Coordination Failures and Government Policy: Evidence From Emerging Countries

by

J. STEPHEN FERRIS Department of Economics Carleton University, Ottawa, K1S 5B6 sferris@ccs.carleton.ca

and

KISHORE GAWANDE Department of Economics University of New Mexico, Albuquerque, NM 87131 gawande@unm.edu

Draft version: May 1998

Coordination Failures and Government Policy: Evidence From Emerging Countries

by Stephen Ferris and Kishore Gawande

Abstract

Rodrik (JIE 1996) argues for the use of government policy in cases where emerging countries are stuck in a low wage equilibrium because of a coordination failure. His coordination failure arises between downstream producers and their upstream intermediate suppliers when the production of high tech final goods requires a special set of differentiated intermediate goods. To qualify, intermediate inputs need to be produced under increasing returns to scale and nontradeable, the latter necessitating domestic production. In addition, a threshold number of varieties of the intermediate goods must be used before high tech production becomes viable. Then because the marginal returns associated with changes in individual intermediate output are markedly below the return that can be realized when a threshold number of intermediate goods are produced in concert, the expectation that a sub-optimal number of varieties will be forthcoming is sufficient to discourage entry into intermediate production and so prevent a high tech sector from becoming viable. The result is that a countrys high tech sector may not take off even when the country has the requisite skills and levels of human capital. In such cases, skilled labor will earn abnormally low returns and net social returns can be realized by affecting coordinated action (through government). Rodrik argues that this scenario plagues many transition countries, especially those characterized by high levels of human capital relative to their endowed level of physical capital. We test two hypotheses from Rodrik's paper: Hypothesis 1: A coordination failure among intermediate producers of inputs into the high tech sector leads to a low wage equilibrium. Hypothesis 2: Government policy is needed to solve the coordination failure among intermediate producers of inputs into the high tech sector and can move a country from a low to high wage equilibrium. Tests of these hypotheses are performed on data from the transition experiences of two sets of Eastern European, African and Asian countries. The tests form part of the growing empirical literature underlying the modeling of long run growth and shorter term transition processes. Such empirical knowledge is needed to better inform policy debate and to suggest directions of promise for future theoretical research. Our empirical tests take a more immediate step by beginning to test the general theory of threshold externalities (e.g. Azariades and Drazen, QJE 1990).

COORDINATION FAILURES AND GOVERNMENT POLICY: EVIDENCE FROM EMERGING COUNTRIES

I.

INTRODUCTION

In this paper we present two different tests of the Rodrik hypothesis that entrepreneurial coordination problems, arising within the intermediate good sector of high-technology industries, can produce a low wage/income trap for some subset of emerging economies. The subsidiary proposition is that the government can be used to overcome the coordination failure and internalize the coordination externality. The reason for presenting two different sets of tests is that no one data set allows a broad enough basis for fully testing both hypotheses, but by combining the advantages of two databases, we can shed more light on the range of coordination issues that surround this important development hypothesis.

The first set of test uses the International Yearbook of Industrial Statistics, (UNIDO 1995). This database presents detailed information on manufacturing industries across a large set of developed and developing countries, particularly in relation to valued added, gross sales, and wage payments. It does not, however, present corresponding detail on the nature of government policies. To test the government intervention hypothesis, then, we selected a subset of countries that had an explicit development strategy of the type advocated by Rodrik. Differential performance by this subset of countries compared with the rest was used to isolate evidence of a special productivity role for government. The second data set, World Development Indicators, 1996, was more extensive in that it covered a wider set of socio-economic

variables and allowed more continuous observations on a number of different government policy variables. This data set then allowed the Rodrik-Ethier externality hypothesis to be placed within more traditional growth theory and so exploit continuity in government data across countries to test for the differential effect of policy on growth. Another advantage of this data was that it allowed implicit comparison of government versus the financial sector as an alternative for overcoming private coordination externalities in the growth process. The analysis begins in Section II with an outline of the Rodrik-Ethier model that underlies the empirical tests. Two methods are used to test the predictions that follow from that analysis. In Section III. A., method 1 uses the discreteness of the subset of emerging countries to test for the role of government in relation to the Rodrik hypothesis. In Section III. B. we present a somewhat broader perspective on coordination and test both the role of government and the transactions costs of coordinating the financial sector for their contribution to the growth process. The paper concludes in Section IV by summarizing our findings.

II.

THE RODRIK-ETHIER MODEL

Here we develop the model that underlies our tests. We begin with Ethiers model of production

(1982), a model that incorporates increasing returns in the number of intermediate input varieties used to produce final output and is used as the basis of Rodriks (1996) coordination failure model. In the Ethier model, two factor inputs--capital (K) and labor (L)--combine to produce two final outputs--wheat (W) and manufactured goods (M). Wheat is produced under constant returns to scale (CRS) while manufactures have the potential of generating increasing returns to scale (IRS). The output of M is written as

M = km,

(1)

where k is an index of scale economies and m is an index of scale of operation (m itself exhibiting CRS). The endowment levels of K and L then determine a transformation function given by W = T(m). (2)

Finished manufactures are assumed to be assembled costlessly from intermediate components produced using symmetric technologies that employ K and L. The output of each component is given by x and the number of different components (determined endogenously) is n. Hence the total output of components is nx and the output of finished manufactures is given by M = na!1(nx), a > 1. (3)

Suppose next that the number of components (the source of scale economies) is limited by the size of the market so that IRS within the firm can arise in equilibrium. Ethier assumes that (ax + b) is the number of bundles required to produce x units of any component, with a, b > 0. The scale variable m becomes m = n(ax + b). (4)

There are now two sources of IRS.1 The first is inherent in the production function; that is, the elasticity of M with respect to n (x fixed) is a > 1. The second source of IRS is the production function of an individual component, ax + b. If b is interpreted as a fixed cost, unit cost falls as the production of the

,where xi is the quantity n of the ith component and is a parameter with 1 > > 0. Higher values of represent greater substitutability among components in the assembly of finished goods, while lower values indicate greater product differentiation.
i '1

