Monday, May 12, 2014

Growth of Ukraine’s Economy

By Yuriy Gorodnichenko (UC Berkeley)
The IMF’s Staff report predicts that Ukraine’s economy is likely to grow at approximately 4 percent per year in the medium run. While this rate is respectable by the standards of developed economies (for example, the U.S. economy grew about 3 percent per year since World War II and only 1 percent since the start of the Great Recession), it is quite low when compared to the growth rate of transition and developing economies. For example, China’s economy has been growing 7 to 10 percent a year for several decades now. Poland’s economy has been growing  about 5 percent a year since mid 1990s. Why did these and similar economies grew so fast and what does it mean for Ukraine?
While the debate about differences in the growth rates across countries continues, the consensus is that relatively poor economies can grow faster because they start from a low base. This low base typically means that these economies can
  • import existing technologies (rather than invent new technologies, which is much harder),
  • employ underutilized resources (this can be literally employ the unemployed but it could also mean shifting workers employed in relatively unproductive agriculture or in home production to manufacturing and services),
  • accumulate capital which is relatively sparse and expensive in these economies (that is, build roads and other types of infrastructure as well as invest in human capital).
A popular estimate of how much these three forces contribute to accelerated growth of poor economies is about 2 percent a year, which is often called the speed of convergence. That is, if income in a rich country is twice as large as the income in a poor country, in one year 2 percent of this gap is going to be eliminated by faster growth of the poor country. In 30 years, the poor country can close a half of this gap ((1-0.02)^30=1/2).
In contrast, advanced economies can grow only because of productivity gains that one can acquire slowly through innovation. Typically, the growth rate of productivity from this source is about 1 to 1.5 percent a year. In short, the poor economies grow because of the three forces listed above and because the technological frontier is expanded by the advanced economies.
In my previous post, I used Poland as a reasonable target of what Ukraine should be in the medium run. Over the course of last 20 years, the Polish economy grew 5 percent a year. Clearly, Poland has been catching up to the incomes of Western Europe and there is still quite some distance to close. Ukraine, however, has a far larger distance to cover to converge Western Europe. If one takes Poland as a benchmark and adds the convergence component due to the low base of Ukraine, then the growth rate of income in the medium run should be
5% + 0.02*ln(GDP per capita [Poland]/GDP per capita [Ukraine])
The World Bank reports that GDP per capita (in PPP $, in year 2012) is 18,303 in Poland and 6,393 in Ukraine. Hence, the growth rate could be 5% + 0.02*ln(18,303/6,393) which is approximately 7%.
This is much higher than 4% predicted by the IMF. Obviously, there are many reasons to be bearish about the Ukrainian economy in the short run, but the growth is likely to accelerate since Ukraine is starting from a low base and is likely to exit a recession some time next year. If economic theory is right here, Ukraine could be a growth miracle in near future.

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