Understanding Economic Growth: Session #1 Rich vs. Poor Countries Robert J. Gordon Northwestern University IMF, April 15, 2005

Understanding Economic Understanding Economic Growth: Session #1Growth: Session #1

Rich vs. Poor CountriesRich vs. Poor Countries

Robert J. GordonRobert J. Gordon

Northwestern UniversityNorthwestern University

IMF, April 15, 2005IMF, April 15, 2005

22

Outline of Session #1Outline of Session #1

Review of Basic Growth TheoryReview of Basic Growth Theory– SolowSolow– What Solow’s Theory Cannot ExplainWhat Solow’s Theory Cannot Explain

Adding Human CapitalAdding Human Capital– What Human Capital Cannot ExplainWhat Human Capital Cannot Explain

What is Added by the New Growth What is Added by the New Growth Theory?Theory?

Summary of Remaining PuzzlesSummary of Remaining Puzzles

33

Poor Countries: thePoor Countries: theFailure to ConvergeFailure to Converge

Why the Basic Theory Predicts Why the Basic Theory Predicts ConvergenceConvergence

Basic Facts on Lack of ConvergenceBasic Facts on Lack of Convergence Left-out Factors Left-out Factors

– Political Capital and the New Political Capital and the New Comparative EconomicsComparative Economics

– GeographyGeography– InfrastructureInfrastructure

The Expanded Production FunctionThe Expanded Production Function

44

How the Concepts RelateHow the Concepts Relateto the Empirical Workto the Empirical Work

Barro’s Cross-Country RegressionsBarro’s Cross-Country Regressions– Basic Findings, his and othersBasic Findings, his and others– Qualifications about MethodologyQualifications about Methodology

Easterly’s Barriers to GrowthEasterly’s Barriers to Growth– Relating Anecdotes to the Expanded Relating Anecdotes to the Expanded

Production FunctionProduction Function– Relating Easterly to the Cross-Country Relating Easterly to the Cross-Country

RegressionsRegressions

55

The Power of CompoundingThe Power of Compounding

The Rule of 70The Rule of 70– How Long for anything to double?How Long for anything to double?– Divide 70 by growth rate?Divide 70 by growth rate?

Why? (the log of 1 is 0; log of 2 is Why? (the log of 1 is 0; log of 2 is 0.693)0.693)

How long to double at 5.7%? 12.3How long to double at 5.7%? 12.3 How long to double at 1.4%? 50How long to double at 1.4%? 50 A far-fetched example? No, Korea vs. A far-fetched example? No, Korea vs.

PhilippinesPhilippines

Copyright © 2003 by Pearson Education, Inc. 2–6

What a Difference Four Decades Makes:South Korea vs. the Philippines

0

4000

8000

12000

16000

20000

24000

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

GD

P P

er C

apit

a ($

)

South Korea

Philippines

77

How far from this ExampleHow far from this Exampleto Solow Growth Theoryto Solow Growth Theory

Key Elements of Solow without Key Elements of Solow without Technical ChangeTechnical Change– Per-person Production Function Per-person Production Function

Y=F(K,N)Y=F(K,N)– Fixed Saving Rate, S/N = s(Y/N)Fixed Saving Rate, S/N = s(Y/N)– Investment Requirement I/N = (n+d)Investment Requirement I/N = (n+d)

(K/N)(K/N)– Equilibrium Condition s(Y/N) = (n+d)Equilibrium Condition s(Y/N) = (n+d)

(K/N)(K/N)


Figure 10-1 A Production Function Relating per Person Output to per Person Capital Input


Figure 10-2 Output, Saving, and Steady-State Investment per Person

Figure 10-3 Equilibrium of Saving and Investment in the Solow Growth Model


Figure 10-4 The Effect of a Higher Saving Rate on Capital and Income per Person

1212

Conclusions to This PointConclusions to This Point

The Model without Tech Change offers The Model without Tech Change offers no Route to Permanently Faster no Route to Permanently Faster GrowthGrowth

Temporarily Faster Growth Created byTemporarily Faster Growth Created by– Higher saving rate (s)Higher saving rate (s)– Slower population growth (n)Slower population growth (n)– Lower depreciation rate (d)Lower depreciation rate (d)

Does Technical Change hold the Key to Does Technical Change hold the Key to Growth?Growth?