A somewhat more general function used in the literature is M ' n

j
n

xi

1/

component increases. However the potential size of x is limited, first, by the size of the market and, second, by the demand for variety that limits the quantity demanded of each individual component. Rodrik (1996) extends Ethiers model in two directions. First, Rodrik models the production of intermediates as being skill-intensive. The unit cost of the finished good is assumed separable in wage, skill, and the unit cost of intermediate components, c(M) = w ?(h) c(x), (5)

where w is the wage rate of unskilled labor, ?(h) is an index of the skill level of the work force, and c(x) is the unit component cost. Note that ?N(h) < 0 and, due to increasing returns, cN(z) < 0. With scale economies each intermediate is produced by a single firm. Since entry is free, price in the intermediate sector will just cover costs. Rodrik makes four assumptions: (I) intermediates are nontradeable; (ii) the output of each intermediate good is a function of the (constant) elasticity of substitution alone so that any change in the scale of intermediates must be due to a change in n; (iii) the high-tech sector does not use labor directly, assembling the final good from intermediate components alone; and (iv) a threshold number nT of intermediates must be available before the finished good can commence production, what we term the industrialization condition. In Rodriks model, depicted in Figures 1 and 2 below, a country is a price taker in the production of one of two tradeable goods: a low-tech good with a unit isocost given by ?(w, r) or a high-tech good with a given unit isocost of f (w, r; n). The low-tech good sells at a world price of 1 and the high-tech good sells at a price of p. The high-tech sector (whose demand for labor is derived from its use of

intermediate goods) employs a capital-labor ratio that is higher than that used in the low-tech sector for given levels of w and r. The factor price frontier then becomes the upper convex envelope of the two curves. Profit maximization together with full employment requires the country to operate at a point of tangency of the factor price frontier with a line whose slope equals the (negative of) endowment capital to labor ratio, denoted as k. Figure 1 depicts a unique low-tech equilibrium. In cases when a fully operational high-tech sector can produce only n* varieties of intermediates, full employment will require the production only of the low-tech good. As Rodrik notes, such an equilibrium results when the skill level of workers, h, is low and when there is scarcity of capital.2 An increase in either h or n will shift the high-tech isocost curve outwards. This is due to the IRS associated with higher skill levels or the increased number of intermediate varieties. Greater productivity allows higher factor payments to both labor and capital. Figure 2 then depicts the coordination problem central to Rodriks paper. Two equilibria are possible: one at D and one at E. If a coordination problem arises, so that only n0 firms (where n0 is small) are able to coordinate their production decisions, the small number of varieties of intermediate goods that can become available permits the realization of only a small portion of the potential economies of scale. This leaves the high-tech isocost curve relatively close to the origin, represented as f (w, r ; n0) = p. In this case, with the low-tech isocost located at ?(w, r) = 1 and the economys capital-labor ratio fixed at k, a low-tech equilibrium at D will result. However, if coordination costs could be overcome so that fully n* varieties could be produced, a high isocost curve would arise permitting the realization of a high income equilibrium. This is represented in Figure 2 by the

In Rodriks model the maximum feasible level of n is n* = L/?(h)c(z)z. With low h (that is, high ?(h) ), and low capital (that is, high c(z)), n* is low.

isocost f (w, r; n*) = p and the high-tech equilibrium at E. There is then an activist role for government if the economy is stuck in a development trap (such as at D) when a higher income equilibrium (such as at E) is available. Rodrik points to two policies a government may use. The first is to make the domestic currency fully convertible and fix the domestic interest rate at a value above the world rate. The resulting inflow of foreign capital will raise wage rates above w0. Once wage rates rise above a level like w1 in Figure 2, the high-tech sector becomes viable even in the absence of complete coordination. As the high-tech technique is adopted and the sector industrializes, it is only a matter of time before more varieties are produced and the equilibrium at E is attained. The second policy requires the country to adopt a high wage-floor that will make the low-tech sector unprofitable and hence induce a start-up of the high-tech sector. The success of that policy, however, is conditional on the presence of a high-skilled workforce capable of sustaining the high-tech equilibrium. Without preexisting skills, the productivity level in the high-tech equilibrium will be insufficiently high to justify the imposition of the high wage rate even should the optimal variety of goods be forthcoming. Rodriks model then suggests two hypotheses that we set out to test: Hypothesis 1: A coordination failure among intermediate producers of inputs into a high-tech sector leads to a low wage equilibrium. Hypothesis 2: Government policy can solve the coordination failure among intermediate producers of inputs in the high tech sector and move a country from a low to high wage equilibrium. Beyond the narrower confines of this model, the Ethier-Rodrik analysis falls into a class of models called threshold externality models after Azariades and Drazen (1990). Other models in this class include: Faini (1984), Murphy, Shleifer, and Vishny (1989), Krugman (1991), and Matsuyama (1991).

10

However, the presence of underdevelopment traps and other potential reasons for nonconvergence in the growth process, as stressed by this line of theoretical research, has not been matched by an equivalent amount of formal empirical work testing for their relevance. Thus while these theories are motivated by insightful observations on ongoing historical events, only Azariades and Drazen (1990) offer an empirical test of their theory. Since these theories all suggest policy prescriptions and lead to recommendations for intervention, an empirical basis is necessary for these policy conclusions to be taken seriously.

III.

METHODS AND TESTS

Two methods are used to test the propositions derived from Rodriks hypothesis. The first tests directly the two Rodrik hypotheses set out above in a cross-country setting using manufacturing data. These tests emphasize the intermediate good dimension of the coordination failure and hence test predictions for the change in the ratio of value added to gross output (VA/GO) on the expected wage change over the 1985-90 time period. An realization of the economies of scope in varieties of intermediate goods, as emphasized by Rodrik, will be registered by a rise in this ratio. Here the effect of government policy is tested by investigating the differential performance of a subset of emerging countries that used explicit development programmes of the type suggested by Rodrik. The second method uses cross-country regressions of growth rates [similar to those used by Barro (1991)] and reexamines the issue of private versus public influences on the growth process. Our focus in this second set of tests is on complementary factors in the growth process that either contribute directly to or are necessarily present in a coordination failure of the type analyzed by Rodrik. Our particular interest is on the link between the financial sector and growth.

11

A.

Method 1: Emerging Economies, Wages, VA/GO and their Interaction

To bring the theory into line with the data for empirical analysis, we introduce one modification to the Rodrik-Ethier model. We assume that the manufacturing sector consists of two subsectors--a low-tech sector and a high-tech sector. Both sectors use intermediate goods, but only the high-tech sector has IRS in intermediate varieties. Low-tech manufacturing is assumed to use only one homogeneous variety of intermediate input, exhibiting CRS in intermediate use3. In this extended model, then, an increase in aggregate output that comes from an expansion of the low-tech sector alone will be associated with an unchanged ratio of intermediate input-to-gross in manufacturing. Here we expect no change in manufacturing wages and no change in the ratio of value added to gross output in manufacturing. In Figure 2, the low and high-tech isocosts remain unchanged and the economy expands through a CRS expansion of low-tech output. On the other hand, if the increase in aggregate output is accompanied by a fall in the ratio of intermediate input-to-gross output use in manufacturing, output growth will have come from the expansion in varieties within the high-tech sector targeted by Rodrik. Not only do a larger number of varieties increase output, but greater variety also requires proportionately less intermediate input use so that the ratio of value added to gross output rises. In this case we expect wages to rise (given the capital-labor ratio in the economy does not fall). In Figure 2, the high-tech isocost shifts right, pushing the point E further to the northeast. This leads to the prediction

UNIDO (1995) data show that even developing countries have a significant intermediate inputs-to-gross output ratio in manufacturing. For example, Kenyas and Indias intermediate inputs-to-gross output ratio in manufacturing was above 0.83 between 1985 and 1990. Similarly, centrally planned economies (as of 1985) frequently had ratios above 0.70. High intermediate goods-to-gross output ratios are not surprising in low-wage economies because typically the share of labor in gross as well as net output is far lower than in high-wage economies.

