macro chapter 9

economic growth 2: technology, empiricism, politics

technical progress in the solow model

• consideration of variable E: work efficiency

• assume that technical progress increases labour input

  • increases E at exogenous rate g = ∆E/E

  • result: new production function Y = F(K,LE)

• LE = labour input in efficiency units = (1+% growth) x L

• if E increases, it acts like an increase in L

what is the solow model

• economic framework

• explains long-term economic growth through capital accumulation, labour growth, + technological progress

• highlights that while saving/investment boost capital, only exogenous technological advancement drives sustained long-growth

solow model formulae

• y = Y/(LE)

• k = K/(LE)

• production function (output per efficiency unit) → y = f(k)

• savings/investments (per efficiency unit) → sy = sf(k) = i

• investment volume required to ensure that capital stock per efficiency unit remains constant (steady rate) → sf(k) = (δ + n + g)k

technical progress in the steady state

• labour-increasing tech progress with rate g has similar effect in solow model, to population growth with rate n

• capital intensity (k): capital stock per unit of labour efficiency

• increase in efficiency units caused by tech progress → reduction in k

• in steady state, investment sf(k) offsets reduction in k due to depreciation, population growth, + tech progress

the golden rule

• describes consumption-maximising steady state

• consumption

  • c* = y* - i*

  • = f(k*) - (δ + n + g)k*

• c* is maximised if MPK = δ + n + g

  • respectively MPK - δ = n + g → GOLDEN RULE

at what rate does the capital per efficiency unit grow?

• ∆k* = 0 in the steady rate

• no growth in k

• no change/growth in capital stock

at what rate does the output per efficiency unit grow?

• y* = f(k*) does not grow/change

at what rate is output per employee growing?

• growth per capital (per employee)

  • growth rate by which employees become more efficient

• it grows by g

• people are more efficient → growth rate of capital stock grows by g

at what rate is the total output growing?

• aggregated output grows by n + g

implications of the solow model

• sustained growth in per capita income is only possible through technological progress

• policy recommendation: stimulate technical progress

solow model sources of growth

• quantity of production factors

  • labor and capital

  • determined by population growth and savings behaviour

• efficiency of the use of production factors: Is determined by technical progress

  • how the technical progress arises is not explained in the model

empirical observations on the solow model (list)

• convergence of economics

• factor accumulation vs production efficiency

• good corporate governance

convergence of economics

• economics coverage with the same savings rate but different capital stocks

  • eg. japan and germany after WWII

• if savings rates or efficiency differ, countries do not converge

• conditional on steady-state variables

• annual convergence is 2%

factor accumulation vs production efficiency

• both variables are important for a high income

• both variables are also correlated and difficult to separate

  • production efficiency attracts capital (eg investment)

  • factor accumulation favours conditions for higher efficiency

good corporate governance

• explains differences in efficiency and thus differences in income across countries

• major differences in quality of corporate governance → USA vs brazil

  • one explanation is lack of competition

  • second explanation is primogeniture

growth policy measures

• influencing savings rate → private savings & government savings

• gov can stimulate private investment with budget surpluses

• private savings can be stimulated through incentives

policy examples

• low taxation of capital income

• higher consumption tax

• tax exemption for private pension plans

private investments

• are efficiently controlled by the market

• capital is deployed where it generates the highest return

• the state should only set competitive framework conditions

government investment

• infrastructure investments necessary but difficult to measure

• can the state generate +ve externalities through its own investments?

  • social returns then exceed private returns

  • effectiveness of industrial policy depends on the ability to measure +vs externalities

    • eg. investments in renewable energy

    • but danger of lobbying & bad investments

conditions for investments

• institutions should be designed so the conditions favour investments, and allocation of investments is efficient

what makes a good institution?

• reliable legal system with legal protection for shareholders & lenders

• protection of property rights

• functioning capital markets

• promoting competition

• limiting corruption

how can the state stimulate technological progress?

• promotion of R&D → research at unis

  • research funding: DFG, Max Planck society, etc

• create framework conditions for companies to engage in R&D: eg through patent right which allows entrepreneurial return from R&D

• international trade

  • ricardo’s theory of competitive advantage

  • shows that countries can/should concentrate on more production-efficient goods