1313

Neutral Technical ChangeNeutral Technical Change

Adds an Exogenous Multiplier of the Adds an Exogenous Multiplier of the production functionproduction function

Y/N = A f(K/N)Y/N = A f(K/N) Convert to growth rates, where Convert to growth rates, where

x = dLN(X)/dtx = dLN(X)/dt

y = a + bk + (1-b)ny = a + bk + (1-b)ny-n = a + b(k-n)y-n = a + b(k-n)

1414

What technical change adds to What technical change adds to the Solow growth modelthe Solow growth model

The growth rate The growth rate aa is exogenous and is exogenous and unexplainedunexplained

To increase the growth rate To increase the growth rate permanently, the growth rate permanently, the growth rate aa must must rise permanentlyrise permanently

No change in other conclusionsNo change in other conclusions– No permanent effect on growth of s, n, dNo permanent effect on growth of s, n, d

Technical change a free good, so Technical change a free good, so prediction of universal convergenceprediction of universal convergence


Figure 11-1 Saving, Investment, and Capital per Hour in Long-Run Equilibrium for a Poor Nation


Figure 11-2 Output per Hour of Rich and Poor Nations During the Period of Convergence


Figure 11-4 The Effect of a Low Saving Rate or High Rate of Population Growth on Output per Worker

1818

Conditional vs. UnconditionalConditional vs. UnconditionalConvergenceConvergence

Traditional Solow factors can explain Traditional Solow factors can explain convergence to a lower levelconvergence to a lower level

List of factors greatly expanded in List of factors greatly expanded in empirical work by Barro and othersempirical work by Barro and others

Barro’s concept of “target GDP” Barro’s concept of “target GDP” related to this diagramrelated to this diagram

Barro is too sanguine on conditional Barro is too sanguine on conditional convergence; hasn’t stopped many convergence; hasn’t stopped many countries from having little or no countries from having little or no growthgrowth

1919

This is the First Puzzle:This is the First Puzzle:Failure of Unconditional Failure of Unconditional

ConvergenceConvergence

As We’ll See, Many Poor Countries As We’ll See, Many Poor Countries Haven’t Converged at AllHaven’t Converged at All

No Evidence that Unsuccessful Poor No Evidence that Unsuccessful Poor Countries can be Classified by s, n, or dCountries can be Classified by s, n, or d

Technical change is a free good, so this Technical change is a free good, so this is an initial candidate for lack of realism, is an initial candidate for lack of realism, but what are the barriers to obtaining it?but what are the barriers to obtaining it?

2020

Second Puzzle that theSecond Puzzle that theSolow Theory Cannot ExplainSolow Theory Cannot Explain

Capital per Capita doesn’t vary Capital per Capita doesn’t vary enoughenough

Y/N = (K/N)Y/N = (K/N)bb

K/N = (Y/N)K/N = (Y/N)1/b1/b

Compare Poor and Rich (b = 0.25)Compare Poor and Rich (b = 0.25)

Y/NY/N 11 1010

K/NK/N 11 10,00010,000

2121

Third Puzzle Third Puzzle the Solow Theory can’t Explainthe Solow Theory can’t Explain Rate of Return on Capital Should be Rate of Return on Capital Should be

Much Higher in Poor CountriesMuch Higher in Poor Countries If Y/K is 10 times higher in rich than If Y/K is 10 times higher in rich than

poor country, then MPK in Rich poor country, then MPK in Rich Country should be just .00025 times Country should be just .00025 times MPK in Poor Country. Why doesn’t all MPK in Poor Country. Why doesn’t all K flow to poor countries?K flow to poor countries?

MPK = b(Y/N)MPK = b(Y/N)(b-1)/b(b-1)/b

MPK = 0.25(10)MPK = 0.25(10)-3.0-3.0

2222

Does Human Capital ProvideDoes Human Capital Providethe Missing Explanationthe Missing Explanation

Expand the Production FunctionExpand the Production FunctionY = A F(K,H,N)Y = A F(K,H,N)

Solving Puzzles 2 and 3 by Fixing the Solving Puzzles 2 and 3 by Fixing the Exponents Exponents

Y/N = (K/N)Y/N = (K/N)0.250.25(H/N)(H/N)0.650.65

Now the sum on capital is 0.9, not Now the sum on capital is 0.9, not 0.250.25

Is this enough?Is this enough?

2323

The Rio Grande PuzzleThe Rio Grande Puzzle

Guatemalan crosses the Rio GrandeGuatemalan crosses the Rio Grande Finds job for $10 per hour instead of Finds job for $10 per hour instead of

$1 per hour$1 per hour Yet there has been no change in Yet there has been no change in

human capitalhuman capital The answer to the Rio Grande Puzzle The answer to the Rio Grande Puzzle

is the same as the answer to the is the same as the answer to the overall puzzle of rich vs. pooroverall puzzle of rich vs. poor

2424

What Does New What Does New (“Endogenous”) Growth Theory (“Endogenous”) Growth Theory

Contribute?Contribute? First contribution to build models without Solow-First contribution to build models without Solow-

like diminishing returnslike diminishing returns– Continuing flow of ideas, spillovers among ideasContinuing flow of ideas, spillovers among ideas

