Think of an economy as reflecting three fundamental features: capital, labor and what I will call the “efficiency factor.” A country’s stock of capital consists of machinery, buildings, land, etc. Labor consists of the country’s human resources that are used in production. The efficiency factor determines how well the country turns capital and labor into output.
Now let’s jump to the bottom line: which of these three factors is most responsible for differences in GDP per person in countries around the world? The answer: it’s the efficiency factor.
by Scott A. Wolla
"Open markets offer the only realistic hope of pulling
billions of people in developing countries out of abject poverty, while
sustaining prosperity in the industrialized world."1
—Kofi Annan, former United Nations Secretary-General
Many people mark the birth of economics as the publication
of Adam Smith's The Wealth of Nations in 1776. Actually, this classic's full
title is An Inquiry into the Nature and Causes of the Wealth of Nations, and
Smith does indeed attempt to explain why some nations achieve wealth and others
fail to do so. Yet, in the 241 years since the book's publication, the gap
between rich countries and poor countries has grown even larger. Economists are
still refining their answer to the original question: Why are some countries
rich and others poor, and what can be done about it?
"Rich" and "Poor"
In common language, the terms "rich" and
"poor" are often used in a relative sense: A "poor" person
has less income, wealth, goods, or services than a "rich" person.
When considering nations, economists often use gross domestic product (GDP) per
capita as an indicator of average economic well-being within a country. GDP is
the total market value, expressed in dollars, of all final goods and services
produced in an economy in a given year. In a sense, a country's GDP is like its
yearly income. So, dividing a particular country's GDP by its population is an
estimate of how much income, on average, the economy produces per person (per
capita) per year. In other words, GDP per capita is a measure of a nation's
standard of living. For example, in 2016, GDP per capita was $57,467 in the
United States, $42,158 in Canada, $27,539 in South Korea, $8,123 in China,
$1,513 in Ghana, and $455 in Liberia (Figure 1).2
NOTE: Liberia's GDP per capita of $455 is included but not
visible due to the scale. The Republic of Korea is the official name of South
Korea.
SOURCE: World Bank, retrieved from FRED®, Federal Reserve
Bank of St. Louis; https://fred.stlouisfed.org/graph/?g=eMGq, accessed July 26,
2017.
Because GDP per capita is simply GDP divided by the
population, it is a measure of income as if it were divided equally among the
population. In reality, there can be large differences in the incomes of people
within a country. So, even in a country with relatively low GDP, some people
will be better off than others. And, there are poor people in very wealthy
countries. In 2013 (the most recent year comprehensive data on global poverty
are available), 767 million people, or 10.7 percent of the world population,
were estimated to be living below the international poverty line of $1.90 per
person per day.3 Whether for people or nations, the key to escaping poverty
lies in rising levels of income. For nations specifically, which measure wealth
in terms of GDP, escaping poverty requires increasing the amount of output (per
person) that their economy produces. In short, economic growth enables
countries to escape poverty.
How Do Economies Grow?
Economic growth is a sustained rise over time in a nation's
production of goods and services. How can a country increase its production?
Well, an economy's production is a function of its inputs, or factors of
production (natural resources, labor resources, and capital resources), and the
productivity of those factors (specifically the productivity of labor and
capital resources), which is called total factor productivity (TFP). Consider a
shoe factory. Total shoe production is a function of the inputs (raw materials
such as leather, labor supplied by workers, and capital resources, which are
the tools and equipment in the factory), but it also depends on how skilled the
workers are and how useful the equipment is. Now, imagine two factories with
the same number of workers. In the first factory, workers with basic skills
move goods around with push carts, assemble goods with hand tools, and work at
benches. In the second factory, highly trained workers use motorized forklifts
to move pallets of goods and power tools to assemble goods that move along a
conveyer belt. Because the second factory has higher TFP, it will have higher
output, earn greater income, and provide higher wages for its workers.
Similarly, for a country, higher TFP will result in a higher rate of economic
growth. A higher rate of economic growth means more goods are produced per
person, which creates higher incomes and enables more people to escape poverty
at a faster rate. But, how can nations increase TFP to escape poverty? While
there are many factors to consider, two stand out.
Institutions
First, institutions matter. For an economist, institutions
are the "rules of the game" that create the incentives for people and
businesses. For example, when people are able to earn a profit from their work
or business, they have an incentive not only to produce but also to continually
improve their method of production. The "rules of the game" help
determine the economic incentive to produce. On the flip side, if people are
not monetarily rewarded for their work or business, or if the benefits of their
production are likely to be taken away or lost, the incentive to produce will
diminish. For this reason, many economists suggest that institutions such as
property rights, free and open markets, and the rule of law (see the boxed
insert) provide the best incentives and opportunities for individuals to
produce goods and services.
North and South Korea often serve as an example of the
importance of institutions. In a sense they are a natural experiment. These two
nations share a common history, culture, and ethnicity. In 1953 these nations
were formally divided and governed by very different governments. North Korea
is a dictatorial communist nation where property rights and free and open
markets are largely absent and the rule of law is repressed. In South Korea,
institutions provide strong incentives for innovation and productivity. The
results? North Korea is among the poorest nations in the world, while South
Korea is among the richest.4
NOTE: While the Republic of Korea (the official name of
South Korea), China, Ghana, and Liberia had similar standards of living in
1970, they have developed differently since then.
