Economic Growth: The Data of Growth and

Development

Anjan Chakrabarti
 The framework:
(i) Observation or facts are prior.
(ii) Theory is the explanation of these facts.

Questions:
(i) How rich are the rich countries, how poor are the
poor?
(ii) How fast do rich and poor countries grow?
The Facts of
Economic Growth
Fact 1: There is enormous variation in per capita
across economies,. The poorest countries have per
capita incomes that are less than 5 percent of per
capita incomes in the richest countries.

Fact 2: Rates of economic growth vary substantially

across countries.
Fact 3: Growth rates are not generally constant over
time. From the world as a whole, growth rates were
close to zero over most of history but have increased
sharply in the twentieth century. For individual
countries, growth rates also change over time.

Fact 4: A countrys relative position in the world

distribution of per capita incomes is not immutable.
Countries can move from being poor to being rich
and vice versa.
Fact 5 Kaldors stylized facts:

1. The real rate of return to capital, r, shows no trend

upward or downward;
2. The shares of income devoted to capital rK/Y, and
labor, wL/Y, show no trend; and
3. The average growth rate of output per person has
been positive and relatively constant over time i.e.
the country exhibits stead, sustained per capita
income growth.
Fact 6 Growth in output and growth in the volume
of international trade are closely related.

Fact 7 Both skilled and unskilled workers tend to

migrate from poor to rich countries or regions.
Solow Economic Growth
 Art of Modelling
All
theory depends on assumptions
which are not quite true. That is what
makes it theory. The art of successful
theorizing is to make the inevitable
simplifying assumptions in such a
way that the final resutls are not
very sensitive.
Robert Solow A Contribution
to the Theory of Economic
Growth
 Production Function
4 variables:
Y = Output

K = Capital

L = Labor
A = Knowledge or effectiveness of labor

Y (t) = F (K(t), A (t) L (t).(1)

Where t = time

Technological progress: Given quantities of K

and L, increase in output die to increase in the

amount of knowledge.
 Features

1. Time does not enter production function

directly but only through K, L and A.
Output changes over time only if the
inputs into production change. Example,
technological progress.
2. 2. A and L enter multiplicatively, where
AL is known as effective labor and
technological progress that enters in this
fashion is known as Harrod neutral.
 Types of technological progress

1. Capital augmenting: If knowledge enters in the

form Y = F (AK, L), technological progress is
capital augmenting.

2. Hicks Neutral: If knowledge enters in the form

Y = A F (K, L), technological progress is known as
Hicks neutral.

3. Harrod neutral: If knowledge enters in the form

Y = F (K, AL), technological progress is labor
augmenting.
Why Harrod neutrality?
 Assumptions concerning the Production Function

1. Production function has CRS in K and L

I,e,
. Y = F ()..1.1
. Implicit assumptions underlying 1.1

(i) Economy is large enough so that gains

from specialization has been exhausted.
(ii) Land and natural resources neglected.
(iii) Idealized capitalist economy with full
employment
 Implication: Allows us to work with the p.f in
intensive form.

K/AL = amount of capital per unit of

effective labor
Y/AL = output per unit of effective labor
Y = F (k, 1) = f (k)intensive form

production function
Output per unit of effective labor is a

function of capital per unit of effective labor

Y = AL f (k)
2nd assumption of PF
F (0, AL) = F (K, 0) = f (0) = 0
f (0) = 0, f/(k) > 0, f// (k) < 0
Marginal product of capital is positive but

declines as capital per unit of effective labor

rises.

3rd assumption of ppf

Inada conditions
Evolution of Input into
Production

dL(t) Ln L(t) L n
dt L

dA(t)AgA(t) A g
dt A

k(t)sY (t)K (t)
n 0, g 0, 0.
 The Solow Economy
Y (t) = F (K(t), A (t) L (t)).(1)

F(K, AL)F(K,AL), 0...(2)

/
y = Y/AL = f (k)(3)

L(t) n L (t), n 0...(4)

A g A(t) , g 0...(5)

k(t)sY (t)K (t), 0...(6)
 Dynamics of the model

S = sY = K K

k(t) s f k (t ))(n g )k (t)