Second contribution is to show why Technical Second contribution is to show why Technical Change is not a free good and doesn’t flow to Change is not a free good and doesn’t flow to poor countriespoor countries– Innovation Activity must be rewarded by patents and Innovation Activity must be rewarded by patents and

copyrightscopyrights– Complementarity of innovation, physical capital, human Complementarity of innovation, physical capital, human

capitalcapital– Explains why poor countries typically import technical Explains why poor countries typically import technical

change through foreign direct investment and why they change through foreign direct investment and why they send their smart youth to rich country graduate schoolssend their smart youth to rich country graduate schools

2525

Problems with New Growth Problems with New Growth TheoryTheory

We still can’t explain what’s wrong with the We still can’t explain what’s wrong with the non-converging poor countriesnon-converging poor countries– Can’t use modern technology without human Can’t use modern technology without human

capitalcapital– Low educational attainmentLow educational attainment– High fertilityHigh fertility– Can’t attract foreign direct investmentCan’t attract foreign direct investment

How to cut through the vicious circle?How to cut through the vicious circle? Barro emphasizes that empirical work builds Barro emphasizes that empirical work builds

on neoclassical (Solow) theory not new theoryon neoclassical (Solow) theory not new theory

2626

The “Failure of Convergence”The “Failure of Convergence”Diagram: the Inverted FluteDiagram: the Inverted Flute

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

0 20 40 60 80 100 120 140

Output per capita as % of US level

2727

Output per worker relative Growth rate of output per

to the United States worker, 1960-2000

Country 2000 1960 Actual Relative to US

Rich countries that converged

Austria 71 60 2.9 0.4

Italy 65 56 2.9 0.4

France 67 64 2.6 0.1

Rich countries that failed to

converge

New Zealand 57 94 1.2 -1.3

Venezuela 19 64 -0.5 -3.0

Argentina 33 60 1.0 -1.5

Poor countries that converged

Hong Kong 80 25 5.4 2.9

Japan 74 37 4.2 1.7

South Korea 48 12 5.9 3.4

Poor countries that fell back

Ghana 4 7 1.1 -1.4

Cameroon 6 14 0.5 -2.0

Mali 3 8 0.0 -2.5

Poor countries that made no

progress

Morocco 11 11 2.6 0.1

India 7 7 2.7 0.2

2828

How to Explain?How to Explain?

Example of Weak albeit Positive Example of Weak albeit Positive CorrelationsCorrelations– Share of Investment in GDP vs. Ratio of Ypc to U. Share of Investment in GDP vs. Ratio of Ypc to U.

S.S.– Educational Attainment in Years vs. Ratio of Ypc Educational Attainment in Years vs. Ratio of Ypc

to U. S. to U. S. Where does the Technology Come From?Where does the Technology Come From?

– Copy? Requires EducationCopy? Requires Education– Pay for Imported Machiner? Too PoorPay for Imported Machiner? Too Poor– Import via Foreign Investment?Import via Foreign Investment?

That’s the big questionThat’s the big question

2929

Figure 11-6Figure 11-6 Output per Worker Output per Worker Relative to the United States and Relative to the United States and

Educational Attainment Measured as Educational Attainment Measured as Years of SchoolingYears of Schooling

3030

Foreign Investment Opens Foreign Investment Opens the Door for Broader the Door for Broader

ExplanationsExplanations ““Political Capital”Political Capital” Legal System: Property Rights, Legal System: Property Rights,

Protection from ThievesProtection from Thieves Fair Tax SystemFair Tax System Opportunity for all, not just relatives Opportunity for all, not just relatives

of Corrupt Dictatorsof Corrupt Dictators

3131

The Cost of Permits and The Cost of Permits and “Diversion”“Diversion”

At one extreme, the United States, few At one extreme, the United States, few permits easily obtainedpermits easily obtained

At other extreme, one study estimated At other extreme, one study estimated cost of starting a small business in Peru at cost of starting a small business in Peru at 32 times the monthly wage32 times the monthly wage– On the convergence chart Peru 26=>14On the convergence chart Peru 26=>14

Chad Jones concept of diversion:Chad Jones concept of diversion:– Theft outside and inside; high taxes; protection Theft outside and inside; high taxes; protection

money (the road through Chad)money (the road through Chad) Predictability: Russia vs. oil companiesPredictability: Russia vs. oil companies

3232

What is the Cause of What is the Cause of Diversion?Diversion?

