Download Lecture notes: “Why are some countries rich and others poor

Lecture notes: “Why are some countries rich and others poor? social, cultural and economic determinants
of industrialisation”.
Lecture 3.
I. Introduction.
Economists are often 2-faced – a simple model of the world for the public, and a very different
discourse amongst themselves – vis. The two sides of Paul Krugman
Public face: single equilibrium, free market models, with strong benefits from free trade, and a
limited role for government action;
Private discussion: multiple equilibria → possibility that govt. action could shift economy from
one equilibrium to another.
Problems of reading economics articles: 1. high level of technical difficulty, maths etc
2. highly abstract artificial models: world modelled as a single, infinitely lived household,
producing one good, using a two factor technology:
but: good models, manage to produce something interesting from this;
bad models: just an exercise in mathematical manipulation
however: economics matters – what we have discussed in the first two lectures is based on the view that
economies should grow – that growth is normal.
II. The neo-classical model, aka the Solow model.
OVERHEAD 1.
GROWTH MODELS I.
1.The Neo-Classical Model (Solow Model):
Ykt = f (At , Kkt , Lkt )
where: f is a production function with constant returns to
scale with respect to K and L(doubling K and L doubles Y);
At is the state of world technology in time period t;
Kkt is the stock of physical capital in country k
in time period t;
Lkt is the total labour input (hours) in country k
in time period t.
2. The Neo-Classical Model with labour-augmenting technical progress:
Y = f (K, AL)
3. The Cobb-Douglas production function with constant returns to scale:
Y = A.Kβ.L1-β
IMPLICATIONS OF THE NEO-CLASSICAL MODEL:
1.
2.
3.
4.
in the long run, economy converges to a steady state, with income levels determined by
technology, the rate of savings and the rate of population growth.
the rate of growth in the steady state is determined exclusively by the growth of technology
in the steady state, profit rates are constant, while wages rise
for economies below the steady state path, there is a strong process of convergence,
Notes:
1. technology is world technology and available to all at zero cost; technology is not owned by anyone
capital is physical capital; as measured by accountants for example (for different reasons)
→ importance of scrapping conventions.
2. model solves for 1. a steady state of growth which is independent of initial conditions;
2. level of income in steady state which is determined by rate of savings, and population
growth;
3. rate of growth which is determined by rate of tech increase in world;
4. strong convergence property.
3. extensions of the model: 1. savings function: make savings a function of time preferences → increased
complexity, and use of dynamic optimisation techniques = a considerable obstacle for the reader.
2. quality adjustment of the labour force (or capital)
4. advantages of the model: 1. very simple – can be used for sector analysis;
2. TFP calculation is mainstay of growth analysis;
3. seems to work well for short/medium term analysis of mature industrial
economies;
4. may be appropriate for a country which imports a lot of technology (Ireland;
UK)
5. Problems with the model (see: Mankiw for analysis)
1. cannot predict the scale of international differences in GDP/capita: only 2-2.5: 1, not
10:1
2. predicts rate of convergence 2x faster than actually happens
3. productivity of capital should be much higher in developing countries: 100x larger, or
500% against 5%. (→ massive convergence due to flows of capital)
OVERHEAD 2
GROWTH ACCOUNTING (TOTAL FACTOR PRODUCTIVITY CALCULATIONS):
(see. D.Romer – Advanced Macroeconomics, 1996, p.26)
From the neo-classical model with labour augmenting technical progress:
ΔY = α ΔK
+
(1- α )ΔL +
ΔA
Where ΔY, ΔK, ΔL and ΔA are proportional changes in GDP, the capital stock, the labour input and technology; α is
the elasticity of output with respect to capital and (1- α) is the elasticity of output with respect to labour.
With perfect competition, all factors are paid their marginal product, so: α = MPK. K/Y, which is the share of capital in
national income (rents + profits), and (1-α) = MPL. L/Y, which is the share of wages in national income.
EXAMPLE (from C. Feinstein et al British Economic Growth, 1856-1973, 1982, p. 208)
Britain 1873-1913: capital share in national income was 43%; labour share was 57%.
Annual rate of growth of labour input (hours)
weighted by labour share
Annual rate of growth of gross capital stock
weighted by capital share
Combined rate of increase of factor inputs
Actual rate of increase of GDP
Implied rate of increase of total factor productivity
0.9
0.57
1.9
0.43
1.3
1.8
0.5
6. Performance of the model in historical analysis
1. Calculation of the TFP residual, is useful check, but quite erratic
OVERHEAD 3
Total factor productivity growth
1. United States 1800-1989 (David and Abramovitz)
2.5
TFP growth
2.0
1.5
1.0
.5
0.0
1800
1820
1840
1860
1880
1900
1920
1940
1960
1980
year
2. Britain 1856-1995 (Feinstein et. al; O’Ma
honey)
3.0
2.5
TFP growth
2.0
1.5
1.0
.5
0.0
1856
1876
1896
1916
1936
1956
1976
1996
year
2. poor explanation of how technology is created: it is not manna from heaven → James Watt and the steam
engine, Watt watches a kettle = fairy story for children
in fact: Newcomen engine had been in use for 60-70 years and had been other attempts to improve
it before Watt invented condenser → massive increase in efficiency and can be used away from coal fields.
