Economic Development, Part 1: Why Are Some Countries So Rich and Others So Poor?

The problem of economic development is a very old question. I mean, it started way back with Adam Smith, and his Wealth of Nations book in 1776 is sort of the famous book. So at the time when he was studying it, if you looked at the richest regions in the world and compared them to the poorest regions in the world, the richest regions were just a fact of too rich compared to the poorer ones.

Now, all of a sudden, we fast forward to 2000, 2010, now, it's a factor of 35 if you think about real GDP per capita. The rich countries are 35 times as rich as the poorer countries. So it's a big gap.

[MUSIC PLAYING]

My name is Ravikumar. I am a research economist at the Federal Reserve Bank of St. Louis, and I've been at the bank since summer 2011. So I'm going to talk about the problem of economic development.

The big question is, how come some countries are so rich and some countries are so poor? So think about the economies where a person is living on $1 a day, and that person can afford very few things, has to live on very bare meals, can't go see a doctor regularly, et cetera. Now, imagine if that person had $35 a day.

All of a sudden, lots of things that are affordable. You can have decent housing. You can go for a decent health care. So all these are -- what we take for granted in the U.S. is hardly imaginable in some countries.

So, now you're asking a simple question as if an accountant would ask. So how much of this is due to inputs and how much of it can be due to things that we do not know? So the way economists look at it is that, let's go measure the inputs. What are the inputs?

Some examples of inputs are physical capital and human capital. So let's think about physical capital for a minute. Physical capital could be all kinds of equipment and structure serving an economy. So you've got buildings, you've got laptops, you've got lathes, you've got assembly lines.

Human capital could be measured in lots of ways. Schooling, for instance, is a form of human capital. Other forms of human capital could be just learning on the experience, on-the-job training.

At best, these inputs account for 40% to 50%. That's all you can explain in terms of cross-country income differences. That means there's a bulk of it that we do not know, that we cannot measure directly using inputs. So that's what's causing these differences.

So the part that we do not know economists typically call total factor productivity. Now, total factor productivity is one of those objects that you don't get to see directly, but you get the inferred indirectly. So it looks at how efficiently these inputs are transformed into output.

So given the same amount of input, a country that transforms it more efficiently will have higher GDP. Countries that take those inputs and transform them inefficiently will have lower GDP, but without a model, it's very difficult to proceed any farther than what I've told you in terms of just accounting. So that's what economists work on right now. I am currently thinking about the angle of how much of a role that international trade plays in thinking about cross-country income differences.