Government officials want to Government officials want to maximize own income, own powermaximize own income, own power

Government officials may not want Government officials may not want the “nuisance” of getting rid of the the “nuisance” of getting rid of the offendersoffenders

Acemoglu and Robinson:Acemoglu and Robinson:– ““Innovations reduce advantage of Innovations reduce advantage of

incumbency”incumbency”– ““Fearing replacement, political elites Fearing replacement, political elites

block change”block change”

3333

Barro’s Political HypothesisBarro’s Political Hypothesis

Some Democracy but not too muchSome Democracy but not too much Very poor countries often have Very poor countries often have

dictators, corruption, incentives for dictators, corruption, incentives for incumbents to block growthincumbents to block growth

Does growth feed democracy or Does growth feed democracy or democracy feed growth?democracy feed growth?

Barro hypothesis: too much Barro hypothesis: too much democracy in rich countries heightens democracy in rich countries heightens concern for redistribution, leads to concern for redistribution, leads to high taxeshigh taxes

3434

Geography: Why are the non-Geography: Why are the non-converging poor in the Tropics?converging poor in the Tropics? Sachs’ four hypothesesSachs’ four hypotheses

– #1. Technologies from temperate zone may #1. Technologies from temperate zone may not be applicable to tropical soils, diseasesnot be applicable to tropical soils, diseases

– #2. Economies of poor tropical regions too #2. Economies of poor tropical regions too poor to develop tropical-relevant techniquespoor to develop tropical-relevant techniques

– #3. Poor agricultural productivity delays the #3. Poor agricultural productivity delays the demographic transition experienced by rich demographic transition experienced by rich countriescountries

– #4. Lingering effect of colonialism, #4. Lingering effect of colonialism, neglecting human capital, focus on ag and neglecting human capital, focus on ag and miningmining

3535

Success and Failure Success and Failure in the Tropicsin the Tropics

Botswana:Botswana:– 7% real GDP growth in 2003 despite being a 7% real GDP growth in 2003 despite being a

tropical, landlocked country (mining)tropical, landlocked country (mining)– Minimal diversion – legacy of British legal Minimal diversion – legacy of British legal

system (compare with Zimbabwe)system (compare with Zimbabwe) Despite dominance of one political partyDespite dominance of one political party

– Biggest problem: pervasive AIDS, declining Biggest problem: pervasive AIDS, declining populationpopulation

Success in SE Asia. SIN and HK are Success in SE Asia. SIN and HK are islands, common thread of ethnic Chinese islands, common thread of ethnic Chinese entrepreneurs and encouragement of entrepreneurs and encouragement of foreign investmentforeign investment

3636

InfrastructureInfrastructure

Roads, ports, airports, telephones Roads, ports, airports, telephones that work, electricitythat work, electricity

Can be financed by government or Can be financed by government or private firms (France vs. Britain)private firms (France vs. Britain)

India vs. ChinaIndia vs. China– Private outsourcing firms often have Private outsourcing firms often have

own generatorsown generators– Primitive airports in IndiaPrimitive airports in India

3737

Summing Up: theSumming Up: theExpanded Production Function Expanded Production Function Traditional, with Human CapitalTraditional, with Human Capital

Y = A F(K,H,N)Y = A F(K,H,N) Expanded with Expanded with

– Political Capital (P)Political Capital (P)– Geography (G)Geography (G)– Infrastructure Capital (R)Infrastructure Capital (R)

Y = A(P,G,T) F(K,R,H,N)Y = A(P,G,T) F(K,R,H,N)

3838

Compare to Barro’s ListCompare to Barro’s List Higher initial schoolingHigher initial schooling Higher initial life expectancyHigher initial life expectancy Lower fertilityLower fertility Lower government consumptionLower government consumption Rule of law indexRule of law index Terms of trade Terms of trade Inflation RateInflation Rate

BUT HOW MANY OF THESE AREBUT HOW MANY OF THESE AREENDOGENOUS, CAUSED BY GROWTH ENDOGENOUS, CAUSED BY GROWTH

RATHER THAN CAUSING IT?RATHER THAN CAUSING IT?

3939

Understanding Economic Understanding Economic Growth:Growth:

Session #2, Europe vs. the U. Session #2, Europe vs. the U. S.S.

Session #2: Europe vs. the U. Session #2: Europe vs. the U. S.S.

4141

Understanding the Facts:Understanding the Facts:Y per capita vs. Y per hourY per capita vs. Y per hour

Standard of Living = Income per capitaStandard of Living = Income per capita– 1.3% growth, doubles every 53 years (Philippines)1.3% growth, doubles every 53 years (Philippines)– 5.6% growth, doubles every 12 years (Korea)5.6% growth, doubles every 12 years (Korea)

For very long-term growth or comparing rich For very long-term growth or comparing rich and poor nations, Income per capita and and poor nations, Income per capita and productivity are the same thingproductivity are the same thing

Not the same thing for short-term or Not the same thing for short-term or comparisons among rich nationscomparisons among rich nations

Y per capita vs. Y per hour is the crux of Y per capita vs. Y per hour is the crux of understanding the data on Europe vs. U. S. understanding the data on Europe vs. U. S.


