Chapter 18 - Policies and Prospects for Global Economic Growth.doc

272Miller•Economics Today, Nineteenth Edition Chapter 18Policies and Prospects for Global Economic Growth273 Answers to Questions for Critical Analysis Nudging the World’s Poor to Make Different Choices (p. 399) Some international policymakers argue that the world’s poor require stronger “nudges,” such as policies that prevent them from making “bad” choices. How might stronger nudges limit economic freedom and potentially slow economic growth? (Hint: Does reducing the range of people’s choices expand or limit their economic freedom?) Reducing the range of people’s choices limits their economic freedom, and thus stronger nudges that limit economic freedom might potentially slow economic growth. Indian Farmers Confront “Dead Land” Problems (p. 401) Why do you suppose that many observers regard India’s agricultural productivity issues related to land use as analogous to the problems arising from dead capital? India’s legal restrictions limit how much farmland an individual may own, providing tenants with strong rights over the use of lands they lease. As a result, landowners have few incentives to rent out their landholdings. The outcomes are analogous to the problems arising dead capital. Myanmar Ends Monopolies’ Control of Financial Information to Spur Foreign Investment (p. 405) What types of asymmetric information problems might have existed as a consequence of the control that Myanmar’s protected natural monopolies exercised over allocation of investors’ funds? Adverse selection and moral hazard might have existed as a consequence of the control that Myanmar’s protected natural monopolies exercised over allocation of investors’ funds. You Are There Will Renewable Energy “Leapfrog” African Nations to Higher Economic Growth? (p. 409) 1. In terms of the basic arithmetic of economic growth, through what mechanism do improvements in labor and capital productivity help to boost the rate of growth of per capita real GDP? Improvements in labor and capital productivity help to boost the rate of growth of per capita real GDP through an increase in the rate of growth in real GDP instead of the rate of growth in population. 2. How might Africa’s productivity improvements help to explain the recent growth reversal between advanced nations and developing and emerging countries? Africa is part of the developing economy, so that its productivity improvements help to explain the recent growth reversal between advanced nations and developing countries. Issues and Applications China’s One-Child Policy Relaxed – To Promote Economic Growth? (pp. 409–410) 1. Why does the fact that population growth has ambiguous effects on real GDP growth complicate the Chinese government’s efforts to accomplish its growth objective? An increase in population growth alone reduces the rate of growth of per capita real GDP. On the other hand, an increase in population growth might help raise the rate of growth of real GDP through an increase in the labor force. 2. In principle, how could a nation maintain a relatively high rate of economic growth even if it also has a relatively high range of population growth? Even if a nation has a relatively high rate of population growth, it can still maintain a relatively high rate of economic growth if its expanded labor force helps raise the nation’s rate of growth in real GDP. Research Project 1. Take a look at the bulge in China’s population of middle-aged and older residents in the Web Links in MyEconLab. 2. For one view regarding what China’s current population trends might mean for its future pool of labor resources, see the Web Links in MyEconLab. Answers to Problems 18-1. A country’s real GDP is growing at an annual rate of 3.1 percent, and the current rate of growth of per capita real GDP is 0.3 percent per year. What is the population growth rate in this nation? Population growth rate = real GDP growth rate ? rate of growth of per capita real GDP = 3.1 percent ? 0.3 percent = 2.8 percent. 18-2. The annual rate of growth of real GDP in a developing nation is 0.3 percent. Initially, the country’s population was stable from year to year. Recently, however, a significant increase in the nation’s birthrate has raised the annual rate of population growth to 0.5 percent. a. What was the rate of growth of per capita real GDP before the increase in population growth? b. If the rate of growth of real GDP remains unchanged, what is the new rate of growth of per capita real GDP following the increase in the birthrate? a. Rate of growth of per capita real GDP = 0.3 percent - 0 = 0.3 percent b. Rate of growth of per capita real GDP = 0.3 percent - 0.5 percent = -0.2 percent 18-3. A developing country has determined that each additional $1 billion of net investment in capital goods adds 0.01 percentage point to its long-run average annual rate of growth of per capita real GDP. a. Domestic entrepreneurs recently began to seek official approval to open a range of businesses employing capital resources valued at $20 billion. If the entrepreneurs undertake these investments, by what fraction of a percentage point will the nation’s long-run average annual rate of growth of per capita real GDP increase, other things being equal? b. After weeks of effort trying to complete the first of 15 stages of bureaucratic red tape necessary to obtain authorization to start their businesses, a number of entrepreneurs decide to drop their investment plans completely, and the amount of official investment that actually takes place turns out to be $10 billion. Other things being equal, by what fraction of a percentage point will this decision reduce the nation’s long-run average annual rate of growth of per capita real GDP from what it would have been if investment had been $20 billion? a. 20 × 0.01 percent = 0.2 percent. b. 10 × 0.01 percent = 0.1 percent. 