2a: Economic growth: theory and data

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Growth: big questions, theoretical toolsWhat does economic growth involve?

Factor accumulation & productivity growthChanging structure of production, consumption & trade

What makes economies richer? What sustains their growth? Growth theory

What determines the mix of goods produced, consumed and traded? Trade theory models for small open economies

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Southeast Asian experience (1)East Asia and Pacific region: generally high and consistent

growth since 1980sEspecially if we ignore the failures! (Gill & Kharas Table 1.2)Progress of leading economies from low to middle income status

Poverty alleviation record is strong (G&K Table 1.7)Inequality rising, but what does this signify?

From high or low base?Changing structure of production, and urbanizationRelative scarcity of some productive factors – esp. human capital

and entrepreneurial abilitiesPolitical economy, and development policy settings

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The “mechanics” of growthWhy do countries grow at different rates? Why do rates of growth change over time?

Is there anything that policy makers can do to influence the rate of growth?

Aggregate production functions: “parables” or “toys” for understanding aggregate economic growth

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Qty of output (Y)

L0 Qty of Variable Input (L)

A: Linear production function

B: Diminishing returns production function

0

YA

YB

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A basic growth modelRelate agg. production (Y, measured in $) to capital stock (K), labor force (L), pop. growth (n), savings (S), savings rate (s = S/Y), consumption (C), investment (I), and capital depreciation rate (d)

Two-factor production function: Y = F(K, L) (1)(Disposition of income) (Y = C + S)Savings out of income: S = s*Y (2)Savings = investment: S = I (3)Change (Δ) in K stock: ΔK = I – d*K (4)Change in labor force: ΔL = n*L (5)

Eq. (1)-(6) can be solved for Y, K, L, I, S, C in terms of s, d and n. Combining (3)-(5) gives:

ΔK = s*Y – d*K (6)Using (5) and (6), aggregate output growth depends on net investment & growth of labor force.

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y

k

y = ƒ(k)

• Expressed in intensive form (output per worker, y = Y/L, and capital per worker, k = K/L)• Diminishing returns to k

• From (6), growth of capital stock per worker : Δk = sy – (n + d)k

i.e. Δk rises with savings/worker, declines with pop growth & physical deprctn.

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y

y = ƒ(k) = output/worker

Δk = sy – (n + d)k, so Δk is vertical diffnce sy curve and (n+d)k.

• At kL, Δk > 0 and “capital deepening”. Compare kH.

• At k0, Δk = 0 with “steady-state” output per worker y0.

• “Steady state” implies constant per capita income

• Convergence: poorer countries (lower k) will grow faster.

sy = savings/worker

k

(n+d)k = depreciation

kL k0 kH

yH

y0

yL

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y

y = ƒ(k)

• Experiment: Increase savings per worker from sy to (s+a)y :

At k0, Δk now > 0. New steady state income is y1.

sy

k

(n+d)k

k0

y0 (s+a)yy1

k1

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y

y = ƒ(k)

• How do we represent a reduction in population growth rate?

What happens to capital accumulation and steady-state income per worker?

sy

k

(n+d)k

k0

y0((n–b)+d)k

k1

y1

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More on Solow growth model Solow: Empirically, technical progress accounts for most

economic growth Think about investments in human capital (education,

training) as a form of technical progress that increases the effective labor endowment.

What about natural resources? Link between Δk and the return on capital

Higher Δk implies higher return on new investment (capital scarcity implies high returns)

Then capital should flow to poorest countries!

Can Solow model explain comparative growth experiences?

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Convergence• Standard Solow model: all countries share same technology,

savings rates, etc• Diminishing returns implies lower growth rate of capital per

worker at higher levels of k• Implication: absolute convergence

Poorer economies will grow more quickly than richerOver time, per capita income levels among similar economies will

become equal, regardless of initial differences. Formally:

GDP growth = a*(Base GDP) + b*(K/L growth); a < 0, b > 0

Southeast Asian experience (2)Sources of economic growth in SE Asia

What factors have contributed most to growth? Labor force growth (“demographic dividend”) Capital investment (domestic and foreign) Improvements in effective labor through education, nutrition, etc Efficiency gains – from trade and specialization; domestic market

activation, etc…. Productivity spillovers and externalities; increasing returns

World Bank: East Asian Miracle (1993), decomposes contribution of some of these to total GDP growth

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Variable Indonesia Malaysia Singapore Thailand

Investment 1.1 1.64 1.69 0.87

Population growth 0.22 0.26 0.18 0.26

Primary enrollments 1.77 2.53 2.93 2.19

Secondary enrollments 0.16 0.5 0.84 0.31

Initial income -1.02 -1.47 -1.74 -1.12

Estimated growth rate 2.23 3.46 3.9 2.51

Actual growth rate 3.72 4 6.03 3.82

Percentage explained 60 87 65 66

Source: East Asian Miracle, 1993

What accounts for the unexplained 13-40%?

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Divergent paths in 3 countries1954-58a 1978 1985 2005

Philippines 380 Rps 510 600 3170

Burma 300 150 186 1020

Thailand 400 490 752 6420

Ratio, Th/Ph 1.05 0.96 1.25 2.02

Ratio, Th/Bu 1.33 3.27 4.04 6.29

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Sources: (1950s: Myrdal, Asian Drama; other years: World Bank. Units: 1950s: Indian Rupees; 1978-85: current $US; 2005: PPP$

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What accounts for divergence within SE Asia?

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Abstraction vs complexity in economic analysis

Obviously the world does not work exactly as described in Solow’s “parable”

Does this invalidate the use of models?Economic models abstract from the complexities of real world

situations in order to understand underlying mechanisms that are thought (or asserted) to be general

What use is a road map drawn on a 1:1 scale?Models yield testable implications and their use helps us to

define research agendasSolow model identifies the central mechanism of growth:

accumulation of capital per worker