Transcript Lecture14 - Stanford University

Economics 216:
The Macroeconomics of Development
Lawrence J. Lau, Ph. D., D. Soc. Sc. (hon.)
Kwoh-Ting Li Professor of Economic Development
Department of Economics
Stanford University
Stanford, CA 94305-6072, U.S.A.
Spring 2000-2001
Email: [email protected]; WebPages: http://www.stanford.edu/~ljlau
Lecture 14
Endogenous Economic Growth
Lawrence J. Lau, Ph. D., D. Soc. Sc. (hon.)
Kwoh-Ting Li Professor of Economic Development
Department of Economics
Stanford University
Stanford, CA 94305-6072, U.S.A.
Spring 2000-2001
Email: [email protected]; WebPages: http://www.stanford.edu/~ljlau
Endogenous Technical Progress
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Technical progress occurs through the expansion of the set of
production possibilities (technical progress) so that a greater level of
output can be produced with the same inputs
The expansion of the production possibilities set is endogenous
rather than exogenous; it is the result of purposive activity (Romer,
Grossman and Helpman)
The expansion can be attributed to investment in knowledge capital
(or more generally to intangible capital)
Investment is motivated by the possibility of monopoly rents
The induced innovation hypothesis--investment in innovation (e.g.,
R&D) occurs in the direction that potentially lowers the cost of
production the most, given the prevailing and expected relative
factor prices
The learning-by-doingLawrence
hypothesis
(Arrow)
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Increasing Returns and Knowledge Capital
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There are increasing returns in the production of knowledge capital
at the firm level
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Fixed cost of entry
Winner-take-all
There are positive externalities in the production of knowledge
capital at the aggregate, macroeconomic level
 Non-appropriability and spillover effects
Once knowledge capital has been created, there is potentially a range
of increasing returns in its utilization in production because the
marginal cost of additional use is zero (Non-rival nature of
knowledge capital, subject to excludability--legal (patents, trade
secrets, knowhow), financial, and technological (including quality of
manpower))
However, knowledge capital can depreciate, and can become
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obsolete, due to changes
in factor prices, the legal environment and
The Creation of Knowledge Capital
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Large fixed investment and thus increasing returns at least over a
range
Uncertain outcome
Winner-take-all and thus market increasing returns to scale
Loser-loses-all
Potential non-appropriability (non-excludability)
Investment can be built upon social knowledge capital (that may be
distinct from and in general less than privately usable knowledge
capital)
Whether there are increasing returns in the creation of knowledge
capital at the aggregate level depends on the extent of the spillover
effects compared to the extent of competitive duplication of
investment--Is the aggregate probability of innovation enhanced? (It
depends on the degreeLawrence
of independence
of the directions of R&D 5
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efforts)
Increasing Returns to Knowledge Capital
 Let
K and K* be the quantities of physical and knowledge
capital respectively, and L be the quantity of labor, then the
production function Y = F(K*, K, L) exhibits constant
returns to scale in K and L by the replication argument
 If K* were non-rival, then the same K* can be used at
more than one installation, thus, in the aggregate, if there
are n installations each with the same K and L, output is
given by Y* = nF(K*, K, L), with n some integer
 If the marginal product of F(K*, K, L) with respect to K*
is positive, then in the the aggregate, production should
exhibit exhibit increasing returns to scale in K*, K and L
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The Role of Excludability:
The Non-Excludable Case
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If K* is not excludable, so that it is freely accessible to all, there are
a number of consequences:
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Since there are problems of non-appropriability and free-ridership in addition
to the intrinsic high risk, private investment in knowledge capital will not be
undertaken
Public investment will be undertaken to the point that the expected marginal
social product of knowledge capital is equal to the social rate of return
Once created, knowledge capital is utilized by private firms until its marginal
private product is zero (reflecting its price)
The contribution of knowledge capital is maximized when the number of firms
is maximized so that the same K* can be utilized to the greatest extent
Thus, the firms will operate at the minimum efficient scale (if in fact F(K*, K,
L) exhibits constant returns to scale in K and L, then the size distribution of the
firms can be arbitrary)
Profit will be zero under perfect competition with free entry and exit
The important point to note is that in equilibrium, the marginal
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product of existing knowledge capital is zero
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The Role of Excludability:
The Excludable Case
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If K* is excludable, then a firm with a piece of knowledge capital
that other firms do not have will have lower operating costs and thus
will be able to establish a monopoly position in the supply of its
output (bear in mind that it is the relative quantities of K* between
two firms that matter, not the absolute quantities when it comes to
profits) and make monopoly profits (this is precisely the motivation
for innovation)
Such a firm will potentially face a downward sloping demand curve
for its output
Private investment in knowledge capital will be undertaken to the
point that the expected marginal private revenue product of
knowledge capital is equal to the private rate of return
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The Role of Excludability:
The Excludable Case
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If the firm is risk-neutral, then (1-1/) F/K* = r/P, where  is
the absolute value of the price elasticity of demand for the output, r
is the nominal rate of interest and P is the price of the output
>1 at the profit-maximizing equilibrium, otherwise no interior
profit-maximizing equilibrium exists
It follows that private investment in knowledge capital will fall short
of the efficiency condition of marginal productivity being equal to
the real private rate of return
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Increasing Returns to Aggregate Knowledge
Capital
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In either case, there is no tendency for infinite expansion of K*
Thus, existence of increasing returns to scale to knowledge capital at
the firm level does not necessarily imply that there are increasing
returns to scale to aggregate knowledge capital in aggregate
production in equilibrium
In particular, it does not necessarily imply that the marginal
productivity of knowledge capital in aggregate production is
increasing in the quantity of aggregate knowledge capital
The existence of monopoly rents implies that the economy does not
operate on the production possibility frontier (Price not equal to
