Thursday, 22 November 2012

Graph of the week: Doubling your GDP

Is it possible to double one's GDP in a single year? Apparently it is:

Source: The Economist
...but only following a significant exogenous shock in the year before. 

Having seen this, I can't help at wonder is this what the demand-side economists mean when they say "broken window" is good for growth? So are broken windows good for growth? I stick with the conclusion of my earlier text and claim No, they are not. 

The graph above seems to suggest that Libya, with its projected growth this year of 122%, should be thankful for what happened in 2011 not only in terms of getting rid of a dictator, but also in spurring rapid economic growth and a swift recovery:  
"Libya’s economy shrank by about 60% in 2011, as the country descended into civil war and foreign oil firms evacuated their staff. Sharp contractions set the stage for rebounds, both economically and statistically. They can create a lot of slack—unused capacity or unemployed workers—that can be swiftly exploited when the economy recovers. They also create a smaller “base”, from which subsequent growth is measured. If a country’s GDP shrinks by 60%, it must grow by 150% just to restore its former size. Thus even if Libya fulfils the IMF’s forecast for this year, its GDP will still be smaller than it was in 2010."
Ok, maybe not that good of a recovery, but it's still impressive. 

So how does this relate to the aforementioned text on Are natural disasters good for growth? It all depends on the stage of development where a country finds itself in. Economies with low levels of capital stock but rich in resources and with a highly mobile, unused labour stock can quickly react to new inflows of capital (such as foreign companies opening up new refineries or mills) or re-opening old capital stock. Libya (and most of the countries on that list - Equatorial Guinea in particular reacted to discoveries of oil reserves) is a good example of this. 

As we can see from the second graph, Libya experienced a 60% decline of GDP in its revolutionary year. So a 122% growth is close to quickly bringing the country back on its potential output path. It was simply a matter of opening the oil refineries and continuing with the construction works that were shut down temporarily due to the revolution. 

In case of a natural disaster this capital stock gets destroyed, not shut down temporarily. This helps explain why Haiti isn't among the countries in the first table. And it can also explain why Japan or the US didn't recovery swiftly and abruptly after their natural disaster shocks. 

As for Libya, it will be restored in 2013 to its low, bad equilibrium. The recovery due to re-using the existing capital won't do any good for its future development nor will it be helpful in shaping Libya's institutions. Just as it wasn't helpful in Equatorial Guinea. They are both stuck in a lower asymmetric equilibrium from which the only way out is a reform of political institutions from extractive to inclusive. Libya made the positive effort of ousting a dictator, but will it be able to consolidate afterwards it is left to be seen.   

Finally, how is having two whole years lost just to bring the economy back to its previous steady-state level supposed to have any positive effect on a country's development? Provided that no institutional changes follow the recovery process. The case of Equatorial Guinea is different in that perspective as incoming capital stock due to the discovery of oil reserves did actually increase the country's potential output. But in Libya it only restored it to its previous bad equilibrium. 

Do you see my point? I can't understand the obsession of restoring the previous output path when the growth model operating under that output path was unsustainable. What is needed are new patterns of sustainable specialization and trade which are likely to bring a country to a higher potential output path. Once again, Equatorial Guinea did experience this, but it failed to adjust its institutions to support the new patterns of specialization and thus lead to a higher development stage. 

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