Economic Growth and Development

Unconditional Convergence

• Many countries exhibit unconditional convergence over the short run, suggesting poorer economies tend to grow faster initially, regardless of their specific characteristics.

• This phenomenon was observed in a graph from 1960-1985, where several countries showed a pattern of catching up in terms of economic output.

Factors Influencing Unconditional Convergence

• Globalization: Increased trade and investment flows facilitate technology transfer and knowledge sharing, enabling developing countries to adopt advanced practices.

• Policy Reforms: Implementation of sound macroeconomic policies, such as fiscal discipline and regulatory reforms, can foster a stable economic environment conducive to growth.

• Human Capital Development: Investments in education and healthcare improve the skills and productivity of the workforce, driving long-term economic development.

Unconditional Convergence: Latest Results

• The $\beta$-coefficient of unconditional convergence is determined by regressing real per capita GDP growth to present day on the log of initial per capita GDP, serving as a key metric for assessing convergence trends.

• Data sources from Maddison, PWT (Penn World Table), and WDI (World Development Indicators) are essential for conducting comprehensive analyses.

• Each point represents the coefficient from a separate, bivariate regression, offering insights into convergence dynamics across different economies.

  • The dependent variable is the annual real per capita growth rate from the year listed until the most recent data round, reflecting the pace of economic expansion.

  • The independent variable is the log of real per capita GDP in the base year, capturing the initial income level.

Sample Selection and Data Considerations

• The sample excludes oil-rich countries and countries with populations under 1 million to mitigate biases and ensure robust results.

• The study uses data and methodology from Patel, Sandefur, and Subramanian, 2018, and takes advantage of credible studies.

• It's important to consider potential biases and limitations when interpreting convergence regressions, such as omitted variable bias and measurement errors.

Conditional Convergence: MRW

• Unconditional growth rate from 1960-85 is plotted against log output per working-age adult in 1960, showing the raw data relationship.

• Conditional growth rate, considering saving and population growth, is also plotted and shows what happens when you account for differences in savings and population growth.

• Conditional growth rate, considering saving, population growth, and human capital shows the impact of levels of education in each country.

• Source: Mankiw, Romer, and Weil, 1992, is important paper in economics which shows economic data.

Key Variables and Their Impact

• Savings Rate: Higher savings rates can lead to increased investment and capital accumulation, fostering economic growth.

• Population Growth: Lower population growth rates can enhance per capita income levels and promote human capital development.

• Human Capital: Investments in education and training improve the skills and productivity of the workforce, driving long-term economic development.

Income and Substitution Effects

• Relative prices can affect economies through income and substitution effects, influencing consumer behavior and resource allocation.

• These effects impact countries with different initial incomes, leading to varied economic outcomes and policy challenges.

• Poor countries tend to have higher returns on investment than rich countries: $r{poor} >> r{rich}$, indicating potential investment opportunities and capital flows.

• Differences in returns impact capital flows from rich to poor, driving investment decisions and shaping global financial dynamics.

• Issues driven by geography and institutions can lead to potential non-convergence, posing challenges for achieving balanced development.

Factors Influencing Income and Substitution Effects

• Trade Policies: Trade liberalization can alter relative prices, affecting exports, imports, and sectoral competitiveness.

• Exchange Rates: Currency fluctuations can impact the relative prices of goods and services, influencing trade balances and investment decisions.

• Technological Change: Technological innovations can shift relative prices, affecting production costs, industry structures, and employment patterns.

Structural Transformation

• Economies develop with the transition from agriculture to manufacturing and services. This is a normal process based on a country's economy.

• The effect of price elasticity on structural transformation and resource allocation determines how countries allocate resources. The more elastic the easier it is to create resources.

• In closed economies, relative sectoral productivity determines relative prices, which influence production and consumption decisions.

• The equation $y = \theta k$ illustrates the relationship, where $\theta$ represents relative productivity; this shows that output is determined by productivity and capital.

• Richer countries have lower manufacturing shares, reflecting the shift towards service-based economies and advanced industries.

• In a closed economy, the transformation is supply-driven, determined by factors such as technology, labor, and capital.

• Equation: $yt = At k^{\alpha}t$, illustrates how the factors work together.

• Openness influences structural transformation, leading to specialization and trade patterns that drive economic restructuring.

Sectoral Shifts and Productivity

• Agriculture: Declining share of employment and value-added as economies develop due to increased productivity and changing consumer demands.

