Economic Policy #09 Growth Policies Growth Policies •Measuring growth •Stylized fact about growth •Growth enhancing policies EP#09: Growth policies 2 Growth vs. stabilization policies •Stabilization policy seeks to mitigate short-term cyclical fluctuations whereas growth policies aim at raising potential level of production in the long run. •But, there are interrelations between long-term trends and short-term fluctuations because of: –precautionary behavior: excessive inflation is bad for long-term growth –unemployment hysteresis: skills of unemployed workers deteriorate and they become less employable even in boom –creative destruction: disputes about cleansing effect of recessions vs. depreciation of capital goods and firm-specific knowledge if the failing companies are not the least-effective ones EP#09: Growth policies 3 Measuring economic growth •GDP per person (per capita) corresponds to the average standard of living •Labor productivity reflects effectiveness of production system •HDI or GNP => measure of development •Comparability issues (prices, exchange rates ...) •GDP per person is not well-being –correction for: pollution, working time, life expectancy, precariousness, inequality, sustainability • • EP#09: Growth policies 4 GDP vs. HDI (2007) Source: Bénassy-Quéré et al. (2010) EP#09: Growth policies 5 Growth and happiness (2010) EP#09: Growth policies 6 Some stylized facts about growth •#1 Growth is a recent phenomenon by historical standards. • EP#09: Growth policies 7 Some stylized facts about growth •#2 GDP per person and productivity can experience significant synchronous and asynchronous inflections across countries at similar development levels EP#09: Growth policies 8 Some stylized facts about growth •#3 Some countries have caught up towards the richest countries, some have not and even further diverged. EP#09: Growth policies 9 Some stylized facts about growth •#4 No stable relationship between inequality and growth, but growth tends to increase inequality within rich countries. • •#5 Among advanced economies, technological change and growth may increase income inequalities. • • EP#09: Growth policies 10 Growth and income distribution: a two way relationship •Growth → inequality •Kuznets (1955): U-shaped relationship between development level and income inequality •Unequal access to finance, education • •Inequality → growth •Risk of political instability/deadlock •Demand for redistributive taxation (Alesina and Rodrik, 1994) •Trickle-down growth: “A rising tide lifts all boats” (J.F. Kennedy) • EP#09: Growth policies 11 Growth and income distribution •Fig. GDP per capita versus Gini coefficient • EP#09: Growth policies 12 Theoretical background EP#09: Growth policies 13 Theoretical background (cont.) •In the short run (a few months to a few years), potential output is exogenous; growth is dominated by cyclical fluctuations and by stabilization policies •In the medium run (a few years), governments can influence potential output through investment and labor supply •In the long run (many years), GDP and the labor/capital mix are determined by demography, technology, institutions and market structures • EP#09: Growth policies 14 Education •Public financing is justified by credit constraints and unequal access to knowledge It is difficult to assess private and social return to human capital –relative returns of primary vs secondary education depend on ‘distance to frontier’ – •Discrepancy between Europe and US in total expenditures on tertiary education. But money is not enough.. EP#09: Growth policies 15 R&D and innovation •Market imperfection: investments to R&D are constrained by the unavailability of funds •Social return on research spending generally exceeds its private return • •=> Public funding of fundamental research and university clusters •=> Incentives to private funding of applied research –Intellectual protection –Innovation-friendly competition regime •=> Channelling private savings towards R&D and innovative SME financing, e.g. through tax rebates • EP#09: Growth policies 16 Unequal R&D effort •R&D expenditures in 2007 in % of GDP –Japan: 3.4%; US: 2.7%; EU-27: 1.8% out of which France: 2.1%, highest = Sweden: 3.6%, lowest = Cyprus: 0.4% •Different dynamics: –US: new innovating SMEs –EU: firms already in place •In the US, innovating firm creation encouraged by: –risk capital and initial public offerings –lower entry cost –more favorable resolution law • EP#09: Growth policies 17 The role of competition and intellectual property •A difficult balance to strike: –Excessive competition / weak intellectual protection are bad –But firms in place should be challenged and patents can be used as deterrent to competition •Recent examples: –EC vs Microsoft –European Parliament discussion on software patentability –WTO ‘TRIPs’ agreement for antiretroviral drug production in low- income countries EP#09: Growth policies 18 Public infrastructures •Government intervention is needed, because: –many infrastructures are natural monopolies –infrastructures involve externalities –market cannot finance infrastructures by itself – –=> European networks program, public-private partnerships EP#09: Growth policies 19 Labor supply •How to increase labor supply? –Through family-oriented policies –Immigration –Welfare-to-work: •in-work benefits •pension reforms EP#09: Growth policies 20 Making markets work better (cont.) •Fig. Product market regulation and labor productivity acceleration in OECD countries EP#09: Growth policies 21 Developing financial markets •Often neglected in growth strategies •Channels on influence on long-term growth: –lower cost of capital –Higher savings –Better allocation of capital •Major issue in post crisis period: is there a trade-off between financial stability and growth? • EP#09: Growth policies 22 Countering distance and history •There is trade-off between geographical equity (e.g. EU structural funds) and economic efficiency (e.g. ’competitiveness clusters’) •Transport infrastructures may encourage agglomeration rather than dispersion => increasing inequality between regions •First best solution: agglomeration + lump-sum transfers to low-income regions EP#09: Growth policies 23 Growth and institutions •Institutions: “The humanly devised constraints that structure human interaction. They are made up of formal constraints (rules, laws, constitutions), informal constraints (norms of behavior, conventions, and self-imposed codes of conduct), and their enforcement characteristics.” •D. North and R. Fogel (1990) • EP#09: Growth policies 24 Improving institutions •General recommendations: • •create legal framework which is conducive to private initiative •put in place effective market regulation •achieve macroeconomic stability • •It is difficult to identify a set of specific recommendations because of different institutional set-ups. EP#09: Growth policies 25 Growth and institutions EP#09: Growth policies 26