2a: Economic growth: theory
and data
0
Growth: big questions, theoretical tools
 What does economic growth involve?
 Factor accumulation & productivity growth
 Changing structure of production, consumption & trade
 What makes economies richer? What sustains their growth?
 Growth theory
 What determines the mix of goods produced, consumed and
traded?
 Trade theory models for small open economies
1
Southeast Asian experience (1)
 East Asia and Pacific region: generally high and consistent
growth since 1980s
 Especially if we ignore the failures! (Gill & Kharas Table 1.2)
 Progress of leading economies from low to middle income status
 Poverty alleviation record is strong (G&K Table 1.7)
 Inequality rising, but what does this signify?
 From high or low base?
 Changing structure of production, and urbanization
 Relative scarcity of some productive factors – esp. human capital
and entrepreneurial abilities
 Political economy, and development policy settings
2
3
4
5
The “mechanics” of growth
 Why do countries grow at different rates?
 Why do rates of growth change over time?
 Is there anything that policy makers can do to influence the
rate of growth?
Aggregate production functions: “parables” or “toys” for
understanding aggregate economic growth
6
The aggregate production function
Y = F(K,L)
Qty of output
(Y)
A: Linear production function
B: Diminishing returns production
function
YB
YA
0
L0
Qty of Variable Input (L)
7
A basic growth model
Relate agg. production (Y, measured in $) to capital stock (K), labor force
(L), pop. growth (n), savings (S), savings rate (s = S/Y), consumption (C),
investment (I), and capital depreciation rate (d)
Two-factor production function:
(Disposition of income)
Savings out of income:
Savings = investment:
Change (Δ) in K stock:
Change in labor force:
Y = F(K, L)
(Y = C + S)
S = s*Y
S=I
ΔK = I – d*K
ΔL = n*L
(1)
(2)
(3)
(4)
(5)
Eq. (1)-(6) can be solved for Y, K, L, I, S, C in terms of s, d and n.
Combining (3)-(5) gives:
ΔK = s*Y – d*K
(6)
Using (5) and (6), aggregate output growth depends on net investment &
growth of labor force.
8
The Solow growth model
• Expressed in intensive form (output per worker, y = Y/L, and capital per
worker, k = K/L)
• Diminishing returns to k
y
y = ƒ(k)
k
• From (6), growth of capital stock per worker :
Δk = sy – (n + d)k
i.e. Δk rises with savings/worker, declines with pop growth & physical deprctn.
9
y
(n+d)k = depreciation
y = ƒ(k) = output/worker
yH
y0
yL
sy = savings/worker
kL
k0
kH
k
Δk = sy – (n + d)k, so Δk is vertical diffnce sy curve and (n+d)k.
• At kL, Δk > 0 and “capital deepening”. Compare kH.
• At k0, Δk = 0 with “steady-state” output per worker y0.
• “Steady state” implies constant per capita income
• Convergence: poorer countries (lower k) will grow faster.
10
Higher savings rate increases per capita income
y
(n+d)k
y = ƒ(k)
y1
y0
(s+a)y
sy
k0
k1
k
• Experiment: Increase savings per worker from sy to (s+a)y :
At k0, Δk now > 0. New steady state income is y1.
Lower population growth raises per capita income
y
(n+d)k
y = ƒ(k)
((n–b)+d)k
y1
y0
sy
k0
k1
k
• How do we represent a reduction in population growth rate?
What happens to capital accumulation and steady-state
income per worker?
More on Solow growth model
 Solow: Empirically, technical progress accounts for most
economic growth
 Think about investments in human capital (education,
training) as a form of technical progress that increases the
effective labor endowment.
 What about natural resources?
 Link between Δk and the return on capital
Higher Δk implies higher return on new investment (capital
scarcity implies high returns)
 Then capital should flow to poorest countries!

Can Solow model explain comparative growth experiences?
13
Convergence
• Standard Solow model: all countries share same technology,
savings rates, etc
• Diminishing returns implies lower growth rate of capital per
worker at higher levels of k
• Implication: absolute convergence
 Poorer economies will grow more quickly than richer
 Over time, per capita income levels among similar economies will
become equal, regardless of initial differences.
 Formally:
 GDP growth = a*(Base GDP) + b*(K/L growth); a < 0, b > 0
14
Southeast Asian experience (2)
 Sources of economic growth in SE Asia
 What factors have contributed most to growth?





Labor force growth (“demographic dividend”)
Capital investment (domestic and foreign)
Improvements in effective labor through education, nutrition, etc
Efficiency gains – from trade and specialization; domestic market
activation, etc….
Productivity spillovers and externalities; increasing returns
 World Bank: East Asian Miracle (1993), decomposes
contribution of some of these to total GDP growth
15
Contributions to growth
Variable
(per cent/year)
Indonesia
Malaysia
Singapore
Thailand
1.1
1.64
1.69
0.87
Population growth
0.22
0.26
0.18
0.26
Primary enrollments
1.77
2.53
2.93
2.19
Secondary enrollments
0.16
0.5
0.84
0.31
Initial income
-1.02
-1.47
-1.74
-1.12
Estimated growth rate
2.23
3.46
3.9
2.51
Actual growth rate
3.72
4
6.03
3.82
60
87
65
66
Investment
Percentage explained
Source: East Asian Miracle, 1993
What accounts for the unexplained 13-40%?
16
Is this convergence?
17
Divergent paths in 3 countries
1954-58a
1978
1985
2005
Philippines
380 Rps
510
600
3170
Burma
300
150
186
1020
Thailand
400
490
752
6420
Ratio, Th/Ph
1.05
0.96
1.25
2.02
Ratio, Th/Bu
1.33
3.27
4.04
6.29
Sources: (1950s: Myrdal, Asian Drama; other years: World Bank.
Units: 1950s: Indian Rupees; 1978-85: current $US; 2005: PPP$
18
What accounts for divergence within SE Asia?
19
Abstraction vs complexity in economic analysis
 Obviously the world does not work exactly as described in
Solow’s “parable”
 Does this invalidate the use of models?
 Economic models abstract from the complexities of real world
situations in order to understand underlying mechanisms that
are thought (or asserted) to be general
 What use is a road map drawn on a 1:1 scale?
 Models yield testable implications and their use helps us to
define research agendas
 Solow model identifies the central mechanism of growth:
accumulation of capital per worker
20