• Manufacturing: Initially expands during industrialization but may decline in advanced economies due to automation and global competition.

• Services: Growing share of employment and value-added as economies mature, driven by rising incomes and demand for specialized services.

More on Structural Transformation

• Relative prices influence economic structure, and countries transition from agriculture to industry based on cost analysis.

• In open economies, the terms of trade are exogenously given, influencing export competitiveness and import costs.

• The "Dutch disease" and original sin impact structural transformation, causing resource curse issues stemming from currency appreciation and debt vulnerabilities.

• Equation: $Yt = K^{\alpha}t (ht Lt)^{1-\alpha}$. It is also expressed as $yt = k^{\alpha}t h^{1-\alpha}_t$, shows the relation between capital, labor, and output.

• Investments in physical and human capital evolve over time: $h{t+1} = ht + sh yt$, illustrating the dynamics of capital accumulation.

• It's essential to note that $ht \neq Lt$, as human capital is distinct from labor; this means one worker is not the same as another.

• Convergence rates of skilled (sk) and unskilled workers (sh) influence convergence:- $g(sk, sh)$, where g is the productivity growth rate.

Specialization and Trade

• Countries may specialize in sectors based on terms of trade and relative productivities, affecting the pace and pattern of development.

• This specialization drives exports and imports, shaping a country's comparative advantage and integration into the global economy.

Recall: effect of human capital from MRW

• Unconditional growth rate from 1960-85 is plotted against log output per working-age adult in 1960, measuring raw economic growth.

• Conditional growth rate, considering saving and population growth, is also plotted, factoring in demographic and savings.

• Conditional growth rate, considering saving, population growth, and human capital, is presented, including education and worker skills.

• Source: Mankiw, Romer, and Weil, 1992 showcases the effects of savings, population, and human capital.

Additional Factors in Growth Models

• Technological Progress: Enhances productivity and innovation, driving long-term economic advancement.

• Institutional Quality: Affects investment decisions and economic efficiency by determining corruption levels.

Factor accumulation vs. productivity

• Identifying the primary drivers of development is important: factor accumulation or productivity growth, and both can be present depending on a country's situation.

• With openness, poorer countries can import technology and goods, boosting industrial output.

• Trade and specialization implications on economic development affect how a country can develop.

• What causes productivity differences across locations determines worker skills and economic output.

• Understanding the underlying causes limiting economic growth influences policy implications.

Policy and Growth

• Investment Climate: Encouraging investments fosters domestic and foreign investments.

• Education Policies: Improve access to education and improve overall skills creating better working conditions.

Revisiting Convergence

• Convergence is not guaranteed, and various factors can influence whether countries converge in income levels.

• Geography, institutions, and policy shape economic outcomes which result in convergence. Every country is different in its resources and governance so policy needs to adjust based on a country's situation.

• Theoretical and empirical perspectives on income convergence affect how economic theory can be applied to real world scenarios.

Influential Factors

• Natural Resources: Availability and management of natural resources affect income and development.

• Political Stability: Stable political environments fosters long-term growth and makes it easier to attract outside investments.

Structural Transformation

• Illustrating structural transformation through the shift in employment and value-added shares across sectors (agriculture, manufacturing, services) in developed countries over time.

• Presenting data showing the decline of agriculture and the rise of manufacturing and services as GDP per capita increases; this showcases how country economies typically evolve as they get richer.

Structural Transformation: Korea 1960-2010

• Demonstrates the shift of employment into manufacturing in Korea from 1960-2010, and the huge growth into manufacturing that Korea experienced.

Structural Transformation: Share of Aggregate Manufacturing

• Share of aggregate manufacturing in total employment and total output for Korea, showing the shift in the workplace and in total output.

Structural Transformation: Summary

• Structural transformation is a key component of economic development, especially since it reflects economic growth.

• It involves a shift in resources from agriculture to manufacturing and services meaning that as countries grow the type of work changes.

• Specialization and trade can accelerate structural transformation, making it faster to develop overall.

Key Aspects of Sectoral Changes

• Labor Productivity: Improving labor productivity in each sector can enhance economic growth.

• Trade Liberalization: Reduces trade barriers, and gives countries the ability to specialize in certain products.

Sectoral Decomposition

• Outlines a framework for analyzing economic activity across sectors and its relation to income and development, helping to show how different industries develop as a country gets richer.

