performance of world economies gavin cameron university of oxford oubep 2006

Performance of World Economies

Gavin Cameron University of Oxford

OUBEP 2006

OXFORD UNIVERSITY BUSINESS ECONOMICS PROGRAMME

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introduction• “Is there some action a government

of India could take that would lead the Indian economy to grow like Indonesia’s or Egypt’s? If so, what, exactly? If not, what is it about the “nature of India” that makes it so? The consequences for human welfare involved in questions like these are simply staggering: Once one starts to think about them, it is hard to think about anything else”, Robert Lucas, 1988.


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important elements of long-run growth

• Technical Change (q.v. Smith’s pin factory)• Over time, technology becomes more advanced, and hence output per

worker rises;• Factor Accumulation (q.v. Ramsey on saving)

• Over time, with sensible property rights, people accumulate capital assets (physical, human and environmental), even though factors are typically subject to diminishing returns;

• Factor Substitution (cf. Ricardo on land)• Over time, factors cannot earn economic rents unless their supply is

restricted, even then, other factors can be used as substitutes;• Product Substitution (q.v. Schumpeter on creative destruction)

• Over time, new varieties and qualities of products are developed, which replace previous types.

http://en.wikipedia.org/wiki/Image:1schumpeter.jpg


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Kaldor’s stylised facts• Per capita output grows over

time and its growth rate does not tend to diminish; the same is true of real wages;

• Physical capital per worker grows over time;

• The rate of return to capital is nearly constant;

• The ratio of physical capital to output is nearly constant;

• The shares of labour and physical capital in national income are nearly constant;

• The growth rate of output per worker differs substantially across countries.

Source: Robert J Gordon (2005)


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Capital per worker (K/L)

Output per worker, Y/L

diminishing returns

Output is produced using a diminishing returns production technology. As more capital is added, the additional increment to output gets smaller. The shape of the curve reflects the production technology – it gets flatter as the output elasticity of capital falls, and steeper as it rises.

Output per worker (K/L)


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... a constant saving rate…


Saving per worker, sY/L

Some constant fraction, s, of output is saved. This saving takes the form of new capital goods.



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…and a constant depreciation rate


Required Investment per worker, (n+d)K/L

Gross investment is required each year, since the stock of capital per worker falls because of physical depreciation and because of labour force growth.



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…the Solow model

The economy is in equilibrium when net investment is zero.


K*/L

Rate of convergence is an increasing function of s, and a decreasing function of n+d and the output elasticity of capital


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The increase in investment raises the growth rate temporarily as the economy moves to a new steady-state. But once the new higher steady-state level of income is reached, the growth rate returns to its previous level.

a rise in the saving rateOutput per worker (K/L)

s’Y/L

sY/L




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faster population growth


The rise in population growth means that more workers need to be equipped with capital each time period, which means that less is available for replacing depreciated equipment. This leads to a fall in the steady-state level of capital.


(n+d)K/L

(n’+d)K/L


Required Investment per worker


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C/L

I/L

the golden rule

The goal of a social planner might be to maximise consumption per capita (where consumption is largest relative to investment per worker). This occurs where the slope of the output per worker curve is the same as the slope of the depreciation per worker curve. The implied saving rate is likely to be different from the market outcome.

Output per worker (K/L) Output per worker, Y/L



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the poverty trap - industrialisation

low income: agricultural

high income: industrial


Saving per worker


medium income: mixed


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the poverty trap – endogenous fertility

low income: high fertility, high mortality

high income: low fertility, low mortality

Required Investment per worker, (n’+d)K/L

Saving per worker


medium income: low fertility, high mortality


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the AK model

Required investment per worker, (n+d)K/L



If there are constant returns to broad capital, net investment might always be positive, so there is no equilibrium level of output per worker.




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Solow vs AK• The Solow model model has two

main predictions:• For countries with the same

steady-state, poor countries should grow faster than rich ones.

• An increase in investment raises the growth rate temporarily as the economy moves to a new steady-state. But once the new higher steady-state level of income is reached, the growth rate returns to its previous level – there is a levels effect but not a growth effect.

• However, the AK model yields the opposite predictions – there is no convergence, and policy changes can have permanent effects.

K/L

t

K/L

‘catch-up’

‘levels effect’

K*/L

‘growth effect’

no ‘catch-up’

t

Solow world

AK world


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Source: O’Mahony and Van Ark (2003)


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1960

1990

Since the 1960s, the distribution of world log income has tended to become more twin-peaked than before. Danny Quah argues that open economies tend to be in the higher peak.

twin peaks

income

number of countries


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the sources of economic growth• Growth of output = weighted growth of inputs + growth of

total factor productivity• Growth of labour productivity = weighted growth of capital

per worker + growth of total factor productivity• Growth of inputs

• Capital and labour• Materials and energy

• Growth of total factor productivity• Higher quality products• New varieties of products• Better ways to use existing inputs


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growth accounting


A rise in technology raises the steady-state level of output per capita. Part of this rise (AB) is the pure effect of technical change (TFP), the other part (BC) is due to ensuing capital accumulation.

A

B

C


Output per worker, Y’/L



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Source: O’Mahony and Van Ark (2003), table 1.4b.


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Source: O’Mahony and Van Ark (2003), table III.14.


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Source: O’Mahony and Van Ark (2003), table III.5.


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high productivity countries• Institutions that favour production over diversion: low

corruption, private property, good institutions;• Low rate of government consumption (i.e. spending

excluding investment & transfers);• Open to international trade;• Well-educated workforce;• International language;• Temperate latitude away from the equator;• Easy access to coast and ports.


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long-run growth• Unemployment and business cycles are important in explaining

short and medium run growth, but play almost no rôle in the long-run: in the long-run, national output is determined by supply.

• In the long-run, the main source of rising living standards is rising output per worker.

• Rising output per worker is due to the steady accumulation of capital (human, physical, social, environmental) and technological progress, promoted by a supportive economic environment.

• The simple Solow model shows that there is an equilibrium level of capital per worker in the absence of technological progress. Recent ‘post-neoclassical endogenous growth models’ attempt to explain technological progress.


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summary• “Productivity Growth isn’t

everything, but in the long-run, it is almost everything”, Paul Krugman, 1990.


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syndicate topics• How do an increased saving rate or an increased population

growth rate affect the Solow model?• Should we expect poor or large countries to grow faster

than rich or small ones?• Assess the relative importance of investment, competition,

enterprise, innovation, and skills on productivity growth.• What factors do you think explain the above five drivers?• Why are some countries rich and others poor?• Does faster growth mean higher unemployment?


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optional spreadsheet task• The country of Davymania starts with 100 units of capital and

30 workers. The working population grows at 2% per annum and capital depreciates at 8% per annum. Output is produced according to the production function Y=√K.√L and the saving rate is 20%.

• Use a spreadsheet to show how capital, labour, and output grow over time.

• What are the equilibrium ratios of capital per worker, and output per worker in this economy?

• Plot the response of capital per worker over time to (a) a change in the saving rate, (b) a change in the population growth rate, (c) a rise in efficiency that allows output to be 10% higher for any given level of capital and labour, (d) a production function of Y=K¼.L¾.

• [Hard] What is the half-life of the gap between any given level of capital per worker and the equilibrium? What saving rate would maximise consumption per worker in equilibrium?

performance of world economies gavin cameron university of oxford oubep 2006

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