Chapter 11
Capital Formation,
Investment Choice,
Information
Technology and
Technical Progress
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Capital Formation, Investment Choice,
Information Technology &
Technical Progress
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Capital Formation & Technical
Progress as Sources of Growth.
Components of the Residual.
Learning by Doing.
Growth as a Process of Increase in
Inputs.
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Capital & Technology (Cont)
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The Cost of Technical Knowledge.
Research, Invention, Development, &
Innovation.
Computers, Electronics, & Information
Technology.
Investment Criteria.
Differences between Social & Private
Benefit-Cost Calculations.
Shadow Prices.
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Total factor productivity
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Total factor productivity (TFP) Output
per combined factor input. TFP grow.th is
a measure of technical progress.
TFP fell almost 1% yearly in the Soviet
Union, 1971-1985.
Productivity growth “is almost everything
. . . in the long run.” (Krugman)
U.S. , Canada, Japan, & Western Europe
real growth in GNP per capita > 1%
annually from mid-19th century to 2000.
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Absorptive capacity
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Absorptive capacity The ability
of an economy to profitably utilize
additional capital.
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This ability depends on the
availability of complementary
factors.
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Sources of growth DCs & LDCs
 In West & Japan, econometric studies showed that
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capital per worker-hour explained less than half of
output per worker-hour.
In LDCs, capital per worker-hour explained more
than half of output per worker-hour.
Technical progress relatively important source of
growth in DCs and capital accumulation relatively
important in LDCs.
Hicks: cannot surmise, though, that capital
accumulation is of minor importance.
Many advances in knowledge are embodied in
new capital.
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Residual or technical knowledge
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Denison & Addison: education, training,
advances in knowledge, learning by
experience, economies of scale, product
variety, improved allocation of
resources, reduction in age of capital, &
decreases in time lag in applying
knowledge.
Balogh & Streeten object to elevating
residual, converting ignorance to
knowledge.
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Figure 11-1’s message
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Reinforces earlier econometric studies
indicating capital contributed more than
productivity to LDC GDP growth.
Sub-Saharan Africa & developing Europe
and Central Asia (mostly transitional) had
negative productivity growth.
World Bank expects productivity to
contribute more than capital to growth in
East Asia & Pacific, 2005-2015.
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Learning by doing
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Technical change is a prolonged process based
on experience and problem solving, that is,
doing, using and interacting.
Learning curve measures how much labor
productivity increases with cumulative
experience.
U.S. Air Force engineers assume constant
relative decline in labor per airframe as number
produced increases (but not to infinity).
Stiglitz – markets for information imperfect,
with spillovers and public-goods character.
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Inputs and technical knowledge
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Growth as process of increase in inputs: if
human capital is an input then most of
growth explained by increases in inputs
(Schultz, Jorgenson, Griliches).
Cost of technical knowledge: cost of
search; efficiency of given technology
varies from country to country; thus T
(technology) in production function is not a
constant.
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Research, invention,
development & innovation
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Basic research.
Applied research.
Invention: Devising new methods &
products.
Innovation: Embodiment in
commercial practice of a new idea or
invention.
cont
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Research, invention,
development & innovation (cont)
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Organized R&D (only a part of
actual research & development).
Monopolist appropriates large
proportion of gains from R&D.
Advantages of “relative
backwardness” and technological
followership.
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Computers, electronics, & information
& communications technology (ICT)
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Solow in 1987: “You can see the
computer age everywhere but in the
productivity statistics.”
True for most major innovations
(steam engine, railroad, electricity,
computers) – substantial time lag
between introduction and widespread
diffusion.
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Can ICT provide LDCs with short
cut to prosperity by bypassing
phases of development? (Pohjola
2001)
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ICT & increased productivity
ICT requires three new directions to benefit
productivity. (David, 2001):
1/ availability of a growing range of purpose-built
and task-specific information technologies (e.g.
supermarket scanners and other data logging
devices).
2/ networking capabilities and networked
environment reconfiguring work organization.
3/ internet technology introduces a new class of
organization-wide data processing applications.
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Contribution of ICT to GDP percapita growth in the U.S.
(not counting increased TFP of non-ICT sectors from
ICT-facilitated work reorganization & knowledge
spillovers).
