Catching up and falling behind?
Explanations for Post-war comparative
performance
1
INTRODUCTION
This lecture will consider four approaches to growth over time, and how growth varies
between countries. It will provide a theoretical but non-technical summary of these
arguments and examine how economists and economic historians have used these
explanations.
1.
Neo-classical growth theory.
2.
The Post-1973 Slowdown in TFP Growth.
3.
New Growth Theory.
4.
Convergence and catch-up.
5.
Institutional Sclerosis.
6.
Conclusion.
2
NEO-CLASSICAL GROWTH THEORY
1.
At the heart of the neo-classical approach to the understanding of growth rate
differences between countries is the concept of the aggregate production
function.
This is a technological relationship which expresses the level of output as a
function of the level of inputs, such as labour, capital, and land, together with
other factors such as the state of technology, the degree of managerial and labour
efficiency, etc.
In practice, the arguments of the production function are normally confined to
just three factors, namely labour, capital and technology. The basis of the
production function is the individual production process at the plant level, and it
is assume that these micro-production functions can be aggregated to produce a
well-defined relationship at the aggregate level, i.e. for the whole economy, for
manufacturing or for individual industries.
2.
In the neo-classical model, the level of output is assumed to increase over time
because of technical progress, even if the volume of factor inputs remains
constant. Technical progress, or total factor productivity, is a residual.
Total factor productivity (TFP) is crucial to the neo-classical model. TFP is the
growth of output less the growth of labour and capital, each weighted by its
factor share. The advantage of using TFP over labour productivity as a measure
of the rate of technical progress is that it explicitly makes an allowance for the
growth of the capital stock. Using the growth of labour productivity as a
measure of the rate of change in economic efficiency is that it is clearly only a
partial index. For example, a rapid growth of labour productivity could be
primarily due to a rapid increase in the amount of machinery with which each
employee has to work. The growth of total factor productivity makes an explicit
allowance for this.
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3.
The two original articles on neo-classical growth economics are Solow’s (1957)
article entitled ‘Technical Change and the Aggregate Production Function’ and
Abramovitz’s (1956) article entitled ‘Resource and Output Trends in the United
States since 1870’. Making the usual neo-classical assumptions, Solow found that
output per hour doubled in the US between 1909 and 1949, and of this over 80
per cent could be attributable to ‘technical change in the broadest sense’ while
less than 20 per cent could be attributed to the growth in the capital-labour ratio.
The seminal full-blown growth accounting study is Denison’s (1967) Why Growth
Rates Differ, which was a detailed study of the sources of growth of eight
European countries and the United States over the period 1950-62. Denison has
since used this approach to examine the productivity slowdown since the early
1970s (1974, 1979, 1984, 1985). The technique has also been used to examine the
sources of growth for the UK in a historical context by Matthews, Feinstein and
Odling-Smee (1982).
All of these studies, then, are attempting to reduce the residual (which, after all,
is nothing more than a measure of our ignorance). Some neo-classical purists
have sought only to augment the estimates of the growth of the inputs and to
thereby reduce the growth of total factor productivity – see Jorgenson and
Griliches (1967) and Jorgenson, Gallop and Fraumeni (1987). Others, especially
Denison, have adopted a far more pragmatic approach by also allowing for
increasing returns, for disequilibrium factors such as the intersectoral movement
of labour.
4.
Table 15a reports a summary of Denison’s (1967) estimates of the sources of
growth for eleven countries during the Golden Age, although for eight countries
the terminal date is 1962. These figures are supplemented with the results of a
study by Kendrick (1981) in Table 15b. Kendrick uses Gross Business Product
because of the difficulties associated with the measurement of output in the
service sector.
We can note that the growth of TFP explains by far the largest part of the growth
of output. On the basis of Denison’s results, the growth of TFP (R 1) on average
accounts for 58 per cent of the growth of output. This ranges from 74 per cent
4
(France) to 40 per cent (Canada). A similar picture emerges from Kendrick’s
results.
5.
A major innovation of Denison (1962) was to adjust the labour force for quality
changes and this has now become standard practice in the growth accounting
literature. It has long been recognised (at least by economic historians) that
education is not merely a consumption good, but also represents an investment
in human capital. General schooling, while not necessarily imparting vocational
skills, has the advantage of making the labour force more flexible in that it can
obtain greater benefit from any subsequent apprenticeships and on the job
training, as well as being more responsive to new ideas and techniques of
production. Education thus tends to raise the efficiency of labour by improving
its quality.