18-4. Consider the estimates that the World Bank has assembled for the following nations: Country Legal steps required to start a business Days required to start a business Cost of starting a business as a percentage of per capita GDP Angola 14 146 838% Bosnia-Herzegovina 12 59 52% Morocco 11 36 19% Togo 14 63 281% Uruguay 10 27 47% Rank the nations in order, starting with the one you would expect to have the highest rate of economic growth, other things being equal. Explain your reasoning. Morocco or Uruguay, then Bosnia–Herzegovina, Togo, and Angola. The cost of starting a business is slightly higher in Uruguay than in Morocco. Starting a business in Uruguay requires fewer legal steps. One of these two nations is likely to experience higher growth, other things being equal, than the others. 18-5. Suppose that every $500 billion of dead capital reduces the average rate of growth in worldwide per capita real GDP by 0.1 percentage point. If there is $10 trillion in dead capital in the world, by how many percentage points does the existence of dead capital reduce average worldwide growth of per capita real GDP? $10 trillion/$0.5 trillion 0.1 percent = 2 percentage points. 18-6. Assume that each $1 billion in net capital investment generates 0.3 percentage point of the average percentage rate of growth of per capita real GDP, given the nation’s labor resources. Firms have been investing exactly $6 billion in capital goods each year, so the annual average rate of growth of per capita real GDP has been 1.8 percent. Now a government that fails to consistently adhere to the rule of law has come to power, and firms must pay $100 million in bribes to gain official approval for every $1 billion in investment in capital goods. In response, companies cut back their total investment spending to $4 billion per year. If other things are equal and companies maintain this rate of investment, what will be the nation’s new average annual rate of growth of per capita real GDP? $4 billion × 0.3 = 1.2 percent. 18-7. During the past year, several large banks extended $200 million in loans to the government and several firms in a developing nation. International investors also purchased $150 million in bonds and $350 million in stocks issued by domestic firms. Of the stocks that foreign investors purchased, $100 million were shares that amounted to less than a 10 percent interest in domestic firms. This was the first year this nation had ever permitted inflows of funds from abroad. a. Based on the investment category definitions discussed in this chapter, what was the amount of portfolio investment in this nation during the past year? b. What was the amount of foreign direct investment in this nation during the past year? a. Portfolio investment is equal to $150 million in bonds plus $100 million in stocks representing ownership of less than 10 percent, or $250 million. (Bank loans are neither portfolio investment nor foreign direct investment.) b. Foreign direct investment is equal to $250 million in stocks representing an ownership share of at least 10 percent. (Bank loans are neither portfolio investment nor foreign direct investment.) 18-8. Last year, $100 million in outstanding bank loans to a developing nation’s government were not renewed, and the developing nation’s government paid off $50 million in maturing government bonds that had been held by foreign residents. During that year, however, a new group of banks participated in a $125 million loan to help finance a major government construction project in the capital city. Domestic firms also issued $50 million in bonds and $75 million in stocks to foreign investors. All of the stocks issued gave the foreign investors more than 10 percent shares of the domestic firms. a. What was gross foreign investment in this nation last year? b. What was net foreign investment in this nation last year? a. $0, because net issues of bonds amounted to $50 million in bonds issued by domestic firms minus $50 in bonds retired by the government, or $0. (Bank loans are neither portfolio investment nor foreign direct investment.) b. $75 million in stocks representing at least a 10 percent ownership share. (Bank loans are neither portfolio investment nor direct foreign investment.) 