1 the origins of modern growth

7/28/2019 1 the Origins of Modern Growth

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Alternative Approaches to

Economic Growth

Dr John McCombie

DirectorCentre for Economic and Public Policy

University of Cambridge

September 2010


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Lecture 1 The Origins of Modern Economic Growth: Harrod-Domar and Solow.

Lecture 2 The Increasing Returns Revolution: EndogenousGrowth Theory and Beyond.

Lecture 3 Technical Change, the Aggregate Production Functionand Neoclassical Growth Theory, Not Even Wrong.

Lecture 4 The Demand Oriented Approach: CumulativeCausation and the Verdoorn Law.

Lecture 5 Economic Growth and the Balance-of-PaymentsConstraint.

Lecture 6 Is Growth Pass? The Economics of Happiness.


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Preamble

An outline of the six lectures

Lecture 1 and 2: A critical overview of the mainstream approach togrowth: Solow and endogenous growth theory

Lecture 3: Why the aggregate production function is not evenwrong. The most controversial lecture. For example, Solowsgrowth model is fundamentally flawed.

Lectures 4 and 5: The Keynesian/Kaldorian approach to economicgrowth

Lecture 6: Increasing economic growth: A fools errand?


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A Tale of Two Paradigms

How do we model economic growth? How useful are mathematical

models of growth? Is there a difference between growth and

development? What do we mean by explanation and

explaining growth? Solow/Romer versus David Landes.

Appreciative versus formal theorizing. (Richard Nelson)

Formal Theorizing

(i) The Neoclassical approach: Supply-oriented growth theory;

Solow and endogenous growth models.

(ii) The Kaldorian/Keynesian Approach: Demand-oriented

growth including models of cumulative causation and the balance-

ofpayments constrained growth model


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But how Useful are these models in Explaining the Really

Big Questions?

Why did no country experience sustained per caputgrowth before the18th Century. Why did the industrial revolution occur in Britain and notin China in the 14th Century or in Italy in Roman times?

Was the industrial revolution inevitable? What were the proximatecauses?

Why has there been such a wide divergence of growth rates over thelast 250 years? Why have there been growth miracles and disasters?

Why has there been divergence, big time?

Is the north-south divide really a temperate/tropical divide?

Why was there a productivity slowdown in the OECD countries after

1973?


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Lecture 1. Models of Economic Growth.

From Harrod-Domar to Solow

Dr John McCombieDirector

Centre for Economic and Public Policy

University of Cambridge

September 2010


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Outline of the Lecture

I shall be looking at the alternative ways economists model growth andwhy there are some fundamental disagreements between them.

1. Harrod (Domar) growth model (savings matter)2. The Solow model (savings do not matter; its technical progress)

3. The growth accounting approach.

4. Limitations of the Solow Growth Model

(i) The growth of productive potential is endogenous, notexogenous (AP Thirlwall)

(ii) Sectoral change is important in accounting for growth ratedisparities (JSL McCombie)


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How do We Assess Models?

(i) Karl Poppers approach of conjectures and refutations

The linear model of scientific progress

Theorytesting rejection of hypothesis new better theory .

Science objectively progresses over time

(ii) Thomas Kuhns Structure of Scientific Revolutions

(a) The paradigm

(b) The paradigmatic assumptions (not testable by fiat)

(c) Normal science versus revolutionschallenge of paradigmaticassumptions

(d) Incommensurability of paradigms

(f) No linear development of science


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What about Economics?

(1) Development within a paradigmpuzzle solving- questionspedagogically determined

(2) But the paradigm prevents fundamental methodological questions

is this necessary bad?

(3) Paradigms persist for a long time.

(4) How do we compare paradigms? Sociological factors andrelativism.

(5) Paradigms in economics: Neoclassical economics, Evolutionaryeconomics, Institutional economics, Marxian economics

Individualistic, utility maximisation (Neoclassical) versusimportance of social class and institutions (Marxian).


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A Gestalt Switch


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The Duck Rabbit Gestalt Switch


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Pseudo-paradigmatic assumptions or heuristic

untestable by fiatan article of faith.

