14.06 Lecture N otesInterm ediate M acroeconom icsGeorge-Marios AngeletosMIT Depar tment of EconomicsSpring 2004Chapter 1IntroductionandGrowthFacts1.1 Introduction• In 2000, GDP per capita in the United States was $32500 (valued at 1995 $ prices).This high income lev e l reflects a high standa r d of living.• In contrast, standard of livin g is much lower in many other countries: $9000 in Mexico,$4000 in China, $2500 in India, and only $1000 in Nigeria (all figures adjusted forpurc hasing power parit y).• How can countries with low level of GDP per person catch up with the high levelsenjoyed by the United States or the G7?• Only by high growth rates sustained for long periods of time.• Small differences in growth rates over long periods of time can make huge differencesin final outcomes.1George-Marios Angeletos• US per-capita GDP grew by a factor ≈ 10 from 1870 to 2000: In 1995 prices, it w as$3300 in 1870 and $32500 in 2 000.1Average growth rate was ≈ 1.75%. If US had gro wnwith .75% (like India, Pakis tan , or the Philippines), its GD P w ou ld be only $8700 in1990 (i.e., ≈ 1/4 of the actual one, similar to Mexico, less than Portugal or Greece). IfUS had grown with 2.75% (like Japan or Taiwan), its GDP would be $112000 in 1990(i.e., 3.5 times the actual one).• At a growth rate of 1%, our c hildren will hav e ≈ 1.4 our income. A t a gro wth rate of3%, our child ren will ha ve ≈ 2.5 our income. Some East Asian countries grew by 6%ov er 1960-1990; this is a factor of ≈ 6 with in just one generation!!!• Once w e appreciate the importance of sustained gro wth, the question is natural: Whatcandotomakegrowthfaster?• Equivalently: Wha t are the factors that explain differences in economic gro wth, andho w can w e con trol these factors?• In order to prescribe policies that will promote grow th, we need to understand whatare the determinan ts of economic gro wth, as well as what are the effects of economicgro w th on social w elfare. That’s exactly where Gro w th Theory comes into picture...1Let y0be the GDP per capital at year 0,yTthe GDP per capita at year T, and x the a verage annualgrowth rate o ver that period. Then, yT=(1+x)Ty0. Taking logs, we compute ln yT− lny0= T ln(1 + x) ≈Tx, or equivalenty x ≈ (ln yT− ln y0)/T.2Lecture Notes1.2 Th e World Distribution of Incom e Levels and GrowthRates• As w e men tioned before, in 2000 there were many countries that had much lo werstandards of living than the United States. This fact reflects the high cross-countrydispersion in the lev el of income.• Figure 12shows the distribution of GDP per capita in 2000 across the 147 countries inthe Summers and Heston dataset. The richest country was Luxembourg, with $44000GDP per person. The United States came second, with $32500. The G7 and most ofthe OECD coun tries rank ed in the top 25 positions, together with Singapore, HongKong , Taiwan, and Cyprus. Most African coun tries, on the other hand, fell in thebottom 25 of the distribution. Tanzania w as the poorest coun try, with only $570 perperson — that is, less than 2% of the income in the United States or Luxem b ur g!• Figure 2 show s the distribution of GDP per capita in 1960 across the 113 coun triesfor which data are a vailable. The richest coun try then w a s Switzerland, with $15000;the United States w as again second, with $13000, and the poorest country was againTanzania, with $450.• The cross-country dispersion of income w as th u s as wide in 1960 as in 2000. Never-theless, there were some importan t mo vemen ts during this 40-y e ar period. A rgentina,Venezuela, Urugua y, Israel, and South Africa w ere in the top 25 in 1960, but none madeit to the top 25 in 2000. On the other hand, China, Indonesia, Nepal, Pakistan, India,and Bangladesh grew fast enough to escape the bottom 25 bet ween 1960 and 1970.2Figures 1, 2 and 3 are reproduced from Barro (2003).3George-Marios AngeletosThese large movements in the distribution of income reflects sustained differences intherateofeconomicgrowth.• Figure 3 sho ws the distribution of the gro w th rates the coun tries experienced bet ween1960 and 2000. Just as there is a great dispersion in income levels, there is a greatdispersion in gro w th rates. The mean growth rate was 1.8% per annum; that is, theworld on average was twice as rich in 2000 as in 1960. The United States did slightlybetter than the mean. The fastest grow ing country was Taiw an, with a ann ual rate ashigh as 6%, which accumulates to a facto r of 10 over the 40-year period. The slowestgro wing country w as Zambia, with an negative rate at −1.8%; Zambia’s residents showtheir income shrinking to half bet ween 1960 and 2000.• Most East Asian countries (Taiwan, Singapore, South Korea, Hong Kong, Thailand,China, and Ja pan), together w ith Bost wana (an outlier as compared to other sub-Saharan African countries), Cyprus, Romania, and Mauritus, had the most stellargro w th performances; they were the “ growth miracles” of our times. Som e OECDcoun tries (Ireland, Portugal, Spain, Greece, Luxemburg and Norw ay) also made itto the top 20 of the gro w th-rates c hart. On the other hand, 18 out of the bottom 20w ere sub-Saharan African countries. Other notable “growth disasters” were Venezuela,Chad and Iraq.1.3 Un conditional versus C onditional C onv e rgence• There a re important movem ents in the world incom e distrib u tion, reflectin g su b stantialdifferences in growth rates. Nonetheless, on a verage income and productivit y differ-ences are v ery persistent.4Lecture Notes• Figure 43graphs a coun try’s GDP per worker in 1988 (normalized b y the US level)against the same country’s GDP per w orker in 1960 (again norm alized by the US lev el).Most observations close to the 45o-line, meaning that most coun tries did not experi-enced a dramatic chan ge in their relativ e position in the w orld income distribu tion . Inother w ords, income differences across countries are very persistent.• This also means that poor countries on average do not grow faster than rich countries.And another w ay to state the same fact is that unconditional convergence is zero. Thatis, if we ran the regressio n∆ ln y2000−1960= α + β · ln y1960,the estimated coefficient β is zero.• On the other hand, consider the regression∆ ln y1960−90= α + β · ln y1960+ γ · X1960where X1960is a set of country-specific controls, such as levels of education, fiscal andmonetary