18-9. Identify which of the following situations currently faced by international investors are examples of adverse selection and which are examples of moral hazard. a. Among the governments of several developing countries that are attempting to issue new bonds this year, it is certain that a few will fail to collect taxes to repay the bonds when they mature. It is difficult, however, for investors considering buying government bonds to predict which governments will experience this problem. b. Foreign investors are contemplating purchasing stock in a company that, unknown to them, may have failed to properly establish legal ownership over a crucial capital resource. c. Companies in a less developed nation have already issued bonds to finance the purchase of new capital goods. After receiving the funds from the bond issue, however, the company’s managers pay themselves large bonuses instead. d. When the government of a developing nation received a bank loan three years ago, it ultimately repaid the loan but had to reschedule its payments after officials misused the funds for unworthy projects. Now the government, which still has many of the same officials, is trying to raise funds by issuing bonds to foreign investors, who must decide whether or not to purchase them. a. adverse selection b. adverse selection c. moral hazard d. adverse selection 18-10. Identify which of the following situations currently faced by the World Bank or the International Monetary Fund are examples of adverse selection and which are examples of moral hazard. a. The World Bank has extended loans to the government of a developing country to finance construction of a canal with a certain future flow of earnings. Now, however, the government has decided to redirect those funds to build a casino that may or may not generate sufficient profits to allow the government to repay the loan. b. The IMF is considering extending loans to several nations that failed to fully repay loans they received from the IMF during the past decade but now claim to be better credit risks. Now the IMF is not sure in advance which of these nations are unlikely to fully repay new loans. c. The IMF recently extended a loan to a government directed by democratically elected officials that would permit the nation to adjust to an abrupt reduction in private flows of funds from abroad. A coup has just occurred, however, in response to newly discovered corruption within the government’s elected leadership. The new military dictator has announced tentative plans to disburse some of the funds in equal shares to all citizens. a. moral hazard b. adverse selection c. moral hazard 18-11. For each of the following situations, explain which of the policy issues discussed in this chapter relates to the stance the institution has taken. a. The World Bank offers to make a loan to a company in an impoverished nation at a lower interest rate than the company had been about to agree to pay to borrow the same amount from a group of private banks. b. The World Bank makes a loan to a company in a developing nation that has not yet received formal approval to operate there, even though the government approval process typically takes 15 months. c. The IMF extends a loan to a developing nation’s government, with no preconditions, to enable the government to make already overdue payments on a loan it had previously received from the World Bank. a. The company had already qualified for funding at a market interest rate, so the World Bank is interfering with functioning private markets for credit. In addition, by extending credit to the company at a below-market rate, the World Bank provides an incentive for the company to borrow additional funds for less efficient investment. b. In this situation, the World Bank effectively is tying up funds in dead capital. There is an associated opportunity cost because the funds could instead be allocated to another investment that would yield more immediate returns. c. In this case, the IMF contributes to a moral hazard problem because the government has every incentive not to make reforms that will enable it to repay this and future loans it may receive. 18-12. For each of the following situations, explain which of the policy issues discussed in this chapter relates to the stance the institution has taken. a. The IMF extends a long-term loan to a nation’s government to help it maintain publicly supported production of goods and services that the government otherwise would have turned over to private companies. b. The World Bank makes a loan to companies in an impoverished nation in which government officials typically demand bribes equal to 50 percent of companies’ profits before allowing them to engage in any new investment projects. c. The IMF offers to make a loan to banks in a country in which the government’s rulers commonly require banks to extend credit to finance high-risk investment projects headed by the rulers’ friends and relatives. a. In this situation, the IMF is making loans that otherwise would already have been forthcoming in the private market, so these funds otherwise could have been made to promote growth in a nation in which private credit would not have been forthcoming. b. This is a situation in which World Bank loans are unlikely to promote economic growth as a consequence of the high level of corruption in this nation. c. In this case, the IMF faces a significant adverse selection problem because most who desire to borrow will be poor credit risks. 