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Chapter 5

Human Development
Human Development Index (UNDP)

• Mahbub ul Haq: Founder HD Report


• Geometric mean of 3 indices (Sen):
– Life expectancy
– Education
– GDP (log transformation)
Lowest: Black-Red
Highest: Dark Green

x j  min( x j )
0 Ij  1
max( x j )  min( x j )
Why the Ln of Income?
• P/cap Incomes ranged from $260 (Liberia) to
$93,383 (Qatar)
– That’s really big
• Would an increase in income in rich countries
affect human development as much as the
same increase in poor countries? (No)
• The natural log compresses the income range
– Ln(260) = 5.56 (Liberia) and Ln(93,383) = 11.44
(Qatar).
An Index of Indexes
• Education Index:
I ( Ei )  I ( EYSCi ) * I (MYSAi )

• HDI:
HDI i  3 I (GNIi ) * I ( LEi ) * I ( Ei )

• EYSC: Expected Years of School Completion


• MYSA: Mean Years of School Attainment
• E: Education
• GNI: (Ln) of Gross Domestic Income
• LE: Life Expectancy
Human Development Highs and Lows
HDI and Income
HDI and (Ln) Income
Why the Variation?
• Non-economic factors?
– E.g., Swaziland and Ukraine have similar levels of per-capita GDP
($4,300, PPP)
– But HIV/AIDS lowered life expectancy to 38 years in Swaziland
(vs. 69 yrs in Ukraine)
• Education and other policies?
– Algeria and Panama ~$6,000
– But 92% of Panamanians are literate vs. 68% of Algerians
• Inequality? According to the World Bank:
– Panama: Gini = 51.9
– Algeria: Gini = 35.3
GNI Rank HDI Rank
GNI Rank -
Country (Lowest to (Lowest to
HDI Rank
Highest) Highest)

The Best and Worst Performers:


Equatorial Guinea 143 54 89

the Worst at Kuwait


Botswana
Oman
181
124
150
129
74
100
52
50
50

Turning
South Africa 109 66 43
Angola 79 40 39
Gabon 121 83 38
187 153 34
Income into
Qatar
Bhutan 82 49 33
United Arab Emirates 185 158 27
Trinidad and Tobago 151 125 26
Human Average, Worst
Best Performers:
137 94 44

Cuba 84 131 -47

Development Georgia
Grenada
76
93
111
121
-35
-28
Palau 110 138 -28
New Zealand 153 180 -27
Madagascar 11 37 -26
Average, Best 88 120 -32
Source: Analysis of data from the UNDP Human Development Report
Delving into the HDI’s Components

• Income (Chapter 3) and income


growth (Chapter 7)

• Education
• Health
Big Challenges: Positive
Externalities and Public Goods
Educating a Country
• Externalities of schooling
– Left to own devices, people underinvest in schooling under
the best of circumstances
– The reason for public education

• Poor countries aren’t the best of circumstances


– High costs of sending kids to school
• Cash
• Opportunity costs

• If you make education available to everyone (like


massive online open courses—MOOC), how do you
make a profit?
– All costs are fixed, like a bridge; IRS
Returns to Scale
• Y=F(L,K) 
• Decreasing Returns to Scale
– Double each input, get less than double the output
– 𝜆𝐹 𝐿, 𝐾 < 𝐹 𝜆𝐿, 𝜆𝐾 where 𝜆>1

• Increasing Returns to Scale


– Double each input, get more than double the output
– 𝜆𝐹 𝐿, 𝐾 > 𝐹 𝜆𝐿, 𝜆𝐾 where 𝜆>1

• Constant Returns to Scale


– Double each input, get double the output
– 𝜆𝐹 𝐿, 𝐾 = 𝐹 𝜆𝐿, 𝜆𝐾 where 𝜆>0
Making a Country Healthy
• When you are healthy, you and the people you work with
are more productive.
– When you are not, you can make others sick

• When investing in health, do people consider the benefits


and costs for the rest of society?
– Free-rider problem: Should I get vaccinated if you do?