12

that a regression model based on Ethier-Rodrik should show wage growth, ? w/w, to be directly related to the growth in the share of value added in (manufacturing) gross output, ? (VA/GO), all else constant. That is, for a regression equation of the form

? w/w = 0 +1 ? (VA/GO) + XG + e,

(6)

the issue of interest is the positivity of 1. X is a set of control variables that includes the level of VA/GO, openness to trade, physical capital and human capital, and e is a normal, homoskedastic error term. As a practical matter, however, a cross country test based directly on (6) will find no significant relationship if only a small subset of countries in the sample have solved their coordination problem and jump isoquants, while most remain on unchanged isoquants (either because they are unable to solve their coordination problem and are stuck in the low-tech equilibrium or they have experienced no technological change and remain stationary in the high-tech equilibrium). The discreteness of these outcomes suggests that most countries will separate into one of two possible equilibria--a low-tech equilibrium for countries that have fallen victim to the coordination problem and a high-tech equilibrium for countries that have been able to overcome it--and relatively few jumping across categories.4 From this perspective, Rodriks hypothesis becomes testable because government is the instrument for resolving this coordination problem and allowing the country to jump isoquants. For this reason we highlight a special set of emerging countries

We are presuming that the only reason countries are stuck in a low-wage equilibrium is the coordination problem. This downplays two possibilities: first, capital scarcity (either physical or human) may cause a low wage equilibrium; and second, a country may be in a diversified equilibrium producing both goods. We deal with the first by excluding countries poor in human-capital. This is in keeping with the spirit of Rodriks model. As for the second, we make the assumption that diversified countries with a high proportion of high-tech goods in the product mix are no different from countries in the purely high-tech equilibrium, while those with a high proportion of low-tech goods in the product mix suffer from a coordination problem.

13

that have attempted to solve this problem either directly through targeted industrial policy (e.g. South Korea, Indonesia, Malaysia), or indirectly through liberalization policies directed at increasing foreign direct investment in high-tech industries (e.g. India and the other emerging Asian countries above) as the focus group of our empirical analysis. The remaining countries, a selection of high, middle, and lower middle income countries for which complete data are available, serve as the control group. Denoting by DE a dummy variable for these emerging countries, we estimate the following model as a test of the Rodrik-Ethier model:

? w/w = 0 +1 [DE ? (VA/GO)] + 2 [(1!DE) ? (VA/GO)] + XG + e,

(7)

where X is a set of control variables (which includes DE among other variables), and e is a homoskedastic normal error term. The prediction testing the Rodrik-Ethier hypothesis is 1 > 0. Depending upon the choice of the control group, 2 may take either sign. For example, if those control group countries in a lowtech equilibrium remain there, while richer countries experience technological change in intermediate varieties enabling them reap greater economies of scale in intermediate varieties, then 2 > 0. To test these hypotheses we use aggregate manufacturing data collected from UNIDO (1995) to measure the changes between 1985 and 1990 in intermediate good use, gross output, wages, and value added. In the resulting estimations, presented as Tables 1.1 and 1.2 below, two different measures of the dependent variable, the wage rate, are used. One is wage per manufacturing worker taken directly from UNIDO (1995). Since these wages are reported in domestic currencies, manufacturing wages were converted to common US dollars using the exchange rate given in the Penn World Tables (PWT): Mark 6 (see e.g. Summers and Heston 1991). The second measure of wage change is the change in real per

14

capita income between 1985 and 1990, again from PWT (RGDPCH). This overcomes the problem of finding an appropriate exchange rate conversion factor for manufacturing wages but introduces a new one. Rodriks theory relates to manufacturing sector and, especially for developed countries, the change in aggregate income (RGDPCH) may be quite different from the wage change taking place in the manufacturing sector alone. To keep consistency across the UNIDO and PWT data sets, only the intersection of the country sets with complete data from the two databases is used and this yields a sample of 46 countries.5 Unfortunately, the time period under consideration does not allow proper integration of East European and CIS countries, since it precedes the transition experience of many of these countries. Later data are not yet fully available and many unresolved data issues pertaining to the CIS countries remain.6 Despite this shortcoming we include four Asian countries in transition: India, Indonesia, Malaysia, and South Korea. They form the focus group of the analysis while the remaining countries form the control group. The control group then allows an indirect test of whether government policy can overcome the coordination problem, bring about industrialization and produce the desired rise in wages. Finally, a set of control variables including: openness (from PWT), capital-output ratio and capital per person (from King and Levine, 1994), and average educational attainment (from World Development Report, 1996) rounds out the data set.
5

The countries in the sample are: DCs: Norway, Hong Kong, Singapore, Italy, New Zealand, Greece, Spain, Austria, Finland, France, Canada, Japan, Australia, Denmark, UK, Sweden, Ireland, USA, W. Germany., Israel. Emerging: India, Indonesia, S. Korea, Malaysia. Other: Central African Rep., Egypt, Mauritius, Morocco, Senegal, South Africa, Costa Rica, El Salvador, Guatemala, Panama, Bolivia, Chile, Colombia, Ecuador, Uruguay, Venezuela, Bangladesh, Iran, Jordan, Phillippines, Cyprus, Turkey. While data on gross output are routinely becoming available for the CIS countries, value added data are missing even at the aggregate level.
6

15

Table 1.1 presents the results from a set of models designed to explain the percent change in real per capita GDP (? RGDPCH/RGDPCH) between 1985 and 1990. The issues of interest are the coefficients on both the ratios VA/GO, ? (VA/GO), %?(VA/GO) and the terms representing the interaction of these ratios with the dummy for emerging countries. Models M1 and M2 present alternative baseline specifications that use as explanatory variables the ratio of value added to gross output (M1) and the change in this ratio (M2) during 1985-90. These regressions do not differentiate between countries that may or may not have undergone transition (i.e., moved from point D to point E in Figure 2). As was expected, these models fit poorly and show nothing of any significance. In terms of the maintained hypothesis, these findings can be interpreted in terms of Figure 2. Imagine that in our sample developed countries are located at E while the developing countries are located at D. Suppose further that over this period no country jumps isoquants (no developed country experiences a new technological breakthrough nor does a developing country solve its coordination problem). Then regression models like M1 and M2 will be unable to explain wage rate changes since the wage changes that do arise will reflect movements along the same isoquants (with no change in VA/GO) due to changes in factor endowments over time, rather than changes produced by technological change or industrialization.

