Transcript New Lecture Note #1

Lecture 1 of Eco 3317
J.D. Han at King’s
Growth Theories
“Frame of Reference”
Conventional Growth
• General Neo-Classcial Model
Harrod-Domar Model
Solow Model (Representative Neo-Classical Model)
• Endogenous Growth Model
- Human Capital
- Others
• Lewis Model
• Rostow Model
• Solow Model is ‘the’ representative Neo
-Classical Growth Model: focusing on
savings and investment.
It explains the long-run evolution of
economy quite well with all being held
Constant – Dynamic Model
The problem is that it really does not
Explain the Asian Economic Growth
-Simplistic
Neo-classical Model focuses too much
on Capital (“Material Things”), and
focuses too little on Human Elements
All matters depend on Human Act(s)
(事在人爲)
Harrod-Domar model is older and cruder,
but opens up the room for other
factors (for economic development),
It may be better for explaining Asian
Economic Development.
Neo-Classical Economics
• Microeconomics that you have learned
• Aggregate Demand does not matter for longrun growth of income
• Macroeconomic Policies of Government
(controlling Money Supply, Government
Expenditures )do not matter for Y in the longrun – “You cannot pull yourself up by your own bootstrap”
1. Neo-classical Mode = Supply
Side Economics
• Economic growth
= Growth of Income
= Growth of aggregate output comes
from
an increase in labour L;
an increas in capital K; and/or
improvement of technology T
In General
• ‘production function’
Y = f (K, L; T)
• Growth function
dY = f (dK, dL; dT)
Specific Formula of Production
Function
Most Widely Used Production Fn is
• “Cobb-Douglas Production Function”:
Y=A K
a
L
1-a
, and a<1
*Realistic and Convenient Features of C-D function:
Diminishing Marginal Return
Constant Return to Scale
*Why are the two features
realistic in Economics?
• Diminishing Marginal Returns(DMR)
eg) Y = F(K,L )
10 = F(5, 5)
13 = F(10, 5)
Decreasing Marginal Productivity of Capital or Labor
dY/dK = MPk, d MPk/ dk <0 or dY2/d2K <0
dY/dL = MPL, d MPL / dL <0
• Constant Return to Scale (CRS)
If Y = F (K, L) is true, Y = F (2K, 2L) = 2 F (K, L) is attainable.
You do not have to take DRS 1.5 Y = F (2K, 2L)
**Diminishing Marginal Returns
as a Fact of Life
• Biological growth- “S curve”(upper part)
Stages of Acceleration (Youth) and Deceleration (Maturity)
Convergence
• Production Function
Stages of Increasing Marginal Return and Decreasing Marginal Return
inflection point between IMR and DMR
Why is IMR no substantive issue?
2. Harrod-Domar Model
Income Growth Rate = Saving Rate x Efficiency
of Capital
dY/Y = dY/dK x
dK/Y
( as S = I = dK )
= dY/dK x S/Y
=
Marginal Product(ivity) of Capital x Savings Ratio
=
=
S/Y
dK/dY
Average Propensity to Save
Incremetal Capital Output Requirement
Note:
• MPK = 1/ ICOR
• Relationship between MPK(dY/dK) and
APK(Y/K)
- When Y/K falls, MPK < APK
- When Y/K rises, MPK > APK
• In general, eventually, the more amount
of capital, the Marginal Productivity of
capital decreases – “Convergence”
Recall: In the latter part of the S curve, the MP of capital is a
decreasing function of capital –“Decreasing Marginal Returns” or “Law
of Diminishing Marginal Return”
This happens as the size of capital grows in the natural course of
economic growth.
• It is a formidable task to keep the
weighted average Marginal Product of
Capital constant or even Increasing for
the entire economy.
Implications of the H-D model
• The key to economic growth is to expand the lev
el of investment: capital accumulation or
‘Mobilization of capital’
• Equally important is the productivity of capital:
the higher the marginal product(ivity) of capital,
the better, or the lower the required incremental
capital-output ratio, the better.
Application and Modification
of Harrod-Domar Model
How to enhance Efficiency of Capital?:
Higher MP of Capital, or lower ICOR
• 1) Through Technological advances or
Technical innovations –
This can happen to any economic system: Market(economy) can
take care of this while government may promote it too.
