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Chapter 3
Outline
Invariably viewed as
crucial determinants
of economic growth
Growth is an exogenous
quantity from an economic
point of view
Technological change
and economic growth
are both endogenous
after all
Endogenous growth:
Fig 3.1
Determination of economic
growth and technological
progress
Economic
growth
Saving rate
times efficiency
minus
depreciation
T
G
B
45
Population growth
Technological progress
Endogenous growth
and technology
Summarize the main implications of
endogenous-growth theory with the aid of a
simple diagram
trace the effects of
certain exogenous
events on economic
growth and
technological
progress, both of
Experiment 1: The saving rate which are
endogenous
Experiment 2: Efficiency
Experiment 3: Depreciation
Experiment 4: Population growth
Endogenous Growth:
Fig 3.2
Economic
growth
G
B
G
A
45
Technological progress
the model is
silent on the time it
takes the economy
to move from one
equilibrium to
another
and about the
stability of the
growth
equilibrium
Endogenous Growth:
Fig 3.2
Economic
growth
G
B
G
A
45
Technological progress
Experiment 2: Efficiency
What happens if efficiency increases?
shifts the G line up to G
thereby increasing both
economic growth and technological
progress
What does the interaction
of saving and efficiency
mean?
it means that a given level of
saving translates increased
efficiency into more growth
increased saving
and increased
efficiency have
qualitatively the
same effect on
economic growth and
technological
progress
Fig 3.2 covers both
cases
Endogenous Growth:
Fig 3.3
Economic
growth
A
G
B
45
Technological progress
Experiment 3:
Depreciation
What happens if capital begins to
depreciate more rapidly than
before?
depends on whether more
has been added to it by the
good conduct of some, than
had been taken from it either
by the private misconduct of
others, or by the publick
extravagance of government
(Smith)
Therefore, if the depreciation of
capital is sufficiently rapid, the
capital stock will decline, so
that output also declines:
economic growth then becomes
negative
Experiment 3: Depreciation
Let us return to the model
If the capital stock begins to
depreciate more rapidly than
before
the G line shifts down to G
the growth equilibrium
moves south-west from A to
B
Economic growth slows down, and so does
technological progress, because it follows
per capita growth, and not vice versa,
through learning by doing
More
depreciation
means less
growth
Endogenous Growth:
Fig 3.4
T
Economic
growth
Experiment 4
T
G
45
H
O
Technological progress
Endogenous growth
accounting
Saving rate
Figures 3.1-3.3
Qualitative reactions of
endogenous economic growth
and technological progress to
changes in the three key
determinants of growth
What if we assign plausible
values to the parameters of our
simple model?
This amounts to growth accounting
that differs from the conventional
kind
Efficienc
y
Depreciation
Endogenous growth
accounting
Table 3.1
Economic Growth
Efficiency
0.30
Efficiency
0.40
Efficiency
0.50
-0.03
-0.02
-0.01
0.00
0.02
0.04
0.03
0.06
0.09
0.06
0.10
0.14
When the saving rate rises from 10% of GDP to 40% ...
annual output growth rises by 9 to 15
percentage points, depending on
efficiency
An increase in efficiency from 0.3 to 0.5 ...
... increases annual growth by 2 to 8
percentage points, depending on the
saving rate
Examples:
Togo
Norway
Table 3.2
Decomposition of
Growth
in Sub-Saharan Africa, East Asia and Pacific,
and the World, 1980-1995
Sub-Saharan
Africa
East Asia
and Pacific
World
Growth, 1980-1995
0.016
0.085
0.027
0.22
0.34
0.24
Efficiency (assumed)
0.40
0.33
0.33
Depreciation (residual)
0.072
0.027
0.052
Endogenous growth
accounting
Table 3.3 shows an example of
conventional economic growth
accounting for comparison
1. Capital growth
through investment
2. Labour-force
growth via population
increase
3. A residual, which is
attributed to total
factor productivity
growth
Table 3.3
Four East
Asian
Countries
1966-1990
Seven Latin
American
Countries
1940-1980
Growth of output
0.039
0.088
0.049
Contribution of capital
0.021
0.044
0.024
Contribution of labor
0.005
0.032
0.013
Contribution of total
factor productivity
(residual)
0.013
0.012
0.012
This means an
increase in total factor
productivity of about
1.25% per year on
average
Population growth has
mattered much more
in East Asia, where it
has added more than
3 per-centage points
to the annual growth
rate of output on
average
Endogenous growth
accounting
What are the implications of the output-input
approach?
