Download labor productivity growth

MBA34
Managerial Excellence – 1° Term
Why are some countries rich and others poor?
How to predict growth?
The firm and its environment - Francesco Giavazzi
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Bocconi 2004
SDA Bocconi 2006
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Growth in living standards: a 20th century phenomenon
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Yet growth not equally fast for everybody
Our question: why do growth rates differ? Why
are some countries rich today and others poor?
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Actual growth rates are result of two forces
Force #1: Poor countries have more scope for catching up
 Other countries have developed new technologies, which
– once invented - can be imported by followers who may
save resources and more easily catch up
 Convergence hypothesis: poor countries grow faster than
rich ones
Force #2: a really poor country may stay poor forever
 If a country is unable to import high technology for it
lacks human capital, infrastructures and institutions or is
closed to foreign trade, catching up may not occur
Which force prevails is empirical matter
What do the data say?
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Growth rate, 1980 – 2000 (per annum)
The “bubbles in a knocked-over flute” diagram
6%
China
India
Usa
4%
2%
0%
-5000
-2%
-4%
5000
15000
25000
Nigeria
-6%
GDP per capita, US $$
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SDA Bocconi-2004
Data
points
weighted by size of population – show no convergence
5
Catch up amongst Europe’s big 4
10
Log of GDP per capita
10
10
9
9
9
9
8
8
8
8
7
7
1861 1869 1877 1885 1893 1901 19091917 1925 1933 1941 1949 1957 1965 1973 1981 1989 1997
Year
France
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Germany
Italy
United Kingdom
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Catch up in Europe
Log of GDP per capita
10.5
10.0
9.5
9.0
8.5
8.0
7.5
7.0
6.5
1921 1926 1931 1936 1941 1946 1951 1956 1961 1966 1971 1976 1981 1986 1991 1996 2001
Year
United Kingdom
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Ireland
Greece
Portugal
Spain
7
Which economies converge?
The US States
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Which economies converge?
Japanese Prefectures
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Which economies converge?
European Regions
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Summing up so far
Big differences in GDP growth rates across countries
No evidence in favor of strict convergence hypothesis
(“income of the the poor guys grows faster than the rich
guys”)
Instead: evidence of convergence within clubs. “Similar
enough” countries show tendency to converge
Hence: need theory of growth consistent with:
 worldwide divergence and
 club convergence
We develop this theory next
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First step: per-capita GDP up for three reasons
Demographics
GDP per capita = product of three components
GDP
GDP
Hours
Pop(15  64)



Pop
Hours Pop(15  64)
Pop
Capital accumulation
and efficiency gains
Our main focus today
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= Hours per employed times
employment rate. It depends
on labor market functioning
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Three potential sources of growth
 Labor productivity
 Hours worked
 Demographics
Demographics potentially important, but left out of
economics
Trends in hours worked do not explain club convergence
(see slides)
 We are left with labor productivity growth as a
convergence driver
 Important and relevant for economists
NEXT: develop a theory (based on MIT Nobel laureate
Robert Solow’s model) of how labor productivity
evolves and then check whether this matches data
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What determines labor productivity?
Question “What determines growth in living
standards?” boils down to asking smaller
question: “What determines growth in
labor productivity?”
Answer to smaller question:
Two things behind labor productivity growth
• Accumulation of capital (machines,
factories, construction)
• Technical and organizational changes,
including human capital improvements
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Aggregate production function
Trick: link sources of GDP growth through the
aggregate production function
Aggregate production function: efficient combinations
of factors of production (capital, labor) and
technology to give long-run GDP
GDP = TF(K, L)
T=efficiency + improved capital and labor quality,
L=total hours worked, K=capital stock
 close counterpart of firm-level concept
 T often called TFP (Total Factor Productivity); not
merely technological, also organizational and
managerial variable
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The production function: properties
The “F” function:
 is linearly homogeneous
 by doubling inputs, output doubled as well
 is subject to positive marginal productivity in
each factor (for given technology)
 return on extra machine always positive. If K
stock increases for given L so does output. Same
for L.
 is subject to diminishing marginal productivity
in each factor (for given technology)
 if economy has few machines, new machines add
a lot of output; if many installed, new machines
add little (congestion effect). Same for L
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From the Production Function
to the Determinants of Labor Productivity
Divide both sides by L, get expression for “Labor
productivity” (GDP per hour worked)
GDP/L = T f(K/L)
In words
Labor productivity goes up for two reasons:
 K/L for given technology
 also known as: ‘capital deepening’
 T (efficiency) for given capital-labor ratio
 Efficiency = social institutions, culture, financial
structure, technology. More discussion next.
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The determinants of labor productivity
GDP per hour worked
8.0
7.0
6.0
5.0
4.0
3.0
2.0
1.0
0.0
0.0
10.0
20.0
30.0
40.0
50.0
60.0
Capital per hour worked
Production function 1995
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Production function 2005
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From levels to growth rates
GDP per hour from production function in levels
GDP/L = Tf(K/L)
Can be reinterpreted in terms of growth rates:
Growth rate of GDP/L =
growth rate of T +
+ (elasticity of output with respect to capital) x
x (growth rate of K/L)
(maths not crucial for the rest of the argument)
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Useful algebra
‘Elasticity of output with respect to capital’  1/3
(=share of capital income over total GDP in most
countries)
Hence: g(GDP/L)=g(T)+(1/3)g(K/L)
Very useful formula: with data for K, L and GDP,
g(T) computed as a residual
g(T)= g(GDP/L) - (1/3)g(K/L)
g(T) (or TFP growth) is also known as ‘Solow
residual’ (from Solow, 1957). It is the
macroeconomists’ measure of technical and
organizational change
Others – more prosaically – label TFP: “a summary
of our ignorance”
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Growth accounting
Decomposition of labor productivity growth in its ‘capital
deepening’ and TFP components is called ‘growth
accounting’
Growth accounting crucial to:
 understand sources of long-run growth
 How much is TFP and how much is K deepening in the
overall growth rate of a country?
