GDP and Economic Growth

Importance of GDP as a Measure of Economic Growth

• GDP facilitates comparisons of economic activity across time and countries.
• GDP has flaws, particularly when comparing income levels across different economies.

Challenges with Exchange Rate Conversions

• GDP is measured in local currency, making direct comparisons difficult.
• Market exchange rates convert GDP into a common currency (usually USD), but this can be misleading.
• Exchange rates can be distorted by government intervention or trade restrictions.

Limitations of Using Exchange Rates for GDP Comparisons

• Market exchange rates reflect prices of traded goods, not non-traded goods.
• Non-traded goods tend to be cheaper in developing countries and GDP is underestimated when using exchange rates.

Purchasing Power Parity (PPP) as an Alternative

• PPP adjusts for price level differences between countries.
• PPP assigns the same value to goods and services across countries for accurate income comparisons.
• Using exchange rates, India’s GDP may seem lower than the U.S., but PPP adjustments show India’s real income level is significantly higher.

International Comparison Program (ICP) and PPP Estimates

• The World Bank oversees the ICP, collecting price data from multiple countries to calculate PPP-adjusted GDP.
• Organizations like the IMF and UN widely use PPP estimates for economic analysis.

Real-World Impact of PPP Adjustments

• Low- and middle-income countries appear much poorer using exchange rate conversions.
• GDP per capita in India is about 12% of the U.S. level using exchange rates but rises to 40% when using PPP.
• Developing countries contribute more to world GDP under PPP calculations.

Historical Perspective on Economic Growth

• Economic historian Angus Maddison estimated nearly zero global per capita income growth from 1 BCE to 1000 CE.
• Between 1000 and 1820, world income grew only 0.05% per year.
• Modern economic growth rates, particularly in countries like China, have vastly outpaced historical averages.

The 2020 Human Development Report (HDR)

• Traditional measures of progress, like GDP, are insufficient.
• Emphasizes human development, focusing on people's freedom and opportunities to live meaningful lives.
• Human activity now shapes the planet, leading to crises like climate change, biodiversity loss, and ocean acidification.
• Environmental challenges interact with existing social and economic inequalities, worsening global development risks.
• The COVID-19 pandemic exposed vulnerabilities in social and political systems, demonstrating reinforcing crises.
• Deeper issues like climate change and inequality persist, forming a vicious cycle of planetary and societal imbalance.
• A shift in how we live, work, and cooperate must occur to continue human development while reducing environmental pressures.
• Embrace bold new solutions, or attempt to return to old ways, risking further instability and decline.

Measuring GDP: Market Transactions and GDP Measurement

• GDP is calculated by summing the value of goods and services produced and sold in a market.
• Non-market activities (e.g., unpaid labor) are excluded, leading to an underestimation of economic activity.
• Hiring someone to dig an irrigation ditch is included in GDP, but if a family member does it, it is not.

The Issue of Non-Market Activities

• A significant portion of labor is unpaid in low-income countries (e.g., family farms in Cambodia).
• Many agricultural activities, especially subsistence farming, do not enter the market.
• Estimates are sometimes included to adjust GDP for farm output consumed by producers.

Hidden Economic Contributions

• Some developing countries (e.g., Moldova, India) estimate and include household garden output.
• Traditional house construction uses local materials.
• Some illegal activities (e.g., opium production in Afghanistan) may also be included in GDP.

Overestimation of Economic Growth

• As economies develop, more transactions shift from the household to the market.
• This shift can make GDP appear to grow even when actual production remains constant.

Problems in Comparing GDP

• Countries produce different mixes of goods and services.
• GDP calculation relies on market prices, but prices may not be representative at the national level.
• Developing countries may lack accurate market data.

GDP Ignores Negative Externalities

• GDP measures goods/services but does not account for societal "bads" such as pollution.
• Steel production contributes to GDP but also pollutes rivers.
• Crime, congestion, and other social issues are ignored along with resource depletion.
• Deforestation and overfishing are not accounted for either.

