Chapter 18
Policies and
Prospects for
Global Economic
Growth
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Introduction
Some governments have sought to promote economic
growth by providing funds to help entrepreneurs open
new businesses.
Many observers, however, question whether
government officials are better able than private
investors to identify entrepreneurial ideas worthy of
funding.
This chapter will help you understand the basis of this
criticism.
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18-2
Learning Objectives
• Explain why population growth can have
uncertain effects on economic growth
• Understand why the existence of dead
capital retards investment and economic
growth in much of the developing world
• Describe how government inefficiencies
have contributed to the creation of
relatively large quantities of dead capital in
the world’s developing nations
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18-3
Learning Objectives (cont'd)
• Discuss the sources of international
investment funds for developing nations
and identify obstacles to international
investment in these nations
• Identify the key functions of the World
Bank and the International Monetary Fund
• Explain the basis for recent criticisms of
policymaking at the World Bank and the
International Monetary Fund
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18-4
Chapter Outline
• Labor Resources and Economic Growth
• Capital Goods and Economic Growth
• Private International Financial Flows as a
Source of Global Growth
• International Institutions and Policies for
Global Growth
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18-5
Did You Know That ...
• In Zimbabwe, the cost of registering business
property to meet the legal requirements for
operating a business is nearly 25 percent of the
value of that property, as compared to 0.5
percent for the United States?
• These figures help economists understand the
determinants of global economic growth—the
topic of this chapter.
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18-6
Labor Resources and Economic
Growth
• Population growth does not necessarily
translate into an increase in labor
resources
• In poor areas, many people do not join the
labor force, or they may remain
unemployed for long periods
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18-7
Labor Resources and Economic
Growth (cont'd)
• We can express the growth rate of per capita real
GDP in a nation as the difference between the
rate of growth in real GDP and the population
growth rate:
Ratio of growth of
per capita real GDP
rate of growth in
rate of growth of
=
–
real GDP
population
– Example: If real GDP grows at a rate of 4% per year and
population growth increases from 2 to 3%, then per
capita real GDP will decline, from 2% to 1%
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18-8
Labor Resources and Economic
Growth (cont'd)
• The arithmetic of the relationship between
economic growth and population growth
can be misleading
• Population growth can affect the growth
rate of real GDP (e.g., with higher labor
force participation rate)
• Whether population growth hinders or
contributes to economic growth depends
on where you live
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18-9
Table 18-1 Population Growth and Growth in Per
Capita Real GDP in Selected Nations Since 1970
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18-10
Labor Resources and Economic
Growth (cont'd)
• The role of economic freedom
– A crucial factor influencing economic growth is
the relative freedom of a nation’s residents
– Only 17 nations, with 17% of the world’s
people, grant their residents high degrees of
economic freedom
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18-11
International Policy Example: Freedom of
Information and Growth in Developing
Nations
• The Indian government requires farmers to sell
soybeans to middlemen who in turn resell the
beans in wholesale markets.
• The middlemen used to have an advantage in
price negotiations because they had up-to-theminute data about wholesale soybean prices.
• Today, farmers can obtain current wholesale
soybean prices through a wholesale buyer’s
network of Internet kiosks. This information has
enable farmers to bargain for better prices on
their corps.
• The resulting higher farmer profits have led to
increases in the supply and consumption of
soybean in India.
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18-12
Labor Resources and Economic
Growth (cont'd)
• Economic Freedom
– The rights to own private property and to
exchange goods, services, and financial assets
with minimal government interference
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18-13
Labor Resources and Economic
Growth (cont'd)
• The role of political freedom
– Political freedom: the right to openly support
and democratically select national leaders
– Economic freedom tends to stimulate economic
growth, which then leads to more political
freedom
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18-14
Labor Resources and Economic
Growth (cont'd)
• Question
– Why do you suppose that per capita real GDP
appears to be related to the extent to which
the rule of law prevails?
