To quantify the implications of common currencies for trade and income, we use data for over 200 countries and dependencies. In our two-stage approach, estimates at the first stage suggest that belonging to a currency union/board triples trade with other currency union members. Moreover, there is no evidence of trade-diversion. Our estimates at the second stage suggest that every one percent increase in a country’s overall trade (relative to GDP) raises income per capita by at least one third of a percent. We combine the two estimates to quantify the effect of common currencies on output. Our results support the hypothesis that important beneficial effects of currency unions come through the promotion of trade.

Many models of growth and development assume that aggregate output is generated by a Cobb Douglas specification for the aggregate production function with labor, physical capital, and sometimes human capital as inputs. In this paper we question the empirical relevance of the Cobb Douglas specification. We consider new World Bank data on GDP, the labor supply, the stock of physical capital and educational attainment per worker for a panel of 82 countries over a 28 year period fi'om 196(b87. These data are used to estimate a general CES production function specification for which the Cobb Douglas specification is a special case. We find that for the entire 82 country 28 year panel we can reject a Cobb Douglas specification for the aggregate production function. When we divide our sample of 82 countries up into several subsamples based on initial levels of capital per worker, we find that we can continue to reject a Cobb Douglas specification. In particular, we find that physical capital and human capital adjusted labor are more substitutable in the richest group of countries and less substitutable in the poorest group of countries than would be implied by a Cobb Douglas specification. We discuss the implications of our findings for the debate concerning convergence in income levels across countries as well as for the plausibility of long run endogenous growth due to the specification of the production technology.

We introduce imperfect creditor protection in a multi-country version of Schumpeterian growth theory with technology transfer. The theory predicts that the growth rate of any country with more than some critical level of financial development will converge to the growth rate of the world technology frontier, and that all other countries will have a strictly lower long-run growth rate. The theory also predicts that in a country that converges to the frontier growth rate, financial development has a positive but eventually vanishing effect on steady-state per-capita GDP relative to the frontier. We present cross-country evidence supporting these two implications. In particular, we find a significant and sizeable effect of an interaction term between initial per-capita GDP (relative to the United States) and a financial intermediation measure in an otherwise standard growth regression, implying that the likelihood of converging to the U.S. growth rate increases with financial development. We also find that, as predicted by the theory, the direct effect of financial intermediation in this regression is not significantly different from zero. These findings are robust to alternative conditioning sets, estimation procedures and measures of financial development.

The historical path of gross domestic product (GDP) per capita in the United States is, except for the interlude of the Great Depression, well characterized by reasonably stable exponential trend growth with modest cyclical deviations: graphically, it is a modestly sloping, slightly bumpy hill. However, almost nothing that is true of U.S. GDP per capita (or that of other countries of the Organisation for Economic Co-operation and Development) is true of the growth experience of developing countries. A single time trend does not adequately characterize the evolution of GDP per capita in most developing countries. Instability in growth rates over time for a single country is great, relative to both the average level of growth and the variance across countries. These shifts in growth rates lead to distinct patterns. While some countries have steady growth (hills and steep hills), others have rapid growth followed by stagnation (plateaus), rapid growth followed by decline (mountains) or even catastrophic falls (cliffs), continuous stagnation (plains), or steady decline (valleys). Volatility, however defined, is also much greater in developing than in industrial countries. These stylized facts about the instability and volatility of growth rates in developing countries imply that the exploding econometric

1 University of Minnesota and the World Bank. I thank the following people for comments, discussions,

I use microeconomic estimates of the effect of health on individual outcomes to construct macroeconomic estimates of the proximate effect of health on GDP per capita. I employ a variety of methods to construct estimates of the return to health, which I combine with crosscountry and historical data on height, adult survival rates, and age at menarche. Using my preferred estimate, eliminating health differences among countries would reduce the variance of log GDP per worker by 9.9 percent, and reduce the ratio of GDP per worker at the 90 th percentile to GDP per worker at the 10 th percentile from 20.5 to 17.9. While this effect is economically significant, it is also substantially smaller than estimates of the effect of health on economic growth that are derived from cross-country regressions.