How Productivity is Related to Output per Capita

Output (Q) Equal to the product of:– Productivity (Q/A)– Hours per Employee

(A/E)– Employment Rate (E/L),

that’s just (1 – U/L)– Labor-force Participation

Rate (L/N)– Working-age Population

(N)

N

L

L

E

E

A

A

Q

N

Q


How Could Europe be So Productive Yet So Poor

Output per Capita (Q/N)In Europe 75% of U. S.Productivity 95% of U. S.The Difference:

– Hours per Employee (A/E)

– Employment Rate (E/L) – Labor-force Participation

Rate (L/N)

N

L

L

E

E

A

A

Q

N

Q

4444

Europe vs. the U. S. Europe vs. the U. S. since 1870since 1870

The History: Europe falls back 1870-1950 The History: Europe falls back 1870-1950 and then catches upand then catches up

The catch-up in 1995 was almost complete The catch-up in 1995 was almost complete in productivity (Q/A)in productivity (Q/A)

The catch-up since 1970 has been The catch-up since 1970 has been incomplete in output per capita (Q/N)incomplete in output per capita (Q/N)

Why?Why?– The collapse of Europe’s A/NThe collapse of Europe’s A/N– Why? The Disagreement with BlanchardWhy? The Disagreement with Blanchard– Q/A: Europe is no longer catching up but Q/A: Europe is no longer catching up but

falling back. Why?falling back. Why?

4545

Part #1: Lots of Data Slides,Part #1: Lots of Data Slides,What are the Data Issues?What are the Data Issues?

Thanks to Peter Neary AER Dec 2004:Thanks to Peter Neary AER Dec 2004:– Geary vs. EKS vs. “QUAIDS”Geary vs. EKS vs. “QUAIDS”

Alternative methods of converting Ypc to Alternative methods of converting Ypc to international PPPinternational PPP– Maddison (1820-1950) uses Geary-KhamisMaddison (1820-1950) uses Geary-Khamis– OECD uses EKSOECD uses EKS– Groningen web site gives bothGroningen web site gives both

My calculations from Neary for EU-15My calculations from Neary for EU-15– 1980 Neary preferred QUAIDS = 741980 Neary preferred QUAIDS = 74– Average Groningen GK and EKS = 74Average Groningen GK and EKS = 74

4646

The Broad Sweep of 2 The Broad Sweep of 2 Centuries:Centuries:

Income per CapitaIncome per Capita

1000

10000

100000

1820 1830 1840 1850 1860 1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000

Europe - 15

United States

4747

Since 1960: Europe Fails Since 1960: Europe Fails to Converge and then Falls to Converge and then Falls

BehindBehind

1000

6000

11000

16000

21000

26000

31000

36000

1960 1965 1970 1975 1980 1985 1990 1995 2000

Europe - 15

United States

4848

Productivity since 1870:Productivity since 1870:Almost Catching Up is Not Almost Catching Up is Not

EnoughEnough

1

10

100

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

Europe - 15

United States

4949

Productivity:Productivity:A Closer Look at Post-1960A Closer Look at Post-1960

0

5

10

15

20

25

30

35

40

45

1960 1965 1970 1975 1980 1985 1990 1995 2000

Europe - 15

United States

5050

The Europe / US Ratios The Europe / US Ratios Are Much More DramaticAre Much More Dramatic

0

20

40

60

80

100

120

1820 1830 1840 1850 1860 1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000

Output per hourOutput per capita

5151

The Ratios Again:The Ratios Again:A Post-1960 Close-upA Post-1960 Close-up

40

50

60

70

80

90

100

110

1960 1965 1970 1975 1980 1985 1990 1995 2000

Output per hour

Output per capita

5252

Ratios of Ratios:Ratios of Ratios:The Real Clue to What is Going The Real Clue to What is Going

OnOn

60

70

80

90

100

110

120

130

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

Hours per employee

Employee to population ratio

Output per capita tooutput per hour ratio

5353

Ratios of Ratios: Ratios of Ratios: The Post-1960 Close-upThe Post-1960 Close-up

60

70

80

90

100

110

120

130

1960 1965 1970 1975 1980 1985 1990 1995 2000

Hours per employee

Employee to population ratio

Output per capita tooutput per hour ratio

5454

Hours per Employee Declined Hours per Employee Declined in Tandem until 1970, then in Tandem until 1970, then

divergeddiverged

0

500

1000

1500

2000

2500

3000

3500

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

Europe - 15

United States

5555

A Close-up of Hours per A Close-up of Hours per EmployeeEmployeeafter 1960after 1960

