Economic Growth II: Technology,

Empirics, and Policy

Chapter 9 of Macroeconomics,
8th edition, by N. Gregory
Mankiw
ECO62 Udayan Roy
 Recap: Solow-Swan, Ch. 7
L and K are used to produce a final good Y =
F(K, L)
k = K/L and y = Y/L = f(k) are per worker
capital and output
The population is P, but a fraction u is not
engaged in the production of the final good.
Therefore, L = (1 u)P.
Both P and L grow at the rate n.
A fraction s of Y is saved and added to capital
A fraction of K depreciates (wears out)
 Recap: Solow-Swan, Ch. 8
In the long run, the economy reaches a
steady state, with constant k and y

sf (kt ) ( n)kt
kt
n 1
 Recap: Solow-Swan, Ch. 8
In the long run, the economy reaches a
steady state, with constant k and y
Like the per-worker variables, k and y,
per-capita capital and output are also
constant in the long run
Total capital (K) and total output (Y)
both increase at the rate n, which is
the rate of growth of both the number
of workers (L) and the population (P)
 Recap: Solow-Swan, Ch. 8
Variable Symbol Steady state
behavior
Capital per worker k Constant
Income per worker y = f(k) Constant
Saving and investment per sy Constant
worker
Consumption per worker c = (1 Constant
s)y
Labor L Grows at rate n
Capital K Grows at rate n
Income Y = F(K, Grows at rate n
L)
Saving and investment sY Grows at rate n
Population P Grows at rate n
Capital per capita (1 u)k Constant
Income per capita (1 u)y Constant
 The sad lesson of Solow-
Swan
It is an undeniable fact that our standards
of living increase over time
Yet, Solow-Swan cannot explain this! Why?
Solow-Swan relies on capital accumulation
as the only means of progress
Therefore, the models failure to show
economic progress indicates that we must
introduce some means of progress other
than capital accumulation
 Technological Progress
Maybe Solow-Swan fails to show
economic progress because there is
no technological progress in it
We need to create a theory with
technological progress
But how?
 Technological Progress
A simple way to introduce
technological progress into the
Solow-Swan model is to think of
technological progress as
increases in our ability to
multitask
 Technological Progress
Imagine that both population and the
number of workers are constant but
that steady increases in the workers
ability to multitask creates an
economy that is equivalent to the
Solow-Swan economy with steadily
increasing population
 Technological Progress
In such an economy, total output would be
increasingexactly as in the Solow-Swan
economy with steady population growthbut
without population growth
That is, under multitasking technological
progress, per capita and per worker output
would be steadily increasing
In this way, a simple re-interpretation of the
Solow-Swan economy gives us what we were
looking forsteadily increasing income per
worker
 Efficiency of Labor
Specifically, section 91 defines a
new variable
E is the efficiency of labor
Specify some date in the past, say 1984,
and arbitrarily set E = 1 for 1984.
Lets say that technological progress has
enabled each worker of 2011 to do the
work of 10 workers of 1984.
This implies that E = 10 in 2011.
 Efficiency of Labor
The old production function F(K,L) no longer
applies to both 1984 and 2011
Suppose K = 4 in both 1984 and 2011
Suppose L = 10 in 1984 and L = 1 in 2011
The old production function F(K,L) will say that
output is larger in 1984
But we know that output is the same in both years
because just one worker in 2011 can do the work
of 10 workers of 1984
We need a new production function: F(K, E
L)
 Y = F(K, E L)
In other words, although the number
of human workers is 10 in 1984 and
1 in 2011, the effective number of
workers is 10 in both years,
and thats what matters in
determining the level of output
The effective number of workers is E
L
 Efficiency of Labor
Assumption: the efficiency of labor
grows at the constant and
exogenous rate g
 Production
As the production of the final good no
longer depends only on the number
of workers, but instead depends on
the effective number of workers,
we replace the production function

