Full text of Inside the Vault : Spring 2009

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

Volume 13
Issue 1
Spring 2009

A n E c o n o m i c E d u c at i o n Ne w s l e t t e r f r o m t h e Fe d e r a l Re s e r v e B a n k S t. L o u i s

Which Came First—
Democracy or Growth?
In today’s world, most rich countries are democratic,
and most dictatorships are poor. In the United
States, democracy goes hand in hand with political
institutions that promote economic freedom.

What’s Your
Question?
Education
and Earnings

Economic
Snapshot
Fourth Quarter Data

Bulletin Board
Summer School
at the Fed
It’s Your Paycheck

Resources
GDP and Pizza

www.stlouisfed.org/education

H

owever, democratic governments, even
in rich countries, often enact redistributive policies that reduce economic freedom
and that are harmful to economic growth.
Therefore, although most economists agree
that economic freedom promotes growth,
it is not clear that more political freedom
(that is, more democracy or political rights)
improves economic performance.

What Factors Create
Economic Growth?
Economic growth is primarily a result of the
accumulation of both physical capital and
human capital. The accumulation of capital
is affected by public policies, which, in turn,
depend on the political institutions that are
in place. In a classic study, Robert Barro
explained that because citizens express their
approval or disapproval when they vote,
democratic institutions provide checks on
government power that impose limits on
politicians’ ability to amass wealth and enact
unpopular policies. These constraints, he
noted, help improve economic freedom.
On the other hand, authoritarian governments may also improve economic freedom

as a matter of policy, without the need of
institutional limits such as those provided by
a democracy.
In a study of about 100 countries from
1960 to 1990, Barro found that at low levels
of political freedom, an increase in political rights might enhance economic growth
by imposing limits on government. But he
noted that in countries that have already
achieved medium levels of democracy,
further increases in political rights might
slow growth because of growing concerns
about income redistribution. Barro’s conclusion that the overall effect of democracy on
growth is slightly negative continues to be
challenged by alternate views.
One alternate view suggests that the
adoption of democracy—or, more generally,
of political institutions that impose checks
and balances on the government—promotes
investment in physical and human capital
and, therefore, growth. In contrast, a second
view suggests that reaching a certain level
of economic development is what allows
countries to adopt better institutions.
continued on Page 2

T h e f e d e r a l r e s e r v e ba n k o f s t. l o u i s : Ce n t r a l t o A m e r i c a’ s e c o n o m y ™

Which Came First?
continued from Page 1

Do Political Institutions Promote Growth?
A study that supports the view that political institutions promote economic performance found a strong
relationship between a measure of protection against
government expropriation (as a measure of political
institutions) and economic performance (measured
by real income per capita) across a large sample of
countries. The study looked at two types of colonization strategies that led to different types of political
institutions.
The first strategy was the creation of extractive states. In these colonies, the main goal was
to transfer much of the resources of the colony to
the European power. Institutions created in these
colonies did not provide much protection of private
property and did not impose checks against government expropriation. Examples of this were the
Spanish colonies in Mexico and Latin America, and
the Belgian colonization of the Congo.
In the second colonization strategy, European settlers migrated in large numbers and created institutions that replicated those in their home country.
These institutions emphasized the protection of
private property and checks against government
expropriation. Examples of these were Australia, New
Zealand, Canada and the United States. The types

2

of institutions adopted in the early stages of either
colonization strategy lasted even after the colonies
became independent.

Or Does Economic Growth Stimulate Democracy?
The second view is that it is economic growth that
stimulates democracy or the adoption of better
institutions. Supporters of this view make the point
that the accumulation of human capital is a more
important determinant of economic growth than
political institutions. Supporters of this belief studied
a large set of countries in the period from 1960 to
2000, classifying them in four categories: autocracies, imperfect autocracies, imperfect democracies
and stable (or perfect) democracies.
In 2000, nearly all countries with high levels of
education were classified as stable democracies, and
nearly all stable democracies were highly educated.
In contrast, nearly all countries run by dictators were
poorly educated. In addition, as education levels
increased, democracies were more common, though
many were imperfect. In 1960, most of the poor
countries in terms of growth were run by dictators.
In the four decades that followed, the growth rates
among poor countries varied, and some of them
managed to get out of poverty while still being
run by dictators.

