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Hoisted from the Archives:
Poverty Traps: The High Price of
Investment Goods in Poor Countries
J. Bradford DeLong
Economics and Blum Center, UC Berkeley; WCEG; and NBER
http://bradford-delong.com
| @delong |
delong@econ.berkeley.edu
June 10, 2019
Here is how Larry Summers and I
formulated it back in the early 1990s, and
I believe that we were correct:
Begin with the large divergence between
purchasing power parity and current
exchange rate measures of relative GDP
per capita levels. The spread between the
highest and lowest GDP per capita levels
today, using current exchange rate-based
measures, is a factor of 400; the spread
between the highest and lowest GDP per
capita levels today using purchasing
power parity-based measures is a factor of
50. If the purchasing power parity-based
measures are correct, real exchange rates
vary by a factor of eight between
relatively rich and relatively poor
economies. And the log GDP per capita
level accounts for 80 percent of the cross-
country variation in this measure of the
real exchange rate, with each one percent
rise in GDP per capita associated with an
0.34 percent rise in the real exchange rate.
Why? Because real exchange rates are
J. Bradford DeLong
Poverty Traps
such as to make the prices of traded
manufactured goods roughly the same in
the different nation-states of the world,
putting to one side over- or
undervaluations produced by
macroeconomic conditions, tariffs and
other trade barriers, and desired
international investment flows. Thus the
eight-fold difference in real exchange
rates between relatively rich and relatively
poor economies is a reflection of an
approximately eight-fold difference in the
price of easily-traded manufactured
goods: relative to the average basket of
goods and prices on which the
"international dollar" measure is based,
the real price of traded manufactures in
relatively rich countries is only one-eighth
the real price in relatively poor countries.
This should come as no surprise. The
world's most industrialized and
prosperous economies are the most
industrialized and prosperous because
they have attained very high levels of
manufacturing productivity: their
productivity advantage in unskilled
service industries is much lower than in
capital- and technology-intensive
manufactured goods.
And a low relative price of
technologically-sophisticated
manufactured goods has important
consequences for nation-states' relative
investment rates. In the United States
today machinery and equipment account
for half of all investment spending; in
developing economies--where machinery
and equipment, especially imported
machinery and equipment is much more
expensive--it typically accounts for a
much greater share of total investment
spending (see Jones, 1994; DeLong and
Summers, 1991).
Consider the implications of a higher
relative price of capital goods for a
developing economy attempting to invest
in a balanced mix of machinery and
structures. There is no consistent trend in
the relative price of structures across
economies: rich economies can use
bulldozers to dig foundations, but poor
economies can use large numbers of low-
paid unskilled workers to dig foundations.
But the higher relative price of machinery
capital in developing countries makes it
more and more expensive to maintain a
balanced mix: the poorer a country, the
lower is the real investment share of GDP
that corresponds to any given fi xed
nominal savings share of GDP.
The gap between nominal savings and real
investment shares of GDP that follows
from the high relative price of machinery
and equipment in poor countries that wish
to maintain a balanced mix of investment
in structures and equipment is immense.
For a country at the level of the world's
poorest today--with a real exchange rate-
based GDP per capita level of some $95 a
year--saving 20
%
of national product
produces a real investment share
2
of
4
J. Bradford DeLong
Poverty Traps
(measured using the "international dollar"
measure) of only some 5
%
of national
product.
In actual fact poor economies do not
maintain balanced mixes of structures and
equipment capital: they cannot afford to
do so, and so economize substantially on
machinery and equipment. Thus here are
three additional channels by which
relative poverty is a cause slow growth:
First, the fact that investment in general--
taking equipment and structures together--
is expensive relative to consumption
goods and services in poor countries
provides them with an incentive to
diminish their nominal savings effort: to
reduce the share of nominal incomes
saved.
Second, the fact that relative poverty is
the source of a high real price of capital
means that poor countries will have a low
rate of real investment corresponding to
any given nominal savings effort, and thus
a low steady-state aggregate capital-
output ratio corresponding to any given
nominal savings effort.
Third, to the extent that machinery and
equipment are investments with social
products that signifi cantly exceed the
profi ts earned by investors (see DeLong
and Summers, 1991), the price structures
in relatively poor developing economies
lead them to economize on exactly the
wrong kinds of capital investment
…
References
"The Singer-Prebisch Thesis," Wikipedia
http://en.wikipedia.org/wiki/Singer-
Prebisch_thesis (accessed June 25, 2007).
J. Bradford DeLong (1997), "Cross-
Country Variations in National Economic
Growth Rates: The Role of 'Technology'",
in Jeffrey Fuhrer and Jane Sneddon Little,
eds., Technology and Growth (Boston:
Federal Reserve Bank of Boston) http://
www.j-bradford-delong.net/
Econ_Articles/Growth_and_Technology/
Role_of_Technology_.pdf (accessed June
25, 2007).
J. Bradford DeLong and Lawrence H.
Summers (1991), "Equipment Investment
and Economic Growth," Quarterly Journal
of Economics 106: 2 (May), pp. 445-502
http://www.j-bradford-delong.net/
movable_type/archives/000606.html
(accessed June 25, 2007).
J. Bradford DeLong and Joseph
Rosenberg (2006), "Problem Set 3:
Economic Growth: Further Explorations,"
U.C. Berkeley Economics 101b, Fall 2006
Version http://delong.typepad.com/print/
20060911_101b_f06_ps3.pdf (accessed
June 25, 2007).
Francesco Caselli and James Feyrer
(2007), "The Marginal Product of Capital"
http://www.aeaweb.org/
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of
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Poverty Traps
annual_mtg_papers/
2006/0106_1430_0703.pdf (accessed June
25, 2007).
Chang-Tai Hsieh and Pete Klenow (2006),
"Relative Prices and Relative Prosperity"
http://www.klenow.com/RPandRP.pdf
(accessed June 25, 2007).
Charles Jones (1994), "Economic Growth
and the Relative Price of Capital," Journal
of Monetary Economics 34, pp. 359-82
https://delong.typepad.com/jones94.pdf
(accessed June 25, 2007).
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