Growth Theories

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Growth Theories
Lecture 1 of Eco 317
J.D. Han at Kings

• Frame of Reference

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• General Neo-Classcial Model
• Harrod-Domar Model
• Solow Model
• Endogenous Growth Model
• Human Capital
• Others
• Lewis Model
• Rostow Model

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Neo-Classical Economics

• Microeconomics that you have learned
• Aggregate Demand does not matter for long-run
  growth of income
• Macroeconomic Policies of Government (controlling
  Money Supply, Government Expenditures )do not
  matter for Y in the long-run You cannot pull
  yourself up by your own bootstrap

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1. Neo-classical Mode Supply Side Economics

• Economic growth
• Growth of Income
• Growth of aggregate output comes from
• an increase in labour L
• an increas in capital K and/or
• improvement of technology T

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In General

• production function
• Y f (K, L T)
• Growth function
• dY f (dK, dL dT)

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Specific Formula of Production Function

• Most Widely Used Production Fn is
• Cobb-Douglas Production Function
• Y A K a L 1-a
• , and alt1
• Realistic and Convenient Features of C-D
  function
• Diminishing Marginal Return
• Constant Return to Scale

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Why are the two features realistic in Economics?

• Diminishing Marginal Returns(DMR)
• eg) Y F(K,L ) 10 F(5, 5) 13 F(10,
  5)
• Decreasing Marginal Productivity of Capital or
  Labor
• dY/dK MPk, d MPk/ dk lt0 or dY2/d2K lt0
• dY/dL MPL, d MPL / dL lt0
• Constant Return to Scale (CRS)
• If Y F (K, L) is true, Y F (2K, 2L) 2 F (K,
  L) is attainable.
• You do not have to take DRS 1.5 Y F (2K, 2L)

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Diminishing Marginal Returns as a Fact of Life

• Biological growth- S curve(upper part)
• Stages of Acceleration (Youth) and
  Deceleration (Maturity)
• Convergence
• Production Function
• Stages of Increasing Marginal Return and
  Decreasing Marginal Return
• inflection point between IMR and DMR
• Why is IMR no substantive issue?
• Returns to Education/Efforts

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2. Harrod-Domar Model

• Income Growth Rate Saving Rate x Efficiency of
  Capital
• dY/Y S/Y x dY/dK
• ( as S I dK )
• Saving Ratio x Marginal Product of Capital

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2. Harrod-Domar Model

• Income Growth Rate Saving Rate x Efficiency of
  Capital
• dY/Y dY/dK x dK/Y
• ( as S I dK )
• dY/dK x S/Y
• Marginal Product(ivity) of Capital x Savings
  Ratio

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• S/Y
• dK/dY
• Average Propensity to Save
• Incremetal Capital Output Requirement

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• In general, eventually, the more amount of
  capital, the Marginal Productivity of capital
  decreases Convergence
• Recall In the latter part of the S curve, the
  MP of capital is a decreasing function of capital
  Decreasing Marginal Returns or Law of
  Diminishing Marginal Return
• This happens as the size of capital grows in
  the natural course of economic growth.
• It is a formidable task to keep the weighted
  average Marginal Product of Capital constant or
  even Increasing for the entire economy.

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Implications of the H-D model

• -The key to economic growth is to expand the
  level of investment capital accumulation or
  Mobilization of capital
• -Equally important is the productivity of
  capital the higher the marginal product(ivity)
  of capital, the better, or the lower the required
  incremental capital-output ratio, the better.

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Limitation of the Harrod-Domar Model

• difficult to stimulate the level of domestic
  savings particularly in the case of developing
  countries
• One way of supplementing the low domestic savings
  would be foreign savings/investment
• However, borrowing from overseas causes debt
  repayment problems later.
• The law of diminishing returns would suggest that
  as investment increases the marginal productivity
  of the capital will diminish, and the capital to
  output ratio rise. Fighting this natural law is a
  formidable task.
• In a word, the model does not give any easy
  recipe for a success of economic development
  while it can explain the surface of the given
  economic growth.