glossary

Which Came First–Democracy or Growth?
Dictatorship—government ruled by an absolute
authority
Democracy—government by all the people, direct
or representative
Political institutions—established governmental
customs, laws or practices
Economic freedom—an environment characterized
by the protection of private property and the ability
of individuals to engage in voluntary exchange of
goods and services
Redistributive policies—actions to reduce unequal
distribution of income typically carried out by taxing citizens with higher incomes and transferring
that wealth to citizens with lower incomes
Economic growth—an increase in a country’s production of goods and services
Political freedom—freedom of individuals in a society

Supporters argue that this evidence suggests that
it was not limits on dictators imposed by institutions
that led to growth, but rather that dictators chose policies that provided security of property rights to foster
investment in physical and human capital—which
then led to growth. The study mentions China as an
example of a dictatorship in which economic growth
has been the result of favorable policy choices and not
of institutional limits on the government.

The Debate Continues . . .
The debate about whether democracy and political
institutions generate growth or whether economic
development leads countries to adopt better institutions is likely to continue. In any event, fundamental
features of Western economic systems, such as free
markets and the importance of securing private
property rights, seem to be safe bets for economies
seeking economic growth.

that is not obstructed by government coercion and
that enables individuals to determine who their
rulers shall be
Physical capital—resources such as machinery and
equipment used to produce goods and services
Human capital— the education, skills and abilities
of workers
Government expropriation—the transfer of a
citizen’s property to the state
Real income per capita—income per person
(adjusted for inflation)
Extractive states—governments that depend on
extracting natural resources, often by force, for sale
or trade
Autocracies—governments in which one person
has unlimited authority, such as the power of absolute monarchs

Classroom Discussion
1.

What are two factors necessary for economic
growth?

2.

Why might you think democracy fosters
economic growth?

3.

Which of the two viewpoints—that democracy
fosters growth or that economic growth fosters
democracy—would be likely to emphasize
education as a key component for a growing
economy?

This article was adapted from “Which Came First—Democracy
or Growth?,” which was written by Ruben Hernandez-Murillo,
senior economist, and Christopher J. Martinek, senior research
associate, both of the Federal Reserve Bank of St. Louis, and was
published in the April 2008 issue of The Regional Economist, a
St. Louis Fed publication.

3

w h a t ’ s y o u r ques t io n ?

Education and Earnings
Q. How are investment in human capital and
personal income in the United States related?

Q. What is the relationship between level of
education and unemployment?

A. There is a strong positive correlation between
investment in human capital through education and
expected earnings. The benefits of education and
experience really show up over the long term:

A. Americans with more education are less likely to
be unemployed. This is especially true in the 25-34
age range of the work force where the jobless rate
can be three or four times higher for the high school
dropout than the college graduate. Although a
substantial difference remains in older age groups, it
is not as dramatic because work experience improves
employment prospects.

Education Level

Estimated lifetime earnings

Less than 9th grade

$976,350

High school dropout

$1,150,698

Bachelor’s Degree

$2,567,174

Master’s Degree

$2,963,076

Professional Degree

$5,254,193

Q. Over time, what has happened to the percentage of people in the United States who have
finished college and per capita income?
A. As the percentage of Americans who finish
college has increased over time, per capita income
has also increased. In 1950, per capita income was
estimated at little more than $10,000, and the
percentage of the population with college degrees
was around 7 percent. In 2004, per capita income
was estimated at slightly less than $35,000 and the
percentage of the population with college degrees
was around 28 percent. States that have a higher
percentage of the population that are college graduates also have a higher per capita income.
Q. In today’s economy, how does investment in
physical capital and investment in human capital
compare in the United States?
A. Although physical capital once drove the U.S.
economy, investment in human capital now takes
precedence. In the early days of the country’s
economic development, most work required muscle
power. Today, there is a shift toward more sophisticated jobs that require more brains than brawn.
Services now dominate the U.S. workplace and
provide 80 percent of the nation’s jobs. Although
some of the work requires only basic skills, many jobs
require handling complex tasks which demands more
investment in human capital.

