The determinants of Economic Growth

Executive summary I. Introduction a. Key Issues that motivate our study and summarise main findings i. Much research has been conducted into the determinants of Economic growth across a cross section of countries. ii. Many techniques have been employed including multivariable regressions, BMA, variants of Edward Learners extreme-bounds analysis and crosssectional versions of the general-to-specific search methodology associated with the LSE approach to econometrics. iii. Several factors and theories that have been examined and identified as important in determining growth include conditional convergence of countries, investment in equipment and the level of initial human capital. Dummy variables to distinction countries such as African and South American countries, membership of OPEC and OECD are also prevalent throughout growth literature. We hope to incorporate and investigate the effects of these variables on growth using our data set of 72 countries. Analysis a. Literature review summary of related work i. Barro (1991) using regression analysis found 1. Significant negative correlation between GDP per capita growth between 1960-1985 and initial levels of GDP if initial human capital was held constant. a. This was further shown by Barro and Sala-i-Martin (1992) but this view was challenged by Durlauf and Quah (1999). 2. Furthermore, holding the initial level of GDP constant, there was a significantly positive correlation between GDP per capita growth and initial levels of human capital. 3. As expected, political instability is inversely related to growth and investment, as are price distortions. Barro also acknowledged that his model did not fully account for the characteristics of countries in Africa and Latin America. ii. The importance of equipment investment was stressed in De Long and Summers (1991) and Temple (1998). iii. Hoovers and Perez (2004)review the empirical work of Levine and Renelt (1992) and Sala-i-Martin (1997) finding investment is relatively important with equipment investment being the second highest positive influence in their analysis with Openness to foreign trade being the most important effect in either direction.

II.

b. Economic Theory formal theoretical model Good summary i. Theory has developed to explain differences in cross-country growth. ii. The neo-classical growth model (Solow 1956) explains that in steady state, growth rates depend on the growth rates of the labour force and technological progress however the model gives little notion of what might determine technological progress. 1. Out of steady state, increasing the rate of utilization of factors of production or increasing capital investment can temporarily increase growth rates. Also the higher the gap between the current level of output and the steady-state level of output the higher the growth rate thereby all countries converge to their respective steady states. 2. As a result of diminishing marginal productivity of capital, the rate of return on capital is lower for countries with higher capital per worker, therefore capital should flow to poorer countries, thus driving convergence. 3. Further the diffusion of knowledge should aid the development of poorer countries who can import the technological advances from technological progress. a. However historical data is more likely to be imprecisely measured than current data therefore making it impossible to distinguish convergence from measurement error of initial income is underestimated. iii. Models of growth with increasing returns suggest looking at industrial organisation, research and development, investment in education and other factors (Romer, 1986, Lucas 1988, Jones 1995 and many others, ably surveyed in Jones and Barro and Sala-i-Martin, 1995). iv. Initial Human capital 1. The human capital incorporated in the Salow-Swan model is exogenous. Lucas considers a model where human capital is endogenous. 2. Models of innovation and research and development are due to Romer (1990) and Jones (1995). Romer endogenized growth in the productivity term (A) whereby the growth of ideas is based on the level of current research. Jones developed his own model setting long-run growth level of technology equal to zero and his model does not imply convergence. . 3. Multicollinearity? c. Data Data used and data sources We used data collected by Fernandez, Ley and Steel (2001) as provided in class. We matched data on 1960 primary and high school enrolment, 1960 life expectancy to data sets collected and published

by Levine and Renelt (1992), Barro and Lee (1993) and Sala-i-Martin (1997a,b) who made use of many sources including Summers and Hestion *1988+, the World Banks *1979+ database which can all be found in the appendix to extend our model into areas of interest including introducing dummy variables for different countries and memberships of international organisations. As noted by David Kim (2011) all data sets will have measurement errors and we hope by using and matching many data sets to get as accurate estimators as possible. Further we used older editions of Summer and Hestons database used by Barro and Lee (2003) due to ease of access and time constraints on data sourcing. d. The Empirical model used how did we use the data? Justify why it was used? (1) GR6089 72 0.0598 (0.0181) -0.0170 (0.0037) -0.0266 (0.0354) 0.0204 (0.0108) 0.0011 (0.0003) 0.2972 (0.04111) (2) GR6089 72 0.0466 (0.0224) -0.0183 (0.0037) -0.0259 (0.0326) 0.0132 (0.0137) 0.0018 (0.0004) -

