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0DVWHULQ(QJLQHHULQJDQG7HFKQRORJ\ 0DQDJHPHQW (&2120,&62)*52:7+$1',1129$7,21 /HFWXUH 1. Theories of Economic Growth 1.2- Endogenous Growth 1.2.2- The Lucas Model (Basic Ideas) 1.2.3- The Stokey Model (Basic Ideas) 2. Economic Integration, Technology Transfer… 2.1- The Grossman & Helpman Model 2.1- The Rivera-Batiz & Romer Model 5HDGLQJV • Rivera-Batiz, Luis and Paul Romer (1988), “Economic Integration and Endogenous Growth”, Quarterly Journal of Economics, 106(2), 531-55. • Stokey, Nancy (1991), “Human Capital, Product Quality, and Growth”, Quarterly Journal of Economics, 106(2) ,587-616. • Grossman, Gene and Elhanan Helpman (1991), “Quality Ladders and Product Cycles”, Quarterly Journal of Economics, 106(2) ,55786. • Lucas, Robert (1988), “On the Mechanics of Economic Development”, Journal of Monetary Economics, 22, 3-42. 1 7+(25,(62)(&2120,&*52:7+ FRQWG (1'2*(1286*52:7+ /XFDV0RGHO$+XPDQ&DSLWDO$SSURDFK • In its 1988 paper, Nobel laureate Robert Lucas presented a model in which the ultimate goal is to endogenise economic growth. In that model, the ‘engine’ of growth is KXPDQ FDSLWDO , as human capital accumulation raises the productivity of both labour and physical capital. This is the main feature of the model. • In spite of having been much upgraded by other contributors, the importance of the Lucas model resides in the fact that he provided the first human capital approach to endogenous growth. • The basic idea of the model is that people divide their time between work and training. So, there is a trade-off, since when taking on training people give up part of their work income, but raise their future productivity, and therefore their future wages. • In essence, this trade-off is just like the typical one appearing in physical capital accumulation: it is a 2 question of postponing income today (and hence consumption) for income tomorrow. Thus, the decisions concerning the accumulation of human depend on the dynamic features of the economy, which makes it endogenous. Since human capital accumulation is the ‘engine’ of growth, growth will itself be endogenous as well. • This model has two types of capital: physical and human capital. The fundamental equation of the model, which is a portfolio equilibrium equation, states that in steady-state the marginal product of the two types of capital must be the same. This implies that the dynamics of accumulation of the two types of capital are interlinked. This prediction of the model seems to make sense in the ‘real world’. • The model is quite simplistic in the sense that its assumptions are quite reductive. The basic assumptions of the model are: - The consumers welfare is given by an intertemporal constant-elasticity of substitution utility function. 3 - The ‘effectiveness’ of training, that is, the rate at which productivity is risen by one additional unit of training is exogenous. • The main results of the model can be summarised as follows. - The higher the productivity of training, the higher will be the increase in the marginal product labour that follows training and hence the higher the future wage rate. This means that the incentives to training are greater and so will be the growth rate of the economy. - The lower is the rate of ‘impatience’, that is the less consumers privilege present relative to future consumption, the more will workers be willing to forsake present consumption to dedicate themselves to training. Therefore, the higher will be the rate of economic growth. 4 6WRNH\0RGHO$3URGXFW4XDOLW\$SSURDFK • In her 1991 paper, Nancy Stokey (Robert Lucas’ wife), devises a model aimed at explaining growth phenomena such as that experienced by some successful new industrialised countries in East Asia, where rapid economic growth has been accompanied by high volume of exports, rapid growth in education and rapid changes in the composition of output. • Labour is heterogeneous and differentiated by the level of human capital. • The technology for human capital accumulation used in the model is one that distinguishes between the private human capital of individuals and the stock of knowledge of the society as a whole. • An individual accumulates human capital by investing, that is, going to school. His level of human capital upon leaving school and entering the labour force depends: - On the OHQJWK of his investment period, which he chooses. - On the HIIHFWLYHQHVV of the time spent, which is determined by the social stock of knowledge. 5 • The level of human capital of an individual upon entering the work force determines his wage over the rest of his life, which he spends working. Thus, his choice about the length of the investment period is made by balancing the opportunity cost of later entry into the work force against higher wage rate paid to more skilled labour. • Private investment in schooling also has an external effect (externality): it causes growth in the social stock of knowledge, which increases the effectiveness of time spent in school. Since it is assumed that individuals are finite lived, this external effect is the only source of steady-state growth. • In much of the related literature in which labour of different skill levels is assumed to be perfectly substitutable in production, that is, 1 unit of labour with human capital ok K is perfectly substitutable by K units of labour with human capital of unity. In contrast, in Stokey’s model human capital is not perfectly substitutable. • This LPSHUIHFW VXEVWLWXWDELOLW\ among different types of labour is modelled by allowing higher-quality labour to perform more highly-valued services. • In the model, goods are differentiated in terms of quality. In this setting, as aggregate human capital grows, output 6 consists of dropping lower-quality goods from production and adding higher-quality goods. This is the most distinctive feature of the model and one that seems extremely important in the ‘real world’. 