Neoclassical paradigm

Markets are competitive; factors are paid their

marginal product; agents optimise subject toconstraints.


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Economic Paradigms

Classical economics

Hydraulic Keynesian Economics: IS/LM Keynesian Economic PostKeynesian Economics ??

AS/AD model; The Neoclassical Synthesis Neo-Keynesian Economics

??

Monetarism

New Classical Economics

The New Neoclassical Synthesis??


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The Paradigmatic Crisis in Macroeconomics

The failure of the New Neoclassical Consensus in

explaining or predicting the sub-prime crisis.

Blanchflower (2009) and Buiter (2009)

Paradigmatic debate about fundamentals.

Renewed interest in Keynes and Minsky, long dismissed asirrelevant.


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Growth Theory

Neoclassical Paradigm

Developments within the paradigm: Linear theory ofdevelopment?

(i) Harrod-Domar growth model (1936/1940)(limitations)(ii) Solow growth model (1956/57) (Nobel prize)

(limitations)(iii) Romer; Endogenous growth model; (1986)(iv) Krugman (1991) New Economic Geography?


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Growth Paradigms

Neoclassical Growth TheorySolow

Endogenous growth theory

Supply oriented; full employment; money is neutral in the long run,long run growth is at the productive potential. Constant returns toscale (Solow); Increasing returns to scale (Endogenous growththeory). Country growth rates are not competitive.

Keynesian Growth Theory

Harrod-Domar

Kaldor/Pasinetti distributional theory

Kaldors two-sector development modelBalance-of-payments constrained growth model

Demand oriented; underemployed resources possible, increasingreturns to scale (Kaldor), BoP constrained growth model. Growth maybe competitive; one countrys growth may be at the expense of

another's.


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Growth Paradigms

Evolutionary Growth Theories

Metcalf/ Nelson/Winter

Path dependenceTechnological transfer

Probabilistic and not optimising models

Institutions and Geography

Douglas North, David Landes, et al.


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Before we look at the theory, let us examine what we

are trying to explain.


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Economic Growth: What Do We Mean?

Three possible meanings:

1. The growth of real output

2. The growth of real output per worker

3. The growth of real output per capita

Focus upon meaning (3) because economics is a subjectabout welfare, but this really depends upon (2). In thelast lecture I shall discuss this further and question

whether it is such a good measure. In fact, does growthbring greater happiness? Discussed in Lecture 6.


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What Are We Trying to Explain?

(1) The wide disparities in living standards. 200 years ago the greatest

difference between the richest and poorest countries was about 1:3.Today it is 1:70 or even greater.

(2) Rates of economic growth and productivity growth (output perworker) vary substantially between countries. Growth rates are notnecessarily constant over time. No correlation between decennial

growth rates.

(3) Economic miracles of the Japan (1950-80); East Asian Tigers(1960- present) and more recently China (1995present) and India(?)

(4) A countrys relative position is not fixed.Some countries can declinerelatively (UK, Argentina), others can improve (China).

.


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Average Growth Rates of GDP of the US, Japan, Selected European

Countries and East Asian Countries, 1971-2008( per cent per annum, constant prices)

1971-1980 1981-1990 1991-2008

United States 3.2 3.2 2.8

Japan 5.3 4.0 1.4

France 3.3 2.4 1.9

United Kingdom 2.0 2.7 2.5

Germany 2.7 2.3 1.7

Italy 3.8 2.2 1.3

European Area* 3.1 2.4 2.0

Hong-Kong 13.9 6.2 4.4

South Korea 10.0 8.9 5.5

Singapore 10.2 8.0 6.5

Taiwan 9.4 8.0 5.3

Source: IMF, World Economic Outlook, April 2008.* Includes: Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy,Luxembourg, Netherlands, Portugal and Spain 2002; plus Slovenia 2007; plus Cyprus and

Malta 2008.


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The Asian Tigers

0.9% world population and 3.5 percent of world

GDP.

India and China as the new economic miracles?

Per capita income is still very low.


