In the Globalization Era, Which Are the Determinants of Growth?

Gentimir, Irina-Elena Article In the Globalization Era, Which Are the Determinants of Growth? CES Working Papers Provided in Cooperation with: Centre for European Studies, Alexandru Ioan Cuza University Suggested Citation: Gentimir, Irina-Elena (2015) : In the Globalization Era, Which Are the Determinants of Growth?, CES Working Papers, ISSN 2067-7693, Alexandru Ioan Cuza University of Iasi, Centre for European Studies, Iasi, Vol. 7, Iss. 1, pp. 60-79 This Version is available at: https://hdl.handle.net/10419/198362 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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Irina-Elena GENTIMIR * Abstract: This paper aims to present the factors that determine the economic growth nowadays, in the globalization era. From geography and climate to innovation and training, these factors diversified depending on the evolution of the economy and economic thought. Because of enhanced mobility as a result of globalization, some of them have lost their importance, others have become fundamental. During the last two decades, hundreds of empirical studies have tried to identify the determinant factors of economic growth. Many researchers have tried to explain economic growth based on changes in these factors, but the results leave room for future analysis. Keywords: Economic growth, factors, theory, economy, research, development JEL Classification: E20; O10, O30, O40 Introduction Nowadays, world economy is still being dominated by rich countries. If we sum up the whole value of the goods and services produced in 2012 in the rich countries and compare it to the value of the world production, we will notice that almost 70% of this value is created in the high-revenue states in the OCDE. Even if we would adjust the calculations in order to eliminate the price differences, so that the rice would have the same price both in the US and China, this percentage of the countries with high revenues maintained to more than 50% in 2012. This percentage is quite impressive, given that less than 15% of the world population lives in these countries. The production asymmetry towards Western Europe and the USA, and, more important, the persistence of this revenue distribution for more than 120 years, has determined the analysts to adopt the concepts of Core of developed economies and Periphery of the developing countries. This is about to change. The world economy passes through a unique historical change. We are about to reach the moment when, for the first time in 120 years, the Periphery would produce much more goods and services than the Core. The economic power transfer can be only compared to the discovery of the New World and with the subsequent growth of the United States as an economic power center. But, as Ben Bernanke, the president of the FED, stated, the inclusion of the USA in the Core has lasted for centuries, while the recent economic power change began in the ‘80s and just 30 years later, we already see a significant change of the world economic environment. * PhD Student, Doctoral School of Economics and Business Administration, ”Al.I.Cuza” University, Iasi, e-mail: [email protected] Irina-Elena GENTIMIR 61 Figure 1 - Global GDP composition by countries and groups Source: Fatas, A., Mihov, I., 2013, p.2 The Determinants of Economic Growth During the last two decades, hundreds of empirical studies have tried to identify the determinant factors of economic growth. Moreover, the theories of economic growth do not totally explain this phenomenon. The problem is that the growth theories are, using a concept belonging to Brock and Durlauf, (2001), insufficient. This means that various growth theories usually are compatible with each other. For example, a theoretical approach assuming that commercial openness counts for economic growth is not logically contradictory to another theoretical approach that emphasizes the role of geography for economic growth. This theoretical opinions diversity makes it hard to identify the most efficient growth stimulation policies. The process that lays at the basis of economic performance is inadequately conceptualized and less understood due to the lack of a generalized or unifying theory and the blind way traditional economy approaches the problem (Artelaris, Arvanitidis, Petrakos, 2007). Although this unifying theory is missing, there are more incomplete theories that discuss the role of different factors that determine economic growth. Two main theories can be distinguished: the neoclassical one, based on Solow’s growth model, has emphasized the importance of investments, and, more recent, the theory of endogenous growth, developed by Mankiw, Romer and Weil (1992) has pinpointed the innovation capacity and human capital. Moreover, other explications have emphasized the non-economic significant influence (the conventional meaning) the factors have on economic performance. These evolutions have led to an approach that distinguishes between the “close” and “fundamental” (or “final”) growth sources. The first one targets aspects such as capital accumulation, IN THE GLOBALIZATION ERA, WHICH ARE THE DETERMINANTS OF GROWTH? 