Economic Development
Lecture 5: Growth Theories III
Life Impact | The University of Adelaide
University of Papua New Guinea
Lecture 5: Growth Theories III
Michael Cornish
Overview
• Endogenous Growth
– Romer Model
• Contemporary Models
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–
–
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Coordination Failure
Multiple Equilibria
The Big Push
Kremer’s O-Ring Theory
• Recap: Growth Theories
Slide 1
University of Papua New Guinea
Lecture 5: Growth Theories III
Michael Cornish
Endogenous Growth: An Introduction
• Decreasing returns to K
– An assumption in Harrod Domar Growth
Model, Lewis Theory of Development,
Neoclassical Growth Model
– Implies investment in K should occur
wherever there is the least capital
– True in long-run, but not always in
short-run!
Slide 2
University of Papua New Guinea
Lecture 5: Growth Theories III
Michael Cornish
Endogenous Growth: An Introduction
• Flaws in the Neoclassical Growth Model
– Conditional convergence in long-run
– Assuming technology is constant, any changes
to income not caused by short-term shifts in K
or L are ‘Solow Residuals’
– Why are Solow Residual so different across
countries with similar levels of technology?
– Trade and domestic market liberalisation often
led to few gains to growth
Slide 3
University of Papua New Guinea
Lecture 5: Growth Theories III
Michael Cornish
Endogenous Growth: The Theory
• Tried to explain the Solow Residuals
• Did not assume diminishing returns to K
• Reinforced central role of I, not just in physical K
but also human K
• Looked at the role of externalities on returns to K
• No conditional convergence
• Market undersupplies human capital investment
– Finally, a role for government!
Slide 4
University of Papua New Guinea
Lecture 5: Growth Theories III
Michael Cornish
Endogenous Growth
• Romer Model
– Firm-level: assumes each individual firm
produces with constant returns to scale
• Yi = AKiαLi1-αK̄ß
• K̄ = economy-wide stock of capital
(‘spillover effects’)
• ß = proportion of growth derived from K̄
– Economy level: assumes increasing returns to
scale are possible
• Y = AKα+ßL1-α
Slide 5
University of Papua New Guinea
Lecture 5: Growth Theories III
Michael Cornish
Endogenous Growth
• Romer Model
– Assume A constant, then ΔY/Y defined as:
• g – n = ßn / 1 – α – ß
• g = output growth rate
• n = population growth
– Without increases in technology or K̄ ‘spillovers’ (ß
= 0), growth is equal to zero
• This matches the Neoclassical Growth Model!
Slide 6
University of Papua New Guinea
Lecture 5: Growth Theories III
Michael Cornish
Endogenous Growth
• Criticisms
– Little empirical support
– Does not include inefficiencies from poor
human capital and infrastructure,
• But why can’t ß take a negative value?
Slide 7
University of Papua New Guinea
Lecture 5: Growth Theories III
Michael Cornish
Contemporary Growth Models
• Coordination Failure
– Stresses existence of complementarities between
necessary conditions for development
– ‘Getting everything right, at the same time’
– Communication problems, expectation mismatches
– First movement costs
– Specialisation and middlemen
– A role for government?
Slide 8
University of Papua New Guinea
Lecture 5: Growth Theories III
Michael Cornish
Multiple
Equilibria
Slide 9
University of Papua New Guinea
Lecture 5: Growth Theories III
Michael Cornish
Case Study: Latin American Time
Slide 10
University of Papua New Guinea
Lecture 5: Growth Theories III
Michael Cornish
Contemporary Growth Models
• The ‘Big Push’
– Economy-wide effort to kick-start development, to
get from low equilibrium to high equilibrium
• Industrialisation
• Inter-temporal effects
• Urbanisation
• Infrastructure
• Training
– Super-entrepreneurs
Slide 11
University of Papua New Guinea
Lecture 5: Growth Theories III
Michael Cornish
Contemporary Growth Models
• Kremer’s O-Ring Theory
– Looks at firm-level
– Assumes strong complementarities among inputs
– Productive workers accrete
Worker 1
Worker 2
Worker 3
Total quality
Firm 1
0.8
0.8
0.8
0.512
Firm 2
0.2
0.2
0.2
0.008
Worker 1 in both firms has a 0.1 increase
Difference
Firm 1
0.9
0.8
0.8
0.576
0.064
Firm 2
0.3
0.2
0.2
0.012
0.004
Firm 1 had a 16 times increase in quality compared to Firm 2
Slide 12
University of Papua New Guinea
Lecture 5: Growth Theories III
Michael Cornish
Contemporary Growth Models
• Kremer’s O-Ring Theory
– Conclusions
• When workers around you have higher skills,
there is a greater incentive to acquire more
skills yourself
• Alternatively, poverty traps can occur!
• Bottlenecks have a multiplying effect on other
production, reducing the incentive to invest in
skills because of the lower expected return
Slide 13
University of Papua New Guinea
Lecture 5: Growth Theories III
Michael Cornish
Recap: Growth Theories
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Linear stages growth: primacy of savings and investment in
facilitating capital formation and growth
Structural change model: prescribes the transfer of resources from
low productivity sectors – specifically, subsistence agriculture – to
high-productivity modern sectors – the industrialised economy
International dependence theory: political economy model with
focus on effects of international and intra-national power imbalances
on resource allocation
Neoclassical growth theory: supremacy of the market as the
engine of growth, technology is the way to beat growth constraints in
the long-run
Endogenous growth theory: prescribes a limited and prudential
role for government in policies that promote ‘spillover’ effects,
particularly centred on human capital formation, infrastructure, and
research and development
Contemporary growth models: Coordination Failure, Multiple
Equilibria, Big Push, Kremer’s O-Ring Theory
Slide 14
University of Papua New Guinea