THE SIMPLE ECONOMICS OF THE GLOBAL ECONOMY

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THE SIMPLE ECONOMICS OF THE GLOBAL ECONOMY

• Or, why are some nations (and some people in
  them) generally rich, while other nations (and
  most people in them) are generally quite poor.

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We start with the simple economics of national
income

• The people in a nation combine their labor with a
  stock of capital and certain raw materials and
  thereby produce good and services.
• What is labor?
• The work and managerial capacity of individuals
• What is capital
• Industrial machinery (trucks, forges, food
  processing facilities)
• Land its store of attributes (soil)
• What is raw materials?
• Minerals, trees, water

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These goods and services produced in the economy
represent the objects we purchase for our homes
and businesses.

• Those purchases are paid for out of the income
  received by those who own labor, capital, and raw
  materials and who sold or rented those objects to
  firms.
• To keep it pure and simple, the total value of
  goods and services produced in a nation represent
  Gross Domestic Product (GDP).
• With the proper accounting concepts, we can also
  say that GDP is a very close approximation of the
  total income received by those who contributed to
  the production process in that nation.

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GDP and GDI

• That is, gross domestic product is, by
  definition, close to gross domestic income
• Those who contributed labor to the production of
  goods and services received wages, tips, and
  salaries from the firms for whom they worked.
• Those who contributed capital to the production
  of goods and services received rent from those
  who used that capital.
• Those who contributed raw materials to the
  production of goods and services received income
  from the firms who bought those raw materials.

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In summary

• There is a direct relation between the total
  VALUE of goods and services produced in a nation,
  and its total national INCOME.
• We do not need to worry about the exact nature of
  that relationthis is a topic covered in a course
  in macroeconomics.
• The point is that in the process of producing
  goods and services, the owners of the factors of
  production (land, labor, capital, and managerial
  talent) necessary to bring forth the goods and
  services will receive payment for those services
  used in that production. Hence GDP
  (approximately) National Income.
• GDP is the most common indicator of the economic
  well being of countries, and thus of their
  income level.

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The point here is to show how the production of
goods and services yields both the outputs of
an economy as well as the income necessary to
purchase those outputs.
FIRMS
Income from households is used to purchase goods
and services from firms
Labor services provided by households result in
incomes flowing to households
HOUSEHOLDS
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The next step is to show how some nations manage
to do this well, while others are less successful

• Those nations who manage to do it well are called
  developed and they tend to be rich.
• Those nations who do it badly are called less
  developed and they tend to be poor.
• I do not like these terms (developed and less
  developed) but that is how the conversation is
  usually structured.

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Before we do that, let us consider the empirical
evidence of rich and poor nations

• The next graph depicts an array of nations from
  the very richest (Luxembourg) to the very poorest
  (Burundi) in 2006.
• The GDP figures here are in terms of purchasing
  power parity in 2006.
• Purchasing power parity seeks to correct income
  levels for underlying differences in price levels
  so that the same income across countries can buy
  approximately the same bundle of goods and
  services

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The ability of a nation to organize its economy
to produce a great deal in the way of goods and
services depends on a number of factors

• The quantity and quality of its labor force
• The quantity and quality of its capital stock
• The quantity and quality of its raw materials
• And if the nation is lacking in the quantity
  of these factors or production it may be
  possible to engage in trade to augment those
  factorsimport labor, import capital equipment,
  import raw materials.

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Quantity is one thing, quality is quite another.
If the quality is low, several strategies exist

• Labor quality can be improved by education
• Capital quality can be improved by technical
  change
• Raw material quality can be improved by cleaning
  up polluted waters, by protecting fish stocks and
  forests.

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GDP depends on the quantity and quality of these
factors of production, but it also depends on
several other issues.

• How are those factors combined in the production
  process? This is both technical and economic.
• Are labor and capital used in the most effective
  physical proportions?
• Are they used according to their relative
  prices?
• What are the legal foundations of the economy?
  These are the economic INSTITUTIONS.
• Are contracts clear and equitable?
• Are property arrangements clear?
• Do credit markets work well?