4

Q. How does having a relatively free economic
environment relate to investment in human capital and GDP per capita?
A. Investment in human capital can’t achieve its full
economic potential without labor market freedom.
When companies and workers are free to make job
decisions, scarce labor resources are channeled to
their best uses, making the economy more productive and allowing investment in human capital to
yield greater dividends. This can be validated by
a comparison of countries through the Index of
Economic Freedom. In reference to GDP per capita
and years of school completed, more-free economies
have a higher GDP per capita when compared to
years of school completed than less-free economies.
Q. What is the Index of Economic Freedom?
A. The Wall Street Journal and the Heritage Foundation track levels of economic freedom using the
Index of Economic Freedom. The Index ranks the
world economies based on 10 categories: business
freedom, fiscal freedom, monetary freedom, trade
freedom, government size, investment freedom,
financial freedom, property rights, labor freedom
and freedom from corruption. The higher the index
score, the higher the degree of economic freedom
in a country.
Source: 2004 Annual Report, Federal Reserve Bank of
Dallas, pp. 7-19; www.heritage.org/research/features/
index/faq.cfm

e c o n o m i c s n apsho t

1.

What is real Gross Domestic Product (GDP)?
Real Gross Domestic Product (GDP) is the market
value of all final goods and services produced
in an economy during a year adjusted for inflation. GDP is the most comprehensive measure
available of U.S. economic activity. Quarterly
changes in real (inflation-adjusted) GDP are
considered the primary measure of growth in
the U.S. economy.

2.

What are the components of GDP?

Q1-’08

Q2-’08

Growth Rate
Real Gross Domestic Product

0.9%

2.8%

-0.5%

-3.8%*

Inflation Rate
Consumer Price Index

4.3%

5.0%

6.7%

-9.2%

Civilian Unemployment Rate

4.9%

5.4%

6.1%

6.9%

*Advance estimate

The components include personal consumption
expenditures (consumer spending), gross private
domestic investment (business investment in
structures, equipment and software, and inventories), government consumption expenditures
and gross investment (government spending),
and net exports (exports of goods and services
less imports of goods and services).
3.

Fourth Quarter 2008

What is the compounded annual
rate of change?
The compounded annual rate of change shows
what the growth rate would be over an entire

year if the same simple percent change continued
for four quarters or 12 months.
4. Which agency is responsible for
reporting GDP?
Gross Domestic Product is reported by the
U.S. Department of Commerce’s Bureau of
Economic Analysis. For more information,
see www.bea.gov.
SOURCE: Bureau of Labor Statistics Customer Handbook,
found at http://www.bea.gov/agency/pdf/BEA_Customer_
Guide.pdf

Real GDP Growth

Compounded annual rates of changes
8
6
4
2
0
-2
-4

2005

2006

2007

5

2008

Q3-’08 Q4-’08

b ulle t i n b o a r d

little rock

Activity-Based Economics:

Pig. E. Bank Economics

It’s Not the Dismal Science

May 6, 2009 | 8 a.m. to 4 p.m.
Federal Reserve Bank of St. Louis—
Little Rock Branch
Stephens Building | Little Rock, Ark.

July 13-17, 2009 | 8:30 a.m. to 4 p.m.
Pulaski Technical College
Little Rock, Ark.
This workshop features microeconomics, macroeconomics,
globalization and technology presentations by awardwinning economic educators.

25 Cents’ Worth of History teaches
Eighth District economics and
history using state coins.

For information about this workshop, go to
http://economicsarkansas.org/calendar/.

To register:
• visit www.stlouisfed.org/
education/conferences,

l o u i s v i l l e / m e m ph i s

• call Julie Kerr at
501-324-8296 or

Focus on Finance

• e-mail julie.a.kerr@stls.frb.org.

lit tle rock/louisville

It’s Your Paycheck!
Little Rock, Ark.
March 11, 2009
Federal Reserve Bank of
St. Louis—Little Rock Branch

A personal finance workshop for K-12 educators
April 2–3, 2009
8:30 a.m. to 4 p.m.
Federal Reserve Bank
of St. Louis—
Memphis Branch
Memphis, Tenn.
To register, e-mail jeannette.n.bennett@stls.frb.org.

Right Start

Bowling Green, Ky.
March 24, 2009
Bowling Green Junior
High School
Evansville, Ind.
April 16, 2009
Southern Indiana Career and Technical Center
Learn more about It’s Your Paycheck, a new high school personal finance curriculum from the Federal Reserve
Bank of St. Louis.
For more information, go to www.stlouisfed.org/
education/conferences.

An Institute for New and Beginning
Teachers of Economics
June 8-11, 2009
Federal Reserve Bank of St. Louis—
Louisville Branch
Crowne Plaza Hotel
Louisville Airport—Kentucky Expo Center
Louisville, Ky.
To register, visit www.econ.org/programs/rightstart.html.