Fundamental equation of the Solow model

 Dynamics: Three
Possibilities

k(t)0,k(t)0,k(t)0.
 Equilibrium condition

K* at which:

k(t)0 or sf (k ) (n g )k

This k* where k(t)0 signifies the

intertemporal equilibrium capital-effective

labor ratio. It is also called the steady state.
 Balanced Growth Path

At steadystate,k(t)0every variables is
growing at the same proportional rate as all
the others.
K, AL, Y and C are growing at the rate n+g.
K/L, Y/L are growing at the rate g.
 Summary
1) Regardless of its starting point, the
economy converges to a balanced growth
path.
2)Balanced growth path implies a situation

of steady state where each variable is

growing at a constant rate.
One the balanced growth path, the growth

rate of output per worker is determined

solely by the rate of technological progress.
 Change in Savings Rate
Change in the saving rate has a level effect
but not a growth effect. It changes the
economys balanced growth path and thus
the level of Y/L at any point in time but it
does not affect the growth rate of Y/L on the
balanced growth path.
Only changes in the rate of technological

progress have any growth effects. All other

changes have only level effects.
The Impact on
Consumption

C (1 s)Y
c f (k ) s f k
dc f / (k *(s, n, g, ) (n g ) dk *(s, n, g, )
ds ds
dc 0 if f / (k ) n g
ds
 Interpretation
(i) f / (k ) n g
When k rises, there is more than enough
additional output per unit of effective labor to
maintain the higher level of capital stock and
so consumption rises.
(ii) f / (k ) n g

Additional output from the increased capital is

not enough to maintain the capital stock at
the higher level. There must be fall in
consumption in order to maintain the higher
capital stock.
 Interpretation
(iii) f / (k ) n g

When k rises, investment per unit of

effective labor must riseby (n+g+ ) times
the change in k in order for the increase to
be sustained. So consumption remains
unchanged.
Golden Rule of Capital
Stock
Marginal change in s has no effect on
consumption in the long run, and
consumption is at its maximum possible
level among balanced growth paths.
f / (k )n g
Solow model (s exogenous): No reason for

capital stock on the balanced growth path

to be equal to the golden rule level than
there is to equal any other possible value.
Feasible alternatives with higher
consumption possible.
 If s is endogenous
Savings is derived from the behavior of
households whose utility depends on
consumption in a scenario with no
externalities, then higher consumption is
possible at every level than what is
specified by the Solow model.
Long Run effect on output

Significant change in s have only a

moderate effect on the levels of output on
the balanced growth path
 Growth Accounting
1. Short run growth is dependent on technological
progress and capital accumulationGrowth
accounting is a way of determining the sources of
growth.
2. Deriving the Solow Residualtotal factor
productivity growth or multifactor productivity growth
3. Decomposing growth of output per worker into
the contribution of growth of capital per worker and
a remaining term aka Solow residual.
4. Solow claimed that 90% of the growth was the
result of technological progress and 10% due to
increase in capital per worker.
Objections to Solow
Calculation
1. Any increase in output per worker that
which is not the result of increased capital
per worker is technological progress.
2. Increases result of not only disembodied
neutral technological progress (improved
technology which allows increase in the
output produced from given inputs without
investing in new equipment) assumed
here, but also of:
(a) increasing returns to scale as output
expands
(b) redistributive effects as factor inputs
switch to more efficient industries.
embodied types of technical change
caused by improvement in the quality of
capital (improved technology which is not
exploited by investing in new equipment.
New technical changes made are embodied
in the equipment).
(d) Improvement in education of labor force
human capital.
Jorgenson and Griliches, 1967, REconStd. The
Explanation of Productivity changes
Step 1. Residual as a measure of contribution
of technological progress or as a measure of
all sources of growth other than the
contribution of capital accumulation via
private return.
Step2. Effort to break down the residual by
considering different types of capital and
labor and to adjust for changes in the quality
of inputs (Young 1994, Griliches 1988).
Step 3: Residual is only a reflection of errors
in measurement. Sum of contributions of
inputs, when correctly measured (via the
Divisia index) must necessarily account for
the growth of output. Residual a statistical
illusion.
 Convergence

Convergence Within vs. Convergence

Across

The remaining stylized facts are of a

different kind, and will concern me less
because they relate more to comparisons
between different economies than to
the course of events within any one
economy.
Robert M. Solow (1970)Growth Theory: An
Exposition.Cambridge University
 Convergence
We may also ask whether poorer countries
tend to catch up with richer ones, or whether
the relative position of each country within
the income distribution
Absolute Convergence:The hypothesis that
poor countries tend to grow faster per capita
than rich ones without conditioning on any
other characteristics of economies.
Underlying assumption: All countries have
same parameters and therefore the same
steady state positions.
 Factors
(i) Diminishing marginal productivity of
capital. This assumption means that output
grows less than proportionally with the stock
of capital. Poor countries (where capital is
scarcer) grows faster than richer countries.
Capital tend to move more to poor countries
because the rate of return is high,
(ii) Technological progress leading to
Technological diffusion: The idea: not having
to reinvent each wheel, followers will be in a
better position to grow quickly than the
technological leader, who will have to assume
the costs and lags associated with the
development of new leading-edge
technologies.
 Convergence
Conditional Convergence: If we allow for
heterogeneity across economies which would
mean economies having different parameters
and steady states then the economies grow
faster the further it is from its steady state.
Possibility: The rich country (with better
parameters) would be predicted to grow
faster per capital than the poor economy;
that is, absolute convergence would not hold.
 Central Result
The neoclassical Solow Model does predict
that each economy converges to its own
steady state and that the speed of this
convergence relates inversely to the distance
form the steady state.
 Limits of Solow Model
1. Growth of the effectiveness of labor is
exogenous. The model takes as given the
behavior of the variable that it identifies
as the driving force of growth. That is,
growth is modeled by assuming it.
2. Effectiveness of labor corresponds to
abstract knowledge. The model does not
identify what effectiveness of labor is. It
is just a catchcall; for factors other than
labor and capital that affect output. It can
correspond to education and skill of the
labor force, strength of property rights,
the quality of infrastructure, cultural
attitudes towards enterpreneurship and
work, and so on.
 Limits of Solow Model
3. Capital is more important than what Solow
perceived it to be. If capital involves more
than physical capital or if physical capital has
positive externalities then the private return
on capital is not an accurate guide to
capitals importance in production.
Calculations may be misleading and in fact
differences in capital may be central to
differences in incomes.
 Endogenous Growth
Theory
1. Open up the mystery variable of A whose
exact meaning is not specified and whose
behavior is given exogenously.
2. Two models to be considered:
A. Driving force of growth is accumulation of