Adjustments and Limitations

• Proposals exist to adjust GDP for these factors, but none are widely adopted.
• GDP remains essential for comparing economic activity across countries and over time despite its flaws.

Limitations of GDP as a Measure of Progress

• GDP focuses on economic output but ignores well-being, environmental sustainability, and income distribution.
• It does not differentiate between productive and harmful activities. Environmental destruction boosts GDP but harms future growth.
• GDP does not capture non-market activities that are crucial for societal well-being. Household work and caregiving are not included.

Need for a Broader Measure of Development

• A new framework should include social, environmental, and economic indicators to assess well-being more accurately.
• The book builds on the work of the Commission on the Measurement of Economic Performance and Social Progress, initiated by former French President Nicolas Sarkozy.

Challenges of Current Economic Indicators

• Inequality and sustainability are overlooked in GDP-focused policymaking.
• Economic crises, like the 2008 financial crash, exposed GDP failures as a predictor of economic health.

A Call for Action

• Governments should adopt new measurement systems that reflect human development, environmental impact, and economic stability.
• The book provides recommendations on how to move beyond GDP in shaping policies for a fairer and more sustainable world.

Purpose of the Report

• Commissioned in 2008 by French President Nicolas Sarkozy.
• Critiques the limitations of GDP as a measure of economic performance and social progress.
• Aims to identify the gaps in GDP measurement, explore alternative indicators, and improve statistical tools to assess well-being and sustainability.

Mismatch Between GDP and Well-Being

• GDP measures economic output but does not reflect inequality, environmental degradation, or quality of life.
• People often feel economic conditions are worse than official statistics suggest, leading to distrust in economic data.

Flawed Economic Assumptions

• GDP does not capture income distribution. A rise in average income may not reflect actual improvements for most people.
• Harmful activities can increase GDP but worsen well-being. Pollution and traffic congestion are examples.
• Market prices fail to account for externalities leading to distorted economic assessments.

Failure to Address Sustainability

• GDP does not measure natural resource depletion, climate change, or environmental risks.
• The 2008 financial crisis highlighted GDP’s inability to detect economic fragility and future risks.

Improve Economic Performance Metrics

• Adapt GDP calculations to better capture modern economies, including service industries, technology, and government output.
• Incorporate quality improvements in products and services to avoid underestimating economic well-being.

Shift Focus from Production to Well-Being

• Move beyond GDP and focus on people’s material well-being, health, education, political voice, and social connections.
• Well-being is multidimensional, and a single indicator cannot fully capture it.

Measure Income, Consumption, and Wealth More Accurately

• Track household income and consumption, not just GDP.
• Measure wealth, including physical, human, and social capital, to assess sustainability.

Include Income Distribution Data

• Provide median income to reflect typical household experiences.
• Track poverty and inequality metrics to understand economic disparities.

Account for Non-Market Activities

• Recognize household and unpaid labor.
• Adjust statistics to reflect leisure time and work-life balance.

Expand Quality of Life Metrics

• Collect objective and subjective well-being data, including life satisfaction, health conditions, and social trust.
• Integrate environmental quality and mental health into economic indicators.

Improve Sustainability Measures

• Use "dashboard" indicators for sustainability tracking natural resource depletion, climate change, and social resilience.
• Develop physical indicators for environmental risks, including CO₂ emissions and biodiversity loss.

