ECON 450 Development Economics

Transcription

1 ECON 450 Development Economics Classic Theories of Economic Growth and Development The Empirics of the Solow Growth Model University of Illinois at Urbana-Champaign Summer 2017

2 Introduction This lecture continues the discussion of the Neoclassical Growth Model. We now look at how the model works in practice. The next step is to introduce the Augmented Solow Model by making explicit another type of capital: Human Capital. Finally, we study the convergence in income across countries.

3 Outline 1 The Model Predictions 2 Are Living Standards of Developing and Developed Nations Converging?

4 The Syrian Crisis Shocks to an economy, such as wars, famines, or the unification of two economies, often generate large one-time flows of workers across borders. One recent example is the increasing number of Syrian refugees in western European countries, such as Germany. What are the short-run and long-run effects on an economy of a one-time permanent increase in the stock of labor? Use a diagram to guide your arguments.

5 The Production Function Revisited Let s take a close look at the production function one more time: Y = F (K, L) = K α (AL) 1 α It exhibits constant returns to scale. It also exhibits diminishing returns on each factor. How? What does the second derivative tell us?

6 Solow s Surprise What does the diminishing returns assumption imply for the quest of sustained economic growth?

7 Solow s Surprise What does the diminishing returns assumption imply for the quest of sustained economic growth? It simply cannot be achieved! (Why?)

8 Solow s Surprise How did we observe sustained growth of output per worker when such sustained growth is not logically possible?

9 Solow s Surprise How did we observe sustained growth of output per worker when such sustained growth is not logically possible? Solow s solution to this paradox was technological change.

10 Solow s Surprise How did we observe sustained growth of output per worker when such sustained growth is not logically possible? Solow s solution to this paradox was technological change. Technological progress increases labor productivity. It is "as if" there were more workers in the labor force. The "effective number of workers" keeps up with the increasing number of machines, so diminishing returns never sets in.

11 Discussion on Technological Progress Is this "labor-saving" technology progress bad for development?

12 Discussion on Technological Progress Is this "labor-saving" technology progress bad for development? Unemployment caused by new machines taking over the jobs of the population

13 The Luddite Fallacy The Luddites were 19th-century English textile workers who destroyed machines which embodied the labor-saving technology introduced during the Industrial Revolution. English government officials, after careful study, addressed the Luddites concern by hanging fourteen of them in January 1813.

14 The Luddite Fallacy

15 The Luddite Fallacy The reason why the argument made by the Luddites is fallacious is that labor-saving technology is another term for output-per-worker-increasing technology. Although some temporary unemployment is inevitable, workers as a whole are better off with more powerful output-producing technology available to them.

16 The Luddite Fallacy Therefore, technological advance translates into higher output per worker, which means more goods and services to all workers. Moreover, economies experiencing technological progress do not show any long-run trend toward increasing unemployment; they do show a long-run trend toward increasing income per worker.

17 Solow in the Tropics What does the Solow model have to say about cross-country differences in economic growth?

18 Solow in the Tropics What does the Solow model have to say about cross-country differences in economic growth? Economists in the 1960s applied the Solow framework to explaining a wide variety of growth experiences, including the poor tropical countries. Given the reasonable assumption that technology is available throughout the world, different countries would have the same rate of technological progress. Therefore, the only difference between poor and rich countries would be in levels of investment in physical capital.

19 Solow in the Tropics Poor tropical countries would catch up to the rich temperate zone with very high returns to capital. But obviously, this Capital Fundamentalist view of country convergence has failed to explain why we cannot observe relative convergence in income levels of different countries. We ll discuss the convergence predictions of the Solow model later on.

20 Solow Model Predictions The central predictions of the Solow model concerns the impact of saving and population growth on real income. Recall the Steady State condition: ( k s = n + g + δ ) 1/1 α Substituting it into the production function and taking logs, we find that steady-state income per capita is log Y (t) L(t) = log A(0) + gt + α 1 α log s α log(n + g + δ) 1 α

21 Solow Model Predictions Let s assume g and δ are constant. Moreover, assume log A(0) = a + ɛ where a is constant and ɛ is a country-specific shock.

22 Solow Model Predictions Thus, at time 0: log Y (t) L(t) = a + gt + α 1 α log s α log(n + g + δ) + ɛ 1 α The above equation should remind you of a certain statistics concept! Which is it?

23 Solow Model Predictions If your answer was "Regression analysis", you are right! Remember that in the linear regression framework, we can estimate the parameters of the equation by OLS. y = α + β 1 x 1 + β 2 x β p x p + ɛ

24 Solow Model Predictions On average, we can assume α = 1/3. That is, capital s share in income is roughly one third. Therefore, the model predicts an elasticity of income per capita with respect to the savings rate of approximately 0.5. Moreover, the elasticity of income per capita with respect to n + g + δ should be close to -0.5.

