A Quick and Dirty Look at Growth &

Development

Timothy M. Devinney

Timothy Devinney Page 1

 Who is Being Described?

The rates of economic growth .... are impressive. National income is planned to
be 160 percent of that [five years ago], an increase of 10.5 percent a year. Although these
figures are slightly lower than claimed in prior forecasts, they are three times those claimed
for the United States. Similarly, it is expected that in five years wages will be 130 percent
of their current level.
It should be roughly a decade and a half before the productivity of ______
surpasses that of the United States. If in the future the populace should begin to exercise
control over the proportion of national income devoted to consumption as compared to
investment this might reduce future rates of economic growth

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 Who is Being Described?

The significant break with the past was the fact that the [population growth] rate
accelerated to 7%. In addition to the striking increase in exports (an eight-fold
increase in thirty years) much of the growth in income could be attributed to
increases in agricultural output. ..... There were two reasons associated why the
upsurge in overseas trade took place. Firstly, there was the growth in the diversity
of new industries. Secondly, there was the growing development of a world-wide
trading system leading to trade increasing much more quickly the growth in any one
country.

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 Who is Being Described?

How did they do it? .....Economic growth depends on two factors: increases
in the supply of productive resources [inputs] and improvements in
techniques of production or technology [efficiency]. In terms of labour
inputs, labour employed in the economy grew at an annual rate twice the
population growth rate. To the increase in the number of workers we must
add an improvement in the quality of the work force that resulted from the
government's large expenditures on schools and universities. ..... When we
look at the growth of capital stock, we find what is the single most distinctive
element of the processes by which the country has attained its growth. Over
the last 38 years, the capital stock rose at an extraordinary rate, increasing by
6.5 percent per year. 37 years ago the level of capital investment was 8
percent of GDP. Today the figure is on the order of 31 percent of total
output.

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 Approaches to Economic Growth

• Solow’s Growth Theory

 Krugman’s Input Theory
 Endogenous Growth Theory
• Porter’s ‘Diamond’ Theory
• Neo-Institutional Theory

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 Solow Growth Theory

Determinants of Growth:
 Productivity (Output per man)
 Productivity (Output per unit of capital)
 Stock of Capital
 Flow of Labour

Q = F(K, L)

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 A Case on Growth: Singapore
(Source: Krugman, Foreign Affairs, 1994)

◆ 1966 - 1990 GDP growth averaged 8.5% per annum

◆ Per capita income growth averaged 6.6% per annum (three times the rate in
the US)
◆ How was this achieved?
– Employment: The employed share of the population rose from 27% to 51%
– Education: In 1966 > 50% of the population had no formal education
In 1990 66% of the population had 12 years of schooling
– Investment: In 1966 investment as a percent of GDP was 11%
In 1990 investment as a percentage of GDP was 40%
◆ Is this sustainable?

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 A Case on Growth: Singapore
(Source: Krugman, Foreign Affairs, 1994)

◆ Is this sustainable?
– Employment: Employment share doubled. It can't double again and as the
population ages and becomes wealthier it should actually decline
– Education: Everyone in Singapore can't go on to get a doctorate
– Investment: 40% is an astonishing number and 70% would be absurd. We would
also expect as wealth rises that more of output is used for consumption.

◆ Is the Singapore example relevant for the rest of Asia?

– Yes. Other countries have similar patterns (e.g., Malaysia)
– No. Singapore as a city-state has unique characteristics that make it easier to
develop

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 Stages of Development Based on Factor Input
Development

Malaysia
Indonesia Hong Kong

Vietnam China India Singapore Korea Japan

Acquisition Adaptation Improvement

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 Porter’s Diamond

Chance Firm Strategy,

Structure and
Rivalry

Supply Conditions Demand Conditions

Related and Supporting

Industries
Government

Source: M. Porter, The Competitive Advantage of Nations, New York: Free Press, 1990.

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 A Sample of Countries Based on Porter's Four
Stages

Factor Investment Innovation Wealth

Burma Taiwan USA
Vietnam Korea Japan
China Singapore Germany
Russia Czech Rep
South Africa Sweden
India
Estonia
Australia

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 Growth in Output, Productivity, Employment
and the Level of R&D
Growth in Mfg Growth in Total Business
Output per Factor Growth in Mfg Expenditure on
Worker Productivity Employment R&D/GDP
Australia 2.9% 0.7% -0.80% 0.74%
Hong Kong 4.8% 2.5% 0.60% NA
India 3.3% 0.1% 1.20% 0.19%
Japan NA 1.2% 2.35% 1.87%
Korea 7.3% 1.4% 5.50% 1.74%
Malaysia NA 1.0% 0.04% 0.46%
Philippines 2.8% NA 1.50% 0.01%
Singapore 2.8% 0.1% 5.70% 0.75%
Taiwan 4.1% 1.5% 5.60% 1.03%
Thailand 4.9% 1.9% 5.10% 0.01%
Other Countries 3.2% 1.9% -0.59% 1.10%
Source: Young, European Economic Review, 1994; OECD

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 Explaining Economic Growth
Source of Growth Rank Percent of Variance
Explained

Investment 2 18%

Primary Education 1 46%

Secondary Education 3 6%

Population Growth 4 6%

Total 79%

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 The Neo-Institutional Theory

◆ Political and economic institutions are the fundamental

determinants of growth not factor endowments—for
example, after WWII both North and South Korea
possessed the same factor endowments
– These institutions define the opportunity set and incentive
structures at work in an economy. The most important of these
institutions are:
✦ private property
✦ rule of law
✦ freedom of exchange (free trade)
– Wealth creation versus rent seeking

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 Economic Freedom and Economic Growth
11.0%

