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Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized / sv4t'x'4.;. vg *-,.-~ 7; Volume 15 ' 2001 Number 2 XI- -l 7, - OXF;ORD I SSN 02s S 6 ()7 THE WORLD BANK ECONOMIC REVIEW EDITOR FranSois Bourguignon, World Bank EDITORIAL BOARD Abhijit Banerjee, Massachusetts Institute of Justin Yifil Lin, China Centerfor Economic Technology, USA Research, Peking University, China Kaushik Basu, Cornell University, USA Mustapha Kamel Nabli, World Bank Tim Besley, London School of Economics, UK Juan Pablo Nicolini, Universidad di Tella, Anne Case, Princeton University, USA Argentina Stijn A. Claessens, University ofamsterdam, Howard Pack, University ofpennsylvania, USA The Netherlands Jean-Philippe Platteau, Facult/s Universitaires Paul Collier, World Bank Notre-Dame de la Paix, Belgium David R. Dollar, World Bank Boris Pleskovic, World Bank Antonio Estache, World Bank Martin Ravallion, World Bank Augustin Kwasi Fosu, African Economic Carmen Reinhart, University ofmaryland, USA Research Council, Kenya Mark R. Rosenzweig, University of Mark Gersovitz, The Johns Hopkins Pennsylvania, USA University, USA Joseph E. Stiglitz, Stanford University, USA Jeffrey S. Hammer, World Bank Moshe Syrquin, University of Miami, USA Karla Hoff, World Bank Vinod Thomas, World Bank Gregory K. Ingram, World Bank Jan Willem, Free University, Amsterdam, The Ravi Kanbur, Cornell University, USA Netherlands Elizabeth M. King, World Bank L. Alan Winters, University of Sussex, UK The World Bank Economic Review is a professional journal for the dissemination of World Bank-sponsored and outside research that may inform policy analyses and choices. It is directed to an international readership among economists and social scientists in government, business, and international agencies, as well as in universities and development research institutions. The Review emphasizes policy relevance and operational aspects of economics, rather than primarily theoretical and methodological issues. It is intended for readers familiar with economic theory and analysis but not necessarily proficient in advanced mathematical or econometric techniques. Articles will illustrate how professional research can shed light on policy choices. Inconsistency with Bank policy will not be grounds for rejection of an article. Articles will be drawn from work conducted by World Bank staff and consultants and from papers submitted by outside researchers. Before being accepted for publication, all articles will be reviewed by two referees who are not members of the Bank's staff and one World Bank staff member. Articles must also be recommended by a member of the Editorial Board. Non-Bank contributors are requested to submit a proposal of not more than two pages in length to the Editor or a member of the Editorial Board before sending in their paper. Comments or brief notes responding to Review articles are welcome and will be considered for publication to the extent that space permits. Please direct all editorial correspondence to the Editor, The WorldBank Economic Review, The World Bank, 1818 H Street, Washington, DC 20433, USA, or For more information, please visit the Web sites of the Economic Review at the World Bank at and Oxford University Press at THE WORLD BANK ECONOMIC REVIEW Volume * Number 2 WHAT HAVE WE LEARNED FROM A DECADE OF EMPIRICAL RESEARCH ON GROWTH? It's Not Factor Accumulation: Stylized Facts and Growth Models 177 William Easterly and Ross Levine Comment on It's Not Factor Accumulation: Stylized Facts and Growth Models 221 Pete Klenow Comment on It's Not Factor Accumulation: Stylized Facts and Growth Models 225 Paul Romer Growth Empirics and Reality 229 William A. Brock and Steven N. Durlauf Comment on Growth Empirics and Reality 273 Lant Pritchett Comment on Growth Empirics and Reality 277 Xavier Sala-i-Martin Applying Growth Theory across Countries 283 Robert M. Solow Crisis Transmission: Evidence from the Debt, Tequila, and Asian Flu Crises 289 Jose' De Gregorio and Rodrigo 0. Valde's Mutual Fund Investment in Emerging Markets: An Overview 315 Graciela L. Kaminsky, Richard K Lyons, and Sergio L. Schmukler The World Bank Economic Review (ISSN ) is published three times a year by Oxford University Press, 2001 Evans Road, Cary, NC for The International Bank for Reconstruction and Development / THE WORLD BANK. Communications regarding original artides and editorial management should be addressed to The Editor, The World BankEconomicReview, 66, avenue d'1ena, Paris, France. Oxford University Press is a department of the University of Oxford. It furthers the University's objective of excellence in research, scholarship, and education by publishing worldwide. SUBSCRIPTIONS: Subscription is on a yearly basis. The annual rates are US$40 ( 30 in UK and Europe) for individuals; US$90 ( 63 in UK and Europe) for academic libraries; US$110 ( 75 in UK and Europe) for corporations. Single