0DLQ5HVXOWV • In this model, economic growth is HQGRJHQRXV , since, as in Lucas model, growth is driven by the individuals investment in human capital which depends on variables internal to the model, such as the rate of ‘impatience’. • The fact that it is the external effect that is driving economic growth means that the growth rate under ODLVVHU IDLUH will be generally lower than the social one, so that the equilibrium is LQHIILFLHQW . The reason is that, since the decision to invest in human capital by any individual is made in such a way as to optimise its private earnings profile, the externalities are not taken into account and investment will be sub-optimal. • The model has another important finding. In an openeconomy setting, in which economies are assumed to trade among themselves, the model shows that for economies that are sufficiently backward relatively to the rest of the world, the optimal investment rate will be generally lower 7 than in the rest of the world. The reason is that, since highskilled labour is relatively abundant in the rest of the world, international trade will push the prices of highquality goods downwards, reducing the incentive of individuals to invest in human capital. 6RPH$SSOLFDWLRQV • This model seems to hold some important implications for a country like Portugal: - It seems consensual that economic development in a country like Portugal means moving away from the actual base of production, which is characterised by essentially low value-added goods. - Also, since the rate at which people invest in human capital is rather low in Portugal, maybe because of the externality identified in the model, some policies like subsidies to education, effective child labour laws and incentives to R&D might be particularly useful. - Finally, if the predictions of the model are right, the fact that Portugal is submerged in a 8 community of more developed countries may imply that Portugal is condemned to grow at lower rates than its EU partners. The argument is that of a relatively backward economy under free trade. The fact that Portuguese people and businesses have access to the higher-quality goods from abroad, constitutes a negative incentive to upgrade out productive system into a higher value-added production base. 9 (&2120,&,17(*5$7,21 7(&+12/2*<75$16)(5$1' *52:7+ $1 (1'2*(1286 *52:7+ $3352$&+ 72 352'8&7 48$/,7< /$''(56 $1' /,)( &<&/(7+(*52660$0+(/30$102'(/ • ,QQRYDWLRQ products. entails the creation of new processes and ,PLWDWLRQ is one means by which new ideas spread through the economy. Together, these two features account for much of what we call ‘technological progress’. • In spite of the fact that innovation and imitation are interlinked, economists now little about how they interact. We would like to know whether imitation, by shortening the length of time the innovator can enjoy monopoly rents, reduces the incentives to innovation and so economic growth. • The model developed by Grossman an Helpman (1991) deals with this issues and goes further by typifying the model according to the world’s economic geography. That is, in the model it is assumed that the ’North’ has a 10 comparative advantage in R&D and so makes the bulk of innovation, whereas the ‘South’ has a factor cost advantage that makes that region to hold a comparative advantage in manufacturing and so in imitating. • There are many goods in this economy and so the model can be seen as a model of ‘patent races’ in which firms in the ‘North’ try to go up in the products TXDOLW\ ODGGHU by devoting resources to R&D. In the ‘South’, firms also devote resources to research, but with the aim of being able to reproduce the technology embodied in the latest patent. • It is assumed that the holder of the latest patent of each product (the OHDGHU ) has an informational advantage in discovering the next quality upgrade when production has already been displaced to the ‘South’, i.e. after some Southern firm has been able to imitate. • The model is one of endogenous growth, since the decisions to invest in learning (R&D in the ‘North and imitation in the ‘South’) involve a comparison of potential profits and research costs. Economic growth is assumed to be equal to the aggregate rate of innovation. 11 • It is assumed that successful innovators in the ‘North’ earn monopoly profits for a while, because their new products are superior to those available from other suppliers. • Successful imitators in the ‘South’ earn rents because their manufacturing costs are lower than those of competitors in the ‘North’. In this sense, the G&H model can be seen as a FUHDWLYH GHVWUXFWLRQ model, as like in Aghion and Howitt, firms that are successful in innovating or imitating reap the whole market share from the incumbent. 0RGHO5HVXOWV • The SS is characterised by permanent product upgrading and by product cycles (i.e., migration in the location of production for a particular type of good from the ‘North’ to the ‘South’ and back again). Each product may exhibit a complex life history, with alternating periods of technological stagnation, rapid growth, etc., but the aggregate rates of innovation and imitation are constant, and so is the rate of economic growth in SS. • This result of the SS equilibrium in the model has some resemblance to what happens in the ‘real world’ in which waves of technological advances in some industries are 12 followed by waves of imitation that spread the technology worldwide. • For example, the beginning of the history of the PC had such a pattern. IBM introduced its original PC based on the 8088 processor in the early 80s. It amassed an enormous market share until firms in Taiwan and South Korea were able to offer competitively priced ‘clones’. Then the ‘South’ began to export massive amounts of PCs to the ‘North’. However, much of the production reverted to the ‘North’ when IBM and others successfully developed the higher quality machines based on the 80286 processor. • Another result consists of the effects of government incentives to innovation, in the ‘North’, and to imitation in the ‘South’. • Subsidies to Northern industries R&D accelerate the pace of innovations and so accelerates the SS rate at which goods flow from ‘North’ to ‘South’. With the same reasoning, subsidies to imitation have a detrimental effect on the rate at which goods climb the quality ladder, as the incentives to innovation in the ‘North’ gets reduced (EXVLQHVVVWHDOLQJHIIHFW). 