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Economic Growth and Development Notes Economic Development

Key Distinctions

• Economic Growth: Increase in real GDP per capita, reflecting the value of goods and services produced per person.

• Economic Development: Broader concept encompassing income growth, distribution, and improvements in well-being.

• Measurement is central: insights into economies must be checked against empirical evidence.

GDP as a Measure of Economic Growth

Limitations:

• Does not capture non-market activities (e.g., unpaid labor, household production).

• Local prices in poor countries are harder to collect.

• Ignores negative externalities (e.g., environmental damage, resource depletion).

European Colonialism

• Acemoglu et al. [2002: 1279]: "Civilizations in Meso-America, the Andes, India, and Southeast Asia were richer than those located in North America, Australia, New Zealand, or the southern cone of Latin America. The intervention of Europe reversed this pattern."

• "The reversal in relative incomes over the past 500 years appears to reflect the effect of institutions (and the institutional reversal caused by European colonialism) on income today."

• "Resulted from the differential profitability of alternative colonization strategies in different environments."

  • Prosperous and densely settled areas ➡ extractive institutions.

  • Sparsely settled areas ➡ Europeans settled in large numbers and created institutions of private property, commerce, and industry.

Benefits:

• Allows comparisons of economic activity across countries and over time.

Comparing GDP Across Countries

• Market Exchange Rates: Can be misleading due to differences in purchasing power.

• Purchasing Power Parity (PPP): Uses a common set of international prices for better comparison.

• PPP-adjusted GDP typically shows that developing nations’ GDP is underestimated at market exchange rates.

Improving GDP Measurement

Findings from CMEPSP (Commission on the Measurement of Economic Performance and Social Progress):

• Capturing quality change is crucial for measuring real income and consumption.

• Government services (security, health, education) must be considered in GDP measurement.

Key Recommendations of CMEPSP:

1. Prioritize income and consumption over production.

2. Focus on household perspectives rather than per capita GDP.

3. Assess income and consumption alongside wealth (physical, natural, human, social capital).

4. Emphasize income, consumption, and wealth distribution.

5. Broaden income measures to include non-market activities (e.g., time use, leisure).

6. Improve measures of health, education, personal activities, environment, social connections, political voice, and security.

7. Assess inequalities comprehensively across quality-of-life indicators.

8. Design surveys to understand quality-of-life linkages for better policy-making.

9. Provide statistical tools for aggregating quality-of-life measures (e.g., HDI).

10. Integrate objective and subjective well-being metrics in national statistics.

11. Sustainability assessment should use indicators tracking changes in key stocks.

12. Environmental sustainability requires physical indicators and clear thresholds for environmental damage.

Implications of Improved GDP Measurement

• Growth and environmental improvements are not necessarily trade-offs.

• A comprehensive well-being measure may reveal positive impacts of environmental improvements even if GDP declines.

Productivity and Economic Growth

• Essential for sustainable GDP growth.

• Higher productivity → higher profits, investment, real wages, jobs, and exports.

• Factors influencing productivity:

  • Human and social capital

  • Property rights

  • Competition

  • Economic and political stability

  • Regulation of public goods

  • Innovation

Harrod-Domar Economic Model

Factor Accumulation, Productivity, and Growth

• Economists have been trying to understand the determinants of economic growth.

• At the core of most theories of economic growth is a relationship between the basic factors of production—capital and labor—and total economic production.

• A country's total output is determined by how much capital and labor it has available and how productively it uses those assets.

• Economic growth depends on increasing the amount of capital and labor available and increasing the productivity of those assets.

Savings, Investment, and Capital Accumulation

1. Aggregate production function: output is a function of the capital stock and labor supply.

   • Y = F(K, L)

2. Total savings (S) is a fixed share of income.

   • S = sY (where s is the average savings rate).

3. Saving-investment identity: in a closed economy, saving must be equal to investment.

   • S = I

4. Capital stock changes over time: two main forces determine changes in capital stock—new investment and depreciation.

   • ∆K = I - (dK) (where d is the rate of depreciation).

5. The supply of labor grows at the same rate as the population.

   • ∆L = nL (where n is the growth rate of population and labor force).

6. Change in capital stock:

   • ∆K = sY - dK

7. The growth rate of output, g, is:

   • g = (s / v) - d

   • Growth depends on:

     • Savings rate s (higher savings boost growth).

     • Capital-output ratio v (higher v slows growth).

     • Depreciation rate d (higher depreciation reduces growth).

Conceptions of Development

Development as Material Growth:

• Authorities command resources to promote:

  • GDP growth

  • Industrial production

  • Technological advancements

  • Firm survival amid competition

Solow’s Economic Growth Model (Prof. Carlos Pio)

From H-D to Solow’s Growth Model

• Solow replaced the fixed-coefficient production function with a neoclassical production function that allows for more flexibility and substitution between factors of production.