• IRS: Public health projects have high fixed costs then low or
negligible marginal costs
– Potable water systems, sanitation, vaccinations, disease
prevention
– Marginal-cost pricing doesn’t work (like bridges, national
security)
Costs
• Cash costs (fixed costs and maintenance costs)

• Opportunity costs
– What’s the next best thing you could be doing with the money?
• Build clinics or school rooms?
• Run a public information campaign to reduce HIV?
• Give cash transfers to poor households?
• Build a new airport that can bring tourists in?
• Put in new roads or cell towers?

– They’re all important; how do we choose?

– How can we estimate opportunity costs?


• Compare benefits from other uses of money and time
Benefits: Usually a Lot Harder
• How do you quantify the economic benefits of
a public health or education project?
– Lives saved; what’s the ECONOMIC value of a life?
– Healthy people are more productive, morbidity
– Human capital theory…

• Of a new road, cell tower, or airport?


– How much new income will these create?
Discounting
• Costs happen right away, but we have to wait to see the benefits
• Income in the future is worth less than now
– …so we have to discount

• Need a discount rate, r—the opportunity cost of money


– What’s the opportunity cost of money?
• Value of next-highest alternative use of money
• The interest rate, the benefit of investing in something else, etc.
• What if there is no bank?

• Lesotho: interest rate = .044 (or 4.4%) in 2012


– Development banks often use 12% to evaluate their projects
– What does a higher discount rate do to a Cost-benefit analysis?

• Need to calculate present value of any future benefits and costs.


Present Value
• The present value (PV) of $100 a year from
now is $100/(1+r)
– If r=.05, we get $100/1.05 = $95.24
– If TWO years from now, $100/(1+r)2

• In general, the PV of income Y received at


time t is:
PVY ,t  Yt / (1  r ) t
Net Present Value of an Investment
T
 Benefits t  Costs t 
NPV    
t 0  (1  r ) t

• If NPV>0 the investment (project) passes the


cost-benefit test

• The trick is always figuring out the benefits


and costs
– …and attach a dollar value to them.
A Private Cost-benefit Analysis of
Going to School

• You’re a kid in a poor village in Lesotho


• Just finished 6th grade
• Should you go on and complete secondary
school (grades 7-9)?
• What are the costs and benefits of going to
school?
Benefits: Human Capital Theory
(Gary Becker, Jacob Mincer)
• Firm’s higher where the marginal benefit of labor is equal to the marginal cost
• Wage=marginal value product of labor:

• The Mincer Equation: Wages thus depend on


schooling (S) and work experience (EXP):
The (private) returns to
schooling

LnWi   0  1Si   2 EXPi  3 EXPi 2   i


Benefits and Opportunity Costs in a
Lesotho Village

• Mincer wage equation: each additional year of


schooling raises the wage by 9.8% for males and
18.6% for females
– So 3 years => 29% and 56%, respectively

• Opportunity cost: Average annual wage, <16


years old: 487 maloti (around US$64) per year for
boys and 279 maloti (US$52) for girls
– There are cash costs, too, but for simplicity we ignore
them
Cost-Benefit Analysis
Males Females
Cumu- Cumu-
Oppor- Benefit lative Oppor- Benefit lative
Year (A) Benefit Benefit
tunity Minus Net tunity Minus Net
(C) (C')
Cost (B) Cost (D) Benefit Cost (B') Cost (D') Benefit
(E) (E')
1 487 0 -487 -487 279 0 -279 -279
2 467 0 -467 -954 267 0 -267 -546
3 447 0 -447 -1401 256 0 -256 -802
4 0 125 125 -1276 0 191 191 -611
5 0 120 120 -1157 0 183 183 -428
6 0 114 114 -1042 0 176 176 -252
7 0 110 110 -932 0 168 168 -84
8 0 105 105 -827 0 161 161 77
9 0 101 101 -727 0 154 154 232
10 0 96 96 -630 0 148 148 379
11 0 92 92 -538 0 142 142 521
12 0 88 88 -450 0 136 136 657
13 0 85 85 -365 0 130 130 787
14 0 81 81 -284 0 124 124 911
15 0 78 78 -206 0 119 119 1030
16 0 74 74 -132 0 114 114 1144
17 0 71 71 -61 0 109 109 1254
18 0 68 68 8 0 105 105 1359
. . .
40 0 26 26 958 0 41 41 2816
NPV NPV
(Sum)=958 (Sum)=2816
NPV=958 (Boys) and 2816 (Girls).
Is It Worth the Wait?