marginal cost), I.e., production is not efficient
Whether social welfare is increased or decreased and by how much
depend on the extent of the monopoly rents and the extent of the
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spillover effects (externalities)
Increasing Returns to Aggregate Knowledge
Capital
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Monopoly profits depend on relative K* and not on absolute K*
Rising or constant marginal productivity of aggregate knowledge
capital in the aggregate production function depends on an
economically significant spillover effect, that is, on the lack of full
appropriability of the benefits of newly created knowledge capital
(e.g., new software on existing computers)
However, even free software does not always have takers (marginal
product = 0)
There is no compelling theoretical or empirical reason to assume that
physical capital and knowledge capital are always used in fixed
proportions--it is assumed solely for the purpose of analytical
convenience
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Increasing Returns at the Microeconomic Level
 Technological
increasing returns to scale
 Market increasing returns to scale
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Technological Increasing Returns to Scale
 High
fixed cost
 Zero or low marginal cost
 Price=marginal cost implies failure to recover fixed cost
 Entry barrier
 Natural Monopoly
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Monopolies Based on Technologies
 Technological
innovations protected by patents, knowhow, trade secrets, copyrights, and other forms of
intellectual property rights provide the basis for
technologically based monopolies
 Excludability
 The product cycle in the absence of network externalities
 Sequential
price discrimination
 Economies of scale and learning by doing
 Commodity phase
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Market Increasing Returns to Scale
 What
is new? We may call it market increasing returns to
scale (as distinct from technological increasing returns to
scale, characterized by the higher the market share, the
higher the marginal revenue, i.e. increasing the market
share enhances the power to raise prices)
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Two Sources of
Market Increasing Returns to Scale
 (1)
Network or use externalities
 The benefit of a product or service to the user/consumer
depends on how many other people are using it-(externalities in consumption or in use, in the demand
curve)
 Thus, the demand curves are interdependent--one can
derive the dynamic profits of such demand curves to obtain
a diffusion profile
 Network externalities—the benefits of standardization
(compatibility, exchangeability, communicability)
 Setting and control of standards=control of market
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Two Sources of
Market Increasing Returns to Scale
 (2)
User-specific investment
 Learning by doing (software, typing keyboard)
 Prior use, habit formation (addiction)
 Example: English is everyone’s second language. Once in
place, it is very difficult to dislodge. (However, the entry
cost of teaching English is very low and that is why there is
no monopoly profit.)
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Implications of Market Increasing Returns to
Scale
 First-move
advantage
 Winner-take-all nature of competition
 Specific market strategies
 Low
or zero initial price (thus driving out competitors and
potential competitors and encouraging addiction), followed by
high monopoly price
 Planned obsolescence
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The Tournament Model of Technological
Competition
 “Winner
takes all”
 Reinforced by increasing returns to scale
 First move advantage
 Path dependence--durability of market shares (and hence
monopoly profits)!
 Example:
 Pharmaceutical
R&D
 VHS versus Beta
 Operating system of personal computers
 The
quality-ladder model of Grossman and Helpman
(1991)
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The Distinction between
Social and Private Rates of Return
 Competition
for monopoly rents
 “Winner takes all” results in negative rates of return for
losers
 Social rate of return can be below private rate of return-possibility of over-investment
 However, monopoly rents provide the incentive for
innovative activity
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Question: Does Endogenous Growth Imply
Macroeconomic Increasing Returns to Scale?
 Externalities
as a source of increasing returns--depends on
the extent of the spillover effect relative to the extent of
uneconomic duplication and competition
 Given increasing returns to knowledge capital, but eventual
decreasing returns in the production of knowledge, the
aggregate output may not necessarily exhibit increasing
returns in conventional inputs and cumulative investment
in knowledge-producing capital
 Even (or perhaps especially) if knowledge capital is made
freely available to all, the value of its marginal product
may reach zero in equilibrium
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The Role of Knowledge Capital
 Is
knowledge capital super-additive or sub-additive?
 Is
social knowledge capital greater than or less than the sum of
privately usable knowledge capital, taking into account the
common initial base of social knowledge capita?
 The
roles of rivalry, excludability, non-appropriability,
spillover, and winner-takes-all
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Aggregation
 What
is the effect of purposive innovation-based technical
progress at the microeconomic level on measured technical
progress at the macroeconomic level?
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Intertemporal Behavior
 Can
the steady-state rate of growth be raised (permanently)
with appropriate government policy (e.g., good
government, good system of law enforcement, stable
currency and financial system)?
 It is necessary to distinguish between an effect on the level
and an effect on the rate of growth and between an effect
on the instantaneous rate of growth and the steady-state
rate of growth
 Are there cycles or waves in innovation?
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The Evolution of Measured Technical Progress
over Time
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Can one explain the evolution of measured technical progress over
time?
Some problems of the recent measures of total factor productivity
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The measurement of labor inputs is based on a standard number of hours, or
hours paid, rather than hours worked--the discrepancy between hours paid and
hours work for employees in the high-technology sector is believed to have
risen during the high-technology boom of the past five years
The change in the accounting practice on expenditure on software not bundled
with hardware from full expensing to capitalizing will in the first few years
result in a higher measured real GDP even though nothing has changed
The hedonic price index adjustment may over-state the pecuniary benefits of
purely technological innovations
The price indexes may not have taken fully into account the shift in the
composition of consumption and investment away from goods to services. The
prices of services, however, have risen faster than the prices of goods
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University
The pricing of upgradesLawrence
of subscription
type
services--how to distinguish 25
between quality improvement and pure price increase