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GDP Per Capita and Output Per Worker in WesternEurope Relative to US 1960

2003/4

GDP per capita as a percentage of

the US (current international $

prices)

Output per worker as a

percentage of the US (constant

2000 prices)

1960 1970 1980 1990 2004 1960 1970 1980 1990 2003

Germany* n/a 77.53 80.80 79.22 71.01 n/a 73.8 82.6 78.9 75.6

France 66.40 77.52 80.99 79.43 72.74 62.3 77.5 88.4 91.2 83.9

UK 76.62 72.12 71.38 72.55 74.52 70.5 68.7 72.1 74.3 76.5

Netherlands 81.43 87.67 85.58 79.32 73.10 90.9 101.4 102.1 84.6 83.6

Austria 65.48 74.06 84.61 83.72 78.37 55.5 74.5 89.4 89.9 88.1

Finland 60.31 68.22 74.36 75.85 65.10 53.7 61.6 70.7 72.7 70.8

Italy 55.47 67.35 71.74 73.65 64.53 54.7 73.6 88.8 84.4 76.8

Spain 37.49 52.48 54.24 56.96 59.39 39.8 61.1 72.4 70.6 68.7

Portugal 27.48 38.81 43.06 48.91 48.73 30.1 43.9 47.5 51.9 50.2

Switzerland 117.5 116.8 108.0 101.1 82.70 103.0 110.8 111.6 96.4 80.0

Sweden 86.89 92.68 85.82 82.78 72.44 79.8 83.3 80.6 74.8 70.9


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Country and region Exponential annual growth rate (1975-96)

GRP GRP per worker GRP per capita

Italy

Valle dAosta

Sicila

Lombardia

Emila-Romagna

Campania

Portugal

Alentejo

AlgarveCentro

Lisboa

Norte

France

Lorraine

Nord-Pas-de-Calais

Champagne-Ardennes

Ile-de-France

Midi-Pyrenees

Languedoc

Basse-Normandie

1.6

1.9

2.7

2.8

3.0

1.5

2.12.2

2.3

2.9

1.0

1.4

1.5

2.5

2.6

2.7

2.8

0.8

2.1

2.3

2.5

3.0

3.2

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2.9

2.9

1.5

1.8

1.9

2.4

2.3

1.9

2.7

1.3

1.6

2.6

2.8

2.8

1.8

1.32.2

1.8

2.3

1.0

1.3

1.4

1.9

2.0

1.9

2.3


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What a Difference a Small Increase in aGrowth Rate Makes

Period in Years 1% 2% 3% 4% 5%

0 1,000 1,000 1000 1,000 1,000

20 1,220 1,490 1,800 2,190 2,650

50 1,640 2,690 4,380 7,100 11,470


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To Recapitulate: Alternative Approaches to

Modeling Growth

The neoclassical approach (paradigm):

- models that emphasize growth ofAggregate Supply:

(a) exogenous growth models(b) endogenous growth models

The Keynesian/Kaldorian approach (paradigm):

- models that emphasize growth ofAggregate Demand

- balance-of-payments growth models


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Harrods (1939) Growth Model

An extension of Keyness GTto a growth context.

If S = Iin the short run, what must be the growth of income for

this to hold for a growing economy? The warranted growthrate.

The key to growth is investment or capital accumulation.

Rostows condition for take-off into sustained growth; viewsof many development agencies until the 2000s (Easterly and

Levine, 2001).


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Harrod Growth Theory

An Essay in Dynamic Theory (Economic Journal, 1939).

Three growth rates:

1. Actual growth rate:

where and

2. Warranted Growth Rate:

Planned investment is:

Planned saving is:

For equilibrium:

or

Dynamic Equilibrium Requires

If not the system will be cumulatively unstable (the knife-edge problem)

s/vga S/Ys YI/K/Yv

*s/vgw

YvI *p sYSp

sYYv *

*s/vgw

wa gg


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Harrod Growth Theory

3.Natural Growth Rate:

where lis the growth of the labour force

And is the growth of labour productivity (technical progress)

Full Employment of capital and labour requires

Assumptions: Fixed coefficients production function (?). Not according to

Harrod.

