Macroeconomic Policy Around the World

This is Unit Sixteen of Principles of Macroeconomics: macroeconomic policy around the world. Unit fifteen finished the domestic picture. This unit takes every model the course has built and points it at economies at very different stages. Carry one idea through. Nothing new is taught here. The work is diagnosis — deciding which problem a country actually has, because the remedy follows from the diagnosis and not from a list of remedies. The capstone turns the course's four goals into four ways that willing parties fail to meet, and then stops at the diagnosis, because deciding what a country should do about it involves judgements about who bears the cost that no model in this course can make. By the end you will name which determinant binds, turn growth rates into doubling times, diagnose unemployment as cyclical or natural rate, trace a hyperinflation and say what indexing protects, and name which coordination failure a country has.

Five entries on one recipe, unequal access to its ingredients, and the measurement problems that follow.

The same recipe everywhere.

MAC 1501 The Same Recipe, Different Starting Points

One production function explains the spread of average incomes across the world: physical capital per worker, human capital and technology. What differs between countries is not the recipe but access to the ingredients, and history, institutions and politics decide that access. This is unit four's machinery pointed outward, not a separate theory.

Comparing incomes at all.

MAC 1502 Measuring Income Across Countries

Comparing incomes across countries needs a converter. Market exchange rates swing for financial reasons, so a country's measured income moves when nothing real has changed, which makes purchasing power parity the better converter. Gross national income per capita is the World Bank's measure, alongside GDP per capita. Unit thirteen built this distinction; here it decides which countries look poor.

How the world is sorted.

MAC 1503 The Four Income Groups

The World Bank sorts economies into four tiers by income per person: low, lower-middle, upper-middle and high. It sets the thresholds and updates them every year. The middle tiers hold most of the world's people; the high tier holds most of the income. This course voices no threshold, because the anchor gives four inconsistent sets of them, and the current figures live with the World Bank.

Size against living standards.

MAC 1504 Size Is Not Standard of Living

A country's total output and its output per person answer different questions. A very large economy can sit in a middle tier, because the total is divided by a very large population. Total output measures weight in the world; output per person measures how people live. Neither measures health, education, safety or rights, and no country scores well on everything.

Growth against development.

MAC 1505 Growth and Development Are Not the Same

Growth is a quantitative increase in what an economy can produce. Development is a qualitative change in how people live, and it requires the gains to be widely shared rather than merely large. Two countries with the same average income can differ sharply in how that income is distributed. So a country can grow without developing, which is why both are reported.

Two entries on diagnosing what actually constrains a country, and on what a growth rate compounds into.

Naming the binding constraint.

MAC 1506 Which Determinant Is Binding

Four things beyond the recipe shape a country's access to the ingredients: geography, demography, industry structure and institutions. From a description, name which one is binding, because the remedy follows from the diagnosis rather than from the list. A landlocked country facing high transport costs to any port has a geographic constraint, and the instruments are roads, rail and regional agreements rather than domestic reform. A country where half the workforce farms at low productivity has an industry-structure constraint, and moving labour into higher-productivity work is the development process itself. A country where contracts cannot be enforced and property is seized has an institutional constraint, and no amount of capital will stay. A country whose population is young and growing fast has a demographic constraint on income per person. These describe conditions, not verdicts about any country, and most economies face more than one at once. Only some are movable: institutions and industry structure can change within a generation, demography across one, and geography not at all.

What a growth rate compounds into.

MAC 1507 Doubling Time and the Convergence Gap

Use unit four's rule of seventy-two to turn growth rates into doubling times, then compound them over a working life: divide seventy-two by the annual growth rate to get the years to double. The point is not the arithmetic but what small differences do when they run for decades. An economy growing at two percent a year doubles its income in about thirty-six years; one growing at six percent doubles in about twelve. Now run both for seventy-two years. The slow economy doubles twice, so income is about four times its starting level. The fast economy doubles six times, so income is about sixty-four times its starting level. Two economies starting level, differing by four percentage points of growth, end a lifetime apart. That is the whole convergence story, and it cuts both ways: a country growing fast from a low base can close an enormous gap within a lifetime, and a country growing a point or two slower than its neighbours for a generation falls behind without anything dramatic ever happening. Remember also that per capita growth is output growth minus population growth, so a fast-growing economy with a fast-growing population may deliver little per person.