Watt (technician at Glasgow medical school) was motivated by financial rewards
Also: 1. London was heated by coal, which was deep mined
2. → large market for steam engines
so: can we produce a better theory?
III. Human capital models
Use a broader definition of capital → Lucas model & others
Capital more broadly defined→ less convergence and lower returns on physical capital + explanation of
lasting income differences
Note: capital is still not owned by anyone → spillovers
And due to this, there is a case for subsidies of human capital production
→ permanent differences in income, which depend on initial endowments and → permanent effects from
shocks
GROWTH MODELS II: A TWO SECTOR MODEL OF GROWTH WITH HUMAN CAPITAL (Lucas
1988)
Production of final goods: Y = f ( K, (1- u).L.H)
Production of human capital: ΔH = g (u).H
Where: H is the stock of knowledge; u is the proportion of the total labour force engaged in research, and
(1-u) is the proportion engaged in final goods production; g is the production function for the production of
knowledge.
IMPLICATIONS OF THE HUMAN CAPITAL MODEL
1. technology grows as a result of decisions to invest in new knowledge;
2. the model converges to a steady state determined by the savings rate and the proportion of the
labour force engaged in research;
3. differences between countries are much more persistent, and can remain large if u is low in
poor countries;
4. rates of profit in poor countries can be held down by low endowments of human capital
and/or low rates of investment in education;
5. model assumes: 1. knowledge is not transferable across frontiers; 2. knowledge creates
benefits which are both internal to the individual who invests in human capital and external (=
spillovers).
IV. Human capital models with learning by doing
Much knowledge is not acquired by formal education but by learning on the job → learning by
doing
Note: this type of knowledge is not easily transferred, and therefore makes a better explanation of
international differences in income levels
GROWTH MODELS III. GROWTH WITH LEARNING-BY-DOING (Lucas 1993)
IMPLICATIONS OF THE LEARNING-BY-DOING MODEL
1.
2.
3.
learning is greatest with new products: economies which specialise in newer goods will have
higher rates of human capital accumulation;
with positive spillovers between high technology goods, this will give advanced economies an
advantage in the production of such goods;
there may be a North-South division between “northern” economies which specialise in newer
goods and “southern” ones, specialising in older goods with few learning benefits.
Liberty ships: 40% annual increase in industry output per manhour, mostly in first 2 years
→ 1. either heavy scale effects, or strong gains from specialisation, BUT it matters what one specialises in
2. the more an economy specialises in new goods the greater the gains from learning
3. with trade model → division between North and South:
North – specialises in new goods with strong learning → more growth, more human capital
accumulation
South – specialises in older goods, little learning etc
How can this be overcome? For large southern countries it may pay to reduce trade, and make gains from
internal learning
OVERHEAD 6
SOME QUOTES (Lucas 1993):
“In Young’s framework there are equilibria in which the poor catch up to the rich, but only when their
larger populations let them enjoy greater scale economies. Young does not emphasize this possibility and I
do not wish to either”
“The main engine of growth is the accumulation of human capital – of knowledge – and the main source of
differences in living standards among nations is differences in human capital.
….for understanding periods of very rapid growth in a single economy, learning on the job seems
to be by far the most central. For such learning to occur on a sustained basis, it is necessary that workers
and managers continue to take on tasks that are new to them, to continue to move up the “quality ladder”.
For this to be done on a large scale, the economy must be a large scale exporter.
This picture… is consistent with any individual small economy following the East Asian example,
producing a very different mix of goods from the one it consumes. It does not appear to be consistent with
the third world as a whole beginning to grow at East Asian rates. There is a zero-sum aspect, with
inevitable mercantilist overtones, to productivity growth fuelled by learning by doing.”
? Brazil v Argentina; India v Pakistan
→ 2 stage economic policy:
1.
very poor country with little industry → autarchy to get some industry
2.
when middle income → export push
2nd quote from Lucas
→ convergence of Lucas with dependency theory!!
V. Human capital models and inequality
A further extension of human capital models – people have to borrow to invest in Human capital
→ effect from inequality on growth (Benabou, Galor & Zeira)
simple idea: 1. households decide whether or not to invest in training, or accept unskilled wages;
2. borrowing is costly due to monitoring costs which rise with amount borrowed
3. training is lumpy – either one is trained or not;
4. with unequal bequests: relatively few train, with more equal bequests or govt. support more do
→ more growth
5. note: realistic for many poor countries and also supported by growth regressions
[but: may be other factors – social capital/ineq. and ineq. → sectional interests]
VI. Endogenous growth theory
1.