Algn

A

nwa

ggg


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The warrantedgrowth rate is given byv

sgw = %3

3

%9ga

But the naturalgrowth rate is given by %6%3%3LAgn

For the economy to grow withoutunemployment/underemployment worsening

requires the savings rate to double to 18%. It will have to save even more if there is

to be a steady growth in per capita income

This gives asavings gap of 9% of GDP which needs to be financed (thefinancing

ap) by overseas aid.

An additional policy is to reduce the growth of the labour force by controlling the

growth of population.

This model provides the justification for the fundamental capital accumulationist

view of growth.


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The Evidence

Hill (1964), Close relationship between growth GNP and share ofinvestment in machinery but not structures for the advanced countries,1953-1962.

De Long and Summers (1991), Similar results for the advanced

countries using more recent data.

Blomstrom et al. (1996). Output growth Granger causes a higherinvestment ratio (the growth of demand is important)

BUT: Easterly (1991, 2000), Time-series data the Harrod Domar

growth model makes no sense theoretically and it fails empirically.

An expedition from Mars arriving on Earth, having read this literature,would have expected the wreckage of a capitalism that had shakenitself to pieces long ago (Solow, 1987) But clearly this is not the case.


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Are Savings the Driving Force Behind Growth?

The major problem is the incremental capital-output ratio (an inverse

measure of the productivity or efficiency of capital) is not constant.

Capital output ratios vary considerably across countries. (Prichett)

Korea I/Y of 21.5%, growth of the capital stock is 12.5% per annum.

Germany, similar I/Y ratio but growth of the capital stock only 4%.

Much public investment in developing countries is simply not

productive (Easterly). Aid Investment; increase in aid increase inGDP

World Bank used this model for development planning purposeswell into the late 1990s when it had been abandoned by growththeorists. (Minimum Standard Model)


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Solows Growth Model (1956)

Problem of the Harrod instabil ity problem

If the warrantedgrowth rate does not equal the actualgrowth rate, thepath of the economy will spiral away from its equilibrium growth path(The knife-edge problem)

There is nothing in the model that will ensure that the warranted willequal the naturalgrowth rate.

The latter problem was solved by Solow (1956) by allowing forsubstitution of capital and labour. The former was solved byremoving the investment function (all savings are assumed to beinvested)

Growth is too easy in the Harrod-Domar model (just increase thesavings/investment rate)


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The Cambridge UK Solution

The savings ratio as a function of the distribution of

income (the propensity to save out of profits > propensity

to save out of wages). Profits rose during a boom and this

ensured the path of the economy was brought back intoequilibrium.

The theory was popular in the early 1970s but has now

disappeared from the textbooks (as has the Harrod-Domarmodel).


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The Aggregate Production Function

Central to all neoclassical growth models. This is a technologicalrelationship -

Output of a country (Y) is a function of

Capital (machines, buildings, IT equipment) (K) Labour (L)

Technology (ideas) (A), proxied by a time trend

Education and skills (human capital) (H)

Managerial efficiency (ME)

Plus ??? Friday cars; Newcastle United

Y = f (K, L, t) or Y = f(K, L, H, t)


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But Does the Aggregate Production Function Exist?

Lecture 3

Can we measure capital without circular reasoning? The CambridgeCapital Theory controversies of 1960-1975.

(Geoff Harcourt)

Can we aggregate micro-production functions to give a well behavedaggregate production function (the aggregation problem)?

(Frank Fisher)

Can the good statistical fits that aggregate production functions givebeen interpreted as a test of the aggregate production function?

(John McCombie and Jesus Felipe)

In Lecture 3, I shall argue that the answer to all these questions isNO

But lets leave these problems for the moment


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The Cobb-Douglas Production Function

After Charles Cobb and Paul Douglas (1928)

It is a technological relationshipwith the properties.

(i) Returns to scale: + = V

(ii) Constant returns to scale = (1- )

(iii) and are technological parameters or output elasticities

(iv) Diminishing returns to each factorK, L.

(v) Substitution between labour and capital

(vi) A = A0exp(t)

(vii) Q andKshould ideally be physical measures

LK)t(AY


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See Next Slide

The early results of Paul Douglas and his

colleagues in the 1930s and 1940s..