• A big “if”: What if educated kids migrate?


– They won’t be in our analysis
– Are we under-estimating the economic benefits of education for rural
kids?
Chapter 7

Growth

Hans Rosling of Gapminder: 200 Years in 4 Minutes


http://www.gapminder.org/videos/200-years-that-changed-the-world-bbc/
Adam Smith…

An Inquiry into the Nature and Causes of the


Wealth of Nations

Economists have been trying to answer this


question:

Why are rich countries rich


and poor countries poor?
Others
• Georg Friedrich Sartorius
– Wrote about the Hanseatic League in Germany

• Mercantilists
Growth in History
• Up to ~500 years ago, most lived in conditions
we would call abject poverty
• Today: Income levels much higher and more
diverse

• Big minority of the world’s population has


achieved rapid, sustained income growth
– Others, more modest->middle income
– Majority: in poverty (though usually better off
than their ancestors)
• What a difference a century makes
Contrasting Growth Experiences
Economic Growth, 1960-2003 (from Table 3-1)
Average Annual
Country
Growth Rate (%)
Negative
Madagascar -1.26
Venezuela -0.67
Slow
Rwanda 0.13
Argentina 0.61
Moderate
Sri Lanka 2.17
India 2.74
Rapid
Indonesia 3.33
China 4.47
Industrialized
Japan 4.11
U.S. 2.43
Why Do Some Countries Grow Faster
Than Others?
…And Some Grow Very Fast?
What Explains This? (The Quest for the
Holy Grail of Growth)
• Factor accumulation: Increasing size of the
capital stock (or labor force)
– Machines, factories, buildings, roads, computers,
etc.

• Productivity growth: Increasing the amount of


output produced by each machine or worker
– Use technologies you have more efficiently
– Technological change
Why We Need a Model
• Because we’re human!
– Trying to recognize and interpret patterns in order
to make sense of the world is a fundamental
human impulse.

• Useful to explore and understand the


complexity of our world

• Generate hypotheses we can test with data


Essentially, All Models Are Wrong,
But Some Are Useful
-George Box, statistician
The Equation for Falling Objects

1 2
d  gt
2
g = 9.8 m/s2
(gravitational
constant)

In popular lore, Galileo Galilei (1564–1642) dramatically refuted Aristotle’s laws of motion
by dropping unequal weights from the Leaning Tower of Pisa. In the scientist’s extensive
writings, however, he never claimed to have conducted an experiment from that tower.
(http://www.endex.com/gf/buildings/ltpisa/ltpnews/1999/ltpsn121899.htm)
…assumes that you are in a vacuum!

Here's the famous footage of the Apollo 15 astronaut that dropped a hammer
& feather on the moon to prove Galileo's theory that in the absence of
atmosphere
http://www.youtube.com/watch?v=5C5_dOEyAfk
So Is It a Bad Model?
• Not for a Hummer H2
dropped from the top of
the Leaning Tower of Pisa
(or a feather dropped on
the moon)

• Yes for a feather dropped


on Earth (or a Hummer H2
dropped from a high-flying
jet)
Starting Point: How Does Income
(GDP) Get Produced?
• By combining labor (L) and capital (K)
• Technology described by an Aggregate Production
Function:
Y  F ( L, K )
Constant Returns to Scale

Y  F ( L, K )
If CRS :
Y L K
 F , 
L L L
y  f (k )
y  Output/Worker
k  Capital/Worker
yk  0, ykk  0
What Explains Capital/worker in an
Economy?
• The amount of investment per worker
– Creates capital

• The population growth rate


– Adds workers and dilutes the amount of capital per worker

• The capital depreciation rate (how quickly capital wears


out during the production process)
– steadily erodes the capital stock
– economies have to keep investing in new capital just to
stay in the same place – like on a treadmill!
Savings Per Worker (sy)

Savings / wkr : sy
(s = the savings rate)
No capital,
no savings,
no income!

