View Chapter 19 Study Notes for the Updated Edition - Pearson

Chapter 19 Policies and Prospects for Global Economic Growth

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Introduction Since the mid-2000s, the volume of microlending—loans in amounts ranging from $100 to around $1,500—has increased substantially Most of the internationally funded microlending has been provided by banks, mutual funds, and hedge funds in the United States and Europe How does these funds contribute to the economic growth of developing nations? Reading this chapter will help you answer these questions

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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 19-3 Copyright © 2011 Pearson Education, Inc. All rights reserved.

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 19-4 Copyright © 2011 Pearson Education, Inc. All rights reserved.

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


Did You Know That... • The World Bank recently reported that 1.4 billion people around the globe live in extreme poverty? • More than 33 percent of those living on less than $1 per day reside in Sub-Saharan Africa • Another 40 percent live in China and India • Evaluating the activities of the World Bank is one topic of this chapter 19-6 Copyright © 2011 Pearson Education, Inc. All rights reserved.

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


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 real GDP

-

rate of growth of 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% 19-8 Copyright © 2011 Pearson Education, Inc. All rights reserved.

Labor Resources and Economic Growth (cont'd) • Population growth can contribute to economic growth • Whether population growth hinders or contributes to economic growth depends on where you live


Table 19-1 Population Growth and Growth in Per Capita Real GDP in Selected Nations Since 1970


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


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


International Example: Savings Freedom Disappears in Argentina • During the global financial crisis in the late 2000s, Argentina’s government seized more than $24 billion in pension funds from private firms and transferred those funds to Anses, Argentina’s social security agency • Argentina’s president claimed that private pension firms were mismanaging pension savings and generating substantial losses, and the move was aimed at protecting savers from losses caused by the global financial turmoil


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


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?


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


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


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


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


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


Figure 19-1 Bureaucratic Inefficiency and Economic Growth


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


Figure 19-2 The Ratio of Private Credit to GDP in Selected Nations


International Example: Sophisticated Finance on Less Than $2 per Day • A group of economists found that even people who get by on less than $2 per day engage in relatively sophisticated financial arrangements: – In India, a woman operated a type of microinsurance operation, in which she pooled the meager savings of several individuals and families – In a relatively isolated South African village, some women operated cooperative microlending businesses by pooling together their savings and authorizing an elected oversight board to extend loans to those among them


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?


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


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


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


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


Figure 19-3 Sources of International Investment Funds


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


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


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?


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


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


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


Figure 19-4 Distribution of World Bank Lending Since 1990


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


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


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


International Example: The IMF Gets an Emergency Cash Infusion—But Why? • Governments of many the world’s wealthiest countries recently provided emergency support to the IMF even though they were in the midst of a financial crisis • Why? Those wealthy nations recognized that their own residents were trying to replenishing their own depleted stocks of liquid assets by cashing in on investments in developing countries • Thus, many developing nations that were already experiencing their own financial crises had prepared to apply for financial assistance from the IMF


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) 19-42 Copyright © 2011 Pearson Education, Inc. All rights reserved.

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?


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


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


International Institutions and Policies for Global Growth (cont'd) • Question – Is it time to replace the World Bank and the IMF?


Issues and Applications: Is Microlending Headed for a Crash? • Some economists have become concerned that commercial microlenders may be extending too many loans • They point, for instance, to the substantial increase in microlending in India- See Figure 19-5


Figure 19-5 Growth of Microlending in India


Issues and Applications: Is Microlending Headed for a Crash? (cont’d) • The risk of default on microloans is substantial because, like U.S. subprime borrowers, most recipients of microloans barely meet standard creditworthiness standards for loans • The “good news” is that even a global microlending meltdown would be a small reflection of the U.S. subprime meltdown, involving less than $20 billion, as compared with trillions of dollars of credit ultimately adversely affected by the U.S. financial crisis 19-49 Copyright © 2011 Pearson Education, Inc. All rights reserved.

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


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 19-51 Copyright © 2011 Pearson Education, Inc. All rights reserved.

Summary Discussion of Learning Objectives (cont'd) • Government inefficiencies and dead capital in developing nations – A negative relation between government inefficiency and economic growth


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


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


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


View Chapter 19 Study Notes for the Updated Edition - Pearson

View Chapter 19 Study Notes for the Updated Edition - Pearson

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