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How to enhance Efficiency of CapitalHigher MP
of Capital, or lower ICOR

• 1) Through Technological advances or Technical
  innovations
• This can happen to any economic system
  Market(economy) can take care of this while
  government may promote it too.
• 2) Though resource allocation by visible hands,
  government, channeling capital into efficient
  areas
• - A specific Economic System/Institution
• key words) Centrally planned economy Economic
  Planning Resource Allocation Planning
  Industrial Policy Promotion of National
  Strategic Industries Key Industry

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Technical Innovation

• Illusive
• Difficult to measure
• Hard to explain causes and impacts
• - Refer to Growth Accounting later.

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To spark Growth, we may need Institutions

• Institution (as opposed to Market Economy)
• covers Government Economic System Value
  System(ethics,religion)
• - Mechanism to Mobilize Capital? How to
  increase Saving Rate?
• - Mechanism to raise the Efficiency of Capital?

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East Asian Governments Role for Promotion of
Economic Growth

• Government Policies are needed to 1)
  encourage/force savings
• 2)and/or to enhance efficiency of capital by
  allocating scarce capital primarily to strategic
  area of industry.

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Case Studies of Governments Forced Savings and
Resource Allocation

• Successes
• -Japan
• by Kozo Yamamuras paper reports that during
  the take-off stage of economic growth of Japan,
  the capital output ratio fell significantly due
  to Innovations(?) and Governments Industrial
  Policy
• -Korea
• Promotion of chae-bol(s)
• Strategic industries of Ship-building, Cars,
  Semi-conductors, IT Industries, etc.

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• 2) Debacles
• Some countries have succeeded in mobilization of
  capital, but failed in the efficient use of
  capital.
• Stalinist Economy
• North Korea
• Great Leap Movement in China

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3. Solow Model
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4. Lewis ModelDual Sector Model of Economic
Growth

• many LDCs had dual economies with a traditional
  agricultural sector and a modern industrial
  sector
• Traditional Sector has too much labor at
  subsistence level
• MPlabour 0 Y C S T C I G
• Modern Sector absorbs labor and becomes the
  source of economic surplus or savings

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How does the Mechanism work?

• The lack of development was due to a lack of
  savings and investment. The key to development
  was to increase savings and investment.
• Lewis saw the existence of the modern industrial
  sector as essential if this was to happen. A
  growing industrial sector requiring labour
  provided the incomes that could be spent and
  saved. This would in itself generate demand and
  also provide funds for investment. Income
  generated by the industrial sector was trickling
  down throughout the economy.
• Urban migration from the poor rural areas to the
  relatively richer industrial urban areas gave
  workers the opportunities to earn higher incomes
  and crucially save more providing funds for
  entrepreneurs to investment.

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Policy Implications of Lewis model

• Induced Displacement of Population from Rural to
  Urban Sector
• Government may use push and pull factors using
  Institutions or System
• -Vanity Effect as a magnet Glamorous/modernize
  d Urban Sector versus Backward/Suppressed
  Rural Area
• -Income Inequality is as a magnet

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Lewis Model is Unbalanced Economic Growth
Strategy(??????????)

• This is a practical strategy.
• Lets reflect on side-effect/problems
• -Sustainability in the long-run Ravaging impacts
  of labor saving technology How much and how
  long is the modern sector absorb the surplus
  labor? What will happen to no-longer-needed
  surplus labor?
• -Inequality between agricultural industrial
  sectors
• Income Inequality Urbanization issues
• Urban/Modern Sector may not Save but Spend Urban
  Consumerism
• Rural-Urban Migration is larger than what the
  urban sector can absorb Rural Poverty simply
  becomes Urban Poverty

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Case Studies Casual Analysis