18-13. Answer the following questions concerning proposals to reform long-term development lending programs currently offered by the IMF and World Bank. a. Why might the World Bank face moral hazard problems if it were to offer to provide funds to governments that promise to allocate the funds to major institutional reforms aimed at enhancing economic growth? b. How does the IMF face an adverse selection problem if it is considering making loans to governments in which the ruling parties have already shown predispositions to try to “buy” votes by creating expensive public programs in advance of elections? How might following an announced rule in which the IMF cuts off future loans to governments that engage in such activities reduce this problem and promote increased economic growth in nations that do receive IMF loans? a. There is an incentive for at least some governments to fail to follow through with reforms, even if those governments might have had good intentions when they applied for World Bank loans. b. National governments most interested in obtaining funds to “buy” votes will be among those most interested in obtaining IMF loans. The proposed IMF rule could help reduce the number of nations whose governments seek to obtain funds to try to “buy” votes. 18-14. Consider Table 18-1. Based on the basic arithmetic of economic growth, what were the average annual rates of real GDP growth since 1990 for those nations experiencing positive rates of annual growth of per capita real GDP? Chile: 3.7 percent + 1.1 percent = 4.8 percent. China: 8.2 percent + 0.7 percent = 8.9 percent. Egypt: 2.5 percent + 1.6 percent = 4.1 percent. Haiti: 1.5 percent + 0.4 percent = 1.9 percent. Indonesia: 3.6 percent + 1.4 percent = 5.0 percent. Malaysia: 3.8 percent + 2.0 percent = 5.8 percent. 18-15. Take a look at Table 18-1. Based on the basic arithmetic of economic growth, what were the average annual rates of real GDP growth since 1990 for those nations experiencing negative rates of annual growth of per capita real GDP? Congo Democratic Republic: ?1.9 percent + 2.8 percent = +0.9 percent. Liberia: ?0.5 percent + 3.0 percent = +2.5 percent. Madagascar: ?1.0 percent + 2.9 percent = 1.9 percent. Togo: ?0.1 percent + 2.5 percent = +2.4 percent. 18-16. Consider Figure 18-1. Average rates of population growth have been higher over the entire period covered by the figure in nearly all emerging and developing nations than in advanced nations. What does this tell us about a comparison of the average rate of growth of real GDP since 2000 in emerging and developing nations compared with advanced nations? The average rate of real GDP growth equals the average growth of per capita real GDP minus average population growth. Because emerging and developing nations have had both higher average growth of per capita real GDP and higher average population growth than in advanced nations since 2000, the average growth of real GDP has been significantly higher in the former than in the latter. 18-17. Take a look at Figure 18-1, and read the related text that discusses the exact values of the average growth rates displayed in the figure. Over the entire interval since 1981, which group of countries has experienced a higher rate of economic growth: emerging and developing nations or advanced nations? The average rate of economic growth for each group equals the sum of the average growth rate between 1988 and 1999 and the average growth rate between 2000 and 2017. For emerging and developing nations, this sum was 4.6 percent + 6.2 percent = 10.8 percent. For advanced nations, the sum was 5.5 percent + 3.3 percent = 8.8 percent. Average growth was higher for the former than for the latter. 18-18. Suppose that a foreign resident is contemplating buying 5 percent of the shares of a company based in a developing nation but is experiencing difficulty determining whether the firm is riskier than others in that country. What type of investment is this foreign resident considering, and what type of asymmetric information problem is he or she experiencing? Because the investment would involve purchasing less than 10 percent of the firm’s shares, this would be a portfolio investment. The foreign resident is having trouble determining higher-risk firms in advance of the investment, so this asymmetric-information problem is an adverse-selection problem. 18-19. Suppose that a foreign resident has bought 20 percent of the shares of a company based in a developing nation but is experiencing difficulty determine whether the firm has responded to this purchase by engaging in risker behavior. What type of investment has this foreign resident undertaken, and what type of asymmetric information problem is she or he experiencing? Because the investment has entailed purchasing more than 10 percent of the firm’s shares, it involves foreign direct investment. The foreign resident is having trouble determining higher-risk firms in following the investment, so this asymmetric-information problem is a moral-hazard problem. Selected References De Soto, Hernando, The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else, New York: Basic Books, 2001. Hogendorn, Jan S., Economic Development, Boston: Addison Wesley, 1997. Istituto Libertad y Democracia (ILD), Web site, www.ild.org.pe. Lynn, Stuart R., Economic Development: Theory and Practice for a Divided World, Prentice-Hall, 2003. Nafziger, Wayne E., Economics of Developing Countries, Prentice-Hall, 1997. Smith, Stephen C., Case Studies in Economic Development, 2nd ed., Boston: Addison Wesley, 1997. Todaro, Michael P. and Stephen C. Smith, Economic Development, Boston: Addison Wesley, 2003. Van den Berg, Hendrik, Economic Growth and Development, Burr Ridge, IL: McGraw-Hill, 2001.