• The capital-output and capital-labor ratios are no longer fixed but vary depending on capital and labor endowments.

• The Solow model retains constant returns to scale.

Development as Freedom (Amartya Sen’s Perspective):

• Development expands real freedoms (beyond just income growth).

• Key freedoms depend on:

  • Social and economic arrangements (education, healthcare).

  • Political and civil rights (public participation, scrutiny).

• Removing major sources of unfreedom:

  • Poverty, tyranny, social deprivation, lack of public facilities.

• Progress measured by enhancement of freedoms and interaction of free agents.

Freedom and Market Access:

• Markets are crucial for development but require social support and regulation.

• Shared norms influence economic and social structures (e.g., gender equity, corruption levels, trust).

The Role of Technology

15. Incorporating technological progress:

    • Y = F(K, T * L)

    • Technological change improves productivity without increasing labor.

    • Technology improves at a constant rate θ.

    • Workforce growth n + θ.

    • Output per effective worker:

      • ye = Y / (T * L)

      • ke = K / (T * L)

Five Instrumental Freedoms:

1. Political freedoms (speech, elections)

2. Economic facilities (participation in trade/production)

3. Social opportunities (education, health)

4. Transparency guarantees

5. Protective security

Requisites for Convergence

• Factors influencing economic growth:

  • Greater economic and political stability.

  • Better health and education.

  • Stronger governance and institutions.

  • More export-oriented trade policies.

  • Favorable geography.

• Conditional vs. Unconditional Convergence:

  • Countries with similar savings rates, population growth, and depreciation will converge in income levels.

  • Poor policy decisions contradicting Solow’s model prevent convergence.

Growth Diagnostic Methodology

• Identifying the most binding constraints on economic growth.

• Differentiating between capital accumulation, labor force dynamics, and technological progress.

• Evaluating institutional and policy factors influencing development.

Latin America’s Development Trap

• High inequality and low growth create a reinforcing trap.

• Key factors:

  1. Concentration of power (economic & political dominance by elites).

  2. Violence (linked to inequality, worsens economic conditions).

  3. Distorted social protection & labor market policies (segmented labor markets, weak redistribution).

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Trends in Inequality:

• Income inequality declined in early 2000s but stagnated in the 2010s, reversing before COVID-19.

• LAC remains the second most unequal region globally.

• Inequality fuels perceptions of unfairness, influencing political attitudes.

Economic Consequences:

• Power concentration distorts policies for elite benefits.

• Weak competition policies allow monopolies.

• Fiscal systems are ineffective at redistribution.

• Business elites influence policies to lower taxes and limit redistribution.

• Labor unions sometimes collude with businesses, reducing competition.

Violence and Inequality Cycle:

• Inequality → violence → worsens inequality.

• LAC has the highest homicide rates globally, hindering investment and productivity.

Challenges in Social Protection:

• Fragmented systems exclude informal workers.

• Limited success in addressing inequality and productivity.

Policy Recommendations:

• Implement universal, inclusive, and growth-friendly social protection.

• Address the structural issues of power concentration, violence, and weak redistribution.

Theories of Economic Growth

PRITCHETT’s Four Key Questions:

1. Why do leading countries sustain technological progress and per capita growth?

2. Why do some countries initiate and sustain rapid growth (convergence)?

3. Why do some countries lose momentum and stagnate?

4. Why do some countries remain in low-growth traps for extended periods?

Two Groups of Countries Since 1870:

• Developed nations: Rapid, similar growth rates with convergence among poorer members.

• Non-developed nations: Slower growth, divergence from rich nations, mixed records of take-offs, stalls, and collapses.

Divergence: India & China’s Historical Reversal

• Pre-18th century: India and China were wealthier than European countries.

• Modern science and industrialization led to divergence.

Justin Yifu Lin on China’s Development:

- "China … fell behind the West in modern times because technological invention in China continued to rely on happenstance and experience, while Europe changed to planned experiment cum science in the scientific revolution of the seventeenth century" [p. 286].

- "China failed to have a scientific revolution … [because] the contents of civil service examinations and the criteria of promotion, … distracted the attention of intellectuals away from investing the human capital necessary for modern scientific research."

- Developing countries today should import modern technologies available at a lower cost and educate the population to promote adaptive innovations on the imported technology.

European Colonialism:

- Acemoglu et al. [2002: 1279]: "Civilizations in Meso-America, the Andes, India, and Southeast Asia were richer than those located in North America, Australia, New Zealand, or the southern cone of Latin America. The intervention of Europe reversed this pattern."

