Download Chapter V: Growth and Employment

Chapter V: Growth and Employment
A.
B.
C.
D.
E.
F.
Accounting for Growth
Efficiency of Labor
Solow model and interpretation
The labor market
Real wages
Population and migration
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Production function again

Key to our analysis of growth will be
the production function: YS = F (L, K, )
Output produced
Capital
Buildings, machinery
infrastructure
Labor
Number of workers
Hours worked
Factor productivity
Technical knowledge
Organization
Efficiency
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Differences in per capita
economic growth
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Index of industrial production
120
Developing
economies
(without China)
115
110
High income
economies
105
100
95
90
Jan 00
Jul 00
Jan 01
Jul 01
Jan 02
Jul 02
Jan 03
Jul 03
Jan 04
Jul 04
Source: Worldbank
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Index of industrial production
170
160
China
150
140
130
120
Other LDCs
110
High income
countries
100
90
Jan 00
Jul 00
Jan 01
Jul 01
Jan 02
Jul 02
Jan 03
Jul 03
Jan 04
Jul 04
Source: Worldbank
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Production and capacity
utilization in the US
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Source: Federal Reserve
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Accounting for growth
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There are large differences in GDP per capita
over time and across countries.
Our first impulse is to interpret this data using
the production function relating per capita output
to the capital/labor ratio.
If the exponent is 0.25, then this function is
(Y/L) = (K/L)0.25
We are interested in the percentage difference
in per capita GDP between two points in time, or
between two countries
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Accounting for growth
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Mathematically, percentage differences
behave like logarithms
log(Y/L) = .25 log(K/L)
It says that for every one percentage point
difference in the capital-labor ratio, we get a .25
percentage point difference in output per worker
If one country has 5 percent higher output per
worker than another country, then we would
expect the more productive country to have 20
percent more capital per worker
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Growth and capital
accumulation
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The “growth residual”
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The capital-labor ratio is certainly important
Countries increase this ratio via investment:
 Most countries with high rates of labor productivity
have investment shares of more than 20% of output
 The majority of low-productivity countries have
investment shares below 20%
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However, differences in the capital-labor ratio
can explain not more than half of the differences
in output per worker
There is an unexplained growth residual:
“labor efficiency”
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The decomposition
of growth
Coverage
GDP
growth
rate
Capital
share
Labor
share
Labor
Efficiency
share
United States
1948-90
3.1
24
28
49
United Kingdom
1957-90
2.5
35
4
61
Germany
1960-90
3.2
36
-7
71
France
1957-90
3.7
33
-1
69
Japan
1957-90
6.7
49
6
46
South Korea
1960-90
8.6
67
19
14
Source: Kim, Jong-Il and Lawrence J. Lau, Journal of the Japanese
and International Economies (Sept. 1994)
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Efficiency of labor
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We include the residual, “efficiency
of labor”, into the production function
log(Y/L) = .25 log(K/L) + .75 log(E)
We are now obligated to produce
some analysis of what determines E
Some plausible factors include:
 education per worker
 knowledge
 economic, political, and social systems
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Growth and education
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Efficiency of labor
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Education is reasonably “measurable”,
but does, again, not explain E in full
Knowledge falls into two categories:
 Knowledge in the public domain
 Proprietary knowledge
Monopolized proprietary knowledge
 Shared proprietary knowledge

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Because most knowledge is public, it does not
explain variations in E across countries
Monopolized proprietary knowledge is often
shared, so again it cannot explain E in full
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Growth and
institutional environment
When we attempt to explain differences
in the efficiency of labor in different countries,
we are inevitably forced
to focus on differences
in economic, political,
and social systems
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Example:
Liberian kleptocracy in 1998