Y = F(K, L) by the new production

function
Y = F(K, E L)
From per worker to per effective
worker
Similarly, we will now redefine k,
which used to be capital per worker
(K/L), as capital per effective worker:
k = K/(E L)
Likewise, we will now redefine y,
which used to be output per worker
(Y/L), as output per effective worker:
y = Y/(E L)
From per worker to per effective
worker
As a result of the redefinition of k and
y, we still have y = f(k), except that
the definitions of y and k are now in
per effective worker form
sy = sf(k), is now saving (and
investment) per effective worker
Only the growth rate of effective
labor is slightly different
From per worker to per effective
worker
In Chapter 8, what mattered in
production was L, the number of
workers, and the growth rate of L
was n
Now, however, what matters in
production is E L, the effective
number of workers, and the growth
rate of E L = growth rate of E +
growth rate of L = g + n
From per worker to per effective
worker
Recall from Chapter 8 that the break-even
investment per worker was ( + n)k
This will have to be replaced by the break-
even investment per effective worker
We can do this by redefining k as capital
per effective worker (which we have
already done) and by replacing n by g + n
Therefore, break-even investment per
effective worker is now ( + n + g)k
 Dynamics: algebra
Ch. 8 No technological Ch. 9 Technological
change Progress

sf (kt ) ( n)kt
kt kt 1 kt
n 1

sf (kt ) ( n g )kt
kt kt 1 kt
n g 1
 Dynamics: graph
As in Ch. 8, in the long run, k and
y reach a steady state at k = k*
and y = y* = f(k*)

sf (kt ) ( n g )kt
kt
n g 1
Describing the Steady State
We just saw that k is constant in the
steady state
That is, k = K/(E L) is constant
Therefore, in terms of growth rates,
kg = Kg (Eg + Lg) = Kg (g + n) = 0
Therefore, the economys total
stock of capital grows at the rate
Kg = g + n
Describing the Steady State
Capital per worker (K/L) grows at the
rate Kg Lg = g + n n = g
Therefore, the per-worker capital
stock, which was constant in
Chapter 8, grows at the rate g
As each workers ability to multitask
increases at the rate g, the capital
used by a worker also increases at that
rate
Describing the Steady State
y = f(k) is constant in the steady state
That is, y = Y/(E L) is constant
Therefore, in terms of growth rates,
yg = Yg (Eg + Lg) = Yg (g + n) = 0
Therefore, the economys total
output grows at the rate Yg = g + n
Recall that this is also the growth rate of the
total stock of capital, K.
Describing the Steady State
Output per worker (Y/L) grows at the
rate Yg Lg = g + n n = g
Therefore, the per-worker output,
which was constant in Chapter 8,
grows at the rate g
Recall that this is also the growth rate of
per-worker capital, K/L.
 Progress, finally!
We have just seen that if we
introduce technological
progress in the Solow-Swan
theory of long-run growth, then
in the economys steady state
Per-worker output (Y/L) increases
at the rate g, which is the rate of
technological progress
This is a major triumph for the
Solow-Swan theory
 Solow-Swan Steady State
Table 9.1 Steady-State Growth
Rates in the Solow Model With
Technological Progress
 Solow-Swan Steady State
Remember from Chapter 8 that, when
the production function follows the
Cobb-Douglas form, the steady state
value of k = k* was given by the
formula

Now the formula changes to sA 1

k
*

n g
Technological Progress: where does
it come from????
But a puzzle remains
So far, the rate of technological
progress, g, has been exogenous
We need to ask, What does g depend
on?
We need to make g endogenous
Endogenous Technological Progress

Remember that in Chapter 8 we had

distinguished between the population (P) and
the number of workers (L)
We had defined the exogenous variable u as
the fraction of the population that does not
produce the final good
Therefore, we had L = (1 u)P or L/P = 1 u
In Ch. 8 we had interpreted u as the long-run
unemployment rate
Now, well reinterpret u as the fraction of
the population that does scientific
research
Endogenous Technological Progress

Once u is seen as the fraction of the

population that is engaged in
scientific research, it makes sense to
assume that
Assumption: the rate of
technological progress increases
if and only if u increases
This assumption is represented by
the technology function g(u)
Example: g(u) = g0 + guu
Endogenous Technological Progress

We now have a theory that gives an

answer to the following question: Why
is growth in living standards slow in
some cases and fast in others?
Growth in per-worker output is
fast when u is high.
That is, our standards of living
grow rapidly when we invest more
heavily in scientific research
 Productivity Slowdown
There was a worldwide slowdown in economic
growth during 1972-1995. Why?
 Growth Accounting
Table 9.3 Accounting for Economic
Growth in the United States