The Regional Human Development Report 2021

• High inequality and low growth reinforce each other, limiting advancements in human development.
• Inequality in LAC extends beyond income disparities including unequal access to education, health services, and employment opportunities.
• Certain groups, such as women, indigenous populations, and Afro-descendants, face compounded disadvantages.
• The region has experienced volatile and generally low economic growth, attributed to factors like low productivity and market concentration.
• High levels of market power among a few large firms stifle competition and innovation.
• The COVID-19 pandemic exacerbated existing inequalities, disproportionately affecting vulnerable populations.
• Comprehensive policy approaches, including investments in education, health, inclusive economic policies, and strengthened social protection systems, should address inequality and low growth simultaneously.
• Market Concentration: much of the region's markets are dominated by a few large firms, leading to reduced competition and innovation.
• Labor Market Dynamics: High levels of informal employment prevail, with many workers lacking access to social protections and benefits.
• The pandemic disproportionately affected marginalized communities, intensifying existing disparities in health, education, and income.
• Vulnerable groups faced greater challenges in accessing healthcare and sustaining livelihoods during lockdowns.
• School closures and the shift to remote learning exposed and widened the digital divide for low-income households.
• Expanding coverage and improving the effectiveness of social safety nets can mitigate the impacts of economic shocks on vulnerable populations,

Development as Freedom

• True progress is achieved by expanding individual freedoms rather than solely focusing on economic growth.

Wealth as a Means to Freedom

• Wealth enables individuals to achieve substantive freedoms.
• The true value of economic growth lies in its capacity to enhance the quality of human life and expand personal freedoms.

Development Defined by Freedom

• Traditional metrics like Gross National Product (GNP) or income per capita are insufficient to capture the true essence of development.
• Development should be assessed by the expansion of freedoms people enjoy, such as political participation, education, and access to healthcare.
• Countries with lower per capita income but higher life expectancy challenge the notion that income alone determines well-being.

Interconnected Freedoms

• Various "unfreedoms" hinder development, including poverty, lack of economic opportunities, social deprivation, and political repression.
• Deprivations are interconnected.

Role of Individual Agency

• Expanding freedoms enhances the ability of people to shape their own destiny.
• Individuals are active participants in their own development.

Freedom as Both Means and End

• Freedom is the primary objective of development (the end) and the principal means of achieving it.
• Processes (such as democratic participation) and opportunities (like access to education) are both vital.

Instrumental Freedoms

• Political Freedoms: Rights enabling individuals to participate in political processes, including free speech, elections, and a free press.
• Economic Facilities: Opportunities to utilize economic resources for consumption, production, or exchange, encompassing access to credit and markets.
• Social Opportunities: societal arrangements that support education and healthcare.
• Transparency Guarantees: The openness and clarity of government dealings, reducing corruption and fostering trust.
• Protective Security: Social safety nets that prevent individuals from falling into abject misery, such as unemployment benefits and famine relief measures.

Interdependence of Freedoms

• Instrumental freedoms are interconnected and mutually reinforcing.
• A holistic approach, addressing all these freedoms, is essential for genuine development.

Democracy and Development

• Democratic systems play a crucial role in safeguarding freedoms and preventing disasters like famines.
• No substantial famine has ever occurred in a functioning democracy.

Divergence in Economic Growth

• The income gap between developed and developing countries has widened significantly over the past 150 years.
• From 1870 to 1990, the income ratio between the richest and poorest countries increased substantially.

Convergence Among Developed Nations

• Within advanced economies, income levels converged as poorer members grew faster than wealthier ones.
• This pattern does not extend to developing nations, where growth rates varied widely.

Historical Income Levels and Growth

• Many developing countries experienced slower growth, leading to significant divergence.

Factors Contributing to Divergence

• Developed countries benefited from steady technological and economic progress.
• Developing countries faced structural challenges, poor governance, and external dependencies.

Volatility in Developing Countries

• Growth rates in developing countries show wide variability, with some experiencing rapid growth and others facing stagnation or economic collapse.
• Many developing countries have not achieved sustained growth and remain trapped in poverty or slow development trajectories.

Policy and Theoretical Implications

• Tailored economic policies, not one-size-fits-all solutions, are needed.
• Understanding the causes of both explosive growth and stagnation in different contexts is crucial for formulating effective strategies.

Colonial Exploitation and Economic Policies

• Resource Extraction: Colonial powers prioritized resource extraction from colonies, often at the expense of local populations' well-being.
• Imposition of Free Market Principles: Colonial administrations enforced laissez-faire economic policies, dismantling traditional safety nets and communal support systems.

