Augmented Solow model analysis of growth with institutional quality factors

Growth Rate

Slow model (1992) is an economic tool used to analyze a country economic growth. The principal conclusion of Slow model is that the accumulation of capital could not only account for the growth rate per person. To address the central question of economic growth, it is critical to move beyond the Slow model. Mankiw et al. (1992) incorporate economic tools such as FDI growth rate, trade, inequality, institutional quality and other core variables such as labor and capital to analyze the growth rate across countries,.

Objective of this paper is to use the core economic variables and non-core economic variables to investigate their potential impacts on the United States growth rates.

Overview of the United States Growth Rates

The United States is the largest and most powerful economy in the world. Presently, the U.S. has the highest level of output with the country GDP valued more than U.S.$14 trillion. The United States is the world most advanced economies and is leading in the information technology and other technical innovation. The United States has a diverse economy and the leading industries include electronics, telecommunications, aerospace, chemicals and military equipment. Between 1991 and 2000, the United States enjoyed a robust growth making the United States to enjoy the largest economic expansion in the history of the country. Although, the U.S. economy recorded a slow growth between 2001 and 2002, however, the country recovered in 2003 and recorded a strong economic growth induced by robust household spending and a strong productivity.

After 2007, the United States recorded serious economic imbalances due to the collapse of housing markets, which led to the U.S. financial instability and culminated into the global financial crisis. In 2008, the U.S. GDP contracted to 0.3% and contracted to 3.5% in 2009. In 2010, the U.S. economy recovered and recorded a 3.0% growth rate, however, came down to 1.7% in 2011. (MarketLine, 2012). The paper uses variables such as FDI growth rate, trade, inequality, institutional quality and other core variables such as labor and capital to analyze their potential impacts on the growth rates of the United States

Potential Impact of Core and Non-Core Variables on the U.S. Growth Rates

This section incorporates the FDI growth rates, trade, inequality, institutional quality and other core variables such as labor and capital to measure the growth rates of the United States.

Foreign Direct Investment

FDI (Foreign Direct Investment) is the total capital inflow into a country. The theoretical literature reveals that FDI contributes to the economic growth and neoclassical growth theory reveals that FDI inflow contributes to the stock of capital in the host countries, which allows the higher growth rates that possibly enhanced domestic savings within the host countries. The endogenous growth theory also argues that technological development stimulates economic growth (Mankiw et al., 1992). Thus, FDI enhances the country's growth rate by allowing the host countries to tap the advanced technologies not available in their countries. More importantly, FDI leads to the increase in the competitions within domestic market, which consequently lead to the greater efficiency of domestic firms. Another area where FDI improve economic growth is the transmission of improved managerial practice from foreign firms to domestic firms. More importantly, FDI strengthens human capitals of the host countries. (Freckleton, Wright, & Craigwell, 2012).

"The U.S. government has maintained its openness toward foreign direct investment

(FDI) and is the world's largest recipient of such investment. According to the UN Conference on Trade and Development, the U.S. ranked in first position in 2010 in terms of FDI inflows. The country received $228bn in 2010 compared to $153bn in 2009." (MarketLine, 2012 P. 26).

Kornecki, et al. (2011) argues that the influx of FDI significantly influences the economic growth of the United States. The authors collected data between 1978 and 1997, which was the period the United States received major influx of foreign direct investment. In 1997, the FDI accounted to the 6.3% of the United States Gross Domestic Product (GDP), 20% of the U.S. export of goods, 4.9% of non-bank employment and 30% of the U.S. import.

Thus, "a rapid inflow of foreign investment paralleled the brisk productivity growth, suggesting a positive link between the growth of productivity and foreign capital. Applying a Cobb-Douglas production function to data from 1988 to 1999, it is found that foreign capital accounted for almost 16% of overall U.S. productivity growth and significant lead to the U.S. economic growth rates" (Kornecki, et al. 2011 P. 2).

Trade

Economic theory generally supports trade liberation and consequently has positive effect on economic growth. Typically, there is a positive linkage between a country's economic growth and openness of international trade. The traditional trade theory argues that trade between countries improves welfare of citizens due to specialization gains and increase the efficiency according to the comparative advantage theory. The dynamic trade theory also reveals that the trading countries enjoy the dynamic gains due to the reallocation of existing resources and trade specialization. The dynamic gains from trade are due to the accumulation of human and physical capital, which enhance the transmission of technology across countries. (Nowak-Lehmann, 2010).