Dep. Var No. obs Const. GDP60 H60 PRIM60 LIFE60 EQPINV

We used robust standard errors in case variables were subject to heterogeneity and Stata Student Edition 11 to perform our regression and graphical analysis due to prior knowledge in this software program. Beginning with our basic regression on the variables given in this assignment (excluding war dummy given as Regression 1) we find that starting initial gross domestic product has a negative effect on growth holding other factors constant with a t-value of -4.63 supporting convergence of countries. Further removing the effort of investment on equipment which was seen to be the strongest effect on growth in line with the results of Hoovers and Perez (this effect will be discussed soon), we still achieve the same convergence result. As mentioned earlier, the Salow-Swan model (1956) implies convergence across countries as diminishing marginal returns from capital implies capital should move from rich to poorer countries increasing their growth at a faster rate.

Linear regression

Number of obs = F( 6, 65) = Prob > F = R-squared = Root MSE = Robust Std. Err. .0116543 .0003092 .0270006 .0438284 .0381243 .0017721 .1017166

72 18.82 0.0000 0.6387 .01147

gdpgrowth prscenroll lifeexp gdpin1960 equipinv highenroll gdp60sq _cons

Coef. .010004 .0011923 .036851 .2960178 .0046649 -.0036048 -.1389745

t 0.86 3.86 1.36 6.75 0.12 -2.03 -1.37

P>|t| 0.394 0.000 0.177 0.000 0.903 0.046 0.177

[95% Conf. Interval] -.0132712 .0005748 -.0170729 .2084864 -.0714746 -.0071438 -.3421166 .0332792 .0018098 .090775 .3835491 .0808044 -.0000657 .0641676

Linear regression

Number of obs = F( 5, 66) = Prob > F = R-squared = Root MSE = Robust Std. Err. .0036777 .0108354 .0003254 .0411101 .0354241 .0181163

72 24.00 0.0000 0.6190 .01169

gdpgrowth gdpin1960 prscenroll lifeexp equipinv highenroll _cons

Coef. -.0170441 .0203818 .0010677 .2972188 -.0265627 .0597845

t -4.63 1.88 3.28 7.23 -0.75 3.30

P>|t| 0.000 0.064 0.002 0.000 0.456 0.002

[95% Conf. Interval] -.0243868 -.0012518 .0004181 .2151398 -.0972892 .023614 -.0097013 .0420154 .0017173 .3792978 .0441638 .0959549

Linear regression

Number of obs = F( 4, 67) = Prob > F = R-squared = Root MSE = Robust Std. Err. .0137262 .0003745 .0046943 .0326267 .0223832

72 13.94 0.0000 0.4406 .01405

gdpgrowth prscenroll lifeexp gdpin1960 highenroll _cons

Coef. .0132442 .0017862 -.0183283 -.0025889 .046555

t 0.96 4.77 -3.90 -0.08 2.08

P>|t| 0.338 0.000 0.000 0.937 0.041

[95% Conf. Interval] -.0141534 .0010386 -.0276981 -.067712 .001878 .0406418 .0025337 -.0089585 .0625342 .0912319

e. Empirical Results Describe findings and how they relate to the economic issue using both statistical and economic information i. Convergence (Solow 1956) ii. Initial GDP per capita iii. Initial Human capital 1. Look into effects from using various education proxies iv. Location / Industry (Pacific Rim, Sub Saharan Africa / Oil exporting countries) v. Can also discuss relationship between growth and 1. Effect of Measurement errors 2. Fertility 3. Investment 4. Other variables: a. Govt expenditures b. Political Instability c. Economic System

d. Market distortions e. African and Latin American countries vi. III. Conclusion a. Briefly summarise issues and key findings