knowledge: explicitly interpret effectiveness

of labor as knowledge and formally models
its evolution over time.
B. Broader view of capital: Human Capital.
 Knowledge
Continuum of knowledge:
1. Basic scientific knowledge
2. Invention of applied technologies useful

in broad classes of goods

Invention of new products
Improvements in the design and use of

products after their invention

Determinants of these different types of

knowledge different: no one theory of

knowledge.
 Common Factors
Shared feature of all types of Knowledge:
Non-rival
A good is non-rival if its use by one allows

its use by others. This property of

knowledge means that production and
allocation of knowledge cannot be governed
by competitive market economy.
Marginal production cost is zero. For
Knowledge production, either, p > MC or
somebody else produces this knowledge.
 Common Factor
Non-Excludability: a good or service is non-
excludable if non-paying consumers
cannot be prevented from accessing it.
Is Knowledge non-excludable? It depends.
1. Nature of Knowledge. Ex: Coca Cola
2. Economic institutions governing property
rights. Ex: Copy right laws
How production and allocation of Knowledge
will depart from perfect competition will
depend on the degree of excludability. Patent
and License.
.
Research and Development
Model
Framework and Assumptions
Effectiveness of labor represents knowledge
or technology. It is plausible that
technological progress is the reason that
more output is produced today from a given
quantity of capital and labor than could be
produced a century or two ago. So,
Model the growth of A rather
than take as given
Framework and Assumptions

I. Introduce R&D and then model the

production of new technologies.

II. Also model the allocation of resources

between conventional goods production and
R&D.
 Formal Modeling

Production function is a combination of labor,

capital and technology to improve technology
in a deterministic wary.
Note: Everything else the same, devoting
more resources to research yields more
discoveries.
Two Simplifications:
(i) Production functions are assumed to be
generalized Cobb-Douglas function.
(ii) Fraction of output saved, fraction of labor
force and the capital stock used in R&D
sector are assumed as exogenous and
constant.
 Specifics

Four variables: L, K, A, Y.
Model set in continuous time.
Two Sectors:
1) Goods producing sector where output is
produced.
2) R&D sector where stock of knowledge is
made.

 Central Questions of Growth Theory
Two central questions:
(i) The growth over time in standard of
living.
(ii) The disparities across the different parts
of the world.
R&D Model is good at answering the first
questiongrowth of knowledge is indeed
a central reason for expansion of output
and standard of living.
Testing of Worldwide Economic
Growth
Michael Kremer: Takes off from the
explanation of the endogenous growth
theories that technological models of
economic growth is an increasing function
of population size.
Extending back to 1 billion BC he shows that

technological progress has led mainly to

increase in the rate of population growth
rather then increase in output per person.
With high population level, there will still be
higher population growth rate.
 Why Human Capital
R&D/knowledge model is not good at
answering the second for two reasons:
technological diffusion from rich to poor
countries takes a very long time and even if
it does (given that the product is non-rival),
marginal product of labor is low and wage
low.
Problem: Not lack of access to advanced
technologies but lack of ability to use that
technology. Differences in incomes is then
dues to the differences in these factors
human capital.
 Human Capital
Human capital: knowledge, skills, and
abilities of the particular workers
Distinction between human capital and

abstract knowledge:
human capital is rival and excludable.
Proposition: Moderate changes in the
resources devoted to physical and human
capital accumulation may lead to large
changes in output per workers. Accounts for
large differences in income.
Two Effects of Human
Capital
1. Including acquired skills and abilities must
raise the estimate of the share of income
that is paid to capital of all kinds. We have
seen it has a positive impact.
2. Devoting more resources to accumulation
of human capital (alongside physical
capital) increases the amount of output
that can be produced in the future.