Development Economic growth represent the expansion of country’s potential GDP or national output. › Economic growth occurs when a nation’s production possibility frontier (PPF) shift outward. › A closely related concept is the growth in output per capita, because it is associated with rising average real incomes and living standards. Human resources: labor supply, education, discipline, motivation. Natural resources: land, mineral, fuels, environmental quality. Capital formation: machines, factories, roads, intellectual property, social overhead capital Technology: science, engineering, management, entrepreneurship. APF shows the relationship between inputs and technology, and total national output. Q = A F(K,L,R) Where Q = output, K = capital, L = labor, R=natural resources, A= level of technology › As technology (A) improves through new invention or the adoption of technologies from abroad, this advance allows a country to produce more output with the same level of inputs Land is primary factor in economic growth lands is freely available When population doubles, national output exactly doubles as population growth continues, all land will be occupied increasing man-land ratio leads to a declining marginal product of labor and hence to declining real wages T.R. Malthus thought that population pressures would drive the economy to a point where worker were at the minimum level of subsistence. › whenever wages were above the subsistence level, population would expand, › Wage below subsistence level would lead to high mortality and population decline › Thus, only at subsistence wages could there be a stable equilibrium of population QC QC
400 300
L=4 200 200 L=4 L=2 L=2
100 200 QF 100 125 QF
(a) Smith’s Golden Age (b) Malthus’s Dismal Science
The major ingredients in the Neoclassical model are capital and technological change. Capital consists of durable goods, including factories and house, equipment, inventories of finished goods an goods in process. Assumptions The economy is competitive and always operate at full employment A production function has constant returns to scale if, for any positive number x, xQ = A F(xL, xK) That is, a doubling of all inputs causes the amount of output to double as well. › Setting x = 1/L, › Q/ L = A F(1, K/ L) Where: Q/L = output per worker K/L = capital per worker, or The preceding equation says that productivity (Q/L) depends on physical capital per worker, or the capital –labor ratio(K/L)as well as the state of technology, (A). In the absence of technological change, capital deepening will increase › output per worker › marginal product of labor › real wages › and also will lead to diminishing returns to capital as the amount of capital per worker increases, output per worker also increases as capital deepening the marginal product of capital will fall In the long-run, the economy enter a steady state in which capital deepening cases, output per worker eventually stop rising (at V in the figure) Technological progress shift the APF upward, raises output per worker Thus, new steady state with higher level output per worker can be achieved This theory is also called Endogenous Growth Theory The new growth theory seeks to uncover the processes by which private market forces, public policy decisions, and alternative institution lead to different patterns of technological change. This approach emphasizes that technological change is an output that is subject to severe market failures because technology is a public good that is expensive to produce but cheap to reproduce. The new growth theory has changed the way we think about the growth process and public policies. › If technological differences are the major reason for differences in living standard among nations, and if technology is a produced factor, then economic-growth policy should focus much more sharply on how nations can improve their technological performance. Growth Accounting Approach (GAA) According to this approach, growth in output(Q) can be decomposed into three separate terms: growth in labor (L) times it weight, growth in capital (L) times it weight, and technological change (TC) Suppose that labor’s growth are gets 3 times the weight of capital’s growth, then equation of growth accounting: % Q growth = ¾ (% L growth) + ¼ (% K growth) + TC Where: › TC represents technological change (or Total Factor Productivity = TFP) that raises productivity › ¾ and ¼ are the relative contributions of each input to economic growth (or equal to the shares of national income of the two factors) How capital deepening would effect per capita output if technological advance were zero? % Q/L growth = % Q growth - % L Growth since, % Q growth = ¾ (% L growth) + ¼ (% K growth) + TC thus, % Q/L growth = ¼ (% K growth) + TC › Output per worker would grow only one- fourth as fast as capital per worker, reflecting diminishing returns How can we measure technological change (TC)? Recall: % Q growth = ¾ (% L growth) + ¼ (% K growth) + TC thus, TC = % Q growth - ¾ (% L growth) - ¼ (% K growth) The most important characteristic of a developing countries › Low per capita income › Poor health › Low level of literacy › Extensive malnutrition › Little capital to work with › Weak market and government institution › Corruption and civil strife › High population growth, but they suffer from out- migration, particularly among skilled worker Poor countries face great obstacles in combining factors of growth, In addition, this countries find that the difficulties reinforce each other in a vicious cycle of poverty, Countries that suffer from a vicious cycle can get caught in a poverty trap The quality of human resources › Control disease and improve health and nutrition › Improve education, reduce illiteracy, and train workers capital accumulation › Encourage saving and investment › Encourage investment from abroad Investment from abroad takes several forms: › Foreign Direct Investment Capital investment owned and operated by a foreign entity. › Foreign Portfolio Investment Investments financed with foreign money but operated by domestic residents. Diminishing Returns and the Catch-Up Effect As the stock of capital rises, the extra output produced from an additional unit of capital falls; this property is called diminishing returns. › Because of diminishing returns, an increase in the saving rate leads to higher growth only for a while The catch-up effect refers to the property whereby countries that start off poor tend to grow more rapidly than countries that start off rich. Technological progress › Promote research and development › Encourage the development of new technologies through research grants, tax breaks, and the patent system › Promote an entrepreneurship spirit › Maintain an economy open to trade › Imitating technology??? Other policies › Foster the rule of law › Make the critical investment in social overhead capital We see how countries must combine labor, capital, natural resources and technology in order to grow rapidly but, how countries might break out of the vicious cycle of poverty and begin to mobilize the four wheels of economic development. The Backwardness Hypothesis: “relative backwardness itself may aid development” 1. Countries buy modern textile, machinery, etc, 2. They can lean on the technologies of advanced countries , 3. They can draw upon the more productive technologies of the leader 4. They can grow more rapidly than did advanced countries Industrialization vs. Agriculture › The lesson of decades of attempts to accelerate industrialization at the expense of agriculture has led many analysts to rethink the role of farming › Industrialization is capital-intensive, attracts workers into crowded cities, and often produces high levels of unemployment › Raising productivity on farms may require less capital, while providing productive employment for surplus labor State vs. Market › The cultures of many developing countries are hostile on the operation of markets › Competition among firms or profit seeking behavior is contrary to traditional practices, religious beliefs, or vested interests › Yet decades of experience suggest that extensive reliance on markets provides the most effective way of managing and promoting rapid economic growth. Growth and Outward Orientation › Outward orientation or openness allowed the countries to reap economies of scale and the benefits of international specialization and thus to increase employment, use domestic resources effectively, enjoy rapid productivity growth, and provide enormous gains in living standards.