(Initially scorn was poured on his efforts by his a

prioristcolleagues at Chicago and the

econometricians, including Horst

Mendershausan)


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Paul Douglas (1976) concluded:

A considerable body of independent work tends tocorroborate the original Cobb-Douglas formula, but more

important, the approximate coincidence of the estimated

coefficients with the actual shares received also

strengthens the competitive theory of distribution anddisproves the Marxian. Many of the original objections

have been answered. Some remain.

I shall return to this in Lecture 3


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Intensive form

Writing the production function its intensive form:

Y/L is output per worker,K/L is capital (number of units) perworker.

Solves the problem of the actual and natural rate of growthbeing different by allowing v to vary.

)1(

1

L

K

AvY

K

andL

K

AL

Y


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Some Useful Results

Factors (labour and capital) are paid their marginal products

The output elasticities (a technological relationship) equal the factor

shares (a value relationship).

= a = rK/Y0.25 (useful for growth accounting)

(1-) = (1-a) = wL/Y0.75

By Eulers theorem (payments to capital and labour just equals thevalue of output)

K

YrandL

Y)(L

Yw 1

rKwLKK

YL

L

YY


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But it is controversial: Why?

The marginal productivity theory of distribution shows that underconditions of perfect competition, each worker gets paid what he/shecontributes at the margin and the latter is determined by thetechnologicalconditions of production.

By such means, a just social and economic order prevails overconflict and potential instability. As Pasinetti (1974, p.125) aptlyremarked:

It is hard to see any rationale for this peculiar set of assumptions,

except that of bringing in a particular shape of technologyand thusof marginal productivityat all costs, as the main determinant ofincome distribution and the rate of profit. It looks as if the marginal

productivity theorists are willing to introduce almost any assumption,if it serves that purpose.

(cited by Blankenburg, 2008)


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Robert M Solow


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The Solow Growth Model

The neoclassical growth model, originated by Robert MSolowin two important papers in 1956 (the theory) and1957 (an empirical application)

Savings do not drive long-term growth rates.

Generate a huge research programme in studying economicgrowth, still continues today.

Awarded the Nobel Prize in 1987 for his pioneering work ingrowth theory


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Back to the Cobb-Douglas Production Function

Y =AKL1-

Divide both sides by L (labour) we get:

What we learn from this is that as the amount ofcapital per worker

increases so does the productivity of labour(output per worker)

L

KA

L

Y


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Questions

Does this mean that to increase a countrys standard of living all that needsto be done is increase investment (increaseKand henceK/L)?

Is the US the most advanced country because it has the largest amount of

capital per worker in the world? It certainly has more capital per worker

than most other countries but is this the explanation?

L

KA

L

Y


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Answers

Does this mean that to increase a countrys standard of livingall that needs to be done is increase investment (increaseKand henceK/L)? NO

Is the US the most advanced country because it has thelargest amount of capital per worker in the world? NO

What is the reason for this surprising result?Why is it the most advanced country in the world?

Assumptions of the Solow


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Assumptions of the Solow

growth model

1 Diminishing returns to scale

2 Technology (A(t)) is a pure public good:

- non-rival(one persons use of it does not reduce another

persons)- non-excludable (Nobody can be prevented from using it)

countries share identical: - technology levels

- tech. progress rate

3. Exogenous technological progress: model ultimately unable to explain why growth occurs!

The Solow diagram


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The Solow diagram

(No technical change)

y = Y/L

k = K/L

y = f(k)

sy = sf(k)

(n + )k

k*

y*

k1 k2

Accounting for National Growth Disparities and


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Accounting for National Growth Disparities and

the Solow Model

y = Y/L

k = K/L

y = f(k)

sy = sf(k)

(n + )k

k*

y*

k1 k2

Absolute convergence: country 1 grows absolutely faster than country

2

Conditional Convergence in


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Conditional Convergence in

the Solow Model

y = Y/L

k = K/L

s2y

s1y

(n + )k

k1*

Country 2 grows faster than Country 1 because further away

from its own steady-state equilibrium

k2*k1 k2


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Technical change to the rescue

In the story so far, the country will reach steady-state

k*, but there will be no further growth. But, of course,

countries keep on growing. Why?

