Long-run Economic Growth. Part II: Sources of Growth and Productivity. Growth accounting. Today. Chris Edmond NYU Stern.

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1 Growth accounting ong-run Economic Growth Part II: Sources of Growth and Productivity Chris Edmond NYU Stern Spring 2007 Where does growth in output per worker come from? Recall ( augmented ) production function Y = AK α (H) 1 α in per worker terms ( ) α Y K = A H 1 α Now take logs ( Y log ) = log(a) + α log ( ) K + (1 α) log(h) 1 3 Today Growth accounting: using growth theory mechanics: how to do growth accounting specific applications United States Korea Japan Ireland China Argentina Productivity and institutions Growth accounting At any two years t and t + T ( ) ( ) log YT +t = log(a T +t T +t ) + α log KT +t ( ) ( T +t ) log Yt = log(a t ) + α log Kt Gives t now take differences, collect terms, and divide by T annual growth rates γ Y γ X = log(x T +t) log(x t ) T = γ A + αγ K + (1 α)γ H t + (1 α) log(h T +t ) + (1 α) log(h t ) Growth in output per worker due to growth in productivity and inputs we can measure γ Y, γ K, γ H (and α) therefore back out implied γ A 2 4

2 United States South Korea.2.5 (at PPP ).5..6 KOR What happened in the US? Y/ K/ H A ,61 70, ,65 177, Growth rate (annual %) Contribution to growth What happened in Korea? Y/ K/ H A 160 4,357 5, ,73 3, Growth rate (annual %) Contribution to growth Example: growth rate of output per worker over γ Y = Contributions to growth log(67, 65) log(31, 61) physical capital: αγ K human capital: (1 α)γ H total factor productivity: γ A

3 Japan Ireland.5 (at PPP ).5 (at PPP ) JPN.5 IR What happened in Japan? What happened in Ireland? Y/ K/ H A Y/ K/ H A 160,45 12, ,030 10, ,415 25, ,24 131, Growth rate (annual %) Contribution to growth Growth rate (annual %) Contribution to growth

4 Is Poland the next Ireland? Similarities to Ireland circa 10 large unproductive agricultural sector low capital intensity and TFP relative to (say) France educated population member of European Union Questions which factors are most important? is it a business opportunity? why or why not? do other transition economies look as good or better? What happened in China? Y/ K/ H A ,6 2003,23 1, Growth rate (annual %) Contribution to growth China Argentina 12 (at PPP ).5 (at PPP ).5 CHN ARG

5 What happened in Argentina? Y/ K/ H A 160 1,24 32, ,24 57, Growth rate (annual %) Contribution to growth What have we learned so far? Growth accounting helps to explain aggregate performance TFP plays an important role in many cases: suggests that applications of the Solow model should include TFP growth Major outstanding question: where does TFP come from? technological innovation good institutions political stability and the rule of law clearly-defined property rights competitive markets: for capital, labor and products 17 1 Where are the opportunities? Why might growth slow down? too much reliance on growth in inputs instead of TFP diminishing returns recall Soviet Union discussion from last class Where do you think the opportunities are? Rest of this class Productivity and institutions an historical example simple game theory, illustrates importance of institutions ( rules of the game ) case studies of productivity change cross-country studies of institutions Bangladesh? India? Malaysia? Argentina? Brazil? Mexico? Russia? Slovakia? got another favorite? Why? 1 20

6 TFP in Atlantic ocean shipping Now we have... GDP Capital and abor Productivity Institutions Source: Douglass North Started with... Roadmap for rest of class Suggestive correlations of real GDP with measures of GDP expropriation risk corruption contract enforceability Capital and abor Productivity Simple game-theoretic model of lending and the benefits from property rights Case-study of competition and productivity Talking points competition/regulation corporate culture 22 24