• England in 18th Century
• Enclosure Movement
• U.S. in 19th century
• Slave-Emancipation
• Japan
• Korea in the 1970s and the 1980s
• New Village Movement (Sae-Ma-Eul-Un-Dong)
• Taiwan (part of China)
• China

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Quantitative AnalysisIncome (Distribution)
Inequality and Economic Growth

• Income Inequality is measured by Gini-Coefficient
  
• Some international comparisons argue as economy
  grows, Gini Coefficient generally rises first and
  then fall
• It is in line with Lewis theory Income
  inequality is not only inevitable, but also
  necessary for economic growth
• - Case studies of Korea, Japan, and China
  (presentation)

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5. Rostow's Model- the Stages of Economic
Development.

• In 1960, the American Economic Historian, WW
  Rostow suggested that countries passed through
  five stages of economic development

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• Stage 1 Traditional Society-dominated by
  subsistence (defined as no economic surplus,
  meaning output being consumed by producers rather
  than traded)
• -trade being carried out by barter, meaning
  goods being exchanged directly for other goods
• -Agriculture being the most important
  industryProduction being labor intensive using
  only limited quantities of capital.
• Stage 2 Transitional Stage (the preconditions for
  takeoff)-Increased specialization starting to
  generate surpluses for trading.
• -an emergence of a transport infrastructure to
  support trade External trade also occurs
  concentrating on primary products Entrepreneurs
  emerge
• -savings and investment grow.
• Stage 3 Take Off-Rapid Industrialization or
  Industrial Revolution
• - Growth concentrated in a few regions of the
  country and in one or two manufacturing
  industries.
• - The level of investment reaches over 10 of
  GNP.
• - The economic transitions are accompanied by
  the evolution of new political and social
  institutions that support the industrialization.
• - The growth is self-sustaining investment
  leads to increasing incomes in turn generating
  more savings to finance further investment.
• Stage 4 Drive to Maturity-Industrial
  Diversification producing a wide range of goods
  and services reliance on exports and imports may
  start decreasing
• Stage 5 High Mass Consumption- Mass
  Consumption(????) Domestic Aggregate Demand is
  the major determinant of Business (Cycles)
• - Consumer durable industries Service
  sector

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• Limitations
• Deterministic Path for All?
• Rostow predict that every economy is going
  through the same stage.
• However, some economies are stuck in the first
  stage forever while other economies take off.
• -leaving a room for cultural explanation
• It does not set down the detailed nature of the
  pre-conditions for growth What sparks the
  take-off?
• -Exogenous Shocks as a Catalyst for Great
  Transformation?
• It is not very helpful as a policy prescription.
  Perhaps its main use is to highlight the need for
  investment.
• Explaining the fast is always easier than
  Predicting
• the future

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Major Contribution of Rostow Model

• Emphasis of Take-Off
• -Economic Development is
• not a continuous process
• -There should be
• some Event for Great Transformation.

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Case Studies Catalyst for Take off

• Catalysis for Take Off Exogenous Shocks
• Japan
• Meiji Revolution Korean War
• Korea
• President Park, Jeong Hee Vietnam War
• China
• Deng Xiao Pings Reform
• Jiang Ze Mins Southern Journey(Nan Xun)
• Iraq War?

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6. Endogenous Growth Theory

• Excellent Summary of Endogenous Growth Models
• http//www.ncl.ac.uk/ncihe/r8_117.htm

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Value System as a Foundation Institution for
Economic Growth

• Max Weber arguned that
• Protestant Work Ethic sanctioned hard work,
  frugality and wise investment.
• Rodney Stark is one of the most highly regarded
  sociology of religion scholars alive today. He
  recently published The Victory of Reason How
  Christianity Led to Freedom, Capitalism, and
  Western Success.
• Professor Tu Wei-Ming at Harvard University said
  that Neo-Confucianism of the Far East is similar
  to protestant ethic.
• - refer to the essence of his idea