Impact of El Niño and Environmental Factors

• Climatic Vulnerability: El Niño events of the late 19th century combined with colonial policies led to massive famines.
• Environmental Degradation: Colonial agricultural practices led to environmental degradation, reducing the land's resilience to natural disasters.

Socio-Economic Transformations

• Creation of the Third World: Exploitative economic policies and environmental mismanagement during the colonial period laid the groundwork for persistent underdevelopment.

Role of Institutions

• Institutions established during colonization significantly influenced long-term economic outcomes.
• In sparsely populated regions, European colonizers instituted inclusive economic and political systems.
• Densely populated and economically prosperous areas were subjected to extractive institutions that hindered local development.

Two Perspectives on Growth

• Economic Perspective: Growth is driven by policies and institutions that create incentives for investment, trade, and innovation.
• Historical and Structural Perspective: Long-term growth is influenced by deep historical, geographic, and institutional factors

Three Major Theories of Long-Term Growth

• Geography Geographic factors influence natural resource availability, public health conditions, and agricultural productivity.

Trade and Economic Openness

• Access to sea-based trade promotes industrialization and economic growth.

Institutions

• Formal and informal rules governing social and economic behavior shape growth.
• Effective institutions protect property rights, limit government corruption, and promote stable investment environments.

Key Arguments

• Not all countries industrialize the same way, and the development path of backward countries differs significantly from early industrializers.
• Late-developing countries can skip technological stages and rapidly adopt the innovations.
• Backward economies require strong state intervention to accelerate industrialization.
• Industrial banks played a critical role in financing large-scale industrial projects.
• Late industrializers often grow faster than early developers.
• However, their industries are large-scale and capital-intensive, rather than small and decentralized like in early-industrializing Britain.

Russia

• Highly backward, with serfdom persisting until 1861.
• Industrialization in driven by state-led efforts.

Colonialism & Famine

• Explores how British colonial policies exacerbated famines in India, China, and Brazil.
• Examines how climate variations (El Niño) contributed to food shortages.
• Criticizes how global markets prioritized profits over local survival, worsening hunger.
• Highlights how British laissez-faire policies failed to prevent mass starvation.

Key Argument

• Economic development is not just about growth and institutions; social structures, particularly family dynamics and welfare systems, play a crucial role.
• Poorly designed welfare institutions resulted in Chile's delayed development whereas Sweden's well-designed welfare institutions contributed to their successful transformation.

The Role of Welfare Institutions in Development

• Sweden: Established universal welfare institutions early, particularly old-age pensions, which reduced fertility rates and allowed families to invest in education.
• Chile: Delayed welfare reforms, leading to high fertility rates, a large unskilled workforce, and persistent inequality.
• Welfare policies are often seen as a cost rather than an investment.
• Sweden’s case shows that early welfare programs create long-term economic advantages by fostering human capital and social mobility.

Factors Influencing Growth

• Factor Accumulation: Increase in capital and labor force.
• Productivity Growth: Efficiency improvements and technological advancements.

Determinants of Growth

• Investment and Savings: Higher savings can lead to greater investment, which contributes to economic expansion, if the resources are allocated efficiently
• Technology and Innovation: Countries that adopt or create new technologies tend to grow faster.
• Institutional Quality: Effective governance, property rights, and corruption levels affect economic performance.

Growth Patterns in Different Regions

• East Asia: Rapid growth due to high savings rates, investment, and export-oriented policies.
• Africa & Latin America: Stagnant or negative growth due to political instability, poor economic policies, or reliance on volatile commodity exports.
• Industrialized Nations: Consistent but slower growth due to high levels of capital and technology.

Sustained economic growth depends on:

• Capital investment
• Technological progress
• Institutional quality

Key Themes and Arguments

• The fundamental problem of most developing countries is high unemployment and underemployment.
• This is primarily due to a shortage of capital equipment and limited productive capacity (rather than wage rigidity or lack of innovation).
• Countries must increase investment and expand their productive capabilities to achieve full employment.