• 2) Though resource allocation by ‘visible
hands’, government, channeling capital into
‘efficient areas’ –
- A specific Economic System/Institution
key words) Centrally planned economy; Economic Planning;
Resource Allocation Planning; Industrial Policy; Promotion of
National Strategic Industries; Key Industry
• For “starter countries, Institutional
Rearrangements are easier than
technical Innovation.
-> “Economics Reform”
-> “Restructuring”
*To spark Growth,
we may need Institutions
• ‘Institutions’
(as opposed to Market Economy)
covers Government; Economic System; Value System(ethics,religion)
- Mechanism to ‘Mobilize Capital’? How
to increase Saving Rate?
- Mechanism to raise the Efficiency of
Capital?
*East Asian Government’s Role
for Promotion of Economic
Growth
• Government Policies are needed to 1)
encourage/force savings;
• 2)and/or to enhance efficiency of
capital by allocating scarce capital
primarily to strategic area of
industry.
* Case Studies of Government’s Forced
Savings and Resource Allocation
1) Successes
-Japan
by Kozo Yamamura or Kazuo Sato’s paper
reports that during the take-off stage of
economic growth of Japan, the average
capital-output ratio fell significantly due to
Innovations(?) and Government’s Industrial
Policy.
-Korea
Promotion of chae-bol(s)
Strategic industries of Ship-building, Cars, Semiconductors, IT Industries, etc.
2) Debacles
Some countries have succeeded in
mobilization of capital, but failed in the
efficient use of capital.
Stalinist Economy
North Korea
Great Leap Movement in China
Still, Modification of the Harrod-Domar
Model is needed to explain growth spurts
• difficult to stimulate the level of domestic savings
particularly in the case of developing countries
• One way of supplementing the low domestic savings
would be foreign savings/investment:
• However, borrowing from overseas causes debt
repayment problems later.
• The law of diminishing returns would suggest that as
investment increases the marginal productivity of the
capital will diminish, and the capital to output ratio rise.
Fighting this natural law is a formidable task.
• In a word, the model does not give any easy recipe
for a success of economic development while it can
explain the surface of the given economic growth.
3. Solow Model
• Focusing on capacity of Savings
to meet the demand for Investment
as Capital Requirements
and, beyond, as Capital Accumulation f
or expansion of Production capacity
• Refer to the Separate PPP
4. Lewis Model:
Dual Sector Model of Economic Growth
• many LDCs had dual economies with a
traditional agricultural sector and a modern
industrial sector
• Traditional Sector has too much labor at
subsistence level. It has to release excessive
labor.
MPlabour = 0; Y = C + S + T = C + I + G
• Modern Sector absorbs labor and becomes
the source of economic surplus or savings
How does the Mechanism work?
• The lack of development was due to a lack of
savings and investment. The key to development was
to increase savings and investment.
• Lewis saw the existence of the modern industrial
sector as essential if this was to happen. A growing
industrial sector requiring labour provided the incomes
that could be spent and saved. This would in itself
generate demand and also provide funds for
investment. Income generated by the industrial sector
was trickling down throughout the economy.
• Urban migration from the poor rural areas to the
relatively richer industrial urban areas gave workers
the opportunities to earn higher incomes and crucially
save more providing funds for entrepreneurs to
investment.
Policy Implications of Lewis model
• Induced Displacement of Population from
Rural to Urban Sector
• Government may use push and pull factors
using Institutions or System
-‘Vanity Effect’ as a magnet:
Glamorous/modernized Urban Sector versus
Backward/‘Suppressed’ Rural Area
-Income Inequality is as a ‘magnet’
Lewis Model is Unbalanced Economic Growth Strategy
(不均衡的经济发展战略）
• This is a practical strategy.
• Let’s reflect on side-effect/problems
-Sustainability in the long-run: Ravaging impacts of labor saving
technology; How much and how long is the modern sector
absorb the surplus labor? What will happen to no-longerneeded surplus labor?
