Chapter V: Growth and Employment

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Chapter V Growth and Employment

1. Accounting for Growth
2. Efficiency of Labor
3. Solow model and interpretation
4. The labor market
5. Real wages
6. Population and migration

2
Production function again

• Key to our analysis of growth will be the
  production function YS F (L, K, ?)

3
Differences in per capitaeconomic growth
4
Index of industrial production
Developingeconomies(without China)
High incomeeconomies
Source Worldbank
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Index of industrial production
China
Other LDCs
High incomecountries
Source Worldbank
6
Production and capacityutilization in the US
Source Federal Reserve
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Accounting for growth

• 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

• 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

• 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
• 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

• 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

• 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
• 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.)
• There is no rule of law, fiscal responsibility,
  protection of private property, etc.

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Institutional convergence?

• 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
briberyThe Economist, January 14th 1999
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Growth models

• 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

(The third term, A(.), is just a specific
formulation of f.)
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Capital accumulationand saving

• 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?
23
Convergence in the EU?
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Solow model more interpretations

1. Countries with a high savings rate might enjoy
   higher investment and economic growth
2. Countries with easier access to world savings may
   experience higher growth by crowding out others
   
3. Countries with high population growth may see
   incomes per capita falling
4. There may be other asymmetries in a
   globalizing world

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Population growth

• Globalization has a severe impact on population
  growth
• Global access to medical progress has led to
  uneven demo-graphic developments
• Productivity growth could be eaten up by
  population growth

Source Worldbank
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Uneven population growth

• Population growth is also very unevenly
  distributed between industrialized and developing
  regions
• There are further important imbalances in the
  labor market

Source Worldbank
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Imbalances in the labor market

• 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

• 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 5-2The economics of saving
• The shift away from thriftThe Economist, April
  7th 2005

31
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

• 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)

K/Pop
Emerging ? Matureeconomies
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Tendencies in worldeconomic growth

Rate of increase of GDP
2002 2003 2004 2005 2006
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
SubsaharanAfrica 3.3 2.4 3.4 4.2 3.9
Developingcountries
OECD
Source Worldbank
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Puzzles of the Solow model

• 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?

• 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)
Source Worldbank
Growth rate per capita (), 1998-2003
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Reading

• Abel, Bernanke and Croushore, Chapter 6

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Globalization and development

• The World Banks Development Report illustrates
  the large improvements in developing countries
  over the course of the 1990s
• 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 !

• Therefore underdeveloped countries could
  eventually catch up to developed countries
• Chances are maximized when there is high domestic
  savings and the government promotes
• 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

• 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
• 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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RD of industrialized countries
Source Worldbank
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Dynamic growth factorsand cultural obstacles

• 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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Pause for meditation