Technical change has the effect of shifting the

y and sy curves over time.

It offsets the effect of diminishing returns.


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In Growth Rate Form

5% = 3% + 0.25(5%) + 0.75(1%)Output = technical + contribution of + contribution of

growth progress capital growth labour growth

100% = 60% + 25% + 15%= 60% + { 40% }

L)1(KAY


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Convergence and Divergence in the Solow Model


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Policy Implications of the Solow Growth Model

Countries will ultimately converge to their steady

state levels of productivity growth.

No need for government intervention.


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Testing the Solow Growth Model

(1) Beta conditional and absolute convergence

Barro and Sala-i-Martin (2004) Strong evidence of regional absolute

convergence (USA, Japan, Europe) (convergence clubs). Rate

of convergence about 2% per annum. Evidence for someconvergence in the advanced countries (but cfBaumols error)

But no evidence of convergence on a world wide scale.

Tt,i

T

Tt,i

it

ylnT

e1

cy

y

lnT

1


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Testing the Solow Growth Model

(2) The augmented Solow model

Good fits to data for all countries initially but improved by

either (i) including human capital or (ii) allowingA0 to

differ between countries.

Mankiw-RomerWeil (1992)

)n(1

sln1

tAlnyln K0

-


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Failure of the Solow Model

The level of technology cannot be the same for all countries. If it were

USA with 15 times per capita income of India would need 900 times

more machines. There should be substantially higher rates of return in

the poorer countries therefore there should be substantial capital flows

in to these countries. Why do many skilled workers in developing

countries migrate to the richer countries.

Cannot explain the big questions of growth.

Does an increase in the investment-output ratio really have no effect onthe long-run (equilibrium) rate of growth?


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The Growth Accounting Approach

Using the aggregate production function we can calculate

for each country the rate of growth not accounted for by

the growth of inputs. We can call this growth of

efficiency, rate of technical progress or the growth of

total factor productivity. Note that this is the A in the

Cobb-Douglas production function.

We can calculate it as

Note that there are very strong assumptions underlying

this.

}K)a(La{YPFT 1


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When Solow (1957) did this using US data 1909-49, hefound to his surprise that the (weighted) growth of theinputs explained only about 15% of productivity growtha very small proportion. The bulk was explained by

technical progress.

The growth accounting approach attempts to explain thisresidual and much of the early pioneering work was done

by Edward Denison (1967).


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This is done by making allowances for

1. The growth of human capital (skills and education).

2. Increasing returns to scale.

3. Disequilibrium factors (the movement of labour from low productivity sectors

(agriculture) to high productivity sectors (manufacturing).

4. Technological diffusion from the more to the less advanced countries. It isfound that differences in aggregate productivity growth are largely explained

by the growth of TFP. In other words, the rapid growth of Japan over the early

post war period was largely due to its rapid growth of TFP. Take the US as the

technological leader, then, say,

5. This assumes that the growth of TFP of the US is due entirely to technical

progress.

ylogTechnoofDiffusionPFTPFT USAJAPAN


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The Eastern Asian Tigers

Singapore, Hong Kong, Taiwan and Korea all experienced rapid growth rates

1966-1990 Growth of (%)

Output Productivity TFP

Hong Kong 2.3 4.7 2.3Singapore 8.7 4.6 0.02

South Korea 8.5 2.8 1.7

Taiwan 9.4 4.6 2.6

Very rapid growth of output and, to a lesser extent, productivity. But TFPgrowth not exceptional and in the case of Singapore nearly zero!


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Singapores rapid growth was due to the growth of the factor inputs.

But the miracle is based on perspiration rather than inspiration I/Y rose from11 to 40%. Once and for all change that cannot be repeated. Increased

education of the workforce can also not be repeated.

Comparison between Singapore (TFP growth 0.02% p.a.) and Hong Kong

(2.3%)

Similarities

The two city cities share some common characteristics.

Both are small (2.5 million) with mainly a Chinese population.

