Chapter 6.pdf

Economics of Development Chapter 4. Theories of Economic Growth: Old and New Classical growth theory Harrod-Domar growth model Neoclassical growth model Production function approach to analysis of growth and studies for developing countries ‘New’ (endogenous...

Economics of Development Chapter 4. Theories of Economic Growth: Old and New Classical growth theory Harrod-Domar growth model Neoclassical growth model Production function approach to analysis of growth and studies for developing countries ‘New’ (endogenous) growth theory and macrodeterminants of growth ‘Growth diagnostics’ and binding constraints on growth 1  Economics of Development Classical Growth Theory All great classical economists concerned with economic growth and development: Adam Smith; David Ricardo; Thomas Malthus; John Stuart Mill; Karl Marx Smith optimistic about growth based on division of labour (specialisation) and increasing returns in industry, but division of labour limited by extent of the market Malthus, Ricardo, Mill pessimistic because diminishing returns in agriculture would cause famine, a rising price of food and decline in the profit rate on capital Marx predicted breakdown of capitalism itself because of falling rate of profit; immiseration of workers and a ‘realization’ crisis 2  Economics of Development Harrod-Domar Growth Model Modern growth theory started with Roy Harrod in 1939. Domar derived same results (independently) 1946 Harrod specifies three growth rates which may only equal each other by chance: actual growth rate (g); warranted equilibrium growth rate (gw); natural growth rate (gn) determined by labour force growth and technical progress –exogenously determined If g ≠ gw, cyclical fluctuations occur If gw ≠ gn, secular stagnation if gw > gn; structural unemployment and inflation if gn > gw Most developing countries have labour and technical progress growing faster than capital accumulation i.e. gn > gw –hence growing unemployment of structural variety 3 Nothing in Harrod model to equalize g, gw and gn  Economics of Development Neoclassical Growth Model Neoclassical growth model of Solow 1956 (also Swan 1956) challenged pessimistic conclusion of Harrod that no mechanism exists to equilibrate gw and gn Neoclassical model predicts economies will converge in the long run on natural rate of growth through capital-labour substitution. – If capital grows faster than labour (gw > gn), more capital intensive technologies used reducing gw by raising required incremental capital-output ratio – If labour grows faster than capital (gn > gw) more labour intensive techniques used raising gw by reducing required incremental capital-output ratio Neoclassical model also predicts convergence of per capita incomes across countries because poor countries with little capital will have higher marginal product of capital and therefore grow faster than rich countries –the assumption of diminishing returns to capital– given same tastes, preferences and 4 technology  Economics of Development Production Function Approach to Analysis of Growth and Studies for Developing Countries Neoclassical production function makes aggregate output a function of labour and capital inputs and technical progress If elasticities of output with respect to labour and capital are known, contribution of labour and capital input to measured growth can be estimated leaving technical progress as a residual Early studies applying production function to developed countries found technical progress most important factor explaining growth Studies for developing countries find capital input most important factor, not technical progress, so no growth ‘miracle’ in fast growing countries Production function very versatile because any growth –inducing variable can be added and its elasticity and rate of return measured e.g. education; R +D 5  Economics of Development ‘New’ (Endogenous) Growth Theory and Macrodeterminants of Growth ‘New’ (endogenous) growth theory formalised in 1980s as challenge to neoclassical assumption of diminishing returns to capital and that countries’ living standards will converge No evidence of convergence in world economy (see Chapter 2) because forces at work to keep marginal product of capital from falling in rich countries Human capital (education) and research and development (R+D) are key factors Empirical research shows there could be conditional convergence if only levels of education and other factors were same across rich and poor countries, but they are not Conditional convergence also consistent with idea of ‘catch up’ and faster structural change in poor than rich countries. 6  Economics of Development ‘Growth Diagnostics’ and Binding Constraints on Growth Studies across countries of macrodeterminants of growth cannot explain experience of individual countries Often country growth very volatile: fast and slow growth doesn’t persist over time ‘Growth diagnostics’ attempts to explain why growth is slow (or fast) in particular countries, and what are binding constraints If investment low, is it due to lack of finance; high cost of finance; low return to investment; or return cannot be appropriated by private agents? Different scenarios require different policies to relieve binding constraints World Bank Commission on Growth and Development finds sustained growth of successful countries most associated with: high savings and investment rates; fast export growth; macroeconomic stability; impact of knowledge and technology, and market-friendly policies 7  Economics of Development Learning Objectives You should now know: Views of classical economists Growth model of Harrod (and Domar) Assumptions and predictions of Solow neoclassical growth model Use of production function for understanding sources of growth Empirical studies using production function Origins and arguments of ‘new’ (endogenous) growth theory Meaning of ‘growth diagnostics’ and binding constraints on growth Characteristics of successful developing economies 8  Economics of Development Summary All great classical economists concerned with growth and development; Smith optimistic; others pessimistic Growth and development theory lay dormant until Harrod’s1939 contribution Solow’s neoclassical growth model tries to show there can be long run equilibrium growth, but assumptions and predictions of model are suspect Neoclassical production function can be used to analyse sources of growth, but factor supplies treated as exogenous Production function studies of developed and developing countries show technical progress most important in developed countries but factor inputs (particularly capital) in developing countries ‘New’ (endogenous) growth theory addresses why living standards across countries not converging. Answer is non-diminishing returns to capital because of human capital formation and endogenous technical progress ‘New’ growth theory studies cannot explain experience of individual countries. ‘Growth 9 diagnostics’ required to identify binding constraints on growth  Economics of Development Websites New School for Social Research (New York) http://www.newschool.edu/nssr/ Economic Growth Resources run by Jon Temple, Bristol University, UK www.bristol.ac.uk/efm/people/jon-r-temple/overview.html Overseas Development Institute www.odi.org Foundation for Advanced Studies on International Development www.fasid.or.jp/english Institute of Developing Economies Japan-External Trade Organization www.ide.go.jp/English/index.html The Vienna Institute for International Economic Studies www.wiiw.ac.at Carnegie Endowment for International Peace http://carnegieendowment.org/ 10