• Emphasizes the need to understand the dynamics of sectoral productivity and labor allocation to effectively distribute labor in the workplace.

Sectoral Decomposition

• Formula to show the components:- $Y = YA + YM + YS$, where $Yi$ = Value added in sector i

Sectoral Decomposition

• Shows that aggregate labor productivity is sectoral output divided by labor:

Sectoral Decomposition

• Formula to show the components:- $Y = YA + YM + YS$, where $Yi$ = Value added in sector i

Sectoral Decomposition

• Shows that aggregate labor productivity is sectoral output divided by labor:- $\frac{Y}{L} = \frac{YA}{L} + \frac{YM}{L} + \frac{Y_S}{L}$

Sectoral Decomposition

• Where $Yi$ is output and $Li$ is labor.

• $$\frac{Y}{L} = \frac{YA}{LA} * \frac{LA}{L} + \frac{YM}{L*M} * \frac{LM}{L} + \frac{YS}{L*S} * \frac{L_S}{L}$$

Sectoral Decomposition

• With:-

  • $$yi = \frac{\text{Value added per worker in sector i}}{yi = \frac{Yi}{Li}}$$

  • $$li = \frac{\text{Share of workers in sector i}}{li = \frac{L_i}{L}}$$

Sectoral Decomposition

• Therefore

Sectoral Decomposition

• Formula to show the components:- $Y = YA + YM + YS$, where $Yi$ = Value added in sector i

Sectoral Decomposition

• Shows that aggregate labor productivity is sectoral output divided by labor:- $\frac{Y}{L} = \frac{YA}{L} + \frac{YM}{L} + \frac{Y_S}{L}$

Sectoral Decomposition

• Where $Yi$ is output and $Li$ is labor.

• $$\frac{Y}{L} = \frac{YA}{LA} * \frac{LA}{L} + \frac{YM}{L*M} * \frac{LM}{L} + \frac{YS}{L*S} * \frac{L_S}{L}$$

Sectoral Decomposition

• With:-

  • $$yi = \frac{\text{Value added per worker in sector i}}{yi = \frac{Yi}{Li}}$$

  • $$li = \frac{\text{Share of workers in sector i}}{li = \frac{L_i}{L}}$$

Sectoral Decomposition

• Therefore: $y = y*A * lA + yM * lM + yS * l*S$

Sectoral Decomposition

• Highlights Two Channels of Development:-

  • Productivity enhancement within sectors $y_i ↑$

  • Reallocation of labor: $\text{lA ↓, lM ↑, lS ↑}$

Additional Considerations

• Technology Adoption: Incorporating new technologies to improve productivity and efficiency across sectors.

• Human Capital Development: Focus on education and training to enhance workforce skills and adaptability.

Discussion on Dualism

• Dualism means differences in production functions across sectors or locations, impacting resource allocation and economic outcomes. Different factors determine industry situations which create production differences.

• Discusses various forms of dualism.

  • Technological dualism involves uneven technology adoption across sectors which leads to a split in development.

  • Social dualism refers to differing social norms which affects a workplace's overall skill.

  • Spatial dualism means geographic disparities affect the economic situation of certain areas.

  • Financial dualism results in unequal access to financial resources which can impact development.

  • Informal sector dualism results from there being discrepancies between formal and informal sectors that limits overall potential.

Discussion on Dualism

• Dualism means differences in production functions across sectors or locations.

• Discusses various forms of dualism.

  • Technological dualism

  • Social dualism

  • Spatial dualism

  • Financial dualism

  • Informal sector dualism

Discussion on Dualism

• Explores how these dualisms impact development and convergence, showcasing how these can affect worker wages.

• Policy measures to address dualism affect worker situations as well. These include skills training, financial programs, etc.

• Migration can help reduce dualism because people skills will be transferred to new industries. Migration leads to urbanization and potential growth.

• The Lewis model serves as a framework for understanding dualism and structural transformation, allowing countries to analyze and change the way their economy is structured, leading to urbanization and overall economic growth.

Strategies to Address Dualism

• Education and Training: Enhancing access to quality education and training programs to reduce skill gaps.

• Infrastructure Development: Investing in infrastructure to connect different regions and promote economic integration.

The Lewis Model

• Lecture 5 part 3 is on The Lewis Model, and explains how developing economies transition.

The Lewis Model: "Economic Development with Unlimited Supplies of Labour" (1954)

• Sir Arthur Lewis created the Lewis Model, which is still studied and taught today.