Three entries on the oldest worry about that population term, and the pattern that replaced it.

The oldest worry.

MAC 1508 The Malthusian Trap

Malthus argued in seventeen ninety-eight that population grows exponentially while food production rises by a constant amount, so requirements must eventually overtake supply and starvation becomes the check on population. The argument rests on diminishing returns to labour on a fixed quantity of land. It did not happen in the economies that industrialised, and the next entry says why.

Why it did not close.

MAC 1509 Why the Trap Did Not Close

Two things defeated the prediction. Capital and technology raised agricultural output far faster than a constant amount per period. And rising incomes turned out to reduce birth rates rather than raise them, because higher incomes raise the opportunity cost of the time spent raising children. Malthus had that second relationship backwards, which is why both lines moved.

The pattern that replaced it.

MAC 1510 The Demographic Transition

Development changes population growth in two stages. Clean water, sanitation and vaccination cut death rates first, which speeds population growth. Birth rates fall later as incomes rise, which slows it again. So population growth rises before it falls, and the rise comes from lives saved. A country in the first stage looks Malthusian and is mid-transition.

Two entries on a strategy built from a different diagnosis, and on what happened when it was tried.

The diagnosis, and its strategy.

MAC 1511 Dependency Theory and Import Substitution

Dependency theory held that poor countries are poor because of their dependence on rich ones, and that trade transfers the gains to the richer partner. The strategy it implied was import substitution: block imports and make those goods at home, copying what industrialised countries already made. This directly challenges comparative advantage, which unit seventeen takes up.

What happened when it was tried.

MAC 1512 Why Import Substitution Failed

Protecting new domestic industries required very high tariffs, which removed the competition that would have disciplined them. The industries built were capital and skill intensive, which is what poor economies have least of. Permit systems for essential imported parts put firms' fortunes in officials' hands. No country relying on this strategy succeeded, while economies that stayed open to trade did.

Three entries on unemployment: which kind a country has, and the workers the measure never sees.

Two kinds, two remedies.

MAC 1513 Cyclical or Natural Rate

Unemployment anywhere is either cyclical, meaning output is below potential, or natural rate, meaning labour-market institutions. The remedy differs completely, so the diagnosis comes first. Cyclical unemployment falls when demand recovers; natural-rate unemployment does not. Treating one as the other prescribes a remedy that cannot work.

Making that call.

MAC 1514 Diagnose the Unemployment

From a description of a country, say whether its unemployment is mainly cyclical or mainly natural rate, and name the matching policy. Two questions: is output below potential, and has the rate persisted through good years as well as bad? Persistence through expansions points to institutions rather than to the cycle. An economy whose unemployment rose three points in a downturn and fell back as output recovered had cyclical unemployment, and the remedies are demand policies with the stabilisers left to work. An economy whose unemployment has sat several points above its neighbours' for two decades, through expansions and contractions alike, has a natural-rate problem, and demand policy will not move it. A third has both, which is the usual case, and the two parts need different treatments at the same time. The natural-rate explanation usually offered is the weight of hiring and firing rules, and the course voices both halves of that without a verdict: the same rules that protect workers in a job can make employers slower to create one.

Workers the measure misses.

MAC 1515 Outside the Wage Labour Market

In many low- and middle-income economies most people farm, fish, trade and take a succession of day jobs. Unit five's definitions barely apply to them: they are neither employed nor unemployed in the sense the measure means. They also cannot specialise, and they fall outside whatever insurance exists. Connecting such workers to wage-paying work is itself a development goal.

Two entries on inflation in the places where it was never brought under control.

The usual mechanism.