Lets take an example of the spectacular
growth performance of the East Asian
economies
Endogenous growth
accounting
Nothing particularly Soviet about saving behaviour in
East Asia or about the way in which savings in the EastAsian countries generally have been channelled into
investment
Saving rates in East Asia have
risen to their present level in
response to climate for saving
which has been ...
friendly
marketorientated
stable
modest inflation
policyinduced
Not interested
mainly in economic
growth as such
but rather
in the fruits of
growth
Level of income
Standard of life
Fig 3.5
Endogenous Growth:
Determination of Capital Per
Worker
and Output Per Head
C
Output
per head
Output/capital
ratio
Capital per worker
Fig 3.6
Endogenous Growth:
An Increase in the Real Interest Rate or in
Depreciation Reduces Capital Per Worker and
Output Per Head
C
C
Experiment 1
Output
per head
P
A
B
Fig 3.6
Endogenous Growth:
An Increase in the Real Interest Rate or in
Depreciation Reduces Capital Per Worker and
Output Per Head
C
C
Experiment 2
Output
per head
P
A
B
Experiment 2: Depreciation
causes the cost of capital to rise
qualitatively the same effect as
that
of an increase in the interest rate
the capital/output ratio falls,
and so do both capital per
worker and output per head
Increased depreciation is likely
to reflect, at least in part, a
deterioration in the quality
and profitability of investment
decisions
Fig 3.7
Endogenous Growth:
An Increase in Static Efficiency
Increases Capital Per Worker and
Output Per Head
C
P
Output
per head
B
P
A
Experiment 3
Experiment 3: Efficiency
Static efficiency increases
The production function shifts
upwards from P to P in Figure
3.7
This causes both capital per
worker and output per head
to increase
The capital/output ratio remains
unchanged because the C line does not
move
Economic growth per capita
must increase at least
temporarily as the economy
moves from A to B
Note: Increased
static efficiency
increases also
dynamic
efficiency
The production
function will be
drifting upwards more
rapidly than before
In sum
Three
important
determinants
of
income per
head
Income per
head is our
main measure
of the standard
of living
In sum
An increase in the
saving rate ...
... results in
accumulation of
capital ...
which tends to drive its
price - i.e. the real
interest rate - down
Fig 3.8
Exogenous Growth:
Determination of Capital Per
Worker and Output Per Head
C
Output
per head
Output/capital
ratio
shows a production
function relating output
per capita to capital per
worker with diminishing
returns
Capital per worker
population growth
then the
productivity gains
capital/outpu
t
depreciatio
ratio
n
increases
Diminishing returns to capital
Output increases more slowly than
capital
The capital/output ratio slows down little by
little
until it stops when the long-run equilibrium growth path has
been reached
Along this path, output, capital,
and labour in efficiency units all
grow at the same rate, which is
exogenously given by
technological progress
What does
that mean?