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18-15
Capital Goods and Economic Growth
• A fundamental problem developing
countries face is that a significant portion
of their capital goods, or manufactured
resources that may be used to produce
other items in the future, is what
economists call dead capital
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18-16
Capital Goods and Economic Growth
(cont'd)
• Dead Capital
– Any capital resource that lacks clear title of
ownership
– A resource that people cannot readily allocate
to its most efficient use
– Is among the most significant impediments to
growth in poor nations
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18-17
Capital Goods and Economic Growth
(cont'd)
• Dead capital and inefficient production
– Nontransferable physical structures are valued
at more than $9 trillion in developing nations
• Dead capital and economic growth
– Disincentives to invest in new capital goods can
greatly hinder economic growth
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18-18
Capital Goods and Economic Growth
(cont'd)
• Government inefficiencies, investment,
and growth
– Governments in many of the world’s poorest
nations place tremendous obstacles in the way
of entrepreneurs
– These entrepreneurs are interested in owning
capital goods and directing them to profitable
opportunities
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18-19
Capital Goods and Economic Growth
(cont'd)
• Government inefficiencies, investment,
and growth
– In a nation with a stifling government
bureaucracy regulating the uses of capital
goods, newly created capital will all too likely
become dead capital
– Thus, government inefficiency can be a major
barrier to economic growth
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18-20
Figure 18-1 Bureaucratic Inefficiency
and Economic Growth
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18-21
Capital Goods and Economic Growth
(cont’d)
• Access to credit matters
– 2006 Nobel Peace Prize winner Muhammad
Yunus of Bangladesh contends that access to
private credit is vital for promoting economic
growth in poverty-stricken countries
– Microlenders are banking institutions that
specialize in making very small loans to
entrepreneurs trying to lift themselves from
poverty
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18-22
Figure 18-2 The Ratio of Private Credit to
GDP in Selected Nations
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18-23
Private International Financial Flows as a
Source of Global Growth
• Question
– Given the large volume of inefficiently
employed capital goods in developing nations,
what can be done to promote greater global
growth?
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18-24
Private International Financial Flows as a
Source of Global Growth (cont'd)
• Answers
– One approach is to rely on private markets
– Another is to entrust the world’s governments
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18-25
Private International Financial Flows as a
Source of Global Growth (cont'd)
• Private investment in developing nations
– Each year since 1995, at least $150 billion in
private funds have flowed to developing
nations in the form of purchases of bonds or
stock
– Nearly all funds that flow into developing
countries due so to finance investment projects
in those nations
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18-26
Private International Financial Flows as a
Source of Global Growth (cont'd)
• Economists group international flows of
investment funds into three categories
1. Loans from banks and other sources
2. Portfolio investment
3. Foreign direct investment
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18-27
Private International Financial Flows as a
Source of Global Growth (cont'd)
• Portfolio Investment
– The purchase of less than 10% of the shares of
ownership in a company in another nation
• Foreign Direct Investment
– The acquisition of more than 10% of the shares
of ownership in a company in another nation
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18-28
Figure 18-3 Sources of International
Investment Funds
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18-29
Private International Financial Flows as a
Source of Global Growth (cont'd)
• Obstacles to international investment
– Markets for loans, bonds, and stocks in
developing countries susceptible to problems
relating to asymmetric information
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18-30
Private International Financial Flows as a
Source of Global Growth (cont'd)
• Asymmetric information as a barrier to
financing global growth
– Adverse selection problems arise
– Moral hazard problems also arise
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18-31
Private International Financial Flows as a
Source of Global Growth (cont'd)
• Question
– To what countries do most residents of
developing nations allocate the majority of
their own foreign direct investment?
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18-32
Why Not … direct more foreign aid to poor
nations to help them grow faster?
• Government officials have fewer incentives than
do private parties when they consider lending to
firms in developing nations.
• Government officials use “other people’s
money”—the funds of taxpayers.
• In contrast, private individuals and firms will earn
lower returns or even incur losses if they fail to do
their best to evaluate risks arising from
asymmetric information problems.
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18-33
Private International Financial Flows as a
Source of Global Growth (cont'd)
• International Financial Crisis
– The rapid withdrawal of foreign investments
and loans from a nation
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18-34
International Institutions and
Policies for Global Growth
• Since 1945, the world’s governments have
taken an active role in supplementing
private markets
• Two international institutions, the World
Bank and the International Monetary Fund,
have been at the center of governmentdirected efforts
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18-35
International Institutions and Policies for
Global Growth (cont'd)
• The World Bank
– A multinational agency that specializes in
making loans to about 100 developing nations
in an effort to promote their long-term
development and growth
– Loans are made to finance improved irrigation
systems, roads, and better hospitals
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18-36
Figure 18-4 Distribution of World Bank
Lending Since 1990
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18-37
International Example: How Cellphones Are
Fueling Economic Development
• In many developing nations, firms have trouble
communicating effectively with customers and
employees because postal and
telecommunications services are inefficient.
• World Bank economists have found that business
communications flourish once cellular networks
have been established.