Models M3 and M4 distinguish between countries that, we will argue, have jumped isoquants because of Rodrik type government policies directed explicitly at increasing the pace of industrialization, especially in higher technology goods. In our sample there are four Asian countries of this type for which full data are available: namely, India, Indonesia, Malaysia, and South Korea. During this period each country experienced major policy changes: India underwent a substantial devaluation and trade liberalization

16

in the middle 1980s; Indonesia began its reforms in 1982 with rapid reform of its financial sector, largely through liberalizing interest rates and credit. Malaysia began its reforms in 1983 with rapid trade liberalization. South Korea began its reforms in 1981. Rapid trade liberalization through large tariff cuts and gradual financial reform through liberalization of interest rates and credit were the main features of its reform. The greatest impact of the reforms in these Asian economies was a large long-term capital inflow through foreign direct investment, since these economies already possessed the requisite human capital. Combined, with low wages and a reformed financial structure, these countries became attractive production locations for Japanese American, and European multinationals. Models M3 and M4 include a dummy variable, DE, to differentiate these emerging countries and so capture the effect of policy changes on per capita income due to factors other than those related to industrialization in high tech goods. An interaction variable consisting of the dummy times the change in the value added to gross output ratio, ? (VA/GO) DE, is then included to test directly this aspect of the Rodrik-Ethier hypothesis. To see whether this interaction ratio also relates to growth in the control group, the interaction term ? (VA/GO) (1! DE) is also included. In both models M3 and M4 there is strong evidence in favor of the Rodrik-Ethier hypothesis, indicated by statistically significant coefficients on [? (VA/GO) DE] in M3 and on [%? (VA/GO) DE] in M4. At least for this set of emerging countries, growth in per capita income was higher the greater was the growth in the ratio of value added to gross output. These results are economically significant as well. The coefficient estimate on [ ?(VA/GO) DE] in M3 indicates that for the set of emerging countries in the sample, a one unit increase in ? (VA/GO) (i.e., the rate of change in VA/GO, or ? 2VA/GO equals 1) increased ?RGDPCH by 6.239. That is, per capita income grew faster by 5.846% in the emerging Asian economies as a result of a one unit increase in the

17

growth in their VA/GO ratio. In percentage terms, the coefficient estimate on [%? (VA/GO) DE] in M4 indicates that for these emerging countries, an increase in ? (VA/GO )of 1% increased ? RGDPCH by 2.204% -- the growth rate of per capita income accelerated by 2.204%. As explained earlier, the predicted effect of intermediate variety on IRS on growth is already accounted for in the regression through the VA/GO ratios. Hence the results above do not merely pick up rapid growth in emerging countries due to general productivity improvements associated with industrialization. Rather the statistically significant positive estimate on the interaction term indicates that an even more rapid growth was achieved by this set of emerging countries with active government intervention policies relative to the control group. Models M5 and M6 include the measure of openness from PWT (OPENNESS) and the change in this measure during 1985-90.7 Edwards (1998) has found that open economies generally experience faster rates of total factor productivity growth. Models M5 and M6 corroborate Edwards finding for our sample in the 1985-90 period. The statistically significant positive coefficient on OPENNESS shows that more open economies did experience faster per capita GDP growth. Surprisingly, however, increasing openness (?OPENNESS) proved detrimental to the rate of growth. Perhaps this was due to the experience of the Latin American and African economies in the sample who experienced simultaneously falling incomes and increased openness. From our perspective, the important point is that the inclusion of openness does not change qualitatively the empirical affirmation of the Rodrik-Ethier model. Models M7 and M8 include the capital-labor ratio as an additional variable.8 It is not statistically

OPENNESS is the PWT openness measure scaled by 100. ? OPENNESS, on the other hand, uses the unscaled PWT values.
8

The original King-Levine measure has been scaled by 100,000.

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significant, surprisingly, and its inclusion does not affect the change in RGDPCH at all. In another set of specifications (not reported here) , we added human capital measures such as the percent of males enrolled at the primary and secondary levels. They add no explanatory power to Models 7 and 8, and in fact reduce the adjusted R2 measure. This is a surprising result in view of the general finding from growth studies that human capital matters, and hence deserves further study. We merely speculate this may be due to two factors. First, our study is over a 5-year horizon, whereas growth studies take a much longer term view. Second, over the 5-year period, after controlling for openness and changes in VA/GO, human capital seems to have mattered little. However, the key issue of interest, namely the coefficient on ?(VA/GO) DE, remains robust to these specification changes, providing a stronger empirical basis for the Rodrik-Ethier model.. Table 1.2 presents results from a set of models using the percent change in manufacturing wage per worker between 1985 and 1990. Data on wage and number of workers from UNIDO (1995) are used to compute the annual wage. The 1990 annual wage multiplied by the ratio of PWT exchange rates, XR85/XR90, in order to express in 1985 prices. Then the percent difference in manufacturing wage during 1985-90 is computed, which is used as the dependent variable in the models reported in Table 1.2. The results based on growth in manufacturing wage differ somewhat from those based on growth in income in Table 1.1, but generally affirm the Rodrik-Ethier hypotheses. Model M1 indicates that the change in the value added to gross output ratio significantly determines the percent change in manufacturing wages for the whole sample. However, the precision of this inference is lost in model M2 when instead of ? (VA/GO) we use %?(VA/GO) to avoid the scale effects present in ?(VA/GO). Models M3 and M4 affirm our earlier finding that an increase in ?(VA/GO) does indeed lead to faster wage growth in the set of emerging

19

countries and that this rate of increase is substantial. M3 shows that for every unit change in ? VA/GO, manufacturing wages jump 30.25% for the set of emerging countries (and by 6.026% for the other countries in the sample). Model M4 shows that a 1% change in ? VA/GO translates into a 9.685% increase in the rate of change of manufacturing wages (and by 1.509% for the other countries in the sample). Models M5 and M6 indicate that while the degree of openness (OPENNESS) now has no impact on manufacturing wage growth (unlike the result in Table 1.1 from the RGDPCH data), positive changes in the degree of openness (?OPENNESS) continue to be detrimental to the growth rate of manufacturing wages. This result seems to be driven by the Latin American countries in the sample, which experienced increased openness and yet declining real wages (e.g Columbia, Peru). The inclusion of the K/L ratio in models M7 and M8 significantly raises the explanatory power of the regression model, while not qualitatively affecting any of the above inferences. In addition, greater capital per person is now found to have a strong effect on changes in manufacturing wages. Because this is significantly different from that found for overall per capita income (from Table 1.1), some explanation is required. Per capita income (RGDPCH) differs from manufacturing by including income generated in other sectors like agriculture and, especially, services. In these sectors, capital-labor ratios are generally lower than in manufacturing not necessarily because less physical capital per unit of labor is required but because more human capital is required for each unit of physical capital. Cross-country studies of GNP growth (e.g. Barro (1991), Azariades and Drazen (1991)) traditionally find human capital to be a strong determinant of growth. The finding that there is no strong relationship between growth in per capita income and the physical capital-labor ratio is quite consistent with this finding. What the results in Table 1.2 show

