Relative Prices and Relative Prosperity

The positive correlation between real (PPP) investment rates and levels of PPP income across countries is one of the most robust findings of the empirical growth literature. We show that this relationship is almost entirely driven by differences in the price of investment relative to output, rather than by differences in nominal investment rates. When measured in nominal terms (i.e., at national prices rather than at PPP prices), investment rates are little correlated with income. We find that the high relative price of investment in poor countries is solely due to the low price of consumption goods in poor countries. Investment prices are no higher in poor countries than in rich countries. These facts suggest that the low real investment rates in poor countries are not due to low nominal savings rates or to high tax or tariff rates on investment. Poor countries instead appear to be plagued by low efficiency in producing investment goods and in producing exportables to trade for machinery and equipment. We are grateful to Francesco Caselli, Bill Easterly, Chad Jones, Sam Kortum, David Romer, and Fabrizio Zilibotti for helpful comments.