Someone does own technology !!
2.
cost of replication of an idea is zero [Romer 1990 and 1994]
3.
→ very different world to neo-classical theory [Aghion and Howitt book – note attempt to be
readable]
note: there are many models and I’m not going to try to deal with all of them → Aghion and Howitt model
1.
Schumpeterian model: creative destruction: value of an idea is destroyed by the next idea to come
along
2.
Costless replication → scale effect: if an idea is used by 7 or 7 million, the cost of production is
the same, but the economic effect is vastly greater → effect of market size
3.
4.
factors in the decision to produce new technology
a.
market size
b.
availability of research workers → more scale effects
c.
state of knowledge, building on other research → spillovers
d.
protection of intellectual property rights [note: may → less than optimal diffusion]
e.
discount rate
f.
extent and duration of expected monopoly
g.
functional form of the research equation
implications: 1: zero tech. progress is also an equilibrium
2
can be threshold effects.
3. accelerating world growth!!!
VII. Some extensions of endogenous growth theory (note: strength of the theory is in the extensions)
1.
Technology transfer: some research imported→ fast convergence, if the build up of
knowledge is faster than the transfer of capital
2.
3.
ambiguity on the effect of monopoly: (Schumpeter’s point)
a.
too much → limited diffusion of ideas due to high charges
b.
but some monopoly power is needed to generate the incentives for research
c.
with capital market imperfections, large corporations may be needed to fund research
leading sector analysis: technological opportunities concentrated in a few sectors → trade
analysis, with the possibility of specialisation
4.
high rates of tech. progress can lead to rapid obsolescence of ideas → accelerated scrapping
of the capital stock (if ideas embodied in capital)→ fall in TFP growth
5.
if tech. progress → rapid change over between sectors and workers are committed to one
sector or another (limited mobility), → unemployment rising when tech change is high
6.
distinction between general purpose technologies and secondary innovations → waves of
improvement following major GPT advances (long wave analysis) and possibility of
recessions following such changes (if disruptive)
7.
scale effects → acceleration
OVERHEAD
Two millennia of economic growth: data from Maddison
1. % increase in average per capita GDP, by century.
400
300
200
100
0
-100
1st
3rd
5th
7th
9th
11th
13th
15th
17th
19th
century
2. % increase in World GDP, by century
2000
1800
1600
1400
1200
1000
800
600
400
200
0
1st
3rd
5th
7th
9th
11th
13th
15th
17th
19th
century
Note: one doesn’t have to be a strong ecologist/environmentalist to find this unsustainable!
Some mechanism will be needed to hold back any further acceleration (does not have to be a mechanism
from within the growth model)
VIII. Some conclusions
Horses for courses: 1. Neo-classical model with adjustments for labour quality → good model for
medium term analysis in advanced countries
2. Human capital models: best for under-developed countries today, who do not create much
technology themselves, and we need to explain why they do not import tech. + capital
3. Endogenous growth theory: best at explaining major historical discontinuities – a macro-macro
model mainly of interest to historians!
EXAMPLE: the effects of colonial expansion and the size of the market on incentives for research
in manufacturing in C18: effect of West African slave trade → world market in standardised manufactures
(Liberty ships!) initially supplied by East India Company’s Indian calicos
1.
British manage to mechanise printing (copper plate printing)
2.
then could compete with Indian yarn → mechanisation
3.
note: sustained research effort – learning from efforts made by others – spillovers into other
sectors (chlorine bleaching) – effect on machinery building: all adds up to a research sector
(why was a similar effort not made in India?)
IX. Implications:
1.
a much more varied range of conclusions than implied by World Bank reports – economists are
still debating the answers
2.
both endogenous growth and learning by doing models can → North-South models of trade, and
the permanent division of the world into core-periphery
3.
→ case for strong action to break out of this (export push, accelerated human capital acquisition,
importing of technology etc)
4.
does the poor country have to do some research to adapt technology to local conditions?
a.
If not → need for education investments etc, and limited role for government
b.
If so → endogenous growth model, and more serious problem of creating incentives for
local entrepreneurs to invest in research (esp. if country is poor, remote and small)
5.
not an issue of exploitation: e.g. multinational company may base research, product development
in rich country, and transfer mature products to poor country: due to human capital resources etc,
but then perpetuates this division
6.
Is this such a bad thing for the poor country? Depends on the alternative: if autarchy →
inefficiency, corruption, and still not much research, then it may be better to accept a middle
income position
7.
life is not fair: there may be no moral justification for the current world distribution of income, but
other countries/cultures may just have to lump it
advantage of the west may not reflect any intrinsic virtue, it may be in part the legacy of the slave
trade, booty capitalists, conquistadors etc – but nothing can be done about that now