Macroeconomics
• ECON2043
• Lecture 4
• Sangmin Aum
• aumsang@khu.ac.kr
Accounting for Growth
Growth Accounting
1/3 2/3
𝐿𝑡
• Consider 𝑌𝑡 = 𝐴𝑡 𝐾𝑡
• Applying the rules for growth rates,
1
2
𝑔𝑌𝑡 = 𝑔𝐴𝑡 + 𝑔𝐾𝑡 + 𝑔𝐿𝑡
3
3
• What is the economic interpretation of this equation?
Growth Accounting
• One can apply the same logic to a production function with
more inputs.
• If we do this in “per person” terms,
1
3
• 𝑔𝑦𝑡 = 𝑔𝐴𝑡 + 𝑔𝑘𝑡
• Here, 𝑔𝐴𝑡 is computed as the “residual” in growth accounting.
Growth Accounting for the US
Growth Accounting for the US
• Most of growth comes from growth in TFP
• Completely unmodeled in Solow (1956), which is a finding of Solow
(1957)
• A growth slowdown began in 1973 → The new economy of
the late 1990s → A growth slowdown since 2003 again
The Asian Miracle?
TFP growth in USSR and China
Japan and China
Dynamics of Catch-up Growth
Why are some countries 50
times richer than others?
Why are some countries 50 times
richer than others?
• How does the production approach and the Solow model
answer this question?
• What are the strengths and weaknesses of this answer?
Why do some countries have such
low levels of capital and TFP?
• Omitted inputs
• Institution/Property rights
• Misallocation
North vs South
Institution, Property rights, and Rule
of Law
• Natural Experiments
• North vs South Korea, East vs West Germany, China vs Hong Kong
• Which institutions?
• Acemoglu and Robinson (2012): Why Nations Fail
• “Reversal of Fortune”
Misallocation and TFP
• Why do differences in institution show up in TFP?
• Suppose two firms making textiles
(1) not very productive, but owned by the Prime Minister’s sister
(2) A small, dynamic startup, much more productive
• Good connections and bad property rights ⇒ less productive firm is
favored by loans, subsidies, etc.
• TFP = How efficiently resources are used
• All inputs allocated to low productivity firm ⇒ low TFP
• Inputs allocated efficiently (e.g. competition) ⇒ high TFP
TFP in advanced economies
FT Global 500 Startups
Misallocation in the US
(Hsieh, Hurst, Jones, and Klenow, 2019)
• Sandra Day O’Connor, Supreme Court Justice (1981-2006)
• Graduated 3rd in her class at Stanford Law School, 1952
• Only job offer in the private sector: legal secretary
• White men in US businesses:
• In 1960, 94% of doctors, lawyers, and managers
• In 2010, 60% of doctors, lawyers, and managers
• Over the past 50 years, the improvement in the US allocation
of talent accounts for 40% of growth in per capita earnings
Economics of Ideas
Objects vs Ideas
• Objects
• Most goods: iPads, houses, oil, computers, etc.
• The economics of objects underlies Adam Smith’s invisible hand
theorem (Perfectly competitive markets lead to the best outcome).
• Ideas
• Instructions or recipes, designs for making/using objects
• Design of iPad, architectural plan for a house, method for turning oil
into plastic, oral rehydration therapy, etc.
• The amount of raw material available is finite, but the number of
ways arranging these is virtually infinite.
Idea Diagram
Ideas
Nonrivalry
Increasing
returns
Problems
with pure
competition
Nonrivalry
• Objects are rival.
• You use a container ship to deliver Lenovo laptops means I cannot
use that same container ship to deliver microwave ovens.
• Gives rise to scarcity, a central focus of economics
• Ideas are nonrival = infinitely usable
• One architecture’s use of the Pythagorean Theorem in designing a
building does not reduce the amount of the theorem available to
anyone else
• The PCR technique can be used by 1 lab, 10 labs, or 1000 labs
simultaneously
Excludability
• The extent to which someone has property rights over a
good and can legally restrict its use.
• Nonrivalry says ideas can be used by many people
simultaneously. But society may provide property rights that
lead to legal restrictions on this, patent.
• Nonrivalry is intrinsic characteristic from nature, whereas
excludability is a feature of the institutions chosen by society.
Increasing Returns
• Suppose Asthma Inc. invents a new drug for treating asthma
• Coming up with the successful, new chemical formula is the hard part
— rough estimates = $2.5 billion to develop a new drug
• Once developed, just an object, subject to standard CRS production
• Example: $2.5 billion R&D, then $10 per dose in manufacturing costs
• Constant returns after invention ⇒ increasing returns including
invention
• $2.5 billion dollars → 1 dose
• $5 billion dollars → about 250 million doses!
• Doubling inputs far more than doubles output!
Increasing Returns
Production Function
• Now let 𝐴𝑡 denote the stock of knowledge
1/3 2/3
𝐿𝑡
𝑌𝑡 = 𝐹 𝐴𝑡 , 𝐾𝑡 , 𝐿𝑡 = 𝐴𝑡 𝐾𝑡
• Constant returns holding knowledge fixed but therefore
increasing returns in 𝐾, 𝐿, and 𝐴 together.
𝐹 2𝐾, 2𝐿, 2𝐴 > 𝐹 2𝐾, 2𝐿, 𝐴 = 2𝐹(𝐾, 𝐿, 𝐴)
• Replication + Nonrivalry → CRS to objects.
• Therefore, there must be IRS to objects and ideas.
Problems with Pure Competition
• Adam Smith’s fundamental invisible hand result:
• Under perfect competition, markets lead to the best of all possible
outcomes.
• Marginal benefits = marginal costs via the price system
• Prices allocate scarce resources to their best uses
• With increasing returns,
• What if Asthma Inc. charges marginal cost?
• Negative profit → No research
• What if Asthma Inc. charges $1000 per dose?
• Many people who would purchase the drug at marginal cost ($10) will not purchase
→ deadweight loss
How to address problems?
• What do firms do?
• Trade secrets to keep monopoly and sell at markup
• Price discrimination by country or by income of customer (to reduce
dead weight loss)
• What do governments do?
• Patents grant monopoly profits for a time to allow firm to recoup
initial investment. How long?
• R&D subsidies and public-private joint ventures. How to know which
to subsidize?