Felipe critiques the Washington Consensus, which promoted:

• Stabilization, liberalization, and privatization.
• Fiscal discipline, free trade, deregulation, and privatization.
• He argues that these policies failed because they did not address the structural constraints on growth.
• Instead, countries that implemented well-targeted reforms (like China, India, and Vietnam) achieved better economic outcomes.

Growth Models

• Explain long-term economic growth and differences across countries.
• Focuses on capital accumulation, productivity, and savings as key drivers.

The Solow (Neoclassical) Growth Model

• Introduced by Robert Solow (1956) as an improvement over Harrod-Domar.
• Key innovation: flexible capital-labor ratios → allows for substitution between factors.
• Explains economic growth in both developed and developing countries.

Capital Accumulation Equation

• Δk=sy−(n+d)k
• Where:
  • s = savings rate
  • y = output per worker
  • n = population growth rate
  • d = depreciation rate
  • k = capital per worker

Steady-State Level of Income

• The economy naturally moves towards a steady-state where capital per worker stabilizes.
• Beyond the steady-state, economic growth only happens through technological progress.

Historical Context of State and Market Roles

• Adam Smith argued markets drive development, while others emphasized state-led strategies.
• After WWII, reconstruction efforts (e.g., Marshall Plan) reinforced capital accumulation as a key driver of growth.

The Stages of Economic Growth

• Rostow outlines five stages of economic development, arguing that all economies progress through these phases.
• The five stages are:
  • Traditional Society
  • Preconditions for Takeoff
  • Takeoff
  • Drive to Maturity
  • Age of High Mass Consumption

Key Takeaway

• Rostow’s theory suggests that economic development follows a predictable, linear path.

The Boom and Bust of Latin American Economies

• 1950-1981: Strong growth (5.3% annually), industrialization, and rising incomes.
• Post-1982: Economic crises, stagnation, and inequality worsened due to neoliberal policies.

Neoliberal Reforms (1980s-1990s)

• Privatization, deregulation, and trade liberalization.
• Initially reduced inflation but increased inequality.

Comparison with East Asia

• East Asia combined ISI with export-led growth, leading to long-term success.
• Latin America failed to transition from ISI to export competitiveness.

Development and Growth: Key Concepts

• Economic Growth = Increase in GDP per capita, measuring output expansion.
• Economic Development = Broader, including improvements in health, education, and living standards.

Comparing Rich and Poor Countries

• Countries differ in income levels, industrialization, health, and education.
• Development is not uniform—some countries leap ahead, while others stagnate.

Unequal Exchange Theory

• Industrialized countries (the center) dominate agricultural-exporting countries (the periphery) in trade, extracting wealth through unfair exchange rates.

Historical Background

• Argentina’s Economic Struggles (1930s-40s): The Great Depression exposed Argentina’s dependence on Britain.
• Industrialization Push: He advocated for import substitution industrialization (ISI)—reducing reliance on agricultural exports and developing domestic industries.

Declining Terms of Trade

• Over time, prices for raw materials (exports of poor countries) fall relative to manufactured goods (exports of rich countries).
• Wage Rigidity. In industrialized nations, workers’ wages rise with productivity, but in agricultural nations, wages remain stagnant.

###Key Idea: The Rise and Challenges of Import-Substituting Industrialization (ISI)

• Import-Substituting Industrialization (ISI) aimed to reduce dependency on foreign imports by fostering domestic industries.
• Initially, ISI was seen as a path to economic independence, but by the 1960s, its limitations became clear.

Trade Strategies

• Nations follow a spectrum of trade policies from isolationism (autarky) to free trade.
• Historically, many nations used import substitution (IS), but it often led to inefficiencies.

Import Substitution vs. Export Promotion

• Import Substitution (IS): Involves high tariffs, quotas, and overvalued currencies to protect local industries.
• Export Orientation: Encourages production for global markets using subsidies, tax benefits, and undervalued exchange rates.

Trade and Economic Growth

• Openness to trade correlates with faster growth, but causality is debated.