The post-war period saw a rapid expansion in the amount of schooling received
by the average worker. The amount of years spent by the representative person
in the education system rose steadily, both through choice as per capita income
rose and because of legislation which raised the minimum school-leaving age in
a number of countries.
Denison constructed an index of the labour input which takes into account the
increasing quality. The estimates of improvement in the quality of the labour
force are relatively small when compared with the size of TFP growth in most
countries. In the case of the US, Denison estimated that it contributed 0.49
percentage points to the growth of output over 1950-62. The growth of
education as not so fast in the other advanced countries over this period. For
Northwest Europe, the contribution was 0.23 percentage points – which
accounted for 5 per cent of the growth of national income.
6.
One of the least understood aspects of the growth process is what determines the
pace of technical change. In his 1967 study, Denison circumvented the
conceptual problem of how to measure the contribution of technical progress.
He simply assumed that the contribution of ‘advances in knowledge’ was the
value of the residual of the most advanced country which was the United States,
and this contribution to output growth (some 0.8 percentage points per annum)
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was imputed to all the other countries. The residual defined as ‘the unexplained
growth of output’ was therefore zero for the US.
procedure.
Hardly a satisfactory
A moment’s reflection should be enough to remind us that some of the most
spectacular technological advances – such as those generated by the NASA space
programme or the Concorde project – were not accomplished without a
considerable research cost. Considerable expenditure is devoted to investment
in research and development (R&D), whether it is on the salaries of designers
and scientists, on their equipment or on the finance of the various prototypes. It
is possible to extend the concept of the production function with these
expenditures being considered as ‘inputs’ and the value of improvements or new
products due to this knowledge as ‘output’. By its very nature, production of
new knowledge, per se, is a very risky and uncertain business and much
expenditure has to be written off with very little to show for it.
Denison was very sceptical about the importance of R&D in his 1967 study. He
says:
The purpose of most – probably the bulk – of R&D expenditures, moreover, is
such that it does not affect the growth rate no matter how successful it may be
. . . [T]here is no way of knowing whether those fruits of organised research
that do affect the measured growth rate contribute 0.1, 0.7, or any
intermediate amount to the total contribution of advanced of knowledge.
The fact that expenditures for research and development have expanded so
much in the United States while estimates of the contribution of advances of
knowledge have not, may suggest that organised R&D is not very important
to growth. But even this remark must be qualified by noting that we do not
know how large has been the increase in R&D expenditures of the types that
are relevant to measured growth.
6
THE POST-1973 SLOWDOWN IN TFP GROWTH
1.
Last week we saw that 1973 marks something of a watershed, with the advanced
countries (unweighted) average growth per annum of both GDP and
manufacturing falling to about one-half of the 1950-73 value.
This has been the most serious macroeconomic disturbance since the Second
World War. As Fischer points out, a 4 per cent growth rate per annum of per
capita income means that it doubles every 18 years, but if the rate falls to 2 per
cent per annum, it takes 35 years to double.
2.
The slower growth in output cannot be explained in terms of a fall in the growth
of the labour input because there was a commensurate fall in the growth of
labour productivity. Moreover, as can be seen from Table 16, TFP growth also
fell pari passu, suggesting that the cause could not be attributed to a slowdown of
the growth of the combined factor inputs.
3.
If we divide the post-1973 period into two sub-periods, 1973-79 and 1979-92
(1979 being the year of the second large increase in oil prices and a peak year in
terms of economic activity), 1973-79 showed a widespread decline in TFP
growth. In the period 1979-92, the picture is rather more complex with
manufacturing industries showing a slight recovery in some countries, but not in
others, and service industries experiencing a further fall in growth rates in most
economies.
4.
Ironically, the original impetus for the growth accounting approach in the 1960s
was the attempt to explain why the residual was so large, but since then the
focus has shifted to trying to account for why it has been so relatively small since
1973. There are two points worth emphasising:
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a.
The slowdown affected all the advanced countries, to a greater or lesser
extent, simultaneously, from the years 1973/4 onwards (although there is
some evidence that the US experienced the slowdown somewhat earlier in
the mid-1960s). The obvious implication is that there is likely to be some
common factor at work. Nevertheless, much of the detailed and
painstaking work in trying to account for the slowdown has been by
American economists concerned with the US economy and, while the
international aspect may not have been completely overlooked, it has not
always been given the prominence it deserves. For example, Denison
(1979), after examining a large number of hypotheses, came to the
conclusion that there may have been no one single cause: everything just
happened to go wrong at once:
Several developments may have combined to slow the advanced in
knowledge itself, and others to retard the incorporation of new
knowledge into production. Similarly inflation, stagnation, soaring
energy prices, high taxes and changing attitudes may have conspired
to exert a large adverse impact on the miscellaneous determinants of
output that forced the residual series into an actual decline.
b.