- "The reversal in relative incomes over the past 500 years appears to reflect the effect of institutions (and the institutional reversal caused by European colonialism) on income today."

- "Resulted from the differential profitability of alternative colonization strategies in different environments."

   - Prosperous and densely settled areas ➡ extractive institutions

^ meaning they focused on exploiting local resources and labor rather than building inclusive economic systems.

- Sparsely settled areas ➡ Europeans settled in large numbers and created institutions of private property, commerce, and industry leading to long term economic growth.

Advantages (and Disadvantages) of Backwardness:

Backwardness: refers to a country's economic lag compared to more developed nations, which can create opportunities to adopt advanced technologies, skip outdated methods, and rapidly industrialize with government support.

- Gerschenkron: Governments of developing and poor countries will, to varying degrees, try to promote rapid industrialization in search of wealth creation. Backwardness provides them with key advantages to explore:

   - Learning from historical paths of more developed nations.

   - Adopting cutting-edge technologies accessible through imports.

- Creating institutions (policies) and organizations (for instance, government agencies) that can accelerate the rates of capital investment needed to promote manufacturing via subsidies or state-owned enterprises.

- [PIO] But local conditions—especially the quality of human capital—will be a tremendous challenge to turn industrialization into prosperity.

- It is also essential to keep international trade free, allowing the importation not only of raw materials and advanced technologies but also of parts and components.

- Governments are also subject to poor ideologies (manufacturing fallacies or fetishisms) and lobbying

- Competition for limited government funds between subsidizing firms to acquire physical capital (machines) and people to acquire capabilities/skills (human capital) has led most developing countries to a combination of inefficient manufacturing firms and poorly skilled, low-productivity labor.

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Harrod-Domar Economic Model 

Factor Accumulation, Productivity, and Growth

- Economists have been trying to understand the determinants of economic growth.

- At the core of most theories of economic growth is a relationship between the basic factors of production—capital and labor—and total economic production.

- A country's total output is determined by how much capital and labor it has available and how productively it uses those assets.

- Economic growth depends on increasing the amount of capital and labor available and increasing the productivity of those assets.

Savings, Investment, and Capital Accumulation

1. Aggregate production function: output is a function of the capital stock and labor supply.

   - Y = F(K, L)

2. Total savings (S) is a fixed share of income.

   - S = sY (where s is the average savings rate).

3. Saving-investment identity: in a closed economy, saving must be equal to investment.

   - S = I

4. Capital stock changes over time: two main forces determine changes in capital stock—new investment and depreciation.

   - ∆K = I - (dK) (where d is the rate of depreciation).

5. The supply of labor grows at the same rate as the population.

   - ∆L = nL (where n is the growth rate of population and labor force).

6. Change in capital stock:

   - ∆K = sY - dK

7. The growth rate of output, g, is:

   - g = (s / v) - d

   - Growth depends on:

     - Savings rate s (higher savings boost growth).

     - Capital-output ratio v (higher v slows growth).

     - Depreciation rate d (higher depreciation reduces growth).

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Solow’s Economic Growth Model

From H-D to Solow’s Growth Model

- Solow replaced the fixed-coefficient production function with a neoclassical production function that allows for more flexibility and substitution between factors of production.

- The capital-output and capital-labor ratios are no longer fixed but vary depending on capital and labor endowments.

- The Solow model retains constant returns to scale.

Basic Equations of the Solow Model

12. Expressing all variables in per-worker terms:

    - Y / L = F(K/L, L/L)

    - y = f(k) (where y = Y/L, k = K/L).

13. Capital accumulation equation:

    - ∆k = sy - (n + d)k

    - Saving per worker increases capital per worker.

    - Population growth (-nk) and depreciation (-dk) reduce capital per worker.

14. Capital deepening: increasing capital per worker boosts productivity.

    - Capital widening: capital stock increases to match labor force growth and depreciation.

The Role of Technology

15. Incorporating technological progress:

    - **Y = F(K, T L)*

    - Technological change improves productivity without increasing labor.

    - Technology improves at a constant rate θ.

    - Workforce growth n + θ.

    - Output per effective worker:

      - **ye = Y / (T L)*

      - **ke = K / (T L)*

Requisites for Convergence

- Factors influencing economic growth:

  - Greater economic and political stability.

  - Better health and education.

  - Stronger governance and institutions.

  - More export-oriented trade policies.

  - Favorable geography.

- Conditional vs. Unconditional Convergence:

  - Countries with similar savings rates, population growth, and depreciation will converge in income levels.

  - Poor policy decisions contradicting Solow’s model prevent convergence.

Growth Diagnostic Methodology

- Identifying the most binding constraints on economic growth.

- Differentiating between capital accumulation, labor force dynamics, and technological progress.

- Evaluating institutional and policy factors influencing development.