Investment / wkr  Savings / wkr


Change in Capital Per Worker

Change in Capital / wkr : k  sy  dk  nk


d  Depreciation
n  Labor Force Growth Rate
Put It All Together:
The Solow Diagram
k  sy  (n  d )k

Point A: Steady
state, long run, or
potential output per
worker
Steady
State: Where
k=0
Solow Diagram from PRL

• Pieces of the graph:


– Horizontal axis is k;
– Two RHS pieces of the Solow equation: sy & (n+d)k;
– Also graphs y (neoclassical production function);
350

𝑦 = 𝑓 𝑘 = 10𝑘 0.5
300

250

200

150

100

50

0
0 100 200 300 400 500 600 700 800 900 1000

• Aggregate Production Function: 𝑌 = 10𝐾 0.5 𝐿0.5


• Per Capita Production Function: 𝑦 = 10𝑘 0.5
– Note: diminishing MPk (because the exponent is between 0 and 1)
350

𝑦 = 𝑓 𝑘 = 10𝑘 0.5
300

250

200

150

100

50

𝑠𝑦 = 0.1𝑦 = 𝑘 0.5
0
0 100 200 300 400 500 600 700 800 900 1000

k
• Blue curve is: 𝑠𝑦 = 0.1 ∗ 𝑦 = 0.1 ∗ 10𝑘 0.5 = 𝑘 0.5
• 𝑠 = 0.1, so blue curve is just 10% the height of the green curve.
• What does height of the blue curve tell us?
– How much capital per worker would increase thanks to savings (which is invested to
buy new machines) if we had no population growth or depreciation.
350

𝑦 = 𝑓 𝑘 = 10𝑘 0.5
300

250

200

150

100

50 𝑛 + 𝑑 𝑘 = 0.04𝑘

𝑠𝑦 = 0.1𝑦 = 𝑘 0.5
0
0 100 200 300 400 500 600 700 800 900 1000

• Orange line is: 𝑛 + 𝑑 𝑘 = 0.04𝑘


• What does height of the dark blue line tell us?
• Thanks to population growth (n=.02) and depreciation (d=0.02), our capital
stock per worker would fall by 4% if we had no new investment.
350

𝑦 = 𝑓 𝑘 = 10𝑘 0.5
300

250

200

150

100

50 𝑛 + 𝑑 𝑘 = 0.04𝑘

𝑠𝑦 = 0.1𝑦 = 𝑘 0.5
0
0 100 200 300 400 500 600 700 800 900 1000

• We can use the Solow Diagram to examine the dynamics of an


economy.
• “Given the amount of k (and thus y) we have today, will k (and thus
y) be growing, shrinking or staying the same?”
350

𝑦 = 𝑓 𝑘 = 10𝑘 0.5
300

250

200

150

100

50 𝑛 + 𝑑 𝑘 = 0.04𝑘

𝑠𝑦 = 0.1𝑦 = 𝑘 0.5
0
0 100 200 300 400 500 600 700 800 900 1000

• Say a country starts with k(0) = 200 so:


– 𝑦 0 = 10 ∗ 2000.5 = 141
• Will it be growing? Shrinking? Not changing?
350

𝑦 = 𝑓 𝑘 = 10𝑘 0.5
300

250

200

150

100

50 𝑛 + 𝑑 𝑘 = 0.04𝑘

𝑠𝑦 = 0.1𝑦 = 𝑘 0.5
0
0 100 200 300 400 500 600 700 800 900 1000

• Growing! Because capital “Gains” > capital “Loss”


– Gain = 𝑠𝑦 0 = 0.1 ∗ 141 = 14.1; (light blue curve)
– Loss = 𝑛 + 𝑑 𝑘 0 = 0.04 ∗ 200 = 8 (dark blue curve)
• So the net change in capital per worker is 14.1 – 8 = 6.1.
A Higher Savings Rate (s’>s) Raises K
and Income/Worker
A Higher Savings Rate (s’>s) Raises K
and Income/Worker
Can the Savings Rate Be Too High?