62 work force and technology, while the last ones, target institutions, judicial and political systems, sociocultural factors, demography and geography. A wide range of studies have investigated the factors that lay at the basis of economic growth. By using various conceptual and methodological approaches, these studies have emphasized a different explanatory parameters set and have offered different perspectives on the economic growth sources. Table 1 - Stages of economic development Characteristics Stages of economic development Preindustrial, agricultural stage Industrial stage Postindustrial stage, based on knowledge Dominant economic sector Agriculture Industry Services The nature of prevalent technologies Labor and natural resources intensive technologies Capital intensive technologies Knowledge intensive technologies The main consumed products Food and handmade clothes Industrial goods Services and information The nature of the production processes Human-nature interaction Human-machine interaction Human-human interaction Determinants of growth/welfare Natural productivity (soil fertility, climate, biological resources) Labor productivity Innovation/intellectual productivity Source: World Bank (2004), Beyond Economic Growth - An Introduction to Sustainable Development, Second Edition, http://www.worldbank.org/depweb/english/beyond/global/chapter9.html Investments are fundamental for the economic growth, identified by the both growth theories, the neoclassic and the endogenous. However, within the neoclassical model, investments have an impact in a period of transition, while the endogenous growth model supports the permanent effect. The importance given to the investments by these theories has led to a high volume of empirical studies that examine the relation between investments and economic growth (for example, Kormendi, Meguire, 1985; De Long, Summers, 1991; Levine, Renelt, 1992; Mankiw, Romer, Weil, 1992; Auerbach, 1994; Barro, Sala-i-Martin, 1995; Sala-i-Martin, 1997a; Easterly, 1999; Bond et al, 2001; Podrecca, Carmeci, 2001). However, the results are not conclusive. Foreign direct investments (FDI) have played a crucial role in the internationalization of the economic activity and represent one of the main sources of technological transfer and economic growth. This major role is emphasized in several models of the endogenous growth theory. The empirical literature that examines the impact of FDI on economic growth has given more or less consistent findings, revealing a positive significant connection between the two ones (for example Hermes, Lensink, 2000; Lensink, Morrissey, 2006). Human capital is the main growth source in most endogenous growth models, as well as one of the key extensions of the neoclassical growth model. Knowing that the “human capital” concept Irina-Elena GENTIMIR 63 mainly refers to the accumulation by the workers of competences and know-how through education and training, most of the studies have evaluated the quality of human capital by using education-related variables (for example, the rates of school registration, Mathematics tests and scientific capacities, etc.). Numerous studies have given proofs that suggest that the educated population is a key determinant of economic growth (see Barro, 1991; Mankiw, Romer, Weil, 1992; Barro, Sala-i-Martin, 1995; Brunetti, Kisunko, Weder, 1998; Hanushek, Kimko, 2000). Though, there were other researchers that have doubted these findings, and, as a result, the importance of human capital as a determining factor of economic growth (for example, Levine, Renelt, 1992; Benhabib, Spiegel, 1994; Topel, 1999; Krueger, Lindahl, 2001; Pritchett, 2001). The simple idea behind the theory of factor accumulation is that greater inputs mean greater outputs. The capital is the oldest known determinant of economic growth: accumulation of capitals is translated as sustainable growth. But in the 1960s and 1970s, before the opening of the global economy, several emerging economies, especially India and China, next to Russia and the countries in Latin America, have shown that investments without openness, or investments without competition, lead to an immediate growth, but they have a negative long-term impact. In the mid of the 1990, the general belief was that the success of East Asia is due to factor accumulation (Young, 1995; Krugman, 1994). Recent studies show that this conclusion is incorrect: There were numerous capital investments in these countries, but it is more important that the commercial openness and towards investments and more than competitive exchange rates have supported productivity growth. Another production factor (and the second growth principle of Lewis) is the human capital – knowledge and education. The theory of the important role of education has been developed just in the 1950s; empirical studies have been carried out just in the 1960s. Now, it is shown that the personal benefit of education is high, frequently very high. But nobody has claimed that education is not necessary for economic growth and development. In the middle of the 1980s, a special attention had been given to social revenues from education, especially from Romer (1986). Though its various production models have emphasized the fact that education generates positive results within the economy, at a lower scale it is difficult to determine which the effects are. Despite these antitheses – there are moments when too much capital does not mean additional growth and when education does not have significant effects – a key aspect of the empirical analysis on growth is the establishment of the determinants of the accumulation of human and capital factors. What does attract investments and determines the enrichments of countries? Could the reallocation of work from traditional agriculture to the modern industry be one of the factors? IN THE GLOBALIZATION ERA, WHICH ARE THE DETERMINANTS OF GROWTH? 