1400

1500

1600

1700

1800

1900

2000

2100

2200

1960 1965 1970 1975 1980 1985 1990 1995 2000

Europe - 15

United States

5656

What Blanchard Neglects:What Blanchard Neglects:Employment per CapitaEmployment per Capita

30%

35%

40%

45%

50%

55%

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

Europe - 15

United States

5757

Employment per Capita:Employment per Capita:The Postwar Close-upThe Postwar Close-up

30%

35%

40%

45%

50%

55%

1960 1965 1970 1975 1980 1985 1990 1995 2000

Europe - 15

United States

5858

An Outline of Issues for An Outline of Issues for DiscussionDiscussion

Contra Blanchard, Europe’s failure to Contra Blanchard, Europe’s failure to converge is not a matter of voluntary converge is not a matter of voluntary vacations!vacations!

Much more is low employment per capitaMuch more is low employment per capita Even lower hours are not entirely Even lower hours are not entirely

voluntaryvoluntary– ““If the French really wanted to work only 35 If the French really wanted to work only 35

hours, why do they need the hours police?”hours, why do they need the hours police?”– Short hours are a victory for parliamentary Short hours are a victory for parliamentary

politics, not for free choicepolitics, not for free choice

5959

What Matters is Ypc, What Matters is Ypc, not Productivitynot Productivity

Europeans have “bought” their high Europeans have “bought” their high productivity ratio with every productivity ratio with every conceivable way of making labor conceivable way of making labor expensiveexpensive– High marginal tax rates (payroll and High marginal tax rates (payroll and

income taxes)income taxes)– Firing restrictionsFiring restrictions– Early retirement (55! 58!) with pensions Early retirement (55! 58!) with pensions

paid for by working peoplepaid for by working people

6161

Europe’s Low E/N Matters as Europe’s Low E/N Matters as much as Low A/Emuch as Low A/E

High UnemploymentHigh Unemployment– High Youth UnemploymentHigh Youth Unemployment– High long-term UnemploymentHigh long-term Unemployment

Low Labor-force ParticipationLow Labor-force Participation– Of Youth (defer to Phelps on Italian 30-year-olds)Of Youth (defer to Phelps on Italian 30-year-olds)– Of ElderlyOf Elderly– Would you believe these French and Italian Would you believe these French and Italian

retirement ages?retirement ages? The OFCE seminar I organized on thisThe OFCE seminar I organized on this

– Casual, just raise taxesCasual, just raise taxes– Casual, just raise retirement ageCasual, just raise retirement age– No Bush #43 hysteriaNo Bush #43 hysteria

6262

Welfare Issues to be Postponed Welfare Issues to be Postponed for General Discussionfor General Discussion

GDP Exaggerates U. S. GDP per CapitaGDP Exaggerates U. S. GDP per Capita– Extreme climate, lots of air conditioning, low Extreme climate, lots of air conditioning, low

petrol prices, huge excess energy usepetrol prices, huge excess energy use– U. S. urban sprawl: energy use, congestionU. S. urban sprawl: energy use, congestion– Crime, 2 million in prisonCrime, 2 million in prison

Undeniable U. S. advantage, all those Undeniable U. S. advantage, all those square feetsquare feet– Inside the housingInside the housing– Outside the housing in the residential lot sizesOutside the housing in the residential lot sizes

U. S. Medical Care InefficiencyU. S. Medical Care Inefficiency– Raises Business Costs, like French taxesRaises Business Costs, like French taxes– Inefficiency, InsecurityInefficiency, Insecurity

6363

The History: The History: Reorganizing an Old StoryReorganizing an Old Story

Organized by time, pre-1913, 1913-50, Organized by time, pre-1913, 1913-50, 1950+1950+

Within time periods, political union vs. Within time periods, political union vs. other (USE device -- notice footnote 17)other (USE device -- notice footnote 17) – Political union vs. “newness”Political union vs. “newness”– The heavy role of government in creating The heavy role of government in creating

the late 19the late 19thth century U. S. growth miracle century U. S. growth miracle Within time periods, reversible or Within time periods, reversible or

nonreversible?nonreversible?

6464

Political Union: Political Union: Materials-intensive Materials-intensive

manufacturing manufacturing Wright, raw materials Wright, raw materials

– part of political union, not just natural endowment part of political union, not just natural endowment US has advantage in resources vs. individual nations, but US has advantage in resources vs. individual nations, but

not all of Europenot all of Europe No fear of Minnesota and Indiana going to warNo fear of Minnesota and Indiana going to war

– Wright: doesn't emphasize enough ag, transport, Wright: doesn't emphasize enough ag, transport, trade trade

Late 19Late 19thth Century: The Dynamo of Chicago Century: The Dynamo of Chicago– Fastest Growing City in the World: 1870-1929Fastest Growing City in the World: 1870-1929– James Cronon’s “Nature’s Metropolis”James Cronon’s “Nature’s Metropolis”– ““Devil and the White City”Devil and the White City”

6565

But it was not all Political But it was not all Political Union: Even a USE Would Union: Even a USE Would

Have LaggedHave Lagged Clear advantages of the New World (which U. Clear advantages of the New World (which U.