After the civil war, president Taylor installs
what it typical for many African countries:
 “State” monopolies
(diamonds, petroleum products, cement, rice imports)
 Price controls (caps on prices shift taxes
and market risks solely onto the producer)
 Arbitrary “charges” with extortionist character
(i.e. large scale and petty corruption)
 Regulatory measures impeding market activities
(licensing of business activities, exporting, etc.)
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There is no rule of law, fiscal responsibility,
protection of private property, etc.
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Institutional convergence?
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The differences in economic, political,
and social systems are enormous explaining
much of the differences in growth rates
Many countries are still working on improving
governance and management techniques
as regards both institutions and processes
Globalization generally supports this through
 Institutional and regulatory competition
 Dissemination of “good practices”
 Conditionality of international lenders
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Reading
Reading 5-1 (Optional)
“A global war against bribery”
The Economist, January 14th 1999
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Growth models
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An influential growth model
was proposed by Robert Solow
The basic idea was to link per
capita GDP to per capita capital,
and labor efficiency:
0.25




GDP
K
K
 f 
, E  A

Pop
Pop  Pop 
(The third term, A(.), is just a specific formulation of f[.])
Robert M. Solow
* 1924.
Nobel prize 1987
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Capital accumulation
and saving
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Solow would link the net accumulation of
capital (= gross investment minus depreciation)
to saving
K = Inet = S, all on a per capita basis
This renders the growth pace dependable,
apart from the production function,
on the accumulation of capital,
and hence on saving
This has a number of consequences:
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Solow model:
interpretations
1. For countries with similar technology
(production function) and similar capital
stock per worker ratios, income levels
per capita should be similar
2. Differences in labor efficiency might
matter in the short run, but in the long
run they should disappear due to the
general availability of knowhow
(convergence thesis)
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Do real wages converge?
Table 5-4
Real Hourly Wage in Manufacturing in Leading Industrial Countries
as a Percentage of the U.S. Wage
Country
1959
1970
1983
1996
Japan
Italy
France
United Kingdom
Germany
Canada
11
23
27
29
29
42
24
42
41
35
56
57
51
62
62
53
84
75
106
103
98
95
131
102
Unweighted Avg.
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43
63
106
100
100
100
100
United States
Source: Salvatore, International Economics, Prentice Hall
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Convergence in the EU?
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Solow model:
more interpretations
4. Countries with a high savings rate might enjoy
higher investment and economic growth
5. Countries with easier access to world savings
may experience higher growth by “crowding
out” others
6. Countries with high population growth may see
incomes per capita falling
7. There may be other “asymmetries”
in a globalizing world
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Population growth
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Source: Worldbank
Globalization has a
severe impact on
population growth
Global access to
medical progress has
led to uneven demographic developments
Productivity growth
could be “eaten up”
by population growth
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Uneven population growth
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Source: Worldbank
Population growth is
also very unevenly
distributed between
industrialized and
developing regions
There are further
important imbalances
in the labor market
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Imbalances
in the labor market
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Flagrant or pending civil wars, kleptocratic
government, “warlords”, corruption, etc.
Exclusions from the labor market
(gender, social status, ethnicity, etc.)
Disparity in human rights, social
protection, and labor standards
Differences in environmental protection
Exclusion from education, professional
training, and know how
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Savings
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In the United States, the growth of
productive capacity roughly equals 2%
to 2.5% a year
In contrast, many of the Asian Tigers enjoy
average annual increases in growth of
double, triple, or even greater amounts
than seen in the United States
The partial answer could be saving
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Saving rates
Economist
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Reading
Reading 5-2
“The economics of saving
The shift away from thrift”
The Economist, April 7th 2005
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Reading: Recession
in the US and household saving
Reading 5-3
„The long hangover“, The Economist,
April 10th 2008
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More on convergence
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According to the convergence thesis,
incomes per capita would be similar over
the longer run
It results from the assumption that the
marginal product of capital falls, so more
“mature” economies would be constrained
more heavily than emerging economies
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Static production function
GDP/Pop
f(K/Pop)
Emerging