The slowdown hit all the industries of the various economies to some
degree, regardless of whether they were manufacturing or services. This
again poses the same question as to why this was the case. One could
perhaps make a case that the potential for technical change had become
exhausted in, for example, one industry, as the number of inventions
dried up. Maddison (1984, p. 70) terms this argument Wolf’s Law after
Wolf and it is the thesis that ‘technical progress will ultimately be retarded
because we will have exploited the easier innovations, there will be less to
discover, and the unknown will be harder to penetrate’. A moment’s
reflection, though, suggests that this is not as plausible as it may at first
seem as an explanation of the slowdown as a whole. What, a few years
ago, may have seemed almost impossible to solve, now, with the advance
of knowledge, may become almost child’s play.
8
NEW GROWTH ECONOMICS
1.
In the 1980s, a series of growth models was devised that sought to challenge the
existing neo-classical theory of growth.
2.
The existing theoretical literature on growth had increasingly become entangled
with disputes in capital theory over the legitimacy of aggregating inputs into
‘factors’ of production, or of aggregating production functions themselves.
The theory had also become more complex with the development of multisectoral models or models with capital goods disaggregated either by sector or
by ‘vintages’.
Nor could the limited data available discriminate among the many variations on
the standard model.
3.
Two developments were important in explaining the recent revival in growth
theory:
a.
The ‘re-discovery’ of a well-known fact – convergence of per capita
incomes across countries was either limited or absent in the world
economy. We will illustrate this in the next section. If exogenous
technical progress was commonplace, shouldn’t standards of living tend
to convergence, especially given the increasing mobility of capital
internationally? It is only recently that growth theorists have become
aware of this absence of convergence, even though development
economists and economic historians had long been aware of it.
b.
Dissatisfaction with existing models arising from a form of ‘intellectual
imperialism’ (Boltho and Holtham).
If something called technical
progress accounted for the steady-state growth rate and for the bulk of
observed growth according to the growth accountants, was it not
regrettable that economists had nothing to say about what determined the
rate of technical progress? Economic tolls were being used to explain
9
many decisions previously thought to be non-economic: economics of
crime and punishment, marriage and parenthood. It is Schumpeter’s
dictum that economic causes should be sought for economic phenomena
that is the motto of the endogenous growth theorists.
4.
The rationale of these new growth models, developed initially by Romer and
Lucas, attempted to dispense with the assumed exogenous technical progress of
the old growth models and to explain steady stage growth endogenously, i.e.
within the model. Broadly speaking, new growth economics identifies four
different views which emphasise various aspects of the growth process: learning
by doing; human capital; research and development (R&D) and public
infrastructure. It also stresses the potential for international spillovers in some of
these areas.
5.
A crucial feature of the old growth models was that capital accumulation is
subject to diminishing returns such that in the long-run, the rate of growth is
independent of the rate of investment and thus of policies which influence
investment. The new growth models abandon this assumption: Scott actually
argues that the law of diminishing returns does not apply to capital, even in the
long run. If investment and technical change are inextricably interwoven, then
capital accumulation will result in a qualitative change in the economic
environment.
6.
Lucas’s seminal (19988) article puts human capital centre stage. Human capital
not only adds to the labour supply, as in Maddison’s growth accounting, but
there is also an externality which augments TFP growth. The new growth theory
also assumes that the initial human capital stock with which an individual starts
is proportional to the existing human capital stock. In other words, it is not
necessary to keep re-inventing the wheel. Knowledge does not totally disappear
with the death of a worker.
7.
A lot of the writing on new growth theory has remained largely theoretical.
10
However, Crafts and Toniolo’s chapter in Economic Growth in Europe Since 1945
does set an agenda for future research.
CONVERGENCE AND CATCH-UP
1.
There are many examples of unusually fast growth by follower countries in
catching-up the leaders.
This view anticipates ultimate convergence of
productivity levels, at least among OECD economies, and predicts that growth of
TFP and ultimately overall growth will increase with the productivity gap
between a country and the leading country of the time.