In Figure 3.8, we
assume that this
adjustment process
has been completed,
so that the C line
reflects a constant
capital/output ratio in
long-run equilibrium
The point of
intersection between
the production function
and the C line shows
the corresponding
long-run equilibrium
values of output per
head and capital per
head
population growth
productivity growth
depreciation
By contrast, the
equilibrium point in
Figure 3.5 reflects
both short-run and
long-run equilibrium
Fig 3.8
Exogenous Growth:
Determination of Capital Per
Worker and Output Per Head, Again
C
Output
per head
Output/capital
ratio
Capital per worker
effects of certain
exogenous events
on output per
Experiment 1: Saving rate
head and capital
per worker, both
Experiment 2: Static efficiency
of which are
Experiment 3: Population growthendogenous
Experiment 4: Depreciation
Experiment 5: Technological progress
Fig 3.9
Output
per head
Exogenous Growth:
An Increase in the Saving Rate
Increases Capital Per Worker and
Output Per Head
The economy moves gradually
from its initial long-run equilibrium
point A to its new long-run
equilibrium point B
Experiment 1
C
P
B
Exogenous Growth:
An Increase in Static Efficiency Increases
Fig 3.10 Capital Per Worker and Output Per Head
Experiment 2
C
P
Output
per head
B
P
A
Point B drifts northeast
along the C line at the
rate of technological
progress
Capital per
Experiment 2: Efficiency
Increase in static
efficiency produces a
temporary boost to
economic growth
shifts the production function upwards
Effects of an increase
in static efficiency
Exogenous Growth:
An Increase in Population Growth or in Depreciation
Fig 3.11 Reduces Capital Per Worker and Output Per Head
Output
per head
Experiment 3
C
P
A
B
But once the adjustment has been
completed, the rate of growth of output
equals the rate of population growth
plus the exogenous rate of
technological progress
Capital per worker
Exogenous Growth:
Fig 3.11
C
Output
per
head
Experiment 4
C
P
A
B
The capital/labour
ratio begins to decline
and output per head
also falls
Capital per
Experiment 4: Depreciation
The capital stock begins to depreciate more rapidly than
before
The current level of
saving and investment is
no longer enough to keep
the capital stock per
worker intact
Exogenous Growth:
An Increase in Dynamic Efficiency (Technological
Fig 3.12 Progress) Increases Capital Per Worker and Output
Per Head
Experiment 5
C
C
Output
per head
P
A
Capital per
worker in
efficiency units
falls
Capital per worker
Experiment 5:
Technological progress
Increased dynamic efficiency
increase in the rate of technological
progress
Affects capital per worker
and output per head in
two ways
1. The production function
begins to drift upwards at faster
pace than before
2. The current level of saving
and investment no longer
suffices to maintain capital in
its original equilibrium
proportion to labour in
efficiency units
because the
quality, i.e.
efficiency, of labour
is now improving
more rapidly than
before
Capital per worker
in efficiency units
falls
Experiment 5:
Technological progress
Notice the
symmetry
If population growth,
depreciation, or
technological progress
increase, then the current
amount of saving and
investment needed to
maintain capital in its
original equilibrium
proportion to labour in
efficiency units increases,
leaving less for the
accumulation of fresh
capital,
which
means
that
The C line
rotates
counterthe
capital/output
ratio
clockwise
to C
Summary of experiments
An increase in the saving rate
increases output per head
(Fig 3.9)
(Fig 3.10)
(Fig 3.11)
(Fig 3.11)
(Fig 3.12)
Summary of experiments
The long-run equilibrium level of output per capita
depends
on
Saving rate Static efficiency Depreciatio
Population growth
as well as on
Dynamic efficiency
even if the long-run
equilibrium rate of growth of
output per head depends
solely on dynamic efficiency
- i.e. technological progress
Summary of experiments
First
How sensitive is the level of output per head?
- to variations in ...
Is it, in particular,
sensitive enough for
us to be able on that
basis to account for
the observed
differences in living
standards across
countries?
Summary of experiments
Second
If an increase in the
saving rate or in static
efficiency or a decrease
in depreciation provides
only a temporary boost
to economic growth
then how
long does it
take? How
long is the
medium term?
