# Presentation: 216430

## New Policiesfor Economic Development

- John B. TaylorUnder Secretary for International AffairsUnited States Treasury
- Bretton Woods Committee Annual Meeting
- June 6, 2002

## 1.3 billion people, less than $1 per day 

- 1.3 billion people, less than $1 per day
- 1⁄2 world’s population, less than $2 per day U.S. average, $90 day.   Why?     **Map source: World Bank*

## The Key to Poverty Reductionis Higher Productivity Jobs 

***Productivity = output (Y) per hour of work (L) = Y/L***
- Sometimes called _labor_ productivity
- It’s “_the_ explanation” why some countries are rich and other countries are poor
- Countries that are behind in productivity are behind in income per capita
- Productivity _growth_ is how to achieve _higher_ income per capita

## A Founding Principle of IDA

- 	“The purposes of the Association are to promote economic development, increase productivity and thus raise standards of living in the less-developed areas of the world....The Association shall be guided in all its decisions by the provisions of this Article.” -- *Articles of Agreement for the International Development Association*

## Economic Growth Theory

- Growth accounting:  higher productivity jobs (Y/L) requires more capital (K/L) or better technology (T)
- If there are no impediments to the flow and use of ***technology*** and ***capital***, then countries or regions that are behind in productivity should have higher productivity growth: _they should be catching-up_
- Three issues:
- Capital should flow to where returns are relatively high
- Spread of technology through education, foreign direct investment, internet, etc.
- Private sector is _the_ creator of higher productivity jobs

## Poor but growing more rapidly 

- 33_01

**LEVEL OF PRODUCTIVITY **

**                          ****OR **

**LEVEL OF INCOME PER CAPITA**

**GROWTH RATE OF **

**PRODUCTIVITY **

**             ****OR **

**GROWTH RATE OF **

**INCOME PER CAPITA**

- Catch-up line

- Rich but growing
- more slowly

- Poor but growing more rapidly

- 33_02

- Florida

- Texas

- New York

- California

- Illinois

**3.5 **

**3.0 **

**2.5 **

**2.0 **

**1.5 **

**1.0 **

**0.5**

**GROWTH RATE OF **

**INCOME PER CAPITA, 1880-1980**

**300**

**1,000**

**5,000**

**INCOME PER CAPITA IN 1880 **

- (RATIO SCALE)

- States in the United States:
- Catch-Up Clearly Seen

## More Advanced Countries: 

- 1.5%

- 2.5%

- 3.5%

- 4.5%

- 0

- 3000

- 6000

- 9000

- 12000

- 15000

- 18000

**REAL GDP PER CAPITA IN 1960 (1995 $)**

**ANNUAL GROWTH RATE OF REAL **

**GDP PER CAPITA, 1960-1999**

- More Advanced Countries:

- Catch-Up Seen Here Too

- Portugal

- Greece

- Spain

- Italy

- Sweden

- Ireland

- UK

- Denmark

- Belgium

- Norway

- Canada

- Austria

- Luxembourg

- U.S.

- Turkey

- France

- Netherlands

## -2.0%

- 0.0%

- 2.0%

- 4.0%

- 6.0%

- 8.0%

- 0

- 2,000

- 4,000

- 6,000

- 8,000

- 10,000

- 12,000

- 14,000

- 16,000

- 18,000

**REAL GDP PER CAPITA IN 1960 (1995 $)**

**ANNUAL GROWTH RATE OF REAL **

**GDP PER CAPITA, 1960-1999**

## Recent Productivity Trends

- East Asia			 		5.5
- United States		 		2.1
- Europe			 		1.2
- Latin America 				0.7
- Middle East				-0.1
- Africa (Sub-Saharan) 			-0.5

**Annual labor**
**productivity growth, **
**1991-99 (%)**

## An Addition to the Millennium Goals: Productivity Growth 

- Countries with lower productivity than the U.S. should grow faster than the U.S.
- The greater the productivity gap between the U.S. and a country the greater should be the productivity growth rate in that country
- Could the goal be quantified?
- Productivity gap 5 times  growth rate difference 3
- Productivity gap 10 times  growth rate difference 5
- Productivity gap 100 times  growth rate difference 9

## Poverty and Productivity Growth

- Some argue that the focus on economic growth will mean less focus on poverty reduction
- Simple logic: With productivity 100 times lower in poor countries, “catch up” in *average* incomes completely dominates changes in income *distribution*
- Empirical studies demonstrate that higher productivity growth increases the income per capita of the lowest quintile by about the same amount as the other quintiles

## Why Isn’t There More Catch Up?

- Very difficult question
- Key factor:  _impediments_ and _disincentives_ to the spread and to the application of technology and capital

## Reasons for Lack of Catch Up

- Poor governance
- weak rule of law, corruption
- creates disincentives to invest, to start up new firms, to expand existing firms
- Poor education
- reduces human capital
- impedes adoption of new technologies
- Restrictions on economic transactions
- lack of openness to trade, state monopolies, and excessive regulation
- reduce incentives for innovation and investment needed to boost productivity

## The New Agenda

**Increase foreign aid**
- (1) Funding for Millennium Challenge Account to increase to $5 billion a year by 2006 — a 50% increase over and above existing U.S. development assistance
- (2) Contribution to World Bank’s International Development Association (IDA) increase by 18%
- (3) Larger fraction of IDA aid in form of outright grants rather than loans
- Let **good performance** determine which countries get aid for economic development

## Millennium Challenge Account

- Good policy performance in three areas:
- “Ruling justly” (lack of corruption)
- “Investing in people” (good education, health policy)
- “Encouraging economic freedom” (reduce trade barriers)
- Theory and evidence says that these will increase productivity growth
- Now working on objective criteria in each area:
- using “growth regression” research over last 10 years
- needs to be simple, robust

## Funding for the Millennium Challenge Account

## Results-Based IDA Replenishment

- U.S. is proposing to increase IDA contribution by 18% in the current replenishment
- Year One: $850 million
- Year Two: $950 million
- Year Three: $1,050 million
- Each $100 million increment in year two and three would depend on performance in combating disease and improving education

## From Loans to Grants

- U.S. has proposed converting IDA loans to grants
- Loans already have highly favorable terms
- Yet inability to repay yields calls for debt forgiveness
- So we want to “stop the debt”
- Grants can be tied to performance, for example, better test scores in basic skills
- Grants promote debt sustainability better than 100 percent debt forgiveness of old MDB debt (GAO)