This paper investigates the linkages between trade policy and economic growth in a panel of 57 countries, between 1970 and 1989. We develop a new measure of trade policy openness, based on the effective policy component of trade shares. This is used in a simultaneous equations system aimed at identifying the effect of trade policy on several determinants of growth. The results of this paper suggest a strong positive impact of trade policy openness on economic growth, with the accelerated accumulation of physical capital accounting for more than one half of this total effect; smaller effects operate through enhanced technological transmissions and improvements in the quality of macroeconomic policy. This decomposition is robust with respect to alternative specifications and time periods. We also successfully test whether the model exhaustively captures the effects of trade policy on growth. 1

Africa’s disappointing economic performance, the East Asian financial crisis, and the weak record of the former Soviet Union have focused attention on the role of institutions in determining a country’s economic growth. This article critically reviews the literature that tries to link quantitative measures of institutions, such as civil liberties and property rights, with growth of gross domestic product across countries and over time. An important distinction is made between indicators that measure the performance or quality of institutions and those that measure political and social characteristics and political instability. The evidence suggests a link between the quality of institutions and investment and growth, but the evidence is by no means robust. I wish to assert a much more fundamental role for institutions in societies; they are the underlying determinant of the long-run performance of economies. North 1990: 107 The role of institutions in promoting growth in developing and emerging economies has sparked renewed interest in recent years (World Bank 1993, 1997; Stiglitz 1998). A burgeoning literature thus seeks to determine the extent to which the quality of public and private economic institutions, the particular structure of governance, and the extent of social capital (or civic engagement) affect growth. Evidence from global cross-country econometric studies is potentially important because the paucity and weakness of both macroeconomic and institutional data for many developing countries preclude robust policy interpretations on a country-by-country basis (Srinivasan 1995; Lal and Myint 1996). If there is clear evidence that weak political and economic institutions significantly hamper growth, policymakers might propose measures that strengthen institutions in particular ways or that encourage more appropriate political structures

This paper proposes a pair-wise approach to testing for output convergence that considers all N(N-1)/2 possible pairs of log per capita output gaps across N economies. A general probabilistic definition of output convergence is also proposed, which suggests that all such output gap pairs must be stationary with a constant mean. The approach is compatible with individual output series having unit roots, or other non-stationary common components and does not involve the choice of a reference country in computation of output gaps. It is also applicable when N is large relative to T (the time dimension of the panel). After providing some encouraging Monte Carlo evidence on the small sample properties of the pair-wise test, the test is applied to output series in the Penn World Tables over 1950-2000. Overall, the results do not support output convergence, and suggest that the …ndings of convergence clubs in the literature might be spurious. However, significant evidence of growth convergence is found, a result which is reasonably robust to the choice of the sample period and country groupings. Non-convergence of log per capita outputs combined with growth convergence suggests that while common technological progress seems to have been diffusing reasonably widely across economies, there are nevertheless important country-specific factors that render output gaps highly persistent, such that we can not be sure that the probability for the output gaps to lie within a fixed range will be non-zero.

We provide a theoretical explanation, based on Schumpeterian growth theory, for the divergence in per-capita income that has taken place between countries since the mid 19th Century, as well as for the convergence that took place between the richest countries during the second half of the 20th Century. The argument is based on the premise that technological change underwent a fundamental transformation in the 19th Century, associated with new scientific ideas and the increasingly scientific content of new technologies. We model this transformation as the introduction of a new method for producing innovations, which we call “modern R&D”. In order to use this method a country’s entrepreneurs must have at least some minimum level of skills, which depends on the technological frontier. Countries not fulfilling this requirement can only create new technologies through an older method, which we call “implementation”. A multi-country Schumpeterian growth model incorporating these ideas implies that countries will sort themselves into three groups. Those in the highest group will converge to an “R&D steady state”, while those in the intermediate group converge to an “implementation steady state”. Countries in both of these groups will grow at the same rate in the long run, as a result of technology transfer, but inequality of per-capita income between the two groups will increase during the transition to the