Mozambique
United States
Table 3.4
Depreciation
rate = 0.08
Saving rate
0.1
Saving rate
0.2
Saving rate
0.3
Saving rate
0.4
General
efficiency 1
1.00
1.41
1.73
2.00
General
efficiency 2
2.83
4.00
4.90
5.66
General
efficiency 3
5.20
7.35
9.00
10.39
General
efficiency 4
8.00
11.31
13.86
16.00
Fundamental implication:
Saving rate rises
Decades!
Capital/output ratio
4,00
3,75
3,50
3,25
3,00
2,75
2,50
0
14 21 28 35 42 49 56 63 70 77 84 91 98
Years
Exogenous Growth:
Determination of Economic Growth and
Efficiency
just as we described
the endogenousgrowth model in
Figures 3.1-3.12
Exogenous Growth:
Fig 3.14 Determination of Economic Growth and
Efficiency
E
Economic
growth
S
Saving rate
Efficiency
Depreciation
Experiment 1:
Experiment 2:
Experiment 3:
Experiment 4:
Exogenous Growth:
An Increase in the Saving Rate Increases
Fig 3.15 Economic Growth for a Long Time, but Not
Forever
Economic
growth
G
B
C
Efficiency
Exogenous Growth:
An Increase in Depreciation Reduces
Fig 3.16 Economic Growth for a Long Time, but Not
Forever
Economic
growth
B
Efficiency
Experiment 2: Depreciation
Exogenous Growth:
An Increase in Static Efficiency Increases
Fig 3.17 Economic Growth for a Long Time, but Not
Forever
E
G
Economic
growth
B
A
S
Efficiency
Exogenous Growth:
Fig 3.18
E
Economic
growth
E
B
G
S
S
Efficiency
Experiment 4: Population
growth
Experiment 5: Technological progress
because consumption
plus saving equals output
It follows that
consumption is also
proportional to output ...
Lets suppose:
On average
nations save and
invest about 20%
of their income
8. Impatience again
4. Depreciation
5. Impatience
Economic
growth
Determination of Economic
Growth and the Real Interest Rate
Population growth
plus technical progress
45
Real interest rate
Impatience minus
population growth
G
Economic
growth
B
S
A
S
45
Real interest rate
Experiment 1
G
Economic
growth
B
A
G
S
S
45
Real interest rate
Experiment 2
Economic
growth
Experiment 3
Economic
growth
B
C
G
S
45
Real interest rate
Experiment 4
Economic
growth
45
Real interest rate
Impatience minus
population growth
Economic
growth
B
A
Experiment 5
45
Real interest rate
Economic
growth
G
A
Depreciation again
B
45
Economic
growth
B
A
G
Experiment 7
Impatience again
45
Real interest rate
Experiment 8
But quantitatively
they
are quite different
400
350
Before
After (Exogenous growth)
After (Endogenous growth)
300
250
200
150
100
50
0
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Years
Table 3.5
Optimal Economic
Growth: Overview of
Results
Economic growth
Real interest rate
Reference
Exogenous growth
Saving rate
Zero/plus
Minus/zero
Fig 3.23
Efficiency (dynamic)Plus
Plus
Fig 3.20
Depreciation
Zero/minus
Fig 3.22
Zero
Fig 3.21
Zero/minus
Endogenous growth
Saving rate
Plus
Zero
Fig 3.27
Efficiency (static)
Plus
Plus
Fig 3.25
Depreciation
Minus
Minus
Fig 3.26
Zero
Fig 3.27
Summary
Main message
Not much qualitative difference
between endogenous and exogenous
growth
efficiency depreciation
Summary
The time span over which saving and
efficiency exert a potentially
strong influence on economic growth ...
lasting decline in the price of its main exports, for example. This shock
lowers the standard of living, and people decide to consume more and
save less out of current income, other things being equal. If this change
is permanent, how would you expect it to influence
I. the rate of growth of output per capita in the long run and
II. the level of income per capita in the long run?
Classroom discussion