issues are available for US$17 ( 13 in UK and Europe) for individuals; US$38 ( 26 in UK and Europe) for academic libraries; US$46 ( 31 in UK and Europe) for corporations. All prices include postage. Individual rates are applicable only when a subscription is for individual use and are not available if delivery is made to a corporate address. Subscriptions are providedfree of charge to non-oecd countries. All subscription requests, single issue and back issue orders, changes of address, and claims for missing issues should be sent to: NorthAmerica: Oxford University Press, Journals Customer Service, 2001 Evans Road, Cary, NC , USA. Toll-free in the USA and Canada: , or Fax: Elsewhere: Oxford University Press, Journals Customer Service, Great Clarendon Street, Oxford OX2 6DP, UK. Tel: Fax: ADVERTISING: Helen Pearson, Oxford Journals Advertising, P.O. Box 347, Abingdon SO, OX14 1GJ, UK. Tel/Fax: REQUESTS FOR PERMISSIONS, REPRINTS, AND PHOTOCOPIES: All rights reserved; no part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without either prior written permission of the publisher (Oxford University Press, Journals Rights and Permissions, Great Clarendon Street, Oxford OX2 6DP, UK; tel: ; fax: ) or a license permitting restricted copying issued in the USA by the Copyright Clearance Center, 222 Rosewood Drive, Danvers, MA (fax: ), or in the UK by the Copyright Licensing Agency Ltd., 90 Tottenham Court Road, London WlP 9HE, UK. Reprints of individual articles are available only from the authors. COPYRIGHT: Copyright (C) 2001 The International Bank for Reconstruction and Development / THE WORLD BANK. It is a condition of publication in the journal that authors assign copyright to The International Bank for Reconstruction and Development / THE WORLD BANK. However, requests for permission to reprint material found in the journal should come to Oxford University Press. This ensures that requests from third parties to reproduce articles are handled efficiently and consistently and will also allow the article to be disseminated as widely as possible. Authors may use their own material in other publications provided that the journal is acknowledged as the original place of publication and Oxford University Press is notified in writing and in advance. INDEXING AND ABSTRACTING: The World Bank Economic Review is indexed and/or abstracted by CAB Abstracts, Current Contents/Social and Behavioral Sciences, Journal of Economic Literature/EconLit, PAIS International, RePEc (Research in Economic Papers), and Social Sciences Citation Index. The microform edition is available through UMI, 300 North Zeeb Road, Ann Arbor, MI 48106, USA. PAPER USED: The World Bank Economic Review is printed on acid-free paper that meets the minimum requirements of ANSI Standard Z (Permanence of Paper). POSTAL INFORMATION: The World Bank Economic Review (ISSN ) is published three times a year by Oxford University Press, 2001 Evans Road, Cary, NC Send address changes to The WorldBank Economic Review, Journals Customer Service Department, Oxford University Press, 2001 Evans Road, Cary, NC THE WORLD BANK ECONOMIC REVIEW, VOL. 15, NO. Z I What have we learned from a decade of empirical research on growth? It's Not Factor Accumulation: Stylized Facts and Growth Models William Easterly and Ross Levine The article documents five stylized facts of economic growth. (1) The residual (total factor productivity, TFP) rather than factor accumulation accounts for most of the income and growth differences across countries. (2) Income diverges over the long run. (3) Factor accumulation is persistent while growth is not, and the growth path of countries exhibits remarkable variation. (4) Economic activity is highly concentrated, with all factors of production flowing to the richest areas. (5) National policies are closely associated with long-run economic growth rates. These facts do not support models with diminishing returns, constant returns to scale, some fixed factor of production, or an emphasis on factor accumulation. However, empirical work does not yet decisively distinguish among the different theoretical conceptions of TFP growth. Economists should devote more effort toward modeling and quantifying TFP. The central problem in understanding economic development and growth is not understanding the process by which an economy raises its savings rate and increases the rate of physical capital accumulation. 