

FF

GG

Quantity

PriceWelfareWelfarelossloss

Price ceiling imposes aPrice ceiling imposes awelfare losswelfare loss equivalent to equivalent tothe triangle the triangle EFGEFG

AA

BB

CC

Consumer surplus = AFGHConsumer surplus = AFGH

HH

JJ

Market Intervention and Economic Welfare

Producer surplus = CGHProducer surplus = CGH

Total surplus = AFGC

Liberalization Increases Economic Efficiency

Modern outputModern output

Traditionaloutput

Traditionaloutput

DD

G

Domestic, distorted price ratio

Domestic, distorted price ratioE

C

HH

O



Traditionaloutput

Traditionaloutput

World price ratioWorld price ratio

DD

G



F

E

A B

C

Price distortionPrice distortion

HH

O

If output gain = If output gain = EE and and price distortion = price distortion = cc, , then then E = mcE = mc22 Output

gain

OC = modern outputCA = traditional outputOA = total output



Traditionaloutput

Traditionaloutput

World price ratioWorld price ratio

DD

G



F

E

A B

C


HHJJ

ImportsImports

ExportsExports

O

KK

Welfaregain

Welfaregain

Output gain



Traditionaloutput

Traditionaloutput

DD

G

F

E

A B

C


HHJJ

O

MN

Q

WelfaregainWelfaregain

Transition takes time: From E to F via M, N, and Q

How Trade Increases Efficiency

Autarky breeds inefficiencyTrade with other nations increases

efficiency by allowing1. Specialization through comparative

advantage2. Exploitation of economies of scale3. Promotion of free competition

Not only trade in goods and services, but also in capital and labor“Four freedoms”

How Trade Increases Efficiency

Trade also encourages international exchange of IdeasInformationKnow-howTechnology

Trade is educationWhich is also good for growth

Large and Small Countries

Small countries need trade to extend their markets beyond their national borders

Large countries need trade less than smallDomestic trade replaces foreign trade

Evidence from around the worldSmall countries have higher ratios of

exports to GDP than large countries

Selected Countries: Exports 1999-2000 (% of GDP)

0

10

20

30

40

50

60

70

80

90

UnitedStates

Japan Germany Belgium Ireland Estonia

Empirical EvidenceOpenness can be defined as export

ratio adjusted for country size (e.g., population)

Evidence shows that open economies tend to grow more rapidly than closed economiesTrade encourages growthGrowth encourages trade

Other measures of openness yield a similar conclusion

Openness and Growth 1965-98

-8

-6

-4

-2

0

2

4

6

-40 -30 -20 -10 0 10 20 30 40

Actual less predicted exports 1965-98 (% of GDP)

An

nu

al

gro

wth

of

GN

P p

er

cap

ita

196

5-98

, a

dju

ste

d f

or

init

ial

inco

me

(%

)

Malaysia

Belgium

Korea

Guinea Bissau

87

countrie

s

An increase in openness by 14% of GDP is associated with an increase in per capita growth by 1% per year.

Bottom LineBottom Line

Increased openness stimulates Increased openness stimulates economic efficiency and growth economic efficiency and growth ......... as long as the gains from trade ... as long as the gains from trade

are well distributedare well distributed

Continued globalization is thus by Continued globalization is thus by no means sure to succeedno means sure to succeed

Need to pay attention to Need to pay attention to distributiondistribution as well as growth as well as growth The EndThe End

Documents

Openness and Thorvaldur Gylfason Or why international trade is good for economic growth Growth