However, the United States experienced trade deficits in last few years due to the U.S. financial crisis that started in 2008. The total trade of the United States fell due to the global financial crisis and shrank by approximately 15% in 2009 leading to a decline in the total trade from $4,332 Billion in 2008 to $3,472 in 2009. However, the country recovered in 2010 and recorded $4,119 billion of total trade and $4,225 billion in 2011. The trade deficit that the United States recorded in 2008 made the country growth rate to contract from 1.9% in 2007 to 0.3% in 2008. However, the U.S. economy recovered in 2010 and recorded the growth rate of 3.0%, however, the country growth rate came down to 1.7% in 2011. (MarketLine, 2012).

Inequality

Economic inequality refers to the gap between the rich and the poor. On the other hand, income inequality refers to the wide disparity of the incomes of group of people within a country. Su, (2010) argues that inequality harms the economic growth of a country in four ways:

First, unequal distribution of income will lead tax distortion thereby reducing the growth rate. Second, inequality within a country could lead to the socio-political instability, which could reduce investment inflow into the county and consequently decline the growth rate. Additionally, the presence of imperfect capital market within a country could reduce human capital investment and consequently reduce the country growth rate. Finally, inequality will lead to a rise in fertility and leading to a fall in human capital and consequently lead to a decline in the growth rate. The growth model shows that inequality generally cause a decline in the aggregate production thereby lower the economic growth. (Su, 2010).

In the United States, recent financial crisis that the country has undergone has led to distribution of inequality of income, which has become a social concern. The CIA World factbook shows that U.S. ranks 43rd out of 140 countries sampled in term of income inequality and measured by Gini coefficient. In 2010, 46.2 million people in the United States lived below the poverty line.

Institutional Quality

The quality of country's institutions is generally linked to the economic development. The institutions define general conditions under which individuals and firms operate. The better the quality of institution arrangement of a country, the more confidence people will have in the country capital market. (Andrew, 2007). The U.S. has a strong legal framework with an independent judicial system. The sound legal framework of the country has been translated into positive investment climate. In 2012, the World Bank ranked the U.S. As the fourth best country to do business due to the quality of the country institutional framework. The country financial regulatory framework is well developed making the financial market open to competition. (MarketLine, 2012). Typically, high quality of the country institution has been a fundamental factor leading to the influx of foreign investment. Typically, foreign investors have a strong belief that their investments are being protected by law making the United States capital market to be well developed. (MarketLine, 2012).

Labor and Capital

Quality of labor is very critical to the country economic growth and the quality of labor is very critical to the country economic development. A country with well-educated citizen will enjoy better economic development than a country with low number of educated citizens. The United States has largest number of higher educational institutions in the world making the country to be among the well-educated country in the world. MarketLine (2012) report shows that the U.S. higher education system is the best in the world with literacy rate reaching 99.0%. Typically, the development of the country labor force makes the United States to be ranked fourth in the Global Human Development Index. The United States generally enjoys high labor productivity, and it is generally believed that the U.S. remains a leader in term of innovation and technological development.

"According to the Bureau of Labor Statistics, labor productivity rose by 69% in the service-providing and mining industries in 2010, up from 42% in 2009. It is widely believed that research and development (R&D), patents, and management innovations have contributed to productivity growth in the U.S., while the diffusion of new technologies and their application in more firms and sectors will continue to boost Productivity." (MarketLine 2012 P. 22).

The increase in the country labor productivity assists the country competitiveness. Typically, the country labor productivity has grown steadily and translated into a sustainable economic expansion. Despite the country impressive labor force, the country is facing the problem of ageing population where the half of the population was more than 36.9 years in 2011.

Technology and accumulation of capital has been the cornerstone of an economic growth and the ICT (Information Communication Technology) remains the driving force of the U.S. economy making the country to enjoy rapid growth rate between 1990 and 2000. The significant development of human capital is due to the country well-established IRP (intellectual property rights).

B. Data Collection

The study collects data from the combination of World Bank World Development Indicators (WDI), OECD (Organization for Economic Cooperation and Development) and Country Watch (2012). The paper collects data of core variable and non-core variables between 2007 and 2012 to demonstrate their impacts on the U.S. economic growth.

The Table 1 reveals the Descriptive Statistics of the data collected.