Mature
economies
K/Pop
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Tendencies in world
economic growth
6,0
Rate of increase of GDP
5,0
Developing
countries
4,0
3,0
2002 2003 2004 20052006
OECD
1.4 2.0 3.1 2.6 2.5
Developing
3.4 4.8 5.4 5.2 5.0
East Asia
6.7 7.7 7.4 6.7 6.3
PECO
4.6 5.5 4.9 4.8 4.7
Latin America
-0.6 1.3 3.8 3.7 3.5
Middle East &
North Africa
3.3 5.1 3.7 3.9 4.0
South Asia
4.3 6.5 7.2 6.7 6.5
Subsaharan
Africa
3.3 2.4 3.4 4.2 3.9
2,0
1,0
OECD
0,0
2002
2003
2004
2005
2006
Source: Worldbank
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Puzzles of the Solow model
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Puzzle 1: Income per capita varies too much across
countries to be explained by neoclassical theory.
Obviously, all countries do not have the same production
function.
Puzzle 2: Poor countries do not have a higher rate of
return on capital. Again, poor countries do not operate on
the same production function as rich countries.
Puzzle 3: Convergence of income is not occurring among
‘rich’ versus ‘poor’ countries or even within regions in the
same country. Convergence occurs among regions in the
same ‘club’, but not among regions outside the ‘club’.
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Globalization:
Is Solow nonetheless right?
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The puzzles that critics of the Solow model
put forward appear to evaporate under the
impact of globalization
The situation of developing countries has
remarkably improved over the last decade
Market integration, trade, improved terms
of trade, the spread of knowledge, and
capital flows were the driving force of
positive developments
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Per capita growth
(percentages, 1998-2003)
1.800
1638
Population moyenne (millions) 1998-2003
1.600
1428
1.400
1.200
1.000
800
605
600
400
446
381
325
200
0
Number of
countries
Falling
(16)
0 and 1%
(8)
1% and 2%
(16)
2% and 3%
(16)
Growth rate per capita (%), 1998-2003
3% and 4%
(14)
More than 4%
(14)
Source: Worldbank
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Reading
Abel, Bernanke and Croushore, Chapter 6
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Globalization
and development

The World Bank’s Development Report
illustrates the large improvements in developing
countries over the course of the 1990’s
 About 3.5 billion people (70% of the population of
developing countries) live in 44 countries (including
China and India) that have seen incomes per capita
rise 2% per year, or faster
 In the 19th century – a period of massive industrial
transformation and advance in living standards -,
per capita incomes in Europe are estimated to have
risen at just 1% per year on average
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Catching up !
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Therefore underdeveloped countries could
eventually catch up to developed countries
Chances are maximized when there is high
domestic savings and the government promotes

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

free-market policies
open and competitive markets
foreign trade liberalization
investment in education (human capital) and
infrastructure (physical capital)
 the maintenance of property rights
 a smaller public or government sector, and low taxes
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But there are “laggards”
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All of the 16 countries where incomes fell have
suffered one or more severe adverse shocks,
including civil war, political instability, financial
crisis, droughts, terms of trade deterioration,
or governance issues
The “political environment” in these countries
is typically hostile to market forces, openness,
civil rights, citizens’ participation, education, etc
Unfortunately some of these factors continue to
haunt these countries and their citizens
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Strategic aspects of growth

The Solow model does not include dynamic
labor efficiency gains through
 Dynamic technology “leads”
 Capital embedded technical progress
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There is a continuous drive to “lead” sector
developments through innovation
Technical progress may also be embedded
in capital and be proprietary for some time
Such elements play an important role in
prevailing “growth strategies” of some major
industrialized countries
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R&D
of industrialized countries
Source: Worldbank
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Dynamic growth factors
and cultural obstacles
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Mastering expertise requires education and
professional training, which will take time
Not only in developing countries, the content
of education often clashes with traditional
paradigms, social values, religion, ethics
This, and other factors, could contribute to
uneven developments of the globalizing
economy, not so much the market itself
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