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These issues concern the productivity of the
economy

• Is the best possible use being made of the
  productive factors (labor, capital, raw
  materials) that are available in the
  nation-state?
• Do the institutions of the economy foster
  productivity?

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THE ORIGINS AND LOGIC OF GDP (and GDI).
NATURAL RESOURCES
TRADE (IMPORTS)
POPULATION
CAPITAL EQUIPMENT
TOTAL FACTOR ENDOWMENTS
INSTITUTIONS
PRODUCTIVITY OF FIRMS IN THE ECONOMY
OUTPUT OF GOODS AND SERVICES (GDP)
TRADE (EXPORTS)
SALES TO OTHER FIRMS AND HOUSEHOLDS
INCOME (GDI)
Modified from Dani Rodrik, In Search of
Prosperity, 2003.
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We see here how everything has to work well (and
in harmony) for the economy to produce much in
the way of goods and services.

• Indeed, perhaps the appropriate metaphor is that
  of a symphony orchestra.
• Each component must do well, and each component
  must complement the actions of all other
  components.
• Natural resources must be abundant and cheaply
  available.
• Labor must be good (educated trained) and
  properly rewarded for its efforts.
• Capital must be good and properly deployed.
• The institutional aspects of the economy must be
  well formulated and conduce to productivity.
• There must be imports of critical factors that
  are in short supply.
• Owners and managers of firms must be alert and
  agile.

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We now turn to the general situation in the
global economy

• The next slide shows a general classification of
  the world into categories depending on the nature
  and extent of their participation in the global
  economy.

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Source Philip W. Porter and Eric S. Shepphard,
1998. A WORLD OF DIFFERENCE, New York The
Guilford Press. P. 19.
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The previous figure depicts countries as core
and periphery

• This terminology concerns the extent of a
  countrys connection toand involvement inthe
  global economy (trade)
• We also see national income differences depicted
  in the figure
• The term NIC means newly independent (from
  Soviet control) countries. They are
  transition economies because they are moving
  from a centralized planned economy to a market
  economy.

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Some time perspective is useful here

• Specifically, world history is one of colonialism
  until the 1960s
• It is also a history of very little international
  trade until after World War II
• This coincided with the wave of post-colonial
  independence across Latin America, Asia, and
  Africa.
• Let us look at this situation of colonial control
  in 1900 (next slide). The vertical axis is a
  RATIO of controlled people (in the colonies) to
  controlling people (in the colonial power)

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We see that the major colonial powers exercised
great control over the political and economic
circumstances in the tropics.Colonialism was
(is) the imposition of economic, political, and
social control by a richer and more powerful
nation over a weaker and poorer nation.For
instance, in 1890 Great Britain and Ireland had a
population of 38 million and ruled an empire with
almost 400 million people.
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The next two figures show

• Trends in the value of exports and imports for
  the United States between 1965 and 1995.
• A comparison of several countries concerning the
  relative importance of foreign trade as a percent
  of national income.
• Notice that while the U.S. is a major trading
  nation, as a share of our national income we are
  much less connected to the global economy than
  are, for example Germany, South Korea, and the
• Netherlands (Figure 1.2).

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The next slides show the situation at the
beginning of the 20th century.Notice the meager
role of trade as a share of the U.S.
economy.Notice also which countries were the
big trading nationsthose that were colonial
powers. We might regard this trade as a
special case since the web of colonial ties was
so pronounced at this time.
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And now we see the growth performance of a few
countries since 1900.The vertical axis is a
growth multiplethat is, how much greater GDP
is over time.
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And where do matters stand today?
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A Picture of the Global Village

• In the next slide we see a simple story about the
  nature of the global village.
• We see that the United States is a minority in
  most every category.
• The important exception is our control of so much
  of the worlds income (GDP).
• This disparity turns out to be a major source of
  both envy and of resentment
• We are envied for what we have, and we are
  resented because much of what we have has come
  from our military and industrial hegemony and its
  associated perverse influences abroad,