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1974-1990 0.69 percentage points yearly.
1991-1995 0.79 percentage points yearly.
1996-2000 1.86 percentage points yearly.
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Low-cost ICT improves . . .
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Allocative efficiency by minimizing
input cost per output.
Technical efficiency by cutting costs by
better access to factor and product
markets (mobile phones reduce
information costs).
Economies of larger-scale production by
breaking labor & capital constraints.
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Explosion of cellular phone technology
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India 56 million cellular phone users by
end of 2004.
Expected to reach > 130 million by 2008.
Continued growth for many years.
Telecommunications deregulation in
1990s facilitated growth.
India, China, & other LDCs can leapfrog
Western landline telephone technology.
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Sachs’ (2000) division of world
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Technological innovators (Schumpeterian
entrepreneurs, discussed in Chapter 12).
Most of OECD plus Taiwan (15% of world’s
population).
Technological adapters (Addison – LDCs’ imitation
of DCs and increased education, major contributors
to TFP).
Mexico, Costa Rica, Argentina, Chile, Tunisia,
South Africa, Israel, most of India, Singapore,
Malaysia, Indonesia, Thailand, coastal China, Baltic
states, Russia (near St. Petersberg), East-Central
Europe (50% of world’s population).
Technologically excluded (rest of world).
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With some exceptions (not all blue are innovators, much of India is
adaptive, etc.), blue-colored (high-income) nations are
technological innovators, red
& green (middle-income) nations
are adapters, & yellow (low-income) nations are excluded.
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Rapid ICT growth
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Moore’s Law: doubling of computer
capacity & halving of computer &
software prices every 2 years.
Pohjola: if auto technical progress
were at the same rate as computer
technical progress (1958-94), price of
car today would be $5!
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ICT growth in Asia
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Half OECD ICT imports from nonOECD countries, primarily in Asia, but
largely from multinational corporations
with headquarters in OECD countries.
Innovators in Asia.
Cellular technology in Bangladesh
benefits petty traders haggling with
middlemen.
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Investment criteria
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Suppose society has a given amount of
resources to invest.
Should society invest in steel,
fertilizer, schools, computers,
agricultural extension, or what?
Maximizing a project’s labor intensity
is not a sound investment criterion.
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Social benefit-cost analysis
more comprehensive
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The net present value (V) of the stream of benefits and
costs is calculated as
V = B0 – C0 + (B1 – C1)/ (1 + r)
+ (B2 – C2)/(1 + r)2 +. . . (BT – CT)/(1 + r)T
where
B is social benefits,
C is social costs,
r is the social discount rate,
t is time, and
T the life of the investment project.
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Interest on capital . . .
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Reflects discount of future income
relative to present income.
Capital invested now represents
potential for higher income in the
future.
$ in future is never worth today’s $.
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What discount rate to use?
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Current interest rate.
Or if distorted, choose a discount rate so
that present value of net income stream is
equal to the value of capital invested
(Equation 11-1).
With numerous projects, can pool risk.
Still, risk averse decision makers can
place less value on probability
distributions with substantial risk or wide
dispersion around the mean.
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Differences between social &
private benefit-cost calculations
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External economies.
Distributional weights.
Indivisibilities.
Monopoly.
Saving & reinvestment.
Factor price distortions (corrected by
using shadow prices).
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What should Dakha, Bangladesh
authorities consider when building
an underground railway?
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Can estimate capital outlays as expect
outlays to take place.
Net social benefits should > or = net
social costs.
Benefits include not only total receipts
but also externalities.
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External benefits & costs (not
included in receipts) . . .
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Price people willing to pay for alternative
transport (auto, taxi, bus, bicycle, &
rickshaw) + time, comfort, & safety
benefits – fare payments.
Environmental benefits (reduced pollution
& congestion) & costs (disruption of
neighborhoods, pollution &
inconvenience of initial construction).
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Shadow prices
 Shadow prices: The adjustment of prices
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to take account of differences between
social cost-benefit and private costbenefit calculations.
Wouldn’t it be easier for LDC
governments to change foreign exchange
rates, interest rates, wages, and other
prices to equilibrium prices than to use
scarce personnel to calculate shadow
prices in these markets?
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