Both were at roughly the same level of development in 1965

Both went through the same set of technologies : textiles clothing

plasticsbanking and financial services.


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Differences

Hong Kong higher initial education levels. Migrants from China (Shanghai)

Hong Kong more laissez faire. Some public policy programmes to do withhousing/social security.

Singapore; Stagnation in the 1950s and 1960s. British bases 13-20% of GDP

Strong government intervention after independence. State targeting ofindustries. Development Bank of Singapore. Labour legislation that wasfavourable for firms.

Large volume of FDI. More than any other SE Asian economy

Singapore: forced saving 10 40%

Hong Kong remained around 20%.

By the late 1980s, Singapore seems to have sur passed Hong Kong on thetechnological ladder, with Singaporean finance increasingly dominatingHong Kong f inance and Singaporean manuf actur ing industri es producingen masse high-technology electronic goods that have eluded most H ongKong entrepreneurs.


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The answer according to Young is that the Singapore forceddevelopment with rapid movement into high-tech industries but with

little time for learning-by-doing.

I am arguing that Singapore is a victim of i ts own targeting policies.

I n individual sectors, Singapore probably had exper iencedproductivity growth. This improvement in productivity, however, is

masked by the further and further movement beyond societys level

of industr ial matur ity; that is growing outputreducing distortion.

(Young)

Paul Krugman draws parallels with the Soviet Bloc in the 1950s


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Biased Technical change

KL

t0

t0

:biasofDegree

)LeB;KeA(fY LK


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The Problem of Biased Technical Change

Factor shares will be constantif we have a Cobb-Douglasproduction function or biased technical change such that:

onsubstitutiofelasticity

changetechnicalaugmentingcapital

changetechnicalaugmentinglabour

)]K()L][(/)1)(a1[(a

)a(shares'capitalofGrowth

K

L

KL

0athatsoLKkL


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Two Possible Explanations

Why did factor shares remain constant in the Asian Tigers despite arapidly growing capital-labour ratio?

(i) The production function is a Cobb-Douglas.

(ii) There was technical change such that:

But in this case we need to use constant-technology factor shares in thegrowth accounting. If we use observedshares they will include theeffect of technical change, but they will attribute this to thecontribution of the growth of factor inputs.

LKkL


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Biased Technical Change

The shares used are the average of the observed shares in the initialand terminal period.

But if the terminal share is affected by technical change

such that

then if we take the initialcapitals share to be equal to the observed,the terminalshare 0 as the length of time T increases.

For small time periods, the use of observed shares and constant-technology shares will give the same result.

)aa(5.0a T0

LKkL


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Biased Technical Change

Felipe and McCombie (2001) used an algorithm to calculate the constant-technology shares.

Example of Singapore

But we do not know values of and also TFP growth dependent on numberof years over which it is calculated. So we can a large range of estimates ofTFP growth. Diamond and McFaddens impossibility theorem

%11.0497.0497.0497.0497.00.1

%55.2077.0467.0000.0439.02.0

growthTFPaaaa *30*1

*30

*1


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Explanation

With a low elasticity of substitution, and a rapid growth of thecapital-labour ratio the rate of biased technical change will have to berapid to prevent capitals share from falling.

We can calculate the rate of biased technical change for Singapore

necessary to prevent capitals share from falling:

Why is there negative rate of capital-augmenting technical change?

annumper%80.2

annumper%00.3

K

L


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Two Big Questions

If the Solow model predicts convergence in productivitylevels; how did the present large disparities in income perhead occur in the first place?

Is there evidence that convergence is currently occurring inthe world as a whole?

The Shortcomings of the Solow


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Model Revisited

(1) Technological progress like manna from heaven

(2) Unable to convincingly account for growth disparities:

- technology = pure public good

- only able to account for growth rate

disparities by speculatingthat different countries have

experienced different shocks

(3) Shortcomings emergence of endogenous growth

models


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The Shortcomings of the Solow Model

Capital and migration flow predictions are wrong. Capital

should flow to the less developed countries asK/L ratio

low there.

Assumes that the growth of productive potential (the

natural rate of growth) is exogenous.