1 Although many development practitioners and researchers continue to target capital accumulation as the driv- William Easterly is senior advisor, Development Research Group, at the World Bank. His address is Ross Levine is with the University of Minnesota. His address is The authors are grateful to Lant Pritchett, who shaped the paper, gave comments, and provided many of the stylized facts. They also thank Francois Bourguignon, Ashok Dhareshwar, Robert G. King, Michael Kremer, Peter Klenow, Paul Romer, Xavier Sala-i-Martin, Rohert Solow, Albert Zeufack, two anonymous referees, and students and faculty at the Economics Education Research Consortium program in Kiev, Ukraine, Harvard University's Kennedy School of Government, and Johns Hopkins School of Advanced International Studies for useful comments. An earlier version of this article was presented at the World Bank conference What Have We Learned from a Decade of Empirical Research on Growth? held on 26 February This is a reversal and slight rewording of Arthur Lewis's (1954, p. 155) famous quote, The central problem in the theory of economic development is to understand the process by which a community which was previously saving and investing 4 or 5 percent of its national income or less, converts itself into an economy where voluntary saving is running at about 12 to 15 percent of national income or more. This is the central problem because the central fact of development is rapid capital accumulation (including knowledge and skills with capital). Though Lewis recognizes the importance of knowledge and skills and later in his book highlights the importance of institutions, many development economists who followed Lewis adopted the more limited focus on savings and physical capital accumulation. (C 2001 The International Bank for Reconstruction and Development / TH- WORI) BANK 177 178 THE WORLD BANK ECONOMIC REVIEW, VOL. 15, NO. Z ing force in economic growth, 2 something else besides capital accumulation is critical for understanding differences in economic growth and income across countries. This conclusion is based on evidence on the sources of economic growth, the patterns of economic growth, the patterns of factor flows, and the impact of national policies on economic growth. This study does not argue that factor accumulation is unimportant in general or deny that it is critically important for some countries at specific junctures. As Robert Solow noted in 1956, economists construct models to reproduce crucial empirical regularities and then use these models to interpret economic events and make policy recommendations. This article documents important empirical regularities about economic growth with the hope of highlighting productive directions for future research and improving public policy. I. SOMETHING ELSE A growing body of research suggests that, even after physical and human capital accumulation are accounted for, something else accounts for the bulk of crosscountry differences in the level and growth rate of gross domestic product (GDP) per capita. Economists typically refer to the something else as total factor productivity (TFP). This article follows that convention. Different theories offer very different conceptions of TFP. These range from changes in technology (the instructions for producing goods and services) to the role of externalities, changes in the sector composition of production, and the adoption of lower-cost production methods. Evidence that confidently assesses how well these conceptions of TFP explain economic growth is lacking. Economists need to provide much more shape and substance to the amorphous term TFP, distinguishing empirically among these different theories. This article examines five stylized facts that illuminate TFP and its determinants to enable more precise modeling of long-run economic growth and the design of appropriate policies. 2. Academic researchers in the 1990s started a neoclassical revival (in the words of Klenow and Rodriguez-Clare 1997b). The classic works in the academic literature's stress on factor accumulation were Mankiw, Romer, and Weil (1992); Barro and others (1995); Mankiw (1995); and Young (1995). The summary of the Global Development Network conference in Prague in June 2000, representing many international organizations and development research institutes, says physical capital accumulation was found to be the dominant source of growth both within and across regions. Total factor productivity growth (TFPG) was not as important as was previously believed (u'ww.gdnet.org/pdfs/ GRPPragueMtgReport.pdfl. A leading development textbook (Todaro 2000) says that an increase in investment is a necessary condition for economic takeoff. The development textbook of Ray (1998, p. 54) refers to investment and saving as the foundations of all models of economic growth. Many development practitioners also stress investment. For example, the International Monetary Fund (Hadjimichael and others 1996, p. 1) argues, The adjustment experience of sub-saharan Africa has demonstrated that to achieve gains in real per capita GDP an expansion in private saving and investment is key. The Bank for International Settlements (1996, p. 50) concludes, Recent experience has underlined the central importance of national saving and investment rates in promoting growth. And the International Labor Organization (1995, p. 12) argues that policies to raise the rate of investment... I Easterly and Levine 179 * Stylized fact 1. Factor accumulation does not account for the bulk of crosscountry differences in the level or growth rate of GDP per capital; something else-tfp-does. In the search for the secrets of long-run economic growth, a high priority should go to rigorously defining TFP, empirically dissecting it, and identifying the policies and institutions most conducive to its growth. * Stylized fact 2. There are huge and growing differences in GDI' per capita; divergence-not conditional convergence-is the big story. An emphasis on TFP growth with increasing returns to technology is more consistent with divergence than are models of factor accumulation with decreasing returns, no scale economies, and some fixed factor of production. Over the past two centuries, the big story has been the widening difference between the richest and the poorest countries. Moreover, the growth rates of the rich are not slowing, and returns to capital are not falling. Just as business cycles look like little wiggles around the big story when viewed over a long horizon, understanding slow, intermittent conditional convergence seems less intriguing than uncovering why the United States has enjoyed steady growth for 200 years while much of world still lives in poverty. * Stylized fact 3. Growth is not persistent over time, but capital accumulation is. Some countries take off, others experience peaks and valleys, a few grow steadily, and some have never grown. Changes in factor accumulation do not closely track changes in economic growth. This finding is consistent across very different frequencies of data. Tangentially, but critically, this stylized fact also suggests that models of steady-state growth, whether based on capital externalities or technological spillovers, will not capture the experiences of many countries. While steady-state growth models may fit U.S. experience over the past 200 years, these models will not fit the experiences of Argentina, the Republic of Korea, Thailand, or Venezuela very well. In contrast, models of multiple equilibria do not fit the U.S. data very well. Thus models tend to be country-specific rather than general theories. Meanwhile, empirical work is still going on to explain why the United States is different, how are critical for raising the rate of growth and employment in an economy. Finally additional investment is the answer-or part of the answer-to most policy problems in the economic and social arena (United Nations 1996, p. 8). Similarly, the World Bank (1993, p. 191) states that in East Asia, accumulation of productive assets is the foundation of economic growth. World Bank (1995, p. 10, 23) promises that in Latin America enhancing saving and investment by 8 percentage points of GDP would raise the annual growth figure by around 2 percentage points. The World Bank (2000a, p. 10) says the saving rate of the typical African country is far below what is needed to sustain a long-term boost in economic performance. The World Bank (2000c, p. 1) says that southeastern Europe can seize trade opportunities only if domestic and foreign entrepreneurs increase their investment dramatically. For more citations, see Easterly (I 999a) and King and Levine (I1994). Although common, the stress on capital accumulation is far from universal among development practitioners and researchers. For example, the World Bank (2000b, p. 4) report on East Asia's recovery suggests that future growth hinges less on increasing physical capital accumulation and more on raising the productivity growth of all factors. Collier, Dollar, and Stern (2000) stress policies, incentives, institutions, and exogenous factors as the main drivers in growth with little mention of investment, as does World DeVelopment Report 2000/ 2001 (World Bank 2000/2001, pp ). 180 THE WORLD BANK ECONOMIC REVIEW, VOL. 15, NO. 2 Argentina can go from being like the United States early in this century to the struggling middle-income country it is today, and how Korea or Thailand can go from being like Somalia to having thriving economies. * Stylized fact 4. All factors of production flow to the same places, suggesting important externalities. Although this has been noted and modeled by Lucas (1988), Kremer (1993), and others, this article further demonstrates the pervasive tendency for all factors of production, including physical and human capital, to bunch together. As a consequence, economic activity is highly concentrated. This tendency holds whether considering the world, countries, regions, states, ethnic groups, or cities. Thus the something else that accounts for the bulk of differences in growth across these units needs to be fleshed out and given a prominent position in theories and policy recommendations. * Stylized fact 5. National policies influence long-run growth. In models with zero productivity growth, diminishing returns to factors of production, and s
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