 make growth projections and discuss growth
prospects in an informed way
 Project past TFP and investment growth (or make
assumptions) to obtain predictions of future growth
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Accounting for labor productivity
growth in the USA
Growth of
labor
productivity
1/3 times
TFP, tech. &
growth of K/L organizational
change
1956-1975
2.5
1.1
1.4
1976-1995
1.2
0.6
0.6
1996-2005
2.6
1.1
1.5
US labor productivity growth mainly driven by TFP
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Capital accumulation with no TFP
growth eventually kills growth:
the former USSR
Growth of
labor
productivity
1/3 times
TFP, tech. &
growth of K/L organizational
change
1971-1975
4.5
3.0
1.5
1976-1980
3.3
3.9
-0.6
1981-1985
2.7
3.5
-0.8
USSR: LP growth mainly driven by K-deepening
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Our theory of growth
In the US, growth mostly due to TFP. In the
USSR mainly by K. Same as USSR often
applies to poorer countries
Is this consistent with production function
model? YES
 US is K-abundant (L scarce, rich country) 
productivity of additional units of capital is low 
growth NOT driven by capital or resource
accumulation, technical and organizational changes
needed
 In K-scarce (L-abundant) poor countries: scope for
“catching-up” through K accumulation, growth
driven by K
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No wonder that:
growth mostly explained by TFP in rich countries
and mostly by K/L in poor countries
OECD 1947-1973
Latin America 1940-1980
East Asia 1966-1990
0
5
10
15
20
25
30
35
40
45
TFP growth as a % of total GDP growth
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The story runs as follows
Flute diagram shows no worldwide convergence
Why?
African and Latin American countries couldn’t
catch up with the rich guys
• “Poor country advantage” more than offset by other
TFP-related gaps
Asian countries did catch up instead
• Huge investment rates more than offset TFP gap
Within the OECD, most countries shared same
(US) technology in an open-economy
environment. This is “club convergence”
• As a result, poorer countries (Gre, Spa, Ita, Ger, Jap)
caught up with the US and the UK
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TFP differences explain a lot of the differences in
output per head
TFP relative to United
States
Why Are Some Countries so Much Richer?
1.6
1.4
1.2
1
0.8
0.6
0.4
0.2
0
0
0.2
0.4
0.6
0.8
1
Output per Worker relative to United States
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What’s behind a name: “TFP”
Data suggest that TFP differences are very important
when explaining differences in output per worker
But what is “TFP”? It is the efficiency with which factors
of production are used
A country may be relatively inefficient because:
(a) Endowed with inferior technology – available
technology may be efficiently used but the technology
itself may not be the best practice
(b) Its chosen technology is adopted inefficiently – there
may be bad work and business practices,
bureaucratic obstacles, bad policies. All such things
lead to inefficient ways of doing things
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Socio-economic and techno-managerial
determinants of TFP
(1) The socio-economic efficiency of countries – the
extent to which institutions affect the efficiency of the
economy. We will refer to this as “institutions” and
“policy”
- “Institutions” refers to the broader institutional
settings including historical factors that help shape
society
- “Policy” refers to the policies implemented, given the
institutional background
(2) Technology and management – the technologies
that are used, how they are implemented, and the
organizational structure of the firm
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Institutions?
• Legal system: Rule of law is key for making the
economy work: one key aspect is protection of property
rights
• Political Institutions: If power is highly concentrated,
the elite may protect their own rights (also important that
“bad rulers” can be `punished’)
• Educational Institutions and Allocation of Talent:
With the “wrong incentives” talent will not necessarily be
allocated to the socially best activities (rent seeking and
pirates)
• Financial Institutions: Finance matters for the
allocation of capital. Inefficient institutions do not allocate
capital to the most productive projects
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Example: If rule of law holds, productivity is
higher …
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… and factor accumulation too
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“Good” policies for TFP growth
Policy affects efficiency
- Property rights protection – without properly defined
property rights, no incentives to do things efficiently or to
invest in capital or in new technology
- Competition / deregulation – will in general promote
efficiency, particularly at times of fast technical change
-Political stability – instability creates uncertainty and
holds back efficiency and investment
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More of “good” policies for TFP growth
Trade policy: The lack of restrictions on foreign trade are
often found to be an important determinant of TFP
•
In next classes, we will see that foreign trade allows a
country to specialize itself in activities where it is
efficient
Can also build a direct relationship to TFP
(a) Protectionism often the result of inefficient firms /
sectors lobbying for protection against foreign
competition – (US steel tariffs, EU?): trade
restrictions allow such inefficient firms to survive
(b) When shielded from foreign competition, domestic
firms may not feel the need to be efficient
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Finance and TFP
Also financial markets matter
• Financial markets provide funding for private enterprises
in two ways
• Bring together lenders and borrowers. This raises
efficiency by lowering costs of starting new projects.
Also promote growth through savings and investment
• Screen good vs. bad projects. Lenders (banks,
financial institutions) assess the prospects of projects
• Evidence indicates that “good” financial markets bear
positive correlation with better economic performance.
Probably because of better allocation of capital – ie. give
rise to higher TFP
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Summing up
Poor countries would have more scope for catching up
(unexploited profit opportunities)
Typically, catching-up forces most powerful in poor
countries with growth-conducive institutions
But many examples teach us that a really poor country may
stay poor forever, if engines of TFP growth disregarded
As catching-up forces exhausted, TFP growth engines
should gain momentum
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