64 Agriculture has always been the starting point of economic growth, both for the western countries on the brink of the industrial revolution, and for the emerging economies of the 20th century. Lewis (1955) stated that the transition of one economy from agriculture to non-agriculture is a sine qua non condition of economic transformation and growth. Figure 2 - Reallocation of labour during economic development Source: World Bank (2004), Beyond Economic Growth - An Introduction to Sustainable Development, Second Edition, http://www.worldbank.org/depweb/english/beyond/global/beg-en.html Cheap and unlimited resources are available in most of the countries right before the beginning of economic growth. In this moment, the ecosystem is balanced; the growth of productivity in agriculture is low, with individuals working in farms. The technological progress, in its interior or the exterior of agriculture, liberates the work. If this progress happens outside the economy, emigration determines the reduction of work in agriculture. In exchange, internal technological progress from the industry makes the work force leave the farm. In both cases, growth is accompanied by a decrease of the agriculture in the GDP economy. The whole literature concludes that, in the incipient development stages, any additional growth in the economy is due to the reallocation of work from the agricultural sectors with low productivity towards non-agricultural sectors (industry and services) with high productivity. Barely in the last development stages, the accumulation of factors and technological changes started to contribute to a greater growth. This reallocation of factors was estimated by Robinson (1976) to reach 16-18% in the first stages of the emerging economies. The theory of reallocation presents numerous implications for the evolution of economic growth and, thus, of the living standards. This reallocation of work force generates an S-shaped flow of revenues growth (and a revenue flow). In the beginning, the workforce in the low-productivity Irina-Elena GENTIMIR 65 agricultural sector (agriculture presents a yearly growth rate of 3%) gradually migrates towards highproductivity sectors (industry and services, with a yearly growth of 6%). Initially, agriculture represented 60% of the output. Meanwhile, productivity growth and factors’ movement determines the reduction of the percentage to barely 20% or less. At this level, the reallocation of the workforce ensures a reduced growth, and, while the decrease towards the lower curve of S is steep, it flattens at the base. This is the S-evolution of the revenues’ level. Within the reallocation theory, growth is modeled as a moderate average of the growth rates in industry and agriculture, the modelling being given by the percentage of each sector in the economy. Figure 3 - Growth in India according to the theory of labour reallocation Source: ***, (a.n.), Determinants of growth, Peterson Institute for International Economics, p.20 The figure above displays a simulation for India. In the first year, 1960, it is assumed that 55% of the real production came from agriculture, and the yearly growths of agriculture and non-agricultural sectors are 2.75% and 6% (these values are close to the ones found in the Indian economy in that period). These differential growth rates predict the evolution of agriculture and the whole GDP growth. In 2011, the percentage of agriculture was 17% and the GDP increased by 5.5%. Nowadays, these percentages are 16% and 8%. These applications of the reallocation theory show that India would have reached a GDP growth rate of 5% in 1983, with or without economic reforms. Innovation and research-development activities can have an important role in the economic progress by increasing the productivity. This is due to the increase of technology use which allows the introduction of new and superior processes and products. This role has been emphasized by various IN THE GLOBALIZATION ERA, WHICH ARE THE DETERMINANTS OF GROWTH? 66 endogenous growth models, and the strong relation between innovation/R&D and economic growth was empirically confirmed by more studies (see Fagerberg, 1987; Lichtenberg, 1992; Ulku, 2004). Economic policies and macroeconomic conditions have sparkled interest as determining factors of economic performances (see Kormendi, Meguire, 1985; Grier, Tullock, 1989; Barro, 1991; Barro, 1997; Fischer, 1993; Easterly, Rebelo, 1993; Barro, Sala-i-Martin, 1995) as they can establish the frame where economic growth happens. Economic policies can influence many aspects of one economy through human capital and infrastructure investments, by improving political and judicial institutions and so on (though there is a debate on the policies that are more appropriate for growth). The macroeconomic conditions are seen as necessary conditions, but not sufficient, for economic growth (Fischer, 1993). Generally, a stable macroeconomic environment can favor economic growth, especially by reducing uncertainty, while macroeconomic instability could have a negative impact on economic growth, through its effects on productivity and investments (such as a greater risk). More macroeconomic factors which influence growth have been identified in the literature, but there is a special focus on inflation, fiscal policies, budgetary deficits and fiscal burden. The analysis of the contribution of policy changes to growth is significant. It is generally accepted that the results of adopting negative policies, such as high inflation, are a major obstacle for growth. Another frequent recommendation in