20

is that physical capital per person do strongly influence how fast manufacturing wages grow. Together, these seemingly contradictory findings imply that productivity growth in manufacturing is relatively more influenced by the amount of physical capital per person than is productivity growth in services, where human capital is the more important determinant. The inclusion of human capital measures (not reported) are not found to be significant. Once again, however, the central finding is that for emerging countries an increase in VA/GO will increase the rate of growth of wages and this is robust across all model specifications. This empirically affirms the Rodrik-Ethier model from this set of models using VA/GO data.

B.

Method 2: Coordination Externalities and the Growth Process

In this part of the paper we use the World Banks Selected World Development Indicators (1996) to place the earlier test of Rodriks hypothesis in a more general socio-economic context. This allows us to broaden the specific production perspective used in Method 1 to look at the more general set of development hypotheses that surround the specific hypothesis advanced by Rodrik. The underlying hypothesis is that persistence through time of Rodrik-type coordination problems will also imply the inoperability, or more generally higher cost, of using other private and public institutions that could either complement or substitute for the entrepreneurial coordination activity stressed by Rodrik. The World Bank database allows us to capture the effects of two such coordinating alternatives. The weakness of the World Bank database for our purposes is that it provides no direct data on the Rodrik hypothesis. However, while the data include no direct observations on the scale of intermediate input activity, the data does permit inferences based on the ability to observe the share of industrial output

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in GNP. Thus, to the extent that an expansion in industrys share of final output represents the increased use of intermediate inputs (and hence successful realization of spillovers), expansions in industrys share of output across countries will be positively related to the countrys growth rate. This prediction is as close as we can come to a direct test Rodriks hypothesis within this data set. The financial sector and associated institutions for borrowing and lending are, perhaps, the most obvious candidate for complementarity with the production externalities emphasized by Rodrik [see also Levine (1997) and Greenwood and Smith (1997)]9. That is, to achieve production spillover externalities, Rodrik hypothesizes the need for the simultaneous entry (or expansion) of a number of separate intermediate firms. Without simultaneity, the private profitability of each input supplier cannot be guaranteed. It follows that to internalize the industrial externality privately, there needs to be a scale of private financing that may be well beyond the economic capacity of the existing financial sector. Somewhat more generally, the higher is the cost of coordinating private borrowing and lending (i.e., the less developed is the internal financial sector), the more costly it will be for the private sector to internalize the technical spillovers available through the simultaneous expansion of intermediate inputs. Operationally, this means that higher real costs of coordinating financial activity reduce the ability of the private sector to internalize spillover externalities and hence reduce the rate of economic growth. This hypothesis is tested below by looking directly at the per unit transaction cost within the financial sector (as measured by the bid-ask spread across countries). Together, this financial coordination cost hypothesis together with the industry scale effect discussed above combine to represent a set of complementary private sector internalizing

Greenwood and Smith stress the interdependence of the scale of economic activity and the cost of coordinating the financial activity, with causality running in both directions.

22

hypotheses to explain economic growth. In addition to Rodrik, a number of other economists [including Azariadis and Drazen (1990); Murphy, Schleifer, and Vishny (1989); Matsuyama, (1991); and Krugman (1991)] have emphasized a wide range of activities that may combine to produce a threshold effect that prevents low income economies from achieving the scale of activity needed to sustain economic growth. To overcome this threshold, many of the same writers see government as the natural alternative to the market for providing the scale of activity needed to internalize these external effects. By more closely aligning private and social costs through different tax and subsidy programmes, governments can rechannel activity in ways that compensate for the externalities and so promote economic growth. In addition, either by purchasing strategic final goods directly or by providing complimentary public services such as information, standardization and organizing services, governments may allow activity to be coordinated at a lower cost than through currently existing private institutions. To the extent that the government is used to coordinate economic activity more effectively, increases in the role played by government in the economy should be associated with increases in the economys rate of growth. In the empirical work below we use two different measures to test the government as coordinator hypothesis. They differ from the test under method 1 by using more continuous measures of governments coordination activity. The first develops a measure of the governments cost of coordinating economic activity. Here we propose the inflation rate as a measure of the governments inability to coordinate effectively. That is, the existence of a higher inflation rate implies greater reliance by that government on money creation as a revenue source and this, in turn, implies greater inability to resolve internal spending conflicts and/or conflicting spending and financing objectives. High rates of inflation are then seen as a low

23

cost (short run) way of resolving coordination inconsistencies and hence provide a meter of the cost associated with coordinating economic activity through the government sector. To the extent that government coordination substitutes for entrepreneurial coordination, higher inflation rates are predicted to be associated with lower growth rates.10 The second test uses a quantity measure of the scale of government involvement in the economy. That is, if the government sector is a successful coordinator of private economic activity, increases in the governments share of GNP will be associated with higher overall rates of economic growth. To the extent that government crowds out private activity, economic growth will be lower. Before presenting the results of these tests, we describe briefly the 1996 World Development Report (WDR) database used to test the hypotheses outlined above. The 1996 WDR database consists of seventeen tables of different socio-economic indicators of development for 133 different countries between 1980 and 1994. The countries range from very low income through very high income countries, grouped into four general categories: low income countries (51), lower-middle-income countries (39), upper-middle-income countries (16), and high income countries (24). The data collected cover a broad range of socio-economic indicators describing the texture of each country in relation to its level of development such as: the stage of each countrys level of economic development (per capita GNP, labor force participation rates, life expectancy); the stage of social development (Gini coefficients, school enrollment measures by level and gender differences); environmental measures of development (infant mortality, access to safe water, sanitation); and measures of current and past economic performance

More traditionally, higher inflation rates correlate with higher variance in the inflation rate and this increases the cost to the community of filtering relative price information from any price level change. This increases the cost of coordinating private sector activity and further retards the growth process.