13 (&2120,& ,17(*5$7,21 (1'2*(1286 *52:7+ 7+( 5,9(5$%$7,= 520(5 02'(/ • Many economists believe that increased economic integration among developed economies has had a positive impact on long run growth. This belief is underpinned by some empirical evidence according to which the creation and transmission of ideas has been important in establishing the modern standards of living. • Conventional attempts to quantify the effects of integration using the neoclassical growth models often suggest that the gains from integration are small, as this type of models only identifies OHYHOHIIHFWV and not JURZWKHIIHFWV. • In dealing with economic integration, the authors use a broad definition of integration. One that includes the exchange of goods as well as of ‘ideas’. • The model used in this paper is basically the Romer’s model we have dealt with in previous lectures. (At this stage, you should revise the main ideas of that model). • Recalling the comparative static exercise we did for the Romer’s model, an increase in + , the level of human capital, would shift both the Romer and the Ramsey line, yielding higher growth rate and interest rate. 14 • In this context, assuming that full economic integration implies a merge of two economies, we see that + would double and so growth would be permanently higher as the growth rate of the ‘production’ of designs would also double. • However, we want to analyse the dynamic behaviour of the economy when there is economic integration. We will do that sequentially, by first considering the impact of goods trade liberalisation and only then will we evaluate the impact of trade liberalisation of goods and ideas. )ORZ RI *RRGV :LWK 1R )ORZ RI ,GHDV %HWZHHQ 7ZR 3UHYLRXVO\&ORVHGDQG6LPLODU(FRQRPLHV • The first point is that because there is only one (aggregate) consumption good that is assumed similar for the two economies, trade will only occur in the intermediate, capital input sector. • The second point is that opening trade in goods has no permanent effect on the rate of growth. In balanced growth the rate of growth of output is equal to the growth rate of , $ $ $ capital, = δ+ , which is determined by the split of human $ + = + $ ++ < between the consumption good sector and the research sector. 15 • It is straightforward to show that such split does not change in balanced growth after trade in goods has been opened, because opening trade has two offsetting effects on the wages of human capital in these two sectors. • In what concerns the consumption good sector, when trade is opened, the machine producers, in order to avoid redundancy and so competition specialise and so the number of machines available for the production of the consumption good doubles. This has the effect of doubling the marginal product (MP) and so the wage rate of +. • In the research sector, opening of trade implies that the market for new designs is twice as large as before. This doubles the prices of patents and doubles the MP of human capital in research. However, since the foreign stock of knowledge is not available for use in research because only goods can be traded, the productivity of human capital remains the same. • It turns out that the wage of human capital doubles in both sectors and so the allocation of + between the two sectors does not change. Consequently, the growth rate of the stock of knowledge and so of the economy’s output, does not change in SS. However, there is a growth effect that results from the fact that at any moment the number of machines in use is twice as much as in autarky. 16 )ORZRI,QIRUPDWLRQ2QWKH7RS7UDGH/LEHUDOLVDWLRQ • As we have seen, trade liberalisation entails specialisation in the types of machines produced, so that after a while the stocks of knowledge of the two economies are completely distinct, and so the ‘area-wide’ stock is twice what was for each economy in isolation. • If flows of ideas is allowed between the two economies then the research sectors of each country have twice as big a stock of ideas to use in creating new designs. In this model, this means that the growth rate of designs jumps from $ = δ+ $ $ to $ = δ+ $ 2 $ + $* . 7 • Thus, even if the share of human capital allocated to the research sector does not change, the growth rate of $ and so the output’s growth rate would double permanently in balanced growth. • However, the increase in $ has the effect of increasing the productivity of human capital in the research sector and no effect on the productivity of + in the output sector. This change in relative productivity raises the wage of human capital in the research sector relative to the output sector. • The consequence is a migration of human capital from the output sector to the research sector, which reinforces the 17 growth effect of the liberalisation of the flow of ideas. So the growth rate in SS more than doubles compared to a situation in which the flow of ideas is not permitted. • From the G&H and R-B&R models we had a flavour of the implications of exchange of goods and ideas to economic growth. In this context, we can summarise some of the most conclusions: - The exchange of goods stimulates the economy if only for the fact that it extends the scope of capital inputs that can be used in production of the final good and also for creating incentives to specialisation and so for higher efficiency. - The exchange of ideas, allows countries to share knowledge and ideas, which naturally amplifies their technological possibilities, but also provide more inputs to the creative process. This creativeness is, as we know, the most important factor of competitiveness in modern economies. • The next step is to look at the impact of foreign direct investment (FDI) in fostering technological progress and growth. 18