developed and emerging countries is the decrease of the financial deficit. Expected benefits vary, including a higher production efficiency, lower losses in the state owned enterprises and a lower eviction of private investments. The reduction of deficits is needed for the macroeconomic stability and sustainable growth. High financial deficits, financed through public credits, also determine an increase of the interest rate, creating an unfavorable environment for foreign investors. Commercial openness has been largely approached in the economic literature as a major determining factor of growth performances. There are solid theoretical reasons to claim that there is a strong and positive connection between openness and growth. Openness influences economic growth through more channels, such as exploiting the comparative advantages, technology transfer and knowledge spreading, scale economies and competition exposure. The openness usually is evaluated through the proportion of exports in the GDP. There is a significant and growing empirical literature which studies the relation between openness and growth. Most of the literature has noticed that the economies which are more open to trade and capital flows have a higher GDP/capita and have developed faster (Dollar, 1992; Sachs, Warner, 1995; Edwards, 1998; Dollar, Kraay, 2000). But, more researchers have criticized the lustiness of these findings, especially due to methodological and Irina-Elena GENTIMIR 67 evaluation reasons (for example, see Levine, Renelt, 1992; Rodriguez, Rodrik, 1999; Vamvakidis, 2002). As mentioned, trade has been long time considered a significant factor, if not the most significant, that supports growth: the comparative advantage offers security, and revenues maximization can be reached by improving trade. More emerging economies have adopted an autarchic, closed, soviet-like model after their independence, hoping for a rapid development. These countries have failed, having to open to foreign trade in order to recover from the disastrous situation caused by themselves. As many of them have grown faster than before, it has been concluded that “trade causes growth”. The opposition to this assertion, came from some researchers such as Rigobon and Rodrik (2004), assumes that as openness can ease trade and trade can ease growth, the revers can easily be accepted. As economy grows, the demand for different products grows, causing the evolution of trade (more imports, thus more exports to finance imports). Thus, econometric models claiming that they show an increase of growth caused by growing trade could in fact show the reverse. This problem can be econometrically solved by using identification techniques for the direction of the causality connection, by using instrument variables – variables that are correlated to one of the independent variables (trade) but not with the other (growth). The word “econometric” supposes an estimation of reality. Estimations are amenable to errors, and the existence of a possible error, no matter what its size is, allows both sides to claim victory. Protagonists claim that they have identified the problem, opponents say that the means are scarce. And the debate continues. Commercial policy can be evaluated through its effects – trade percentage in the GDP – or through the instruments that influence the trade. These instruments refer to indicators and tariffs’ policy, strongly supported by statistics. In many cases, though tariffs were reduced and import protection was lowered, growth did not speed up. In other cases, growth was reported, though tariffs were high. Yet, no study has emphasized the fact that high tariffs lead to rapid growth after the Second World War. The more external-oriented economies are, the richer they become – observation that is available no matter how deep we search in history. Though, the openness as an empirical concept has barely been studied in World Development Report from 1991, issued by World Bank. Starting from that year, numerous articles have been written and various indexes for the evaluation of economic openness have been developed. Approaching economic openness is also debated. Researchers and politicians are afraid that reducing import tariffs would allow foreign companies, with modern methods and low costs, to IN THE GLOBALIZATION ERA, WHICH ARE THE DETERMINANTS OF GROWTH? 74 Does the size of the middleclass have effects on growth? Yes, and it is emphasized by the analysis of the 1980-2011 period. Each 10% growth of the middleclass since 1980 determined a yearly growth of 0.3%. And panel data for o period of 5 years display the same effect. Conclusions Economic growth has been evaluated from simple to complex, depending on the evolution of society. From simple models, explained by geography, to econometrical models, that include a rising number of variables, researchers have tried to emphasize which are the factors that support economic growth, but also its effects on society and environment. Even though economic growth supposes the rise of living standards, some researchers contest its effects on the environment. Policymakers target a sustainable growth, which is to ensure high revenues for individuals, but they must also take into account the needs of future generations. Thus, resources used for the actual growth must be carefully managed so that the future generations would succeed in satisfying their own needs. A balance between growth and consumption must be maintained for the future society not to be affected. 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