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«Abstract Developing countries will face stronger headwinds in the decades ahead, both because the global economy is likely to be significantly less ...»

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The Past, Present, and Future of

Economic Growth

Dani Rodrik

Abstract

Developing countries will face stronger headwinds in the decades ahead, both because the global

economy is likely to be significantly less buoyant than in recent decades and because technological

changes are rendering manufacturing more capital and skill intensive. Desirable policies will continue to

share features that have served successful countries well in the past, but growth strategies will differ in

their emphasis. Ultimately, growth will depend primarily on what happens at home. The challenge is therefore to design an architecture that respects the domestic priorities of individual countries while ensuring that major cross-border spillovers and global public goods are addressed.

Keywords: Economic growth, cross-border spillovers, income distribution, China, income inequality, industrialization, global supply chains, natural resource exporters

WORKING PAPER 1

JUNE 2013 Global Citizen Foundation Phone: +41 (0) 225 18 0265 e-mail: info@gcf.ch The Past, Present, and Future of Economic Growth Dani Rodrik

1. Introduction The last decade has been an extraordinarily good one for developing countries and their mostly poor citizens—so good in fact that it has become commonplace to look upon them as potential saviors of the world economy. Their economies have expanded at unprecedented rates, resulting both in a large reduction in extreme poverty and a significant expansion of the middle class.

Recently, the differential between the growth rates of developing and advanced countries expanded to more than 5 percentage points, assisted in part by the decline in the economic performance of the rich countries (figure 1.1). China, India, and a small number of other Asian countries were responsible for the bulk of this superlative performance. But Latin America and Africa resumed growth as well, catching up with (and often surpassing) the growth rates they experienced during the 1950s and 1960s (figure 1.2).

Economic growth is a precondition for the improvement of living standards and lifetime possibilities for the “average” citizen of the developing world. Can this recent performance be sustained into the future, decisively reversing the “great divergence” that split the world into rich and poor countries since the 19th century?

In answering this question, optimists would point to improvements in governance and macroeconomic policy in developing countries and to the still not-fully exploited potential of economic globalization to foster new industries in the poor regions of the world by outsourcing Dani Rodrik is the Rafiq Hariri Professor of International Political Economy at the John F. Kennedy School of Government, Harvard University. He is grateful for comments and suggestion by all the participants in the Towards a Better Global Economy project, especially Jere Behrman, Kemal Derviş, and Chang-Tai Hsieh. This paper was prepared for the Towards a Better Global Economy Project funded by the Global Citizen Foundation. The author alone is responsible for its content. Comments or questions should be directed to dani_rodrik@harvard.edu.

and technology transfer. Pessimists would fret about the drag that rich countries exert on the world economy, threats to globalization, and obstacles that late industrializers have to surmount given competition from China and other established export champions.

Figure 1.1 Growth Trends in Developed and Developing Countries, 1950–2011 Source: Updated from Rodrik 2011b.

The weights one places on these considerations—and many others—depend on one’s views as to the ultimate drivers of economic growth in lagging countries. Extrapolation is not necessarily a good guide to where the world is headed.

We can also turn the question about the sustainability of growth around and pose it in a different form: what kind of changes in the institutional framework within countries and globally would most facilitate rapid growth and convergence? This is a normative, rather than positive, question about the needed policies. But answering it requires yet again a view on what drives growth. The more clearly articulated that view, the more transparent the policy implications.

This paper provides a longer-term perspective on economic growth in order to deepen the understanding of the key drivers of economic growth, as well as the constraints that act on it.

Figure 1.2 Developing Country Growth Trends, by Region, 1950–2011

Source: Updated from Rodrik 2011b.

It presents an analytical framework that is motivated by the empirical evidence and embeds the conventional approaches to economic growth. Although orthodox in many ways, the framework highlights a somewhat different strategic emphasis that provides a better account of the heterogeneity in growth performance around the developing world.

The paper emphasizes two key dynamics behind growth. The first is the development of fundamental capabilities in the form of human capital and institutions. Long-term growth ultimately depends on the accumulation of these capabilities—everything from education and health to improved regulatory frameworks and better governance (Acemoglu and Robinson 2012; Allen and others 2013; Behrman and Kohler 2013). But fundamental capabilities are multidimensional, have high set-up costs, and exhibit complementarities. Therefore, investments in them tend to yield paltry growth payoffs until a sufficiently broad range of capabilities has already been accumulated—that is, until relatively late in the development process. Growth based on the accumulation of fundamental capabilities is a slow, drawn-out affair.





The second is structural transformation—the birth and expansion of new (higher-productivity) industries and the transfer of labor from traditional or lower-productivity activities to modern ones. With the exception of natural-resource bonanzas, extraordinarily high growth rates are almost always the result of rapid structural transformation, industrialization in particular. Growth miracles are enabled by the fact that industrialization can take place in the presence of a low level of fundamental capabilities: poor economies can experience structural transformation even when skills are low and institutions weak. This process helps explains the rapid take-off of East Asian countries in the postwar period, from Taiwan in the late 1950s to China in the late 1970s.

The policies needed to accumulate fundamental capabilities and those required to foster structural change naturally overlap, but they are distinct. The first types of policies entail a much broader range of investments in skills, education, administrative capacity, and governance; the second can take the form of narrower, targeted remedies. Without some semblance of macroeconomic stability and property rights protection, new industries cannot emerge. But a country does not need to attain Sweden’s level of institutional quality in order to be able to compete with Swedish producers on world markets in many manufactures. Furthermore, as I discuss below, fostering new industries often requires second-best, unconventional policies that are in tension with fundamentals. When successful, heterodox policies work precisely because they compensate for weakness in those fundamentals.

