Lecture Development policy: Economic growth

Lecture Development policy: Economic growth includes content: the neoclassical growth model, the Solow model of growth, labor productivity in the Solow model, neoclassical growth model with endogenous technology,... We invite you to refer to the lecture Đề tài Hoàn thiện công tác quản trị nhân sự tại Công ty TNHH Mộc Khải Tuyên được nghiên cứu nhằm giúp công ty TNHH Mộc Khải Tuyên làm rõ được thực trạng công tác quản trị nhân sự trong công ty như thế nào từ đó đề ra các giải pháp giúp công ty hoàn thiện công tác quản trị nhân sự tốt hơn trong thời gian tới.

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FULBRIGHT SCHOOL OF PUBLIC POLICY AND MANAGEMENT

Economic Growth

Development Policy

Summer 2023

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Adam Smith The Wealth of Nations (1776)

• The sources of economic growth are specialization and the division

of labor.

• Smith anticipated modern manufacturing:

• Skills develop when performing repeated tasks: “learning by

doing” – we now call this dynamic increasing returns

• The assembly line: no time lost switching between tasks; speed

and precision

• Mechanization of simple tasks (capital equipment)

• Specialization and the division of labor depend on the size of the

market → Smith never assumed that everything produced will

automatically find a market

Adam Smith

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Hla Myint and ‘Vent for Surplus” in Southeast Asia

• Southeast Asia traditionally exported plantation crops (rubber,

coffee, rice) bringing land into production (recall Southeast Asia’s

land-abundant past)

• Myint was an early proponent of export-led growth (opposed to

the export pessimism of Gunnar Myrdal)

• Export markets create opportunities to realize economies of scale

→ example of shrimp and catfish in MRD

• Profitability drives capital investment, which increases productivity

and profits (recall the Lewis Model).

Hla Myint

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The neoclassical growth model

▪ Neoclassical economists assume full employment and savings

always equal to investment

▪ The neoclassical growth model made other assumptions to keep

the math simple

▪ The economy consists of one sector (no movements from agriculture to

industry)

▪ Constant returns to scale and diminishing returns to capital

▪ Technology changes over time but at a constant rate.

▪ The labor force grows at the same rate as the population (all labor is

employed)

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The Solow model of growth

𝑌 = 𝑇𝐾 𝛼 𝐿 1−𝛼

▪ where Y is income (GDP), T is constant technological progress

(constant), K is capital and L is labor.

▪ α is the elasticity of output with respect to capital, and (1- α ) is the

elasticity of output with respect to labor

▪ Because α + (1- α) = 1, we know the system has constant returns to

scale and diminishing returns to capital and labor.

▪ Increasing K and L by 1% results in a 1% increase in Y

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Labor productivity in the Solow model

𝑌

▪ Y/L is labor productivity (output per person) Let’s call that q

▪ K/L is the capital-labor ratio (the amount of capital per worker)

Let’s call that k.

▪ 𝑞 = 𝑇(𝑘) 𝛼 or labor productivity is equal to technology applied to

the capital-labor ratio, growing at a constant rate but less than one

▪ The level of labor productivity (q) depends on the amount of capital

per worker (k)

▪ But there are diminishing returns to capital so the rate of growth of

q is slower when the capital-labor ratio is higher (α is less than 1).

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At higher levels of K/L, more capital does not increase labor

productivity (Y/L)

Source: Frances Stewart 2019

productivity growth quickly declines to zero

raises the level of labor

productivity, but not the growth rate of labor

productivity

0,0%

0,5%

1,0%

1,5%

2,0%

2,5%

3,0%

3,5%

0,0

0,2

0,4

0,6

0,8

1,0

1,2

K/L

T=0.6 T=0.75

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The neoclassical growth model

▪ Classical economists like Adam Smith and Hla Myint emphasized capital

investment, the division of labor and trade as the sources of economic

growth.

▪ Neoclassical growth models use some restrictive assumptions that

changed the growth policy agenda for a generation

▪ The assumption of diminishing returns to capital led many economists to conclude

that investment doesn’t matter

▪ The assumption that technology is external to investment led economists to see

technology as unrelated to economic policy

▪ The assumption of a single sector blinded economists to the importance of the

manufacturing sector in the early stages of development

▪ The assumption of full employment led to the conclusion that poor countries had

to trade-off between investment and consumption

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What does the Solow model mean?

• The main conclusion is that economic growth should be faster in poor

countries (lower K/L) and slower in rich countries (higher K/L).

• We should see convergence in incomes over time between poor and rich

countries (we will discuss this I the next class).

• The savings rate affects the level of income at the steady state (higher K/L

at the steady state), but not the rate of economic growth, which is external

to the model (technological change and the rate of population growth)

• Investment always equals savings and there is no unemployment → a

supply side model with no role for demand

• A higher investment rate can’t raise the rate of growth: growth is largely

explained by technology, which is not explained.

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Neoclassical growth model with endogenous

technology

• The conclusions of the Solow model were increasingly at odds with the real

world

• Poor countries were not converging with the rich

• Technology has a direct relationship to labor productivity and is not constant or the

same for every country

• Constant returns to scale and diminishing returns to capital were but not very realistic

• “Endogenous growth theory” drops the assumption of constant returns to scale

and diminishing returns to capital.

• The investment rate matters because diminishing returns will not set in at higher K/L

ratios

• If there are positive externalities from research and development activity, then returns

to capital will not fall (Romer).

• Or education, or trade, or infrastructure or any other reason that prevents Y/L from

falling as K/L rises

Tiêu đề	Economic Growth
Trường học	Fulbright School of Public Policy and Management
Thể loại	Development Policy
Năm xuất bản	Summer 2023

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