14.06 Lecture NotesIntermediate MacroeconomicsGeorge-M arios AngeletosMIT Department of Eco nomicsSpring 20041 Introduction and G rowth Facts1.1 Introduction• In 2000, GDP per capita in the United States w as $32500 (valued at 1995 $ prices).This high income leve l reflects a high standard of living.• In contrast, standard of living is much lower in many other coun tries: $9000 in Mexico,$4000 in Ch ina, $2500 in India, and only $1000 in Nigeria (all figures adjusted forpurc hasing power parity).• 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.• US per-capita GDP grew by a factor ≈ 10 from 1870 to 2000: In 1995 prices, it was$3300 in 1870 and $32500 in 2000.1Average grow th rat e was ≈ 1.75%. If US had grown1Let y0be the GDP per capital at y ear 0,yTthe GDP per capita at year T, and x the average annualgrowth rate over 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.1with .75% (like India, Pakistan, or the Philippines ), its GDP would 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% (lik e 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 children will ha ve ≈ 1.4 our income. At a growth rate of3%, our c h ild ren will have ≈ 2.5 our income. Some East Asian countries grew by 6%over 1960-1990; this is a factor of ≈ 6 within just one gener ation !!!• Once we appreciate the importance of sustained growth, the question is natural: Whatcandotomakegrowthfaster?• Equivalently: What are the factors that explain differences in economic grow th, andho w can we con trol these factors?• In order to prescribe policies that will promote grow th, w e need to understand whatare the determinants of economic growth, as w ell as what are the effects of economicgro w th on social welfare. That’s exactly where Gro w th Theory comes into picture...1.2 The World Distribution of Income Levels and Growth Rates• As w e mentioned before, in 2000 there were many count ries that had much lowerstandards of living than the United States. This fact reflects the high cross-coun trydispersion in the lev el of income.• Figure 12shows the distribution of GDP per capita in 2000 across the 147 coun tries inthe Summers and Heston dataset. The richest coun try was Lux embourg, with $44000GDP per person. The United States came second, with $32500. The G7 and most ofthe OECD coun tries ranked in the top 25 positions, to gether with Singapore, HongKong , Taiwan, and C yprus. Most African countries, on the other hand, fell in the2Figures 1, 2 and 3 are reproduced from Barro (2003).2bottom 25 of the distribution. Tanzania was the poorest coun try, with only $570 perperson — that is, less than 2% of the income in the United States or Luxem burg!• Figure 2 shows the distribution of GDP per capita in 1960 across the 113 countriesfor whic h data are a vailable. The richest country then was Switzerland, with $15000;the United States w as again second, with $13000, and the poorest coun try w as againTanzania, with $450.• The cross-coun try dispersion of income wa s thus as wide in 1960 as in 2000. Never-theless, there were some importan t mo vements during this 40-y ear period. Argentina,Venezuela, Uruguay, 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, P akistan, India,and Bangladesh grew fast enough to escape the bottom 25 bet ween 1960 and 1970.These large movements in the distribution of income reflects sustained differences intherateofeconomicgrowth.• Figure 3 shows the distribution of the grow th rates the countries experienced between1960 and 2000. Just as there is a great dispersion in income lev els, there is a greatdispersion in grow th rates. T he mean grow th rate was 1.8% per annum ; that is, theworld on average w a s t w ice as rich in 2000 as in 1960. The United States did slight lybetter than the mean. The fastest gro wing country w as Taiwan, with a annual rate ashigh as 6%, which accumulat es to a factor of 10 o ver the 40-year period. The slowestgro wing country was Zambia, with an negativ e rate at −1.8%; Zambia’s residents showtheir income shrinking to half between 1960 and 2000.• Most East Asian countr ies (Taiwan, Singapore, South Korea, Hong Kong, Thailand,China, and Japan), together with Bostwana (an outlier as compared to other sub-Saharan African countries), Cyprus, Romania, and Mauritus, had the most stellargro w th performances; they w ere the “gro wt h miracles” of our times. Some OECDcoun tries (Ireland, Portugal, Spain, Greece, Luxemburg and Norway) also made it3to the top 20 of the growth-rates chart. On the other hand, 18 out of the bottom 20w ere sub-Saharan African coun tries. Other notable “gro wth disasters” w ere Venezuela,Chad and Iraq.1.3 Unconditional v ersus Conditional Con vergence• There are im portant movements in the world incom e d istrib u tion, reflec tin g su bstantialdifferences in growth rates. Nonetheless, on a verage income and productivity differ-ences are very persistent .• Figure 43graphs a coun try’s GDP per w orker in 1988 (normalized by the US level)against the same country’s GDP per worker in 1960 (again normalized by the US level).Most observations close to the 45o-line, meaning that most countries did not experi-enced a dramatic ch an ge in their relative position in the w orld income distribution. Inother w ords, incom e differences across countries are very persistent.• This also means that poor countries on average do not grow faster than rich countries.And another way to state the same fact is that unconditional convergence is zero. Thatis, if we ran the reg res sio 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, suc h as levels of education, fiscal andmonetary policies, market competition, etc. Then, the estimated coefficient β turnsto be positiv e (in par