Question

Between 2000 and 2009, real output per person in the emerging world grew at an average annual rate of 7.6%, 4.5 percentage points higher than the rate seen in rich countries. As a result, the gap between the developed and developing worlds narrowed quickly over the period. Since 2009, growth rates in the developing world have dropped and were only 1.1 percentage points higher than developed countries in 2013. Projections for 2014 put growth in developing countries just 0.39 percentage points above those in developed countries. a) Use the economic growth model to explain the convergence hypothesis. Include a diagram in your response. b) Discuss what factors could have driven the rapid growth in the developing world from 2000- 2009. c) What factors are important to sustain long run growth in these developing economies? Explain. d) In 2009, per capita GDP in developed economies was on average 3.6 times as large as in developing economies. If per capita growth maintained the same rates as between 2000 and 2009, it would take about 30 years for developing countries to catch up to the developed world. If per capita growth slows to 4.2% in developing countries and remains at 3.1% in developed countries, how many years would it take developing economies to catch up to developed economies? (Round to the nearest year)

Answer 1

a. Economic growth can be shown through PPC model. In this model PPC - Production possibility curve shifts to right and hence country can produce at higher potential.

The convergence theory in short states that poorer countries grow at faster rates than richer economies. Because, capital-rich countries have higher diminishing returns to capital. Also a fact that developing countries can follow production methods, technologies, and institutions of developed countries. Hence all countries 'converge'.

b) Discuss what factors could have driven the rapid growth in the developing world from 2000- 2009.

A strong demand from developed countries. As developed countries were thriving, they invested a lot of money in developing countries. It is also a fact that world economy was having a very high pace of liberalization and privatization that led to globalization. Asian countries were showing high readiness to adopt latest technologies to increase production and productivity. Also, to get lower costs many companies were moving to developing countries. Information technology revolution created many jobs all across the world and played important role in achieving high standard of living.

c) What factors are important to sustain long run growth in these developing economies? Explain.

All developing economies should adopt a proper mix of demand side policies which have fiscal and monetary policies.

During an inflationary level, govt. can adopt contractionary fiscal policy(Raising tax rates and decreasing govt. spending) and central bank can have contractionary monetary policy ( raising interest rates and lowering money supply ).

During an deflationary level, govt. can adopt expansionary fiscal policy(lowering tax rates and increasing govt. spending) and central bank can have expansionary monetary policy ( lowering interest rates and increasing money supply ).

However, both these policies have policy conflicts. Example to raise economic output expansionary policies may lead to inflation and cause vicious cycle in an economy.

To avoid these conflicts, a solid supply side policies are needed. These policies are of two types- Market based and interventionist based.

In market based- labour market reforms, encouraging competition and creating a business friendly environment is involved. In Interventionist based policy focus is on creating human and physical capital. If this capital is supporting the policies implemented by govt and central bank then policy conflicts can be lowered and long run solid development can be achieved. However, it should be noted that supply side policies are long term ,need time and investments.

Hence if policymakers want to maintain short term employment at highest level and does not want to stress govt. budget then capacity building through supply side policy along with proper combination of monetary and fiscal policies is needed so that economy is kept busy without inflationary impacts.

Along with these policies exchange rate policies like devaluation or revaluation can also be considered.

d. It will take 10 years.

When gap of 3.6 times:   30 years

When gap of 1.2 times….?

3.6 x= 1.2*30= 36

x= 10 years.