• A recent World Bank study further found that
adding an extra 10 cellphones per 100 people in a
typical developing country raises the nation’s
average annual rate of economic growth by 0.8
percentage point.
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18-38
International Institutions and Policies for
Global Growth (cont'd)
• The International Monetary Fund
– A multinational organization that aims to
promote world economic growth through more
financial stability
– The IMF assists developing countries primarily
by making loans to their governments
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18-39
International Institutions and Policies for
Global Growth (cont'd)
• When a country joins the IMF, it deposits
funds into an account called a quota
subscription
– A nation’s account with the International
Monetary Fund, denominated in special drawing
rights
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18-40
International Institutions and Policies for
Global Growth (cont'd)
• These funds are measured in terms of an
international unit of accounting called
special drawing rights (SDRs)
• SDRs have a value based on a weighted
average of four key currencies
– The euro, the pound sterling, the yen, and the
dollar
– At present, one SDR is equal to just under
$1.50
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18-41
International Institutions and Policies for
Global Growth (cont'd)
• The World Bank’s Mission
– To make loans to developing nations that fund
projects incapable of attracting private
financing from investors at home or abroad
– The World Bank makes many loans to countries
that have no trouble attracting financing
– Some observers contend that a number of
countries that receive funds are inappropriate
recipients of development assistance (i.e.
China)
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18-42
International Institutions and Policies for
Global Growth (cont'd)
• Asymmetric information and the World
Bank and the IMF
– Conditions on loans exist to reduce adverse
selection and moral hazard problems but are
often imprecise
– Have the World Bank and the IMF contributed to
international financial crises?
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18-43
International Institutions and Policies for
Global Growth (cont'd)
• Rethinking long-term development
lending: a main theme of development
economics has been market reforms
– Markets work better when a developing nation
has more effective institutions
• Basic property rights
• Well-run legal systems
• Uncorrupt government agencies
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18-44
International Institutions and Policies for
Global Growth (cont'd)
• Alternative institutional structures for
limiting financial crises
– Many proposals for change diverge sharply
– Economists recommend improvements in
standards
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18-45
You Are There: Putting Meager Capital to Work
in India
• In India, streets are becoming more crowded with
street vendors who have lost their jobs during the
worldwide economic downturn.
• Consequently, market clearing prices in the street
market are declining fast, while police officers are
soliciting higher bribes in exchange for not
enforcing the laws limiting street selling.
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18-46
Issues & Applications: Supporting Private
Entrepreneurs with Public Funds
• Some governments try to promote
entrepreneurship by providing public support to
the entrepreneurs that their officials conclude are
most likely to succeed.
• Their efforts, however, rarely succeed in
promoting economic growth due to asymmetric
information problems—the adverse selection
problem in identifying entrepreneurs most likely
to succeed; and the moral hazard problem with
entrepreneurs receiving the funds.
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18-47
Summary Discussion of Learning
Objectives
• Effects of population growth and personal
freedoms on economic growth
– Increased population growth has contradictory
effects on economic growth
– There is evidence of a positive relationship
between economic freedom and growth
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18-48
Summary Discussion of Learning
Objectives (cont'd)
• Why dead capital deters investment and
slows economic growth
– Few people in less developed countries
establish legal ownership of capital
– Unofficially owned resources are known as
dead capital
– In many developing nations, there is a
disincentive to accumulate capital, which limits
growth prospects
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18-49
Summary Discussion of Learning
Objectives (cont'd)
• Government inefficiencies and dead capital
in developing nations
– A negative relation between government
inefficiency and economic growth
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18-50
Summary Discussion of Learning
Objectives (cont'd)
• Sources of international investment funds
and obstacles to investing in developing
nations
– Sources include bank loans, portfolio
investment, and foreign direct investment
– Obstacles include problems relating to
asymmetric information such as adverse
selection and moral hazard
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18-51
Summary Discussion of Learning
Objectives (cont'd)
• The functions of the World Bank and the
International Monetary Fund
– The World Bank’s function is to finance capital
investment
– A fundamental duty of the IMF is to stabilize
international financial flows
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18-52
Summary Discussion of Learning
Objectives (cont'd)
• The basis for recent criticisms of the World
Bank and IMF policymaking
– The World Bank has extended credit to
companies and governments that could have
obtained private funds
– The World Bank and IMF have failed to
effectively deal with adverse selection and
moral hazard, suggesting more stringent
conditions on credit access are needed
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18-53