25 Solow Model Predictions First Results

26 Solow Model Predictions First Results The model explains a large fraction of income variation (Adjusted R 2 = 0.59 for two of the samples). However, the estimated impacts of savings and labor force growth are much larger than the model predicts. (Why?) One possible explanation for this result is that the proposed specification ommits one important component of the growth process: human capital accumulation.

27 Solow Model Predictions Adding Human Capital to the Solow Model At the theoretical level, including human capital may add some insights on how differences in human capital stock affects the growth process. At the empirical level, human capital enters the first specification on the error term. Expliciting it might lead to different results.

28 Solow Model Predictions Adding Human Capital to the Solow Model Now consider the following production function Y (t) = K (t) α H(t) β (A(t)L(t)) 1 α β We have now two equations representing the change in the stock of capital per effective unit of labor over time: k(t) = s k y(t) (n + g + δ)k(t), ḣ(t) = s h y(t) (n + g + δ)h(t)

29 Solow Model Predictions Adding Human Capital to the Solow Model We can obtain steady state values by making k(t) = ḣ(t) = 0. ( k s 1 β k s β h = n + g + δ ( h sk α = s1 α h n + g + δ ) 1/1 α β ) 1/1 α β

30 Solow Model Predictions Adding Human Capital to the Solow Model Substituting the previous equation into the production function and taking logs we have log Y (t) L(t) = log A(0) + gt α + β log(n + g + δ)+ 1 α β α + 1 α β log s β k + 1 α β log s h + ɛ

31 The Model Predictions Solow Model Predictions Adding Human Capital to the Solow Model

32 Solow Model Predictions Adding Human Capital to the Solow Model Now the results in Table II strongly support the augmented Solow model. The model explains almost 80% of the cross-country variation in income per capita in two of the samples. The last lines of the table give the values of α and β implied by the coefficients.

33 Outline 1 The Model Predictions 2 Are Living Standards of Developing and Developed Nations Converging?

34 Are Living Standards of Developing and Devolved Nations Converging? At the dawn of the industrial era, average real living standards in the richest countries were no more than three times as great as those of the poorest. Today, the ratio approaches 100 to 1.

35 Are Living Standards of Developing and Devolved Nations Converging? If the growth experience of developing and developed countries were similar, there are two important reasons to expect that developing countries would be "catching up" by growing faster on average than developed countries. The first reason is due to technology transfer. Today s developing countries do not have to "reinvent the wheel".

36 Are Living Standards of Developing and Devolved Nations Converging? This should enable developing countries to "leapfrog" over some of the earlier stages of technological development, moving immediately to high-productivity techniques of production.

37 Are Living Standards of Developing and Devolved Nations Converging? As a result, they should be able to grow much faster than today s developed countries are growing now or were able to grow in the past, when they had to invent the technology as they went along and proceed step by step through the historical stages of innovation.

38 Are Living Standards of Developing and Devolved Nations Converging? The second reason to expect convergence if conditions are similar is based on factor accumulation. In traditional neoclassical analysis, the marginal product of capital and the profitability of investments would be lower in developed countries where capital intensity is higher, provided that the law of diminishing returns applies.

39 Are Living Standards of Developing and Devolved Nations Converging? Given one or both of these conditions, technology transfer and more rapid capital accumulation, incomes would tend toward convergence in the long run as the faster-growing developing countries would be catching up with the slower-growing developed countries.

40 Are Living Standards of Developing and Devolved Nations Converging? Whether there is now convergence in the world economy depends on two levels of how the question is framed: whether across average country incomes or across individuals (considering the world as if it were one country); whether focusing on relative gaps or absolute gaps.

41 Relative Country Convergence The most widely used approach is simply to examine whether poorer countries are growing faster than richer countries. In the meantime the relative gap in incomes would be shrinking, as the income of poor countries would become an increasingly large fraction of income of rich countries. But globally, evidence for relative convergence is weak at best, even for the most recent decades.

42 Relative Country Convergence: World, Developing Countries, and OECD

43 Relative Country Convergence: World, Developing Countries, and OECD

44 Absolute Country Convergence In the period, while income grew 24% in high-income OECD countries, it grew 56% in South Asia and 196% in China. But due to their relatively low starting income levels, despite higher growth, income gains were still smaller in absolute amount than in the OECD.

45 Growth Convergence versus Absolute Income Convergence

46 Absolute Country Convergence That is, even when the average income of a developing country is becoming a larger fraction of developed country average incomes, the difference in incomes can still continue to widen for some time before they finally begin to shrink.

47 Population-Weighted Relative Country Convergence The high growth rate in China and India is particularly important because more than one-third of the world s people live in these two countries. This approach frames the question so as to weight the importance of a country s per capita income growth rate proportionately to the size of its population.

48 Country Size, Initial Income Level, and Economic Growth

49 Population-Weighted Relative Country Convergence Although it is true that conditions have remained stagnant or even deteriorated in many of the least developed countries, because of their smaller population sizes with the populationweighted approach this divergence effect is more than compensated for by growth in countries with large populations.