10

24

(growth rates of income, exports/imports, foreign debt, etc.). One less fortunate aspect of the data is that while many variables are included in these tables, most are unavailable for all countries for all time periods (and a large part of the data base is missing for the pre-1990 time period).11 In terms of variables of interest that are missing, measures of the size of the capital stock stand out. Despite these limitations, however, the data set does provide a wide range of variables that can be used to proxy the hypothesized variables and to provide appropriate controls. The specific hypotheses that we test is whether the Rodrik intermediate good externality hypothesis and/or any other coordination/externality hypothesis adds to our ability to explain growth rate differences across countries. By increasing our ability to explain, we mean improving the explanatory power of a simple growth theory model. Hence in simple growth models, there is a direct link through the production function from the growth rates of capital and labor to the growth rate of real output. Importantly, however, that growth rate is conditional on the initial condition, with the growth rate predicted to fall with increases in the relative level of per capita income.12 This hypothesis, that growth rates converge across countries over time, called the (conditional) convergence hypothesis, has received considerable empirical attention as a test of standard neoclassical growth theory (see Barro and Sala-I-Martin, 1995). For our purposes, we supplement this standard list with two variables describing the quality of the labor force: a measure of the physical health or well-being of workers (measured as life expectancy) and a measure of the change in human capital embodied in the labor force (measured as the change in the percentage of the age group

11 12

These are primarily the countries of the former Soviet Union.

The marginal product of capital (and growth rate) falls with increases in the per capita capital stock and hence varies inversely with the level of per capita income.

25

in high school). The set of these variables then represents the base case against which the potential contribution of the externality hypotheses can be evaluated. The base case representing the explanatory power of simple growth theory is presented in the OLS regression equation:

gy = a 0 + a 1GNPPC87 + a 2gpop + a 3?(I/Y) + a 4?(% inHighS) + a 5 (Life) + e

(8)

where gy is the average annual rate of growth of real income between 1990 and 1994; GNPPC87 is real per capita gross national product in 1987; gpop is the population growth rate; ?(I/Y) is the change in the share of investment in GNP; ?(% inHighS) is the change in the percentage of the relevant age group in high school; Life is the life expectancy at birth; and e is a random variable. The predicted signs for the coefficients of the control variables are: a 1 negative (conditional convergence); a2 , positive; a3 , positive; a4 , positive (education as a form of human capital); and a 5, positive (life expectancy as a proxy for physical health). The OLS estimation results for the base case are presented as the first column in Table 2 [entitled Growth rate of Y -- Base Case (1990s)]. The results presented in that table are for the set of 46 countries that have observations on each of the variables used in the most complete form of the test (i.e. column 4).13 We report in footnotes the regression result for the largest number of countries in the data set that have

These countries, in order of ranking, include: Malawi, Bangladesh, Niger, Guinea-Bissau, Nigeria, Burkina Faso, Togo, Gambia, Nicaragua, Benin, Mauritania, Zimbabwe, China, Honduras, Senegal, Cte dIvoire, Sri Lanka, Egypt, Lesotho, Indonesia, Guatemala, Papua New Guinea, Bulgaria, Ecuador, El Salvador, Jamaica, Paraguay, Colombia, Poland, Thailand, Venezuela, Botswana, Mauritius, Chile, Trinidad and Tobago, Hungary, Oman, Korea, Finland, Italy, Canada, France, Sweden, Denmark, and Japan.

13

26

complete observations on all the variables in that test.14 As inspection indicates, the base case performs reasonably well with traditional growth theory represented by the equation as a whole explaining thirty percent of the variation in real growth rates across countries. The data is also consistent with the predictions of each individual hypothesis--all the estimated coefficients have their predicted sign and many are significantly different from zero (using the conventional five percent confidence interval). The overall result suggests that rate of growth of real output across countries is, as expected, positively related to population growth, the growth of investment, the age intensity of high school attendance and overall health of the population in our sample. The prediction of conditional convergence is also confirmed. The coefficient of the countrys level of per capita GNP, measured as purchasing power GNP relative to the US in 1987 (GNPPC87), is significantly different from zero at one percent. Relative to the base case model, we now test the hypothesis that the government complements the private sector in coordinating the development process. The results of the two government coordinating hypotheses are presented in the second column of Table 2. As the summary statistics indicate, the addition of the two government measures does improve the predictive power of the equation. Both coefficients are significantly different from zero at the one per cent significant level. On the other hand, only one of the predictions of the government as coordinator hypothesis is consistent with the data.15 As described earlier,

For example, the regression result for the 73 countries with coverage of all base case variables was: gy = - 6.49 - 0.051*GNPPC87 + 0.851**gpop + 0.124*? (I/Y) + 0.077**? (% inHighS) + 0.131*(Life), (4.08) (0.020) (0.553) (.032) (0.043) (0.059) AdjR2 = .306 * (**) significantly different from zero at 5 (10) percent. The corresponding result for the 72 countries in the sample that had observations on all variables was gy =-8.23 -0.055*GNPPC87+ 0.878*gpop+0.115*? (I/Y)+ 0.088*? (% inHighS) + 0.156*(Life)-0.005*Inf-0.204*(G/Y) (3.35)(0.019) (0.376) (0.037) (0.044) (0.051) (0.001) (0.074) AdjR2 = .430 * (**) significantly different from zero at 5 (10) percent.
15

14

27

the inflation rate is our measure of the cost of coordinating activity across countries through the government relative to the private sector and the predicted negative relationship between that coordination cost and the rate of growth of output is consistent with the data. Lower rates of growth arise when the inflation rate is large, although the absolute size of this effect is small.16 On the other hand, the quantitative measure of the scale of governments intervention in the economy is inconsistent with the hypothesis that government was successful in enhancing economic performance. Over our time period (between 1980 and 1994) and country set, changes in the government share of GNP are inversely correlated with real rates of growth. Countries experiencing faster growth rates in the size government tended to grow more slowly and this is inconsistent with the successful use of government to complement the private sector in internalizing production externalities or spillovers in our sample.17 We now add the Rodrik and the financial sector predictions to the base case regression equation. This is presented as the third column of Table 2. Considered as a group, the addition of the private sector coordinating hypothesis more than doubles the explanatory power of the base case (the adjusted R2 rises from .298 to .689) and dominates the base case enhanced by government (adjusted R2 = .369) as an alternative explanation of successful private sector coordination.18 Individually, the direct measure of industrial growth (and its implied effect on the demand for intermediate services) is significantly positive (at

While the inflation rate is statistically negative (at one per cent)in its effect on growth, the coefficient suggests that its economic significance is small. A ten percentage point rise in the inflation rate reduces real growth by only five one hundreds of one percent point. It is in part because this finding could be expected that we divided our sample into emerging and control countries under Method 1. That is, a negative result on average need not be inconsistent with the special role played by government in a minority of cases where the coordination externality is internalized. The number of countries with complete coverage of all Rodrik/financial variables is 47 so that the regression equation with complete sample coverage is virtually identical with the equation in Table 2.
18 17