Table 1: Descriptive Statistics

Trade Volume

GDP Growth Rate

Growth of Capital

Employment Growth

Labor Productivity

FDI

Mean

1,88

Mean

14,58333

Mean

2234,167

Mean

-0,12983

Mean

1,0515

Mean

267,6667

Standard Error

0,058878

Standard Error

0,283333

Standard Error

85,41874

Standard Error

0,746653

Standard Error

0,011862

Standard Error

29,46486

Median

1,9

Median

14,4

Median

Median

0,066

Median

1,052

Median

Mode

1,9

Mode

#N/A

Mode

#N/A

Mode

#N/A

Mode

#N/A

Mode

#N/A

Standard Deviation

0,144222

Standard Deviation

0,694022

Standard Deviation

209,2323

Standard Deviation

1,828919

Standard Deviation

0,029057

Standard Deviation

72,17386

Sample Variance

0,0208

Sample Variance

0,481667

Sample Variance

43778,17

Sample Variance

3,344943

Sample Variance

0,000844

Sample Variance

The results of regression analysis are presented in Table 2, 3, 4, 5, and 6. All the results of the regression analysis strongly support that the FDI, employment growth, trade volume, labor productivity and growth of capital improve the economic growth of the United States. The P-values of all these variables shows their positive impact on the U.S. economic growth. The economic theory supports the findings of regression analysis conducted which the reveals that increase of inflow of FDI into the United States, labor productivity, employment growth rate, growth of capital and increase in trade volume enhance the U.S. economic growth. However, the literatures support that inequality does not increase economic growth. (Temple, and Johnson, 1998).

Table 2: GDP Growth Rate and FDI

SUMMARY OUTPUT

Regression Statistics

Multiple R

0,088507

R Square

0,007833

Adjusted R. Square

-0,24021

Standard Error

0,772895

Observations

6

ANOVA

df

SS

MS

F

Significance F

Regression

1

0,018866

0,018866

0,031581

0,867586

Residual

4

2,389468

0,597367

Total

5

2,408333

Coefficients

Standard Error

t Stat

P-value

Lower 95%

Upper 95%

Lower 95,0%

Upper 95,0%

Intercept

14,35553

1,32015

10,87416

0,000406

10,6902

18,02085

10,6902

18,02085

X Variable 1

0,000851

0,004789

0,177711

0,867586

-0,01245

0,014148

-0,01245

0,014148

Table 3: Trade Volume and GDP Growth Rate

SUMMARY OUTPUT

Regression Statistics

Multiple R

0,715333

R Square

0,511701

Adjusted R. Square

-1,5

Standard Error

0,112676

Observations

1

ANOVA

df

SS

MS

F

Significance F

Regression

6

0,053217

0,008869

4,191699

#NUM!

Residual

4

0,050783

0,012696

Total

10

0,104

Coefficients

Standard Error

t Stat

P-value

Lower 95%

Upper 95%

Lower 95,0%

Upper 95,0%

Intercept

0

0

X Variable 1

0,511297

-1,08694

X Variable 2

-2E-285

5,2E-285

X Variable 3

8,8E+264

-9E+264

X Variable 4

-4E+196

3,9E+196

X Variable 5

-0,28782

1,059833

-0,27157

0,799392

-3,23039

2,654749

-3,23039

2,654749

X Variable 6

0,148651

0,072606

2,047364

0,110019

-0,05294

0,350237

-0,05294

0,350237

Table 4: Growth of Capital and GDP Growth Rate

SUMMARY OUTPUT

Regression Statistics

Multiple R

0,715333

R Square

0,511701

Adjusted R. Square

-1,5

Standard Error

0,542215

Observations

1

ANOVA

df

SS

MS

F

Significance F

Regression

6

1,232346

0,205391

4,191699

#NUM!

Residual

4

1,175987

0,293997

Total

10

2,408333

Coefficients

Standard Error

t Stat

P-value

Lower 95%

Upper 95%

Lower 95,0%

Upper 95,0%

Intercept

0

0

X Variable 1

0,511701

4

0,127925

0,904382

-10,5941

11,61748

-10,5941

11,61748

X Variable 2

5,25E+82

-5,2E+82

X Variable 3

5,54E-50

5,54E-50

X Variable 4

-8,79759

8,797592

X Variable 5

8,111795

3,168654

2,560013

0,062637

-0,6858

16,90939

-0,6858

16,90939

X Variable 6