Chinese people older than 50 save more than 60 percent of their income.
They remember the “bitter years:”
- the Great Famine (1958 to 1961)
- violence of the Cultural Revolution (1966 to 1976)
One young Chinese man said: “Maybe I’m too busy to have a lot of time
spending money.”

Source Data: OECD, World Bank, Standard Chartered, Turkish State Planning Office, British Office for National Statistics
http://www.businessweek.com/printer/articles/46918-how-household-savings-stack-up-in-asia-the-west-and-latin-america
Keith B. Richburg, “Getting Chinese to stop saving and start spending is a hard sell.” The Washington Post, 7/5/2012,
http://www.washingtonpost.com/world/asia_pacific/getting-chinese-to-stop-saving-and-start-spending-is-a-hard-sell/2012/07/04/gJQAc7P6OW_story.html
Explaining Household Savings
http://www.businessweek.com/printer/articles/46918-how-household-savings-stack-up-in-asia-the-west-and-latin-america

• China: 38%
– No national safety net
• India: 34.7%
– India's savings rate has been building along with the acceleration of its GDP growth
• Turkey: 19.5%
– Turkish savings, high by U.S. standards, are not enough for a developing country
• Switzerland: 14.3%
– The Swiss vie with Swedes and Austrians to be the top savers in the West
• Ireland: 12.3%
– The Irish savings rate quadrupled over two years in response to the financial crisis
• Britain: 7%
– British savings have declined sharply since the early 1990s
• Brazil: 6.8%
– Latin American economies generally have low savings rates
• U.S.: 3.9%
– U.S. savings are up from a 1.7% low but far below a postwar average of 7% or so
• Japan: 2.8%
– The savings decline in Japan from 15% in 1992 is the most dramatic in the industrialized world
• Australia: 2.5%
– The Australians, like the Americans, have had a huge housing boom compensating for the loss in savings
Higher Population Growth or
Depreciation Do the Opposite
Higher Population Growth or
Depreciation Do the Opposite
Some Testable Implications of the
Solow Model
 Big success stories have growing capital per
worker
– China, Asian Tigers confirm this
– Higher k means higher productivity, wages
You Always Come Back to the
Steady State

? Shocks can throw economies off their steady


state—but they eventually return
– See the bombing Vietnam box
– San Francisco after the ’89 earthquake
– New Orleans after Katrina?
The Convergence Hypothesis
• Given s and n, countries’ incomes should
converge. Lower income, higher growth?

Are poor
countries
growing faster
than rich ones?

(Hard to see a
pattern here)
There Isn’t Even Convergence Within
Countries!
• See Hans Rosling’s video
• Shanghai is like Italy
• Rural Guanzhou is like Ghana
• Oaxaca vs. Mexico City
• US South vs. the rest
• The “Farmworker Towns” of California’s San
Joaquin Valley
– …with per-capita income less than Mexico’s!
Things Explaining Growth
• Capital investment
• Political rights
• Openness to trade
• Black markets
• Colonial legacy
• War
• Religion
• …to name a few
The Biggest Question of All

• What explains the production function?


– That’s where technological change is

• Henry Ford, the internet, Silicon Valley

• Concentration of technological change in rich


countries keeps convergence from happening
(increasing returns to scale)
Exogenous Technological Change in
the Solow Model
Exogenous Technological Change in
the Solow Model
The Gazillion Dollar Question:
What Makes Technological Change
Happen?
Each unit of capital investment not
only increases the stock of physical
capital but also increases the level of
the technology for all firms in the
economy through knowledge spillovers