9.0% Correlation = -0.55

7.0%
Economic Growth

5.0%

3.0%

1.0%

-1.0%

-3.0%

-5.0%

-7.0%
0 0.5 1 1.5 2 2.5 3 3.5 4 4.5

Economic Freedom

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 Characterising Legal and Regulatory Institutions
Legal Environment
Invisible Hand Government not above the law
and uses its power to supply
minimal public goods. Courts
enforce contracts.
Helping Hand Government is above the law
but uses power to help
business. State officials
enforce contracts.
Grabbing Hand Government is above the law
and uses power to extract rents. Disorganised corruption.
The legal system does not
work. Mafia replaces the state
as enforcer.
Timothy Devinney
Regulatory Environment
Government follows the
rules. Regulation is minimal
and there is little corruption.
Government aggressively
regulates to promote
business. Organised
corruption.
Predatory regulations.
Source: Frye and Shliefer
Page 16
 Asian Hands

Invisible Hand Helping Hand Grabbing Hand Invisible Hand

Hong Kong Japan China Taiwan

Singapore Korea India
Malaysia Indonesia

New Zealand Philippines

Australia Thailand

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 Rules of Economic Growth

Output is driven by the quantity, quality and

distribution of inputs
Current growth says nothing about the
sustainability of growth in the long run
Exports are a limited means to growth
Economic growth requires economic freedom
Where’s there’s return, there’s risk

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 The Stability of Growth
Growth in 1975-84 & 1985-92

9.0%

7.0%

5.0%
Correlation=0.46
Growth in 1985-1992

3.0%

1.0%

-1.0%

-3.0%

-5.0%

-7.0%
-7.0% -5.0% -3.0% -1.0% 1.0% 3.0% 5.0% 7.0% 9.0% 11.0% 13.0%

Growth in 1975-1984

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 The Stability of Growth
Growth in 1960-65 & 1966-74

20.0%

15.0% Correlation=0.29

10.0%
Growth in 1966-1974

5.0%

0.0%

-5.0%

-10.0%
-10.0% -5.0% 0.0% 5.0% 10.0% 15.0%

Growth in 1960-1965

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 The Stability of Growth
Growth in 1965-74 & 1985-92

11.0%
9.0%
7.0%
Growth in 1985-1992

5.0%
3.0% Correlation=0.10
1.0%
-1.0%
-3.0%
-5.0%
-7.0%
-7.0% -2.0% 3.0% 8.0% 13.0% 18.0%

Growth in 1965-1974

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 Economic Openness and Growth

11.0%

9.0%

7.0%
Correlation=0.46
5.0%
GDP Growth

3.0%

1.0%

-1.0%

-3.0%

-5.0%

-7.0%
0.00 50.00 100.00 150.00 200.00 250.00 300.00 350.00

Openness (Exports + Imports)/GDP

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 Historic and Current Economic Openness

350.00

300.00 Correlation=0.85

250.00
Openness in 1985-1992

200.00

150.00

100.00

50.00

0.00
0.00 50.00 100.00 150.00 200.00 250.00 300.00

Openness in 1960-1965

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 Government Intervention and Growth

11%
9%
7%
5%
3%
Growth

1%
-1% Correlation = -0.23
-3%
-5%
-7%

20 40 60 80 100 120 140 160

Government Share of GDP

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 Risk & Return in Economic Growth
Actual 3-Yr
1994 Return on
Relative 3-yr Return on
Equity
Cost of Capital Equity
Investment
Investment
Phillipines 2.89 229% -14.80%
Malaysia 2.50 135% -24.60%
Singapore 2.44 90% -9.10%
Thailand 2.33 149% -22.40%
China 2.19 107% -22.30%
Asean Countries 2.00 142%
Japan 1.94 11% 13.50%
Taiwan 1.89 48% 10.20%
Hong Kong 1.86 88% -32.20%
All Emerging Markets 1.58 58%
All Far East 1.56 80%
USA 1.47 33% -3.22%
Europe 1.39 24%
Indonesia 1.14 35% -20.00%
South Korea 1.08 29% 16.80%
Australia/New Zealand 1.00 30% -12.00%
Source: Micropal, Bloomberg & Author

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 Risk & Return in Economic Growth

0.5
Log of Return (3-Year)

0.4

0.3

0.2

0.1

0.0
1.00 1.50 2.00 2.50 3.00
Cost of Capital (3-Year)

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 Economic and Social Indicators
New
Item Australia Zealand Malaysia India Source of Information

2 NR 3 5 Heritage Fnd*
ion 4 NR 2.5 5 Heritage Fnd*
rnment
3 NR 2 3 Heritage Fnd*
umption
tary Policy 2 NR 1 2 Heritage Fnd*
gn Investment 2 NR 2 3 Heritage Fnd*
ng 1 NR 3 4 Heritage Fnd*
s/Prices 2 NR 2 2 Heritage Fnd*
rty Rights 1 NR 2 3 Heritage Fnd*
ation 3 NR 2 4 Heritage Fnd*
ary System 10 10 9 8 BIC** (Mean = 7.33)
Tape 9.25 10 6 3.25 BIC** (Mean = 6.37)
ption 10 10 6 5.25 BIC** (Mean = 6.99)
cal Stability 8.5 8.5 8.42 7.0 BIC** (Mean = 7.61)
linguistic
32 37 72 89 ANM*** (Mean = 34.6)
onalisation
stic Economy 18 10 7 32 IMD**** (rank out of 45)
ce 15 16 19 30 IMD**** (rank out of 45)
tructure 6 7 22 43 IMD**** (rank out of 45)
gement 25 7 15 32 IMD**** (rank out of 45)
ce & Technology 42 22 29 33 IMD**** (rank out of 45)
e (Education, etc.) 31 13 34 44 IMD**** (rank out of 45)
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