The Lewis Model

• Emphasizes the migration of labor from agriculture to industry. People move from agriculture to industry due to increased wages and economic growth.

• Key assumptions of the Lewis Model include:-

  • Abundant labor in agriculture, with low marginal productivity. This emphasizes the model.

  • A modern industrial sector has increased manufacturing capacity.

  • Wage differentials between sectors leads to economic mobility depending on skills that workers have.

The Lewis Model

• Labor moves from agriculture to industry, resulting in structural transformation.

• The implications of this labor transfer is that economies urbanize and modernize.

• Profits are reinvested which leads to expansion in the modern sector, and leads to economic improvements.

Labor Transition Dynamics

• Productivity Gains: Increased productivity in both agriculture and industry leading to higher overall economic output.

• Wage Adjustments: Wage adjustments lead to overall economic improvements.

The Lewis Model

• Explains the dual-sector economy: traditional agricultural sector and modern industrial sector, which is typical in developing economies.

• Assumptions of the Lewis model:-

  • Unlimited supply of labor in the agricultural sector, and increased capacity for production.

  • Constant real wage in the industrial sector, leading to urbanization and economic growth.

  • Capital accumulation in the industrial sector can lead to more urbanization.

Essential Dynamics in the Model

• Capital Formation: Investing in capital goods and tech drives productivity growth.

• Market Integration: Integrated product and labor markets across sectors to allocate resources. This means that different parts of the economy start to affect each other.

The Lewis Model

• Mechanisms of labor transfer and wage dynamics influences economic growth. How labor is structured is crucial for long term growth.

• Profits drive industrial expansion, giving capital for further investment.

• Technological progress influences wages and employment by making manufacturing more efficient.

• The Lewis model explains structural transformation, with labor shifting from agriculture to industry; this has been the key to economies transitioning.

Key Factors

• Innovation Uptake: Speed of adopting labor saving technologies affects the productivity numbers in the economy

• Skill Development: Increasing skills for the workforce lead to more urbanization and overall economic improvements.

The Lewis Model

• Marginal product of labor in agricultural is small, a very important consideration for the Lewis model.

• Agricultural production:- $Q*A = L^{\alpha}_A A T^{1-\alpha}$

The Lewis Model

• Marginal product of labor: $\frac{\partial QA}{\partial LA} = \alpha L^{\alpha -1} A T^{1-\alpha}$

Additional Factors to keep in mind

• The degree of labor surplus

• Technology effectiveness.

The Lewis Model

• Agricultural wage (wA) remains constant despite labor leaving for the industrial sector due to surplus labor - a quirk of the model. Industrial wages remain high due to worker skills.

• The Lewis model is supply side model where labor supply is perfectly elastic, meaning the demand adjusts to available workers. Industrial wages remain high due to worker skills.

The Lewis Model

• Industrial wage (wI) is higher than the agricultural wage (wA), which helps kick start urbanization.

• Profits accrue in the industrial sector and these profits are reinvested into capital and infrastructure.

• The economy transitions when agricultural labor is depleted, marking the end of the Lewis model, and the full transition to a post-industrial society.

Additional Considerations in Model

• Labor Unions: Labor unions can bid up wages for workers.

• Automation: Automation can displace workers and make output more efficient.

The Lewis Model

• Labor moves from agriculture to industry due to skills developments.

• The implications of this labor transfer is that industries can expand and provide higher output.

• Agricultural wage, wA, remains lower than the industrial wage, wI because cost of living is typically lower.

The Lewis Model

• Highlights that profits will increase, meaning wI will rise as overall output increases. Increased profits give companies more capital for investment.

Sectoral Interactions

• Inter-sector Linkages Understanding how the relationship goes will lead to a better society overall.

• Wage Policies Need to be flexible and adapt to a changing society

The Lewis Model

• Labor transfer affects the equilibrium wage in both sectors, and impacts how the overall economy functions.

• Industrialization leads to urbanization. Development spurs investment which leads to a virtuous cycle.

• The implications for income distribution and inequality means that as wages grow for workers they will become fairer over time.

• Shift in labor to industry leads to wage and productivity changes, meaning labor skills will grow, and they can demand increased wages which helps to make growth fair.

• When wA rises, profits are shared, so wI rises; meaning workers are being compensated fairly in both sectors of the economy as the economy progresses.

• Reinvestments fuel further industrial expansion and it all goes back into the industrial sector; showcasing