-Paul Romer, economist, entrepreneur, activist


Object Gaps and Idea Gaps
• Object Gap: “Nations are poor because they
lack valuable objects like factories, roads, and
raw materials.”
• Idea Gap: Nations are poor because their
citizens do not have access to the ideas that
are used in industrial nations to generate
economic value.”
– Closing the idea gap requires interaction and
communication with the rest of the world
Endogenous Growth

Keys to Increasing Returns to Scale


Technological change (new f(k))
Spillover effects
Agglomeration effects

Increasing capital also increases technology


From Solow to Endogenous (“New”)
Growth Models
• Key difference: Increasing Returns to Scale: Doubling inputs
more than doubles output. How?
• Positive externalities:
– Effect of my education on yours
– Spread of new ideas (e.g., Ford’s assembly line; “spillovers”)
– R&D Investments -> new knowledge benefiting everyone
• The internet
– Growth perpetuates itself through technological change

• Facebook: 0 to $100 billion in 9 years


– Google: 0 to $343 billion in 13 years
– What country’s production looks like Google’s?
Does this apply to LDCs?
• Japan (in the 1970s and 80s), Korea, India (Bangalore), now
China (?)
– Making the jump from off-shoring to innovating
• Will Mexico manage to do it? (They’re trying!)
• What about the rest of the world? Zimbabwe?
– They can grow rapidly by adapting technologies developed in
countries with high R&D capability
– But hard to have a tech boom
• Does a country have to innovate to develop?
A Different Kind of Steady State: The
Poverty Trap
(from Chapter 3)

At+1 (Assets next year)


45°
Recursion B
function At+1> At
graph

A
At+1< At

‘Rolling 0 At (Assets this year)


marbles’
profile
At (Assets this year)
Poverty trap
What’s the Answer, Then?
Jeffrey Sachs: The Big Push

• The millennium villages: Development with


massive aid
Counterpoint: William Easterly

• Getting incentives right


• Aid can be bad
• Who do you agree with? (Check out videos)
Chapters 7

Growth Part 2

Hans Rosling of Gapminder: 200 Years in 4 Minutes


http://www.gapminder.org/videos/200-years-that-changed-the-world-bbc/
Put It All Together:
The Solow Diagram
k  sy  (n  d )k

Point A: Steady
state, long run, or
potential output per
worker
Steady
State: Where
k=0
A Higher Savings Rate (s’>s) Raises K
and Income/Worker
A Higher Savings Rate (s’>s) Raises K
and Income/Worker
Higher Population Growth or
Depreciation Do the Opposite
Higher Population Growth or
Depreciation Do the Opposite
Some Testable Implications of the
Solow Model
 Big success stories have growing capital per
worker
– China, Asian Tigers confirm this
– Higher k means higher productivity, wages
The Convergence Hypothesis
• Given s and n, countries’ incomes should
converge. Lower income, higher growth?

Are poor
countries
growing faster
than rich ones?

(Hard to see a
pattern here)
There Isn’t Even Convergence Within
Countries!
• See Hans Rosling’s video
• Shanghai is like Italy
• Rural Guanzhou is like Ghana
• Oaxaca vs. Mexico City
• US South vs. the rest
• The “Farmworker Towns” of California’s San
Joaquin Valley
– …with per-capita income less than Mexico’s!
The Biggest Question of All

• What explains the production function?


– That’s where technological change is

• Henry Ford, the internet, Silicon Valley

• Concentration of technological change in rich


countries keeps convergence from happening
(increasing returns to scale)
Exogenous Technological Change in
the Solow Model
Exogenous Technological Change in
the Solow Model
The Gazillion Dollar Question:
What Makes Technological Change
Happen?
Each unit of capital investment not
only increases the stock of physical
capital but also increases the level of
the technology for all firms in the
economy through knowledge spillovers

-Paul Romer, economist, entrepreneur, activist


Object Gaps and Idea Gaps
• Object Gap: “Nations are poor because they
lack valuable objects like factories, roads, and
raw materials.”
• Idea Gap: Nations are poor because their
citizens do not have access to the ideas that
are used in industrial nations to generate
economic value.”
– Closing the idea gap requires interaction and
communication with the rest of the world
Endogenous Growth