-Inequality between agricultural – industrial sectors
Income Inequality; Urbanization issues
- Urban/Modern Sector may not Save but Spend: Urban
‘Consumerism’
- Rural-Urban Migration is larger than what the urban sector can
absorb: Rural Poverty simply becomes Urban Poverty
Case Studies: Casual Analysis
• England in 18th Century
Enclosure Movement
• U.S. in 19th century
Slave-Emancipation
• Japan
• Korea in the 1970s and the 1980s
*New Village Movement (Sae-Ma-Eul-Un-Dong)
• Taiwan (part of China)
• China
*Quantitative Analysis:
Income (Distribution) Inequality and Economic
Growth
• Income Inequality is measured by Gini-Coefficient
• Some international comparisons argue as economy
grows, Gini Coefficient generally rises first and then
fall
• It is in line with Lewis’ theory: Income inequality is not
only inevitable, but also necessary for economic
growth
- Case studies of Korea, Japan, and China
(presentation)
5. Rostow's Modelthe Stages of Economic Development
.
• In 1960, the American Economic
Historian, WW Rostow suggested that
countries passed through five stages of
economic development
•
Stage 1 Traditional Society
-dominated by subsistence (defined as no economic surplus, meaning output being consumed by producers
rather than traded);
-trade being carried out by barter, meaning goods being exchanged directly for other goods;
-Agriculture being the most important industry;Production being labor intensive using only limited
quantities of capital.
•
Stage 2 Transitional Stage (the preconditions for takeoff)
-Increased specialization starting to generate surpluses for trading.
-an emergence of a transport infrastructure to support trade; External trade also occurs concentrating on
primary products; Entrepreneurs emerge
-savings and investment grow.
•
Stage 3 Take Off
-Rapid Industrialization or Industrial Revolution
- Growth concentrated in a few regions of the country and in one or two manufacturing industries.
- The level of investment reaches over 10% of GNP.
- The economic transitions are accompanied by the evolution of new political and social institutions that
support the industrialization.
- The growth is self-sustaining: investment leads to increasing incomes in turn generating more savings to
finance further investment.
•
Stage 4 Drive to Maturity
-Industrial Diversification; producing a wide range of goods and services; reliance on exports and imports
may start decreasing
•
Stage 5 High Mass Consumption
- Mass Consumption（大众消费）; Domestic Aggregate Demand is the major determinant of Business
(Cycles)
- Consumer durable industries; Service sector
Limitations
• Deterministic Path for All?
Rostow predict that every economy is going through the same
stage.
However, some economies are stuck in the first stage forever
while other economies “take off”.
-leaving a room for ‘cultural explanation’
• It does not set down the detailed nature of the pre-conditions
for growth; What sparks the take-off?
-Exogenous Shocks as a Catalyst for Great Transformation?
• It is not very helpful as a policy prescription. Perhaps its main
use is to highlight the need for investment.
* Explaining the fast is always easier than Predicting
the future
Major Contribution of Rostow’ Model
Emphasis of ‘Take-Off’
-Economic Development is
not a continuous process;
-There should be
some Event for Great Transformation.
*Case Studies: Catalyst for Take off
Catalysis for Take Off= Exogenous Shocks
Japan
Meiji Revolution; Korean War
Korea
President Park, Jeong Hee; Vietnam War
China
Deng Xiao Ping’s Reform
Jiang Ze Min’s “Southern Journey(Nan Xun)”
Iraq War?
Neo-classical Model focuses too much
on Capital (“Material Things”), and
focuses too little on Human Eelement
All matters depend on Human Act(s)
(事在人爲)
• We need a new Frame of Reference
which puts more emphasis on
Human Factors
6. Endogenous Growth Theory
Y = F(K,L:T) does not fully explain
divergent growth experiences acrss
countries. There has to be an additional
factor endogenous to countries.
Excellent Summary of Endogenous
Growth Models
http://www.ncl.ac.uk/ncihe/r8_117.htm
*Value System as a ‘Foundation’ Institution for Economic
Growth:
• Max Weber arguned that
“Protestant Work Ethic” sanctioned
hard work, frugality and wise
investment.
• Rodney Stark is one of the most
highly regarded sociology of religion
scholars alive today. He recently
published The Victory of Reason:
How Christianity Led to Freedom,
Capitalism, and Western Success.
• Professor Tu Wei-Ming at Harvard
University said that NeoConfucianism of the Far East is
similar to protestant ethic.
- refer to the essence of his idea