As an economy develops, the dualism between modern and traditional sectors disappears and economic activities become more complex across the board. Correspondingly, these two drivers merge, along with the sets of policies that underpin them. Fundamentals become the dominant force over structural transformation. Put differently, if strong fundamentals do not eventually come into play, growth driven by structural transformation runs out of steam and falters.

This paper is organized as follows. The next section describes the consequences of recent growth performance on the global income distribution. The salient facts that emerge from the analysis are that growth in developing countries (especially China) has been a boon to the “average citizen” of the world and created a new global middle class. Section 3 examines economic history. It highlights the role of differential patterns of industrialization in shaping the great divergence in the world economy between a rich core and a poor periphery. Section 4 summarizes the growth record to date in the form of six empirical regularities (“stylized facts”).

Key among them is the presence of unconditional labor-productivity convergence in manufacturing industries. Section 5 interprets the policy experience of successful economies in light of this empirical background. Section 6 presents an explicit analytical framework that distinguishes distinction among three types of economic sectors: a traditional sector with stagnant technology; a modern service sector, where productivity depends on (slow-moving) fundamental capabilities; and an industrial sector that benefits in addition from an unconventional convergence dynamic. Section 7 uses the framework to present a 2 x 2 typology of growth outcomes based on the evolution of capabilities and the speed of structural transformation. The analysis yields four cases: no growth, slow growth, episodic growth, and rapid sustained growth. Section 8 formally defines the limits to industrialization. Section 9 examines the quantitative limits to industrialization. Extensions of the framework to global supply chains (section 9) and natural resource exporters (section 10) are followed by a prognosis (section 11) and discussion of policy implications (section 12).

–  –  –

Source: Author’s calculations, based on Milanovic 2011.

Note: n.a. = Not applicable.

The good news is that this ratio has fallen significantly since the 1980s, driven by the fact that median income rose much more rapidly than average income. In 1988, the world’s median income stood at $846 (in 2005 purchasing power parity–adjusted dollars). By 2005, this figure had risen to $1,209, an increase of 43 percent over the course of less than two decades. The increase in average world incomes over the same period was only 12 percent (from $3,523 to $3,946). Correspondingly, global inequality fell substantially, at least when measured by this indicator.2 This happened even though within-country inequality rose in most large economies, such as the United States and China (but not Brazil), as table 2.1 shows.

Global inequality rose by some measures, as table 2.2 shows.

Figure 2.1 shows the change in the global interpersonal distribution of income between 1988 and

2005.3 It shows a rightward-shift in the distribution, indicating a rise in average incomes. Much more noticeable is the change in the shape of the distribution. In 1988, the global distribution exhibited clear humps at each end, one for poor countries and another for rich countries (the latter with a much smaller mass). By 2005, the two humps had virtually disappeared, merging in the middle of the distribution. What happened in between those dates is that China, which housed a substantial proportion of the world’s poor in the 1980s, filled out the middle of the distribution. Since the 1980s, China has transformed itself from a poor country, in which the bulk of its population stood below the global median, into a middle-income country, in which median income has caught up with the global median (see table 2.1). Today, China’s income distribution is centered at the middle of the global income distribution. The result is that the global economy now has a much larger middle class, with Chinese households making up a large part of it.

Figure 2.1 Global Income Distribution, 1988 and 2005

Source: Author’s calculations, based on Milanovic 2011.

The distribution is generated by fitting a kernel smoothing on the ventile or decile data (depending on availability) for incomes within countries.

The impact that Chinese economic growth has had on the global distribution of income reflects an important feature of global inequality—the fact that the bulk of global inequality is accounted for by differences in average incomes across rather than within countries. The relevant numbers are shown in table 2.2, which decomposes global inequality into within- and between-country components. It shows three measures of inequality that are based on more information than the average-median ratio: the Gini coefficient, the log mean deviation, and the Theil index. Of these, only the last two are decomposable. Depending on the measure and time period, inequality across countries—that is, differences in per capita incomes between countries—accounts for 75– 80 percent of global income inequality; inequality within countries is responsible for a quarter or less of global inequality. For this reason, rapid growth in China has greatly expanded the world’s middle class, despite the fact that China’s income distribution has become markedly less equitable.

Table 2.2 Decomposition of Global Inequality, 1998 and 2005

–  –  –

Source: Author’s calculations, based on Milanovic 2011.

Note: n.a. = Not applicable.

A longer-term perspective can be obtained by combining these data with the historical evidence on global income distribution provided by Bourguignon and Morrisson (2002), which goes back to the early part of the 19th century. The within-country component of global inequality remained relatively stable over the long term. But the between-country component rose sharply, from 5 log-points in 1820 to 33 log-points in 1929 to 76 log-points in 2005 (figure 2.2). The share of global inequality that is accounted for by between-country inequality rose from 12 percent in 1820 to 73 percent in 2005. Thanks to differential patterns of economic growth in different parts of the world, it is increasingly the country in which one is born that determines one’s economic fortunes (Milanovic 2011).

Figure 2.2 Global Income Inequality, 1820–2005 Source: Author’s calculations, based on Milanovic 2011.



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