7 Expropriation risk Corruption GDP and Expropriation Risk GDP and Corruption og Real GDP per Capita, UX CHE NOR AUT CAN DNK JPNSGP NDGBR FRA FIN BE IS SWE IR ITA AUS NZ ESPTWN PRT HKG CYP ISR BHS KOR MT GRC ARG MYS CH GABTTO URY BRA THA MEX BWA TUR VEN ZAF CO PRY TUN CRI PAN PER IDN JAM ECUEGY MARJOR DOM SYR GTM SV PNG KA ZWE GUY PH BO IND CIV CMR PAK HND COG SEN BGD KEN GHA GMB ZMB TGO SE NGA MWI NER MDG TZA HTI SDN Expropriation Risk ZAR og Real GDP per Capita, UX CAN CHE DNK SWE NOR ND FIN IS NZ BFA HKG BE AUT AUS JPN SGP KWT GBR FRA IR ISR ZAF CRI ITA ESPTWN CYP BHS PRT KOR GRC SAU MT ARG MYS CH URY TTO GAB BRA MEX BWA TUR THAVEN CO TUN PAN PRY PER JOR ECU DOM MAR EGY SYR SV PNG JAM GTM IDN ZWE KA PH BO GUY CIV IND COG CMR HNDPAK HTI SEN BGD KEN GHA GMB SDN NGASE MDG MWI NER ZMBTGO TZA 4 6 Corruption ZAR Source: Demirguc-Kunt and evine. 25 Source: Demirguc-Kunt and evine. 27 Suggestive correlations only Contract enforceability Part of a multivariate regression Idea is to look at impact of expropriation risk on GDP, holding constant the level of development Key concern: correlation versus causality Some more examples... og Real GDP per Capita, 16 7 GDP and Contract Enforceability AUSJPN CAN DNK CHE ITA FRA FIN ND BE AUT GBR NOR SGP SWE IR ESP ISR KOR TWN PRT GRC ARG MYS CH VEN MEX BRA THA ZAF TUR CO PER IDN MAR ECU EGY PH BO PAK IND CIV KEN NGA 6 ZAR Contract Enforceability Source: Demirguc-Kunt and evine. 26 2

8 ending game Repay or default? Example to see importance of institutions Rules of the game lender offers $0 million to borrower for one year lender s cost of funds is 5%, charges %, the competitive risk-adjusted rate borrower has project that generates if repay, have 5 = 5 0 (principal and interest) if default, have 0 = 5 25 (lawyers, Swiss accounts) deal generates value of = 5 5 ender end Don't end Borrower Payoffs (ender, Borrower) (0,0) Repay (5,5) What happens? Default (-5,0) 2 31 ending game end or not? Payoffs (ender, Borrower) Payoffs (ender, Borrower) ender Don't end (0,0) ender Don't end Outcome (0,0) end end Social Optimum Borrower Repay (5,5) Borrower Repay (5,5) Default Default (-5,0) (-5,0) 30 32

9 Make it costly to default! essons from the lending game Creditor rights help borrowers too! ender Don't end Payoffs (ender, Borrower) (0,0) making it easy to default kills off the loans market, this hurts borrowers and lenders when this happens, positive NPV projects are not funded and TFP is lower than it could be end Countries with stronger creditor rights have more lending, lower borrowing costs Borrower Repay (5,5) What if return is risky? Default Change rules of the game: so default doesn't pay (so well)! (-5,1) Everybody better off Competition: a case study World iron ore markets ender end Don't end Borrower Default Social Optimum = Outcome! Payoffs (ender, Borrower) (0,0) Repay (5,5) collapse in world steel production in early 10s, especially in Atlantic basin an exogenous shock to iron ore producers, increases probability of mine closures ( competitive pressure ) note: high transport costs segment market Atlantic basin countries face more competitive pressure, respond by increasing productivity but Pacific basin countries do not face more competitive pressure and do not increase productivity (-5,1) Change rules of the game: so default doesn't pay (so well)! 34 36

10 Steel and pig iron production ittle increase in competitive pressure Australia Brazil India Source: Galdon-Sanchez and Schmitz. 37 Source: Galdon-Sanchez and Schmitz. 3 Atlantic and Pacific pig iron production Big increase in competitive pressure Canada France Sweden US South Africa Source: Galdon-Sanchez and Schmitz. 3 Source: Galdon-Sanchez and Schmitz. 40

11 Talking points A blaze of amateur sociology? Property rights? Solow, on explanations of slow productivity growth in the UK The absence of clear property rights is a major problem in many developing countries. This hits small businesses hardest, since lack of clear claim to (say) real estate makes it difficult for them to finance new or expanding businesses. It would take a small business months to get the approvals to operate legally in Peru. (Hernando de Soto, paraphrased) Talking points What have we learned today? Corporate culture? Toyota taught the industry to make cars properly. Its culture has been absorbed by employees around the world. The magic is that Toyota people put themselves outside the comfort zone: when they hit one target, they set another, in a relentless pursuit of excellence. (The Economist, January 2, 2005). TFP has as much to do with social institutions as with technology and innovation Highlights political stability and rule of law clear property rights (may not matter who, as long as it s clear) competition Incentives must favor producing value, rather than taking it from someone else Measures of institutional performance are widely available, but these concepts are inherently subjective 42 44