S. uniquely? Which others (C, AU, NZ, S. uniquely? Which others (C, AU, NZ, Argentina?)Argentina?) – AgriculturalAgricultural

Land intensity indirectly responsible for ascendancy of Land intensity indirectly responsible for ascendancy of American manufacturingAmerican manufacturing

– NewnessNewness Common language, self-selection of ambitious immigrants, Common language, self-selection of ambitious immigrants,

high motivation, labor mobilityhigh motivation, labor mobility

– American system of manufacturing (guns, watches, American system of manufacturing (guns, watches, British anquish at Crystal Palace 1851)British anquish at Crystal Palace 1851)

– PolicyPolicy Land for the railroadsLand for the railroads The Homestead Act!The Homestead Act!

6666

Post-1913: Exploiting the great Post-1913: Exploiting the great inventionsinventions

Vs. David-Wright on electricity in 1920s US mfgVs. David-Wright on electricity in 1920s US mfg– Much more emph needed on ICEMuch more emph needed on ICE– Much more emph needed on 1930-50, not just 1920sMuch more emph needed on 1930-50, not just 1920s

Huge US lead in exploiting both electricity and Huge US lead in exploiting both electricity and ICEICE – U. S. in 1929 had 80% of world motor vehicle U. S. in 1929 had 80% of world motor vehicle

productionproduction– U. S. in 1929 had 90% of world motor vehicle U. S. in 1929 had 90% of world motor vehicle

registrationsregistrations No mystery about the “Arsenal of Democracy”No mystery about the “Arsenal of Democracy”

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Post-1913: The Great Post-1913: The Great CompressionCompression

ImmigrationImmigration – Restrictive legislation in the 1920sRestrictive legislation in the 1920s– A respite for low-skilled workers (compare now)A respite for low-skilled workers (compare now)

Trade barriersTrade barriers– No importation of low-skilled labor via goods No importation of low-skilled labor via goods

(compare now via China) (compare now via China) New deal pro-union legislationNew deal pro-union legislation

– Pure rents for semi-skilled high-school drop-Pure rents for semi-skilled high-school drop-outsouts

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World War IIWorld War II!!The Victory of the ArsenalThe Victory of the Arsenal

The miracle occurred in an ad-hoc The miracle occurred in an ad-hoc system of government loose control system of government loose control over business improvisationover business improvisation

The basis was laid starting with The basis was laid starting with Henry Ford in 1914Henry Ford in 1914

Herbert Hoover did something goodHerbert Hoover did something good Role of the American system and the Role of the American system and the

engineerengineer References: Overy, WaltonReferences: Overy, Walton

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Post WWIIPost WWII

France: penetration of electricity and ICE: France: penetration of electricity and ICE: exactly 40 years laterexactly 40 years later– That wonderful Landes quoteThat wonderful Landes quote

Reversal of initial U. S. advantagesReversal of initial U. S. advantages– Raw materials Raw materials – Political union Political union – Newness depreciates Newness depreciates – Reversal of the Great compression Reversal of the Great compression

Did Europe do anything creative except catch up? Did Europe do anything creative except catch up? – Welfare stateWelfare state– Combining auto with public transportCombining auto with public transport

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The Great Paradox: Europe’s The Great Paradox: Europe’s catching up stops after 1995catching up stops after 1995

1973-95 Europe, starting 40 years late, 1973-95 Europe, starting 40 years late, continues to exploit great inventionscontinues to exploit great inventions– Copies U. S. interhighway system but retains Copies U. S. interhighway system but retains

railroads and builds TGV railroads and builds TGV The teetering U. S. has run into The teetering U. S. has run into

diminishing returnsdiminishing returns– Old inventions, electricity and ICE, fade awayOld inventions, electricity and ICE, fade away– The Solow “computer paradox”The Solow “computer paradox”

1995-2004. Europe's productivity growth 1995-2004. Europe's productivity growth doesn't revive, the great European funk. doesn't revive, the great European funk.

