Page 19 - FINAL CFA II SLIDES JUNE 2019 DAY 4

LOS 12.a: Compare factors favoring and limiting economic READING 11: CURRENCY EXCHANGE RATES: UNDERSTANDING EQUILIBRIUM VALUE
growth in developed and developing economies.

Main metric is GDP ( or GDP per capita) but investors MODULE 12.1: GROWTH FACTORS AND PRODUCTION FUNCTION
are keen on GDP growth rate: Determining factors are:

PRECONDITIONS FOR GROWTH

1. Savings and investment is + correlated with economic development. To to grow, private and public sector investment must provide a
sufficient level of capital per worker. If insufficient domestic savings, attract foreign investment in order to grow.

2. Financial markets and intermediaries augment economic growth by efficiently allocating resources (between potential users based on
risk and return, provide for liquidity and opportunities for risk reduction, and pooling small amounts of savings from investors to finance
larger projects. Note that financial sector intermediation may lead to declining credit standards and/or increases in leverage, increasing
risk but not economic growth).

3. Political stability, rule of law, and property rights environment also influence economic growth. Countries that have not developed a
system of property rights for both physical and intellectual property will have difficulty attracting capital. Similarly, economic uncertainty
caused by wars, corruption, and other disruptions poses unacceptable risk to many investors, reducing potential economic growth.

4. Investment in human capital is complementary to growth in physical capital. Countries that invest in education and health care systems
tend to have higher growth rates. Developed countries benefit the most from post-secondary education spending, which foster
innovations. Less-developed countries benefit the most from spending on primary and secondary education, which enables the
workforce to apply the technology developed elsewhere.

5. Tax and regulatory systems need to be favorable for economies to develop. All else equal, the lower the tax and regulatory burdens,
the higher the rate of economic growth. Lower levels of regulation foster entrepreneurial activity (startups), which have been shown to be
positively related to the overall level of productivity.

6. Free trade and unrestricted capital flows are also + related to economic growth. It promotes growth by providing competition for
domestic firms, thus increasing overall efficiency and reducing costs. Additionally, free trade opens up new markets for domestic
producers. Unrestricted capital flows mitigate the problem of insufficient domestic savings as foreign capital can increase a country’s
capital, allowing for greater growth. Foreign capital can be invested directly in assets such as property, physical plant, and equipment
(foreign direct investment), or invested indirectly in financial assets such as stocks and bonds.