Keys to Increasing Returns to Scale


Technological change (new f(k),
f(A,k).
Spillover effects
Agglomeration effects

• Increasing capital also increases technology


From Solow to Endogenous (“New”)
Growth Models
• Key difference: Increasing Returns to Scale: Doubling inputs
more than doubles output. How?
• Positive externalities:
– Effect of my education on yours
– Spread of new ideas (e.g., Ford’s assembly line; “spillovers”)
– R&D Investments -> new knowledge benefiting everyone
• The internet
– Growth perpetuates itself through technological change

• Facebook: 0 to $100 billion in 9 years


– Google: 0 to $343 billion in 13 years
– What country’s production looks like Google’s?
Does this apply to LDCs?
• Japan (in the 1970s and 80s), Korea, India (Bangalore), now
China (?)
– Making the jump from off-shoring to innovating
• Will Mexico manage to do it? (They’re trying!)
• What about the rest of the world? Zimbabwe?
– They can grow rapidly by adapting technologies developed in
countries with high R&D capability
– But hard to have a tech boom
• Does a country have to innovate to develop?
A Different Kind of Steady State: The
Poverty Trap
(from Chapter 4)

At+1 (Assets next year)


45°
Recursion B
function At+1> At
graph

A
At+1< At

‘Rolling 0 At (Assets this year)


marbles’
profile
At (Assets this year)
Poverty trap
What’s the Answer, Then?
Jeffrey Sachs: The Big Push

• The millennium villages: Development with


massive aid
Counterpoint: William Easterly

• Getting incentives right


• Aid can be bad
• Who do you agree with? (Check out videos)
One More Model: Bank Centered
Economic Growth
• Richard Werner
– Quantitative Theory of Credit

– Princes of the Yen


https://www.amazon.com/Princes-Yen-Central-Bankers-
Transformation/dp/0765610493

https://www.youtube.com/watch?v=p5Ac7ap_MAY
Fractional Reserve Banking
• The US dollar, the Chinese Yuan, the Japanese
Yen, the Euro etc. have no single measure, no
backing at all, created at will by banks.

• A central bank has the ability to print new


currency and lend it through the banking
system but also other private banks can also
create new money through the extension of
loans in a fractional reserve system.
Total Reserves
10% Required Total Loans: $81,000
Reserves $10,000 + $9,000 = $19,000 +$90,000 = $171,000

Example
BANKING
SYSTEM

$100,000 $81,000
$90,000

Javier Charlotte

Justin
Lots of new money!
• An initial deposit of $100,000 with a 10% reserve
requirement, creates:

– 1/reserve requirement * deposit (withdraw) = amount


created (amount withdrawn)
– 1/0.1 * $100.000 = $1,000,000

• Money multiplier effect


Step
Iinflation and Instability-Banking Crises
• US 1929
– Great Depression

• US Savings & Loan 1980s and 90s


– Cost $153 billion

• Housing Bubble 2007-2009


– Washington Mutual, largest bank failure in US history, went from 45
dollars a share to 0. Bought by Chase.
– Wachovia-bank bank run of $5 billion in one day. Merged into Wells
Fargo.
– Trillions of dollars in losses.
Other Implications for Developing
Countries
• Central bank governance is important

• Caution when borrowing on international


markets, by the central bank AND by private
domestic banks

• More research on role of banks in


creating/destroying economic growth
Debt Relief
• 7th year-At the end of every seven years you
must cancel debts.

• Jubilee-Return of ancestral lands, every 50


years.

• Modern Translation: Personal Bankruptcy


Laws or National Bankruptcy? Land reforms or
special help for the poor?
Good examples
• Norway
– Net Surplus of 150%

• In and Out Burger


– “Debt-free growth. In-N-Out maintained a policy of opening new
stores in its earlier years only when they could be paid for without
debt. This policy has been relaxed over the years, yet In-N-Out still
refrains from overleveraging itself in the quest for expansion. A
quest that has killed off less astute companies over the years.”
– http://hubpages.com/business/What-Makes-In-N-Out-
Burger-a-Successful-Business