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Topic #3: The DiagnosisTopic #3: The DiagnosisBasic Paradox about ITBasic Paradox about IT

Both Europe and U. S. Rapidly Both Europe and U. S. Rapidly Adopted New Economy TechnologyAdopted New Economy Technology– Personal ComputersPersonal Computers– Web AccessWeb Access– Mobile PhonesMobile Phones

But Europe hasn’t taken offBut Europe hasn’t taken off Conclusion: Role of IT in U. S. revival Conclusion: Role of IT in U. S. revival

must have been exaggeratedmust have been exaggerated

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Output per Hour by Industry Group, EU and US, 1990-2003

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

12.0

1990-1995 1995-2001

US ICT Pro

EU ICT Pro

US ICT Using

EU ICT Using

US Non-ICT

EU Non-ICT

Finding the Culprit Industries

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Where is the Difference? Where is the Difference? The Van-Ark DecomposionThe Van-Ark Decomposion

Explaining the difference in Europe Explaining the difference in Europe vs. US productivity growth post-1995vs. US productivity growth post-1995– 55% retail trade55% retail trade– 24% wholesale trade24% wholesale trade– 20% securities20% securities– Rest of the economy: ZERORest of the economy: ZERO

U. S. negative in telecom, U. S. negative in telecom, backwardness of mobile phonesbackwardness of mobile phones

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U. S. Retail MiracleU. S. Retail Miracle

Not uniform, concentrated in “large Not uniform, concentrated in “large stores charging low prices with self-stores charging low prices with self-service format”service format”

ALLALL of productivity gains post-1990 of productivity gains post-1990 attributable to attributable to NEWNEW establishments establishments and closing of old establishmentsand closing of old establishments

Average pre-1990 establishment had Average pre-1990 establishment had zero zero productivity growthproductivity growth

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Europe in RetailingEurope in Retailing

Not uniform – Carrefour, IkeaNot uniform – Carrefour, Ikea U. S. “Big Boxes” (Wal-Mart, Home Depot, U. S. “Big Boxes” (Wal-Mart, Home Depot,

Best Buy, Target)Best Buy, Target) Europe: Europe:

– Land-use regulation, planning approvalLand-use regulation, planning approval– Shop-closing restrictions on hoursShop-closing restrictions on hours– Central-city congestion, protection of central-Central-city congestion, protection of central-

city shopping precinctscity shopping precincts– Prohibition on discounting by large new storesProhibition on discounting by large new stores– Related to Phelps’ corporatismRelated to Phelps’ corporatism

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Not enough emphasis on new Not enough emphasis on new vs. oldvs. old

It’s not just that land-use planning It’s not just that land-use planning prevents Wal-mart from setting up a prevents Wal-mart from setting up a new big box on every highway new big box on every highway interchange in Europeinterchange in Europe

It’s that the MIX of retailing in Europe It’s that the MIX of retailing in Europe is heavily composed of small, old-is heavily composed of small, old-fashioned firmsfashioned firms

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Education and Education and University ResearchUniversity Research

U. S. leadership in secondary education, U. S. leadership in secondary education, 1910-401910-40

U. S. leadership in college education, post U. S. leadership in college education, post WWIIWWII

U. S. research universities America’s leading U. S. research universities America’s leading export industry even in dismal 1972-95, still export industry even in dismal 1972-95, still the envy of the worldthe envy of the world– Competition between state and privateCompetition between state and private– U. S. peer reviewed grants to young professors, not U. S. peer reviewed grants to young professors, not

young studentsyoung students– Contrast with Europe tuition subsidiesContrast with Europe tuition subsidies

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Let’s not Forget:Let’s not Forget:Germany is being Strangled by Germany is being Strangled by

EuroEuro No more monetary policyNo more monetary policy If inflation soars in Portugal or Ireland, If inflation soars in Portugal or Ireland,

German workers are unemployedGerman workers are unemployed Fiscal policy is strangled by the 3% Fiscal policy is strangled by the 3%

deficit ruledeficit rule Germany is MUCH MORE threatened by Germany is MUCH MORE threatened by

Poland and Czech than U. S. by MexicoPoland and Czech than U. S. by Mexico Different immigration dynamicsDifferent immigration dynamics

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Conclusion (for now)Conclusion (for now)

Economic research has focused on Economic research has focused on particular European problemsparticular European problems– Land use vs. big boxesLand use vs. big boxes– Employment taxes and low empl per Employment taxes and low empl per

capitacapita Bigger issuesBigger issues

– Low fertility rate vs. retirement agesLow fertility rate vs. retirement ages– Stark contrast: Czech/Poland vs. MexicoStark contrast: Czech/Poland vs. Mexico– Stark contrast: U. S. can absorb Stark contrast: U. S. can absorb

immigrants and Europe cannotimmigrants and Europe cannot

Documents

Understanding Economic Growth: Session #1 Rich vs. Poor Countries Robert J. Gordon Northwestern University IMF, April 15, 2005