In this view, the recent slowdown in Europe reflects the closing of the
productivity gap between Europe and the US. Abramovitz is one of the key
writers on catch-up factors and he argues that catch-up is not automatic nor is its
potential always fully realised. He argues that catch-up depends on what he
terms ‘social capability’. Differences in social capability are sustained by market
failures: inadequate education, capital markets and political economy
considerations.
The catch-up thesis is popular among contemporary American scholars, in their
attempts to explain why US income levels are being steadily approached by
those of other relatively wealthy countries, and why the growth rates of the USA
have not been as fast as those of most of its rivals.
2.
Figure 1a plots the data by region on a linear scale and suggests no obvious
‘convergence’ within Europe: the tracks of real GDP per head are approximately
parallel. West Europe overhauls North Europe, and South Europe overhauls
East Europe in the mid-1960s.
When the same data are charted on a logarithmic scale (Figure 1b), there is a
slightly stronger indication of convergence. In this form, the data can be
regarded as indicating rates of income growth (a straight line on this scale
represents a constant rate of growth – the steeper such a line, the faster the
11
growth rate).
Thus the gaps between richer and poorer regions of Europe
remained roughly the same in absolute dimensions, although the poorer regions
grew at slightly faster rates. As von Tunzelmann has suggested, rather than
convergence, it might be better to adopt Abramovitz’s 1986 title, ‘Catching up,
forging ahead and falling behind’ – as a way of describing the variations across
the countries of post-war Europe.
12
INSTITUTIONAL SCLEROSIS
1.
In 1982, Mancur Olson published The Rise and Decline of Nations, which, as its title
suggests, is an attempt to provide a broad explanation as to why long-run
economic growth may differ substantially between countries. In the book, Olson
expressed dissatisfaction with the orthodox growth accounting approach because
it does not address the fundamental causes of differences in growth rates.
2.
Consequently, he has presented a sweeping theory of why growth rates differ,
drawing heavily on public choice theory and the neo-classical theory of politics.
The focus of interest is on how and why ‘special interest groups’ develop, and
how they can be an influential contribution to the explanation of disparities in
economic growth.
3.
Olson’s argument can be used to explain why the residual found in the growth
accounting studies differs between the advanced countries, although he does not
put it in these terms. Implicit in his theory is the proposition that it is those
countries with the lowest rates of growth of TFP which suffer the most from the
pernicious effects of special interest groups.
4.
The central tenet of Olson’s argument is, thus, that differences between countries
in their rate of economic growth can largely be explained by the extent to which
‘special’ or ‘common interest’ groups have organised in each country. These
special interest group include trade unions, employers’ organisation, cartels,
professional organisation and lobby groups. Olson’s thesis is that ‘on balance,
special-interest organisations and collusions reduce efficiency and aggregate
income in the societies in which they operate’. Any political decision that
benefits a few individuals or firms while spreading the costs over the whole (or a
substantial proportion) of the population is likely to be adopted, even though the
net effect may be to actually reduce GDP. Hence the greater the extent to which
these pressure groups, which acquire economic rents through lobbying etc., have
developed in a country, the lower will be the overall pace of economic growth.
13
5.
Olson’s theory is essentially one about the determinants of disparities in longrun economic growth as, in the absence of dramatic shocks, the density of
coalitions will increase only slowly over time. Without plodding through all the
studies which have analysed his thesis, Olson’s work is much less satisfactory as
an explanation of the sudden post-1973 slowdown.
14
CONCLUSIONS
1.
Policy implications of growth models:
a.
If specific growth factors can be shown to improve productivity and given
the implication in all these models of a divergence between private and
social costs, a case can be made for subsidies, or other policy interventions
to raise investment, or R&D or human capital (or, perhaps, together).
b.
However, some authors of these models are reluctant to draw strong
policy conclusions: one reason is that any government action carries
dangers of its own:
2.
–
Government borrowing or taxation may be required to finance new
policies and governments may face a trade-off between the
beneficial effects of subsidies and the injurious effects of higher
taxes. The new models at least allow such controversial issues in
public finance theory to be set in a growth context.
–
There are also public choice problems: can the authorities be
expected to make the correct choices and is this compatible with the
interests of bureaucrats and politicians? Would not discretionary
action lead to ‘rent-seeking’ behaviour? Even Scott is wary of the
danger that pressure groups will hijack in their favour any policy
that might help investment.
Finally, the literature is largely at the stage of illustration – showing how various
factors could have an influence on growth – rather than demonstration –
showing how some factors do have such an influence. Nor does the literature
touch upon the institutional and legal framework which, according to Crafts, is
very important in explaining cross-country differences in growth rates.