The one-sector model ignores the large structural and

sectoral change that accompanies growth

The Endogeneity of the Natural Rate of Growth


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Thirlwalls Analysis

1. Reasons why the natural rate of growth is likely to beendogenous and implications. (i) Flexibility of laboursupply. (ii) Growth of labour productivity positively relatedto the growth of output (Verdoorn law).

2. A technique for estimating the natural rate of growth.

3. Estimating the endogeneity of the natural rate of growth.

4. Estimates of the endogeneity of the natural rate of growthfor OECD and Latin American countries.


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Estimating the Natural Rate of Growth (gn)

1. %U = a b (g) Natural rate:%U = 0gn = a/b

OR

2. g = a1 b1 (%U)

gn = a1 (generally gives the better statistical fits)

3. g = a2 + b2D c2 (%U)

whereD = 1 whenga

> gn

(a2 + b2) givesgn in boom periods. If b2 > 0, then the natural

rate of growth increases during boom periods.


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The Endogeneity of the Natural Rate of Growth

Relation between growth and change in unemployment

0 %U

a2

a1

a2+ b2

Natural rate (gn)

g

Sensitivity of the Natural rate of Growth to the Actual Rate of Growth


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Country Naturalrate

Natural rate inboom periods

Increase in Natural Rate inBoom periods

Absolutedifference

(2)-(1)%

increase

Australia 3.9985 5.7131 1.7146 42.9Austria 3.1358 4.9563 1.8205 58.1Belgium 3.5239 4.9102 1.3863 39.3Canada 3.8352 5.2613 1.4261 37.2Denmark 2.9424 4.7826 1.8402 62.5

France 2.8270 3.9343 1.1073 39.2Germany 3.5054 4.7091 1.2037 34.3Greece 4.5089 7.6711 3.1622 70.1Italy 3.3439 5.9104 2.5665 76.8Japan 4.5671 8.7199 4.1528 90.9Netherlands 3.2817 5.3151 2.0334 62.0Norway 3.9722 5.0094 1.0372 26.1

Spain 4.0623 6.0928 2.0305 50.0UK 2.5438 3.8022 1.2584 49.5USA 2.9911 3.6642 0.6731 22.5

Average 3.5359 5.3634 1.8275 51.7


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Conclusions

In general, the results show substantial elasticity of the

labour force and productivity growth, certainly significant

to suggest that the natural rate is not exogenous, but is veryresponsive to demand conditions in the economy.

(Thirlwall, 2010)


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Productivity Growth and Structural Change

in the Postwar Advanced Countries

1. Need to explain substantial disparities between growthrates between the advanced countries in the post-war

period.

2. Need to explain the post 1973 slowdown3. What was the role of sectoral change?

4. Large shift of labour out of agriculture and services (?) toindustry.

5. Movement of labour will contribute positively toproductivity if losing sector has a lower level ofproductivity (agriculture) than the gaining sector(manufacturing)

G i i P d ti it D t th I t t l


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Gains in Productivity Due to the Intersectoral

Reallocation of Labour in the Postwar periodAssumption 1

All sectors are subject to constant returns to scale

Assumption 2.

Industry has increasing returns to scale; agriculture surplus labour andservices constant returns to scale.

Calculated using the definition of total productivity in terms of the growthof the three sectors

(i) Standardised growth rate. The growth that would have occurred if allthe sectors employment had growth at the same rate.

(ii) Structural growth rate. The differential growth rate of employmentbetween the various sectors. It captures the effect on productivity ofthe net transfer of labour between sectors under the two assumptions.


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The Results

If the decline in the rate of transfer of labour

between sectors and the fall in industrial

productivity could explain the productivity growth

slowdown, there should be no differences in the

standardised rates of growth between 1950-73 and

1973-1985.

The structural rate of growth should be such as tomake the standardised rates of growth roughly

equal in the two periods.


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Conclusions

Shortcomings of the Solow model and Growth

accounting:

Exogenous technical change

Problem of calculating total factor productivity growthDoes it make sense to try to separate the growth of factor

inputs and technical change?

Is the growth of productive potential independent of the

growth of demand?

How useful are one-sector models?

1 the origins of modern growth

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