Focus on the Economy
June 23-25, 2009
Millsaps College
Jackson, Miss.
To register, visit www.mscee.org and click on
“Focus on the Economy”.

6

b ulle t i n b o a r d

Arkansas History and the Great Depression
Curriculum Workshop
A one-day professional development workshop
July 10, 2009 | 9 a.m. to 4 p.m.
Northeast Arkansas
Education Cooperative
Walnut Ridge, Ark.
To register, e-mail jeannette.n.bennett@stls.frb.org.

Kids and Money
Workshop
A one-day professional
development workshop
July 17, 2009 | 9 a.m. to 4 p.m.
Northeast Arkansas
Education Cooperative
Walnut Ridge, Ark.
To register, e-mail jeannette.n.bennett@stls.frb.org.

s t. l o u i s

Summer School at the Fed
June 8-10, 2009
Federal Reserve Bank of St. Louis
St. Louis, Mo.
To register for this two and one-half day program on the
role of government through SIUE, contact Mary Anne Pettit
at 618-650-2583 or e-mail mpettit@siue.edu.  To register
through UMSL, contact Sharon Laux at 314-516-5249 or
e-mail lauxs@umsl.edu.

e i gh t h d i s t r i c t

Annual Educator Conferences
Fiscal Policy: What Does It Mean for the
Economy and Why Does It Matter to You?
Louisville, Ky.
July 21, 2009 (grades 5-12)
Little Rock, Ark.
July 22, 2009 (grades K-12)
Fayetteville, Ark.
July 23, 2009 (grades K-12)
Memphis, Tenn.
Nov. 4, 2009 (elementary)
Nov. 5, 2009 (secondary)
St. Louis, Mo.
Oct. 13, 2009 (grades 5-8)
Oct. 14, 2009 (grades 9-12)
This one-day conference will cover the role of fiscal
policy in the economy. Robert Rasche, Senior Vice President of Research at the Federal Reserve Bank of St. Louis,
will provide content.
For more information, go to www.stlouisfed.org/
education/conferences.

l i t t l e ro c k / lo u i s v i l l e /m e m ph i s

Hot Topics in the News Essay Contest
March 18, 2009, is the deadline for entries to the Little
Rock, Louisville and Memphis contests.

7

Bank Contacts
Little Rock
Billy Britt
501-324-8368
Louisville
David Ballard
502-568-9257
Memphis
Jeannette Bennett
901-579-4104
St. Louis
Mary Suiter
314-444-4662
Barb Flowers
314-444-8421

f e a t u r e d resources

GDP and Pizza
Economics for Life

The Federal Reserve Bank of St. Louis offers an online course for high school students. The
course defines Gross Domestic Product (GDP), explains the difference between nominal and
real GDP, defines per capita GDP, explains how economists measure economic growth, and
discusses monetary and fiscal policy as related to GDP. This course is designed to help students
in civics, economic and social studies classes understand challenging economic content—and
explain why these topics are import for citizens to understand.
GDP and Pizza: Economics for Life includes:

•
•
•
•

an in-class pre- and post-assessment activity,
an online pre- and post-test with data reported to the teacher,
two online class periods of instruction that include reading and self-checks for
understanding, and
video clips of an economist explaining the content.

To participate in a workshop or learn more about the course, contact: Billy Britt in
Little Rock at billy.j.britt@stls.frb.org, David Ballard in Louisville at david.b.ballard@stls.frb.org,
Jeannette Bennett in Memphis at jeannette.n.bennett@stls.frb.org or Mary Suiter in St. Louis
at mary.c.suiter@stls.frb.org.
www.stlouisfed.org/education/gdp.html

prsrt std
U.S. POSTAGE
PAID
ST. LOUIS, MO
PERMIT NO. 444

Federal Reserve Bank of St. Louis
P.O. Box 442
St. Louis, Mo. 63166-0442
Inside the Vault is written
by Barb Flowers, senior economic education specialist,
and Mary Suiter, manager of
economic education, at the
Federal Reserve Bank of
St. Louis, P.O. Box 442,
St. Louis, Mo., 63166.
The views expressed are
those of the authors and are
not necessarily those of the
Federal Reserve Bank of
St. Louis or the Federal
Reserve System. Please direct
all comments and questions
about the publication to 314444-8421 or barbara.flowers@
stls.frb.org.