SOURCE: World Bank, retrieved from FRED®, Federal Reserve
Bank of St. Louis; https://fred.stlouisfed.org/graph/?g=eMGt, accessed July 26,
2017.
While this seems like a simple relationship—if government
provides strong property rights, free markets, and the rule of law, markets
will thrive and the economy will grow—research suggests that the
"institution story" alone does not provide a complete picture. In
some cases, government support is important to the development of a nation's
economy. Closer inspection shows that the economic transformation in South
Korea, which started in the 1960s, was under the dictatorial rule of Park
Chung-hee (who redirected the nation's economic focus on export-driven
industry), not under conditions of strong property rights, free markets, and
the rule of law (which came later).5 South Korea's move toward
industrialization was an important first step in its economic development (see
South Korea's growth in Figure 2). China is another example of an economy that
has grown dramatically. In a single generation it has been transformed from a
backward agrarian nation into a manufacturing powerhouse. China tried market reforms
during the Qing dynasty (whose modernization reforms started in 1860 and lasted
until its overthrow in 1911) and the Republic Era (1912-1949), but they were
not effective. China's economic transformation began in 1978 under Deng
Xiaoping, who imposed a government-led initiative to support industrialization
and the development of markets, both internally and for export of Chinese
goods.6 These early government-supported changes helped develop the markets
necessary for the current, dramatic increase in economic growth (see Figure 2).
Trade
Second, international trade is an important part of the
economic growth story for most countries. Think about two kids in the school
cafeteria trading a granola bar for a chocolate chip cookie. They are willing
to trade because it offers them both an opportunity to benefit. Nations trade
for the same reason. When poorer nations use trade to access capital goods
(such as advanced technology and equipment), they can increase their TFP,
resulting in a higher rate of economic growth.7 Also, trade provides a broader
market for a country to sell the goods and services it produces. Many nations,
however, have trade barriers that restrict their access to trade. Recent
research suggests that the removal of trade barriers could close the income gap
between rich and poor countries by 50 percent.8
Conclusion
Economic growth of less-developed economies is key to
closing the gap between rich and poor countries. Differences in the economic
growth rate of nations often come down to differences in inputs (factors of
production) and differences in TFP—the productivity of labor and capital
resources. Higher productivity promotes faster economic growth, and faster
growth allows a nation to escape poverty. Factors that can increase productivity
(and growth) include institutions that provide incentives for innovation and
production. In some cases, government can play an important part in the
development of a nation's economy. Finally, increasing access to international
trade can provide markets for the goods produced by less-developed countries
and also increase productivity by increasing the access to capital resources.
Notes
1 Globalist. "Kofi Annan on Global Futures."
February 6, 2011; https://www.theglobalist.com/kofi-annan-on-global-futures/.
2 Data from the World Bank retrieved from FRED®;
https://fred.stlouisfed.org/graph/?g=erxy, accessed July 26, 2017.
3 World Bank. "Poverty and Shared Prosperity 2016:
Taking on Equality." 2016, p. 4;
http://www.worldbank.org/en/publication/poverty-and-shared-prosperity.
4 Olson, Mancur. "Big Bills Left on the Sidewalk: Why
Some Nations are Rich, and Others Poor." Journal of Economic Perspectives,
Spring 1996, 10(2), pp. 3-24.
5 Wen, Yi and Wolla, Scott. "China's Rapid Economic
Rise: A New Application of an Old Recipe. Social Education." Social
Education, March/April 2017, 81(2), pp. 93-97.
6 Wen, Yi and Fortier, George E. "The Visible Hand: The
Role of Government in China's Long-Awaited Industrial Revolution." Federal
Reserve Bank of St. Louis Review, Third Quarter 2016, 98(3), pp. 189-226;
https://dx.doi.org/10.20955/r.2016.189-226.
7 Santacreu, Ana Maria. "Convergence in Productivity,
R&D Intensity, and Technology Adoption." Federal Reserve Bank of St.
Louis Economic Synopses, No. 11, 2017; https://doi.org/10.20955/es.2017.11.
8 Mutreja, Piyusha; Ravikumar, B. and Sposi, Michael J.
"Capital Goods Trade and Economic Development." Working Paper No.
2014-012, Federal Reserve Bank of St. Louis, 2014;
https://research.stlouisfed.org/wp/2014/2014-012.pdf.
© 2017, Federal Reserve Bank of St. Louis. The views
expressed are those of the author(s) and do not necessarily reflect official
positions of the Federal Reserve Bank of St. Louis or the Federal Reserve
System.
Glossary
Factors of production: The natural resources, human
resources, and capital resources that are available to make goods and services.
Also known as productive resources.
Capital resources: Goods that have been produced and are
used to produce other goods and services. They are used over and over again in
the production process. Also called capital goods and physical capital.
Standard of living: A measure of the goods and services
available to each person in a country; a measure of economic well- being. Also
known as per capita real GDP (gross domestic product).
Trade barrier: A government-imposed restriction on the
international trade of goods or services.
Thanks https://research.stlouisfed.org/publications/page1-econ/2017/09/01/why-are-some-countries-rich-and-others-poor/
No comments:
Post a Comment