16

28

one percent level) in its effect on economic growth and is consistent with Rodriks productivity growth arising from intermediate input use in high-tech industries. The hypothesis that links our measure of the size of the transactions cost in the financial sector (lending minus the borrowing rate) to the growth rate is also confirmed. A higher per unit cost of coordinating financial intermediation will produce a significant reduction in the rate of economic growth.19 The suggestion that the stage of development of the financial sector plays a significant role in the growth process is not new, yet evidence confirming this interaction is relatively scant. Our finding that the cost of financial intermediation is inversely related to income growth deserves some emphasis, in part for this and in part for two related reasons. First, most measures of the role of the financial sector use quantity measures of the scale of the financial activity (see Levines 1997 survey) to proxy the stage of development of domestic financial markets and hence the cost of coordinating finance. Our result, on the other hand, confirms the predicted effect of financial intermediation on development using a direct measure of cost. This focus on the cost of financial intermediation will become increasingly important in a world where the ongoing integration of world markets means that the real cost of finance will become increasingly disconnected from the scale of the domestic industry. Second, the role of financial intermediation in development is often viewed as facilitating increased specialization and lowering transactions costs by allowing the expansion of on the shelf production processes that are already economically attractive (Levine, 701). While this is usually thought of in terms of the adoption of new technical innovations, the ability to internalize market externalities through organizational innovation is equally relevant. Our results

It is interesting to note that 40 of the 46 countries covered are low or middle income countries so that this equation is not biased by including relatively more high income countries.

19

29

then suggest that the financial development literature is not necessarily distinct from the production externality literature emphasized by Rodrik. The approaches complement rather than compete as theories of development. Finally, when the government hypotheses of column 2 are added together with the base case as enhanced by private sector hypotheses of column 3, the addition of the government variables add very little to the explanatory power of the equation and actually reduce the size of the F statistic. This result is presented in the last column of Table 2. The combined result is still interesting, however, in showing that the two private externality variables retain both their sign and significance in the presence of the government sector alternative. In terms of the two government variables, however, only the inflation rate retains its significance while the size of government now is unrelated with the growth rate.

VI.

CONCLUSION

In this paper we attempt a comprehensive test of hypotheses about development traps and coordination failures, due to Rodrik and based on the production model of Ethier. The coordination failure occurs in the production of intermediate goods in high-tech sectors where the production of intermediate goods enjoys IRS in variety. However, a threshold number of varieties must be produced before the hightech sector can industrialize. Then coordination failure among would-be producers of intermediate varieties may keep this sector from industrializing if these producers do not perceive a large enough market for their products. In this case, government policy is essential for moving the economy out of the development trap. We use two different sets of cross-country data to test the validity of Rodriks theory. The first

30

set of econometric models has as its focus the relationship between the value added-to-gross output ratio, VA/GO, and growth in manufacturing wages over 1985-1990. Among a sample of 46 countries, our focus group is five emerging Asian countries which undertook large economic reforms during or preceding this period. For these countries, the empirical results affirm the Rodrik-Ethier hypothesis that coordination failures in intermediate goods can cause underdevelopment traps and that policy can overcome the source of the failure. The second set of econometric models has as its focus the relationship between financial constraints (which may be a reason for coordination failures by raising the cost to producers of intermediates) and growth, and employs a Barro-type of specification. Financial constraints are measured as the difference between the borrowing and lending rate, with high absolute values of the difference implying high costs of financial intermediation due to an underdeveloped financial sector. We find a strong inverse relationship between this difference and growth, and we hypothesize that one mechanism behind this (reduced-form) result is that the coordination failure hypothesized by Rodrik is aggravated by the underdeveloped state of the financial market, hence leading to an underdevelopment trap. This connection between financial constraints and development is just beginning to be investigated in the literature (see Levine 1997), and our finding and hypothesized connection to coordination failures deserves further study. The coordination failure model of Rodrik one of a set of underdevelopment trap models, more generally known as threshold externality models (Azariades and Drazen 1990). Empirical investigation of this important body of literature is surprisingly lacking. This paper is a step in the direction of uncovering the rich possibilities that further research into the threshold externality problem may hold for economic development.

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REFERENCES

Azariadis, Costas and Allan Drazen, 1990, Threshold Externalities in Economic Development, Quarterly Journal of Economics, 55, 2, 501-526. Barro, Robert J. and Xavier Sala-I-Martin, 1995, Economic Growth, McGraw-Hill, New York. Edwards, Sebastian, 1998, Openness, Productivity and Growth: What Do We Really Know? Economic Journal, 108, 383-398. Ethier, Wilfred J., 1982, "National and International Returns to Scale in the Modern Theory of International Trade," American Economic Review, 72, 3, 389-405. Faini, R., 1984, Increasing returns, nontraded inputs, and regional development, Economic Journal, 94, 308-323. Summers, Robert and Alan Heston, 1991, The Penn World Table (Mark 5): An expanded Set of International Comparisons, 1950 - 1988, Quarterly Journal of Economics 56, 2, 327-368. Greenwood, Jeremy and Bruce Smith, 1997, Financial Markets in Development, and the Development of Financial Markets, Journal of Economic Dynamics and Control, 21, 145-81. King, Robert G., and Ross Levine, 1994, Capital Fundamentalism, Economic Development, and Economic Growth, Carnegie-Rochester Conference Series on Public Policy, 40, 259-292. Krugman, Paul, 1991, History versus Expectations, Quarterly Journal of Economics, 56, 2, 651- 67. Levine, Ross, 1997, Financial Development and Economic Growth: Views and Agenda, Journal of Economic Literature, 35, 688-726. Lucas, Robert, E. Jr., 1988, "On the Mechanics of Development Planning", Journal of Monetary Economics, 22, 1, 3-42. Matsuyama, Kiminori, 1991, Increasing Returns, Industrialization, and Indeterminacy of Equilibrium,Quarterly Journal of Economics, 56, 2, 617-50. Murphy, Kevin, Andrei Schleifer, and Robert Vishny, 1989, Industrialization and the Big Push, 97, 5, 1003-1026. Rebelo, Sergio, 1991, "Long-Run Policy Analysis and Long-Run Growth" Journal of Political Economy,
32

33

99, 3, 500-21. Rodrik, Dani, 1996, "Coordination failures and government policy: A Model with applications to East Asia and Eastern Europe," Journal of International Economics, 40, 1-22. Romer, Paul, M., 1987, "Growth Based on Increasing Returns Due to Specialization," American Economic Review, 77, 2, 56-62. , 1990, "Endogenous Economic Change," Journal of Political Economy, 98, 5, part II, S71S102. Spence, Michael, 1976, "Product Selection, Fixed Costs, and Monopolistic Competition," Review of Economic Studies, 43, 2, 217-35. Uzawa, Hirofumi, 1965, "Optimal Technical Change in an Aggregative Model of Economic Growth," International Economic Review, 6, 18-31. UNIDO International Yearbook of Industrial Statistics, 1995, UNIDO: Vienna. World Development Report: From Plan to Market ,1996, Oxford University Press (for the World Bank): Oxford.