MAC 1516 Inflation Where It Is Not Solved

Where inflation runs very high the mechanism is almost always the same: a government covering large deficits by creating money. That is unit twelve's equation of exchange made concrete. Sustained inflation of this kind has reached tens, hundreds and in extreme cases millions of percent. Monetary policy can prevent this, and there is no long-run gain from allowing it.

Tracing one through.

MAC 1517 Trace a Hyperinflation

Work a hyperinflation from its fiscal cause to its monetary effect, then say what indexing does and does not protect. The chain is short: a deficit that cannot be funded by borrowing or taxing is covered by creating money, the money stock rises far faster than output, and the price level follows. Take an economy whose money stock quadruples in a year while real output is flat. Unit twelve's equation says the price level must rise roughly fourfold if velocity holds. But velocity does not hold: people expecting prices to rise spend money faster, so velocity rises too and prices rise by more than the money stock did. Now apply indexing. A worker whose wage is indexed to prices keeps roughly their real wage; a worker whose wage is not indexed sees it fall in real terms every month. A lender who indexed the loan is repaid in real terms; one who did not is repaid in currency worth a fraction of what was lent. Indexing protects the terms of a contract, not the economy. Countries have grown steadily while indexing wages and loans against inflation of ten to thirty percent, so this is a survivable arrangement rather than a solution. What indexing cannot do is restore what unit six said inflation costs: the effort everyone spends protecting themselves against price changes is effort not spent producing anything.

One entry to close the unit, and to turn the course's four goals into a single idea.

Four coordination failures.

MAC 1518 The Four Goals as Four Coordination Failures

Here the unit's governing idea pays off. The anchor closes this chapter with a frame worth carrying into the capstone, because it makes the course's four goals into one idea: each of them, looked at closely, is a failure of coordination between parties who would both gain from meeting. Cyclical unemployment is aggregate demand meeting aggregate supply below potential — willing workers and willing employers exist, and the spending that would connect them is missing. Natural-rate unemployment is a different failure between the same two parties: both exist, and the rules or the information between them prevent the match. Inflation is demand outstripping what an economy can supply, so the price level does the rationing. And a trade imbalance is domestic saving out of line with domestic investment, with the gap made up abroad. Naming which failure a country has is the diagnosis, and every model in this course is a tool for making that naming precise. Take one country diagnosed four ways. Unemployment is high and rose in the last two years while output fell: cyclical, so demand policy and the automatic stabilisers apply. Unemployment is high and has been high for twenty years through expansions too: natural rate, so the instruments are training, job matching and the design of employment rules, and demand policy will not touch it. Prices are rising at forty percent a year while the budget deficit is financed by the central bank: a monetary failure with a fiscal cause, and the remedy is fiscal before monetary. The current account deficit is nine percent of output and financed by short-term foreign money: a saving-investment imbalance carrying the exposure unit thirteen described. Four answers, four instruments, and the same four models throughout. Three cautions. First, most real countries have more than one of these at once, and the instruments can conflict: demand policy that treats the cyclical problem does nothing for the structural one and may worsen the monetary one. Second, on foreign aid the course reports a genuine disagreement rather than a conclusion. The case for it points to clinics, schools, water, power and roads that would not otherwise be built. The case against holds that aid is captured by those who control it, displaces other investment, and follows the giver's politics rather than the recipient's need. The point both sides concede is that aid tied to specific long-term investment has a modest role, while the sums involved are small for giver and receiver alike. Third, the diagnosis is not the prescription. This unit names which failure an economy has and stops there, because deciding what a country should do about it involves judgements about who bears the cost that no model in this course can make.

Look at what you can now do. You can name which of the four determinants binds a country, and say which of them can move within a generation and which cannot move at all. You can turn growth rates into doubling times and compound them, and say why four percentage points of growth end a lifetime apart. You can diagnose unemployment as mainly cyclical or mainly natural rate, by asking whether it persisted through the good years too. You can trace a hyperinflation from its fiscal cause to its monetary effect, and say what indexing protects and what it cannot reach. And you can name which coordination failure a country has — and stop there, because the diagnosis is not the prescription. Unit seventeen asks why two countries trade at all.