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It is estimated that the richest 40 percent of
the global village receive (have control over)
94 percent of the worlds income, while the
remaining 60 percent of the population receive
(have control over) only 6 percent of the
income. Indeed, the richest 20 percent of the
worlds people receive (have control over) almost
83 percent of all the income (purchasing power)
in the world. Having control over income is
directly translatable into the ability to consume
goods and services. That is, since most people
spend as much as they have (earn), the more
income you have the more stuff you can acquire.
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This is the basis for the claim that the U.S. has
a small share of the worlds population380
million (/-) out of a total of 6 billion (/-)
(about 6 percent) yet we consume some large
proportion (25-35 by some estimates) of stuff.

• The next slides indicate the distribution of
  income in the world. We see that a small
  fraction of the worlds population (left scale)
  has control over a very large share of total
  income (right scale).

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Distribution of the Worlds Income
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Measuring income distribution

• The previous graph reveals the shares of national
  income received by different income categories.
  That is, we can look at the richest 20 percent of
  the population, the second richest 20 percent,
  etc. These categories that break the population
  into fifths are called quintiles. If we divided
  the population into quarters we would call them
  quartiles, and into tenths we would call them
  deciles.
• I like to compute the share of income received by
  the richest and poorest quintiles (fifths).

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This comparison of income shares depicts what I
call economic involution. In mathematics,
involution refers to the process of multiplying a
number by itself a large number of times. It is,
in essence the raising to a power. In
embryology, involution refers to the in-growth
and curling inward of a group of cells. I
define economic involution as a process whereby a
large share of national income goes to a small
group of households. In the following tables I
show, for a sample of countries, the share of
national income accruing to the richest 20
percent of households (the numerator) as a ratio
of the share of national income accruing to the
poorest 20 percent of households (the
denominator). I call this 20/20 Involution or
I-20/20.
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Notice in the following tables that countries in
sub-Saharan Africa and Latin America tend to have
greater degrees of income inequality than we find
in Asia.Also notice the differences between the
group of European countries (Sweden, Finland,
Norway, Italy, Germany). These are very rich
countries and yet they have a much more
egalitarian ethic than we have in the U.S.This
fact reflects, in some indirect way, the moral
views regarding social stratification. That
is, the distribution of income within a country
is a policy variable that can be manipulated.
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I-20/20 for a sample of countries in sub-Saharan
Africa (source World Development Indicators,
IBRD, 2004)
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I-20/20 for a sample of countries in Latin
America(source World Development Indicators,
IBRD, 2004)
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I-20/20 for a sample of countries in
Asia(source World Development Indicators, IBRD,
2004)
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I-20/20 for a sample of high-income
countries(source World Development Indicators,
IBRD, 2004)
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Notice that being rich (that is, having a high
per capita GDP) has little bearing on the extent
of inequality in how that income is received
(shared) among the population.Compare the U.S.
and Norway
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Notice, as well, that being poor has little
bearing on the degree of inequality.Compare
Guatemala and Peru, or Lesotho and Ghana
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Summary

• We see great disparities in GDP (and income)
  across countries, and within countries.
• At the extreme, Luxembourg has 83 times the per
  capita GDP as does Sierra Leone.
• Considering income distribution within countries,
  the richest quintile in Sierra Leone has 58 times
  the income as does the poorest quintile.
• At the other extreme, we see that the most
  egalitarian nations (Finland and Norway) have an
  I-20/20 ratio of only 3.7.

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Income, Human Well Being, and the Environment

• We are dealing with enormous disparities of
  incomeand thus purchasing poweracross nations
  of the world, and also within individual
  nations.
• These disparities influence how individuals use
  the environment, and they influence the welfare
  of people within individual nations. In fact,
  one of the dominant factors related to poor
  health and well being of a population is NOT the
  level of income within an individual country. It
  is, instead, the disparities of income WITHIN
  individual countries.