FIGURE 1 Low tech Equilibrium: Low tech isocost given by ?(w,r) = 1. High tech isocost given by f (w,r; n) = p. Economy wide capital-labor endowment ratio = k.

FIGURE 2 Coordination failure and multiple equilibria: n0 is the maximum number of intermediate-good firms that can coordinate before deciding to produce. Here n0 = 1. With perfect coordination among intermediate-good firms, the equilibrium number of components is n*.

Table 1.1
Method 1: Change in VA/GO and % Change in Per Capita Income (Penn Tables), 1985!1990
Dependent Variable Constant VA/GO (1990) ? (VA/GO ) (1985!1990) % ? in VA/GO (1985!1990) Emerging Country Dummy (DE) ? (VA/GO) (1!DE) (1985!1990) ? (VA/GO) DE (1985!1990) %? (VA/GO) (1!DE) (1985!1990) %? (VA/GO) DE (1985!1990) OPENNESS (1990) ? OPENNESS (1985!1990) K/L (1985) N Adj. R2
46 !.003 46 !.006 46 0.173 46 0.170 46 0.359 46 0.359

M1
.236** (.108) !.360 (.309) .783 (.689)

M2
.219** (.104) !.307 (.294)

M3
.181 (.104) !.239 (.294)

M4
.167 (.101) !.199 (.280)

M5
!.023 (.108) .157 (.270)

M6
!.020 (.103) .141 (.261)

M7
!.014 (.108) .073 (.297)

M8
!.013 (.103) .057 (.278)

.215 (.199) .143* (.079) .497 (.632) 6.239** ( 2.630) .154 (.183) .152* (.078) .193** (.072) !.066 (.580) 5.052** (2.372) .022 (.164) .197** (.071) .196** .(.072) .016 (.589) 5.345** ( 2.403) .052 (.168) .200** (.0 71)

2.204** (.883) .110** (.031) !.129* (.067)

1.722** (.792) .111** (.031) !.126* (.066) .102** (.033) !.099 (.076) 1.540 (1.760) 46 0.355

1.822** (.801) .101** (.032) !.094 (.075) 1.633 (1.760) 46 0.357 4.641**

0.926 0.859 3.410** 3.356** 5.285** 5.290** 4.613** F-statistic 1. ** (*) Significantly different from zero at 5 (10) percent 2. Standard errors in parentheses. 3. Data Sources: UNIDO (1995), Penn World Tables (Summers and Heston, 1991), World

37 Development Report (1996), and King and Levine (1994). Emerging countries (DE=1) include: India, Indonesia, South Korea, and Malaysia.

4.

Table 1.2
Method 1: Change in VA/GO and Percent Change in Manufacturing Wage, 1985-1990
Dependent Variable Constant VA/GO (1990) ? (VA/GO ) (1985!1990) % ? in VA/GO (1985!1990) Emerging Country Dummy (DE) ? (VA/GO) (1!DE) (1985!1990) ? (VA/GO) DE (1985!1990) %? (VA/GO) (1!DE) (1985!1990) %? (VA/GO) DE (1985!1990) OPENNESS (1990) ? OPENNESS (1985!1990) K/L (1985) N Adj. R2 46 0.06 46 0.039 46 0.097 46 0.074 46 0.362 46 0.356 5.240** M1 .815** (.482) !1.068 ( 1.384) 6.806** ( 3.079) 1.756 (.898) !.389 (.382) 6.026* ( 3.056) 30.25** ( 12.70) 1.509* (.892) 9.685** ( 4.313) .054 (.144) !1.354** (.309) !.336 (.384) !.099 (.330) 3.609 ( 2.676) 20.12* ( 10.94) .946 (.763) 6.388* ( 3.670) .069 (.144) !1.383** (.307) !.070 (.137) !.900** (.319) 22.35** (7.36) 46 0.470 6.837** !.055 (.327) !.066 (.301) 4.803* ( 2.469) 24.38** ( 10.06) 1.344* (.706) 7.779** ( 3.370) !.056) (.137) !.928** (.316) 22.66** (7.42) 46 0.467 6.758** !.011 (.298) M2 .654 (.470) !.556 ( 1.329) M3 1.032** (.505) !1.594 ( 1.421) M4 .858* (.494) !1.052 ( 1.366) M5 .822 (.498) !.697 ( 1.290) M6 .698 (.477) !.346 ( 1.212) M7 .946* (.455) !1.916 ( 1.241) M8 .796* (.434) !1.513 ( 1.296)

2.465* 1.933 2.234* 1.916 5.343** F-statistic 1. ** (*) Significantly different from zero at 5 (10) percent

39 2. 3. Standard errors in parentheses. See Notes below Table 1.1

40

Table 2 OLS Cross Country Regressions-- WDR Data, 1996

Dependent Variable Constant GNPPC (1987) GrPopulation rate (1990s) GrInvestment GNP share GrH.S.Education Life Expectancy Inflation Rate (1990s) GrGovernment GNP share GrIndustry GNP share Borrowing ! Lending Rate No. of Obs. AdjR2 F!statistic
1. 2. 3.

Growth rate of Y: 90s Growth 90s Growth Base Case rate with Govt rate with (1990s) Externalities !2.31 (4.59) !0.066** (0.026) 0.141 (0.628) 0.120** (0.042) 0.075 (0.055) 0.096 (0.066) !7.01 (4.16) !0.071** (0.024) 0.452 (0.591) 0.101** (0.045) 0.080** (0.060) 0.159** (0.061) !0.004** (0.001) !0.164** (0.074) 0.318** (0.050) !0.320** (0.114) 46 .298 4.83** 46 .369 4.75** 46 .689 15.25** !0.708 (3.53) !0.043** (0.018) 0.629 (0.489) 0.103** (0.043) 0.042 (0.035) 0.089* (0.052)

90s Growth rate (aggregate) !3.67 (3.24) !0.049** (0.018) 0.897* (0.484) 0.096** (0.045) 0.031 (0.037) 0.133** (0.051) !0.003** (0.0009) !0.078 (0.051) 0.279** (0.060) !0.348** (0.110) 46 .710 13.19**

** (*) Significantly different from zero at 5 (10) percent Standard errors in parentheses. Data from World Development Report, 1996.

41