BEC 4241 – Development Economics

Course facilitator – Dr. H. M. N. Hennayake

Group 06

Pattern and Sources of Technological Progress

1
Introduction

2
 Introduction

• When economies began modern industrial development through the process of 'industrial
revolution' or 'take-off, economic growth depended more heavily on capital accumulation.

• Historical data suggest that the pattern of economic growth experienced by advanced
economies in their early industrialization stage was akin to the description of capitalist
economic development by Marx.

• The pattern of economic growth in the initial stage of industrialization was similar to Marx's
theoretical prediction called 'Marx pattern', whereas the pattern in the advanced stage was
abstracted by Kuznets from accumulated empirical data called the 'Kuznets pattern'.

3
Stylization of the two
patterns

• This table summarizes characteristics of the Marx pattern that appear in the initial stage of
industrialization (Phase I) and the Kuznets pattern in the advanced stage (Phase II) in terms of
'stylized facts' in the major economic indicators of the growth process.
• On the other hand, presumed common trends in major economic indicators for Phase I were those
implied in Marx's theory of capitalist economic development, except on the interest rate.
• The profit rate can be constant if the rate of surplus value can be increased due to technological
progress
• Moreover, if the rate of return to capital were to decrease very fast, Marx's prediction of the
increasing income share of capital could be violated.
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Stylized facts in the two phases of modern economic
growth
• In the Marx pattern, If
capital per capita (K/N)
and capital-labour ratio
(K/L) increased faster
than income per capita
(Y/N) and labour
productivity (Y/L)
respectively

• If wage-rental ratio (w/r) decreases • If wage-rental ratio (w/r) increases

smaller than the increasing capital- faster than the increasing capital-
labour ratio (K/L) labour ratio (K/L)

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Conti…
• Marx's theory predicted an
increase in the rate of saving
relative to national income (S/Y)
in the capitalist development
process

• The largely stable rate of saving

in the Kuznets pattern under the
increased income share of labour

• production function shifts are shown in the form of

small versus large contributions of TFP (total factor
productivity) growth to growth in per capita and
per worker outputs

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Trends in the rates of saving, interest, and wages
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Trends in the rates of saving, interest, and wages
✓ we try to see if trends in saving rate, interest rate, and wage rate were also consistent with
the hypothesis in the case of Japan
➢ World War I boom period and a
❑ Saving Rate subsequent slump during the
World Depression period, a basic
rising trend in the saving rate
from about 5 to 10 per cent could
be observed.

➢ the post-World War II period the

saving rate remained relatively
stable at a high level within the
25-35 per cent range.

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Gross Domestic Saving rate movement in Sri Lanka

• In this picture we can see Sri

Lanka domestic saving rate
movement in 1960- 2020

• That time period can observe

in upward and downward
trend saving rates

9
❑Interest rate
• Real interest rate = Nominal interest rate - rate of change in the wholesale price index

➢ The real interest rate shows neither an

upward nor downward trend can be
observed for either the earlier or the
later phases of industrialization in
Japan except two world war period.

➢ The earlier phase in japan, real interest

rate oscillated violently with no
systematic trend

10
Real interest rate in Sri Lanka,

• In this picture we can

see Sri Lanka real
interest rate movement
in 2001- 2019

• In this period only 2010

real interest rate got
negative value( -10.25)
other years got positive
values.

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❑ Wages
• The real wage rate in manufacturing began a • In post-war recession, average wage rate in
rising trend with the World War I boom and manufacturing not decline and increased
also, agriculture increased during the boom payments to more educated and skilled workers
period but returned to the prior level with the on the other hand, agricultural wages largely
post-war recession. stable trend.
• Chemical industries preferred to employ better • After world war II, both agricultural and
educated labor in a log term in the matter of manufacturing wage rate sharply raising trend
internalize investment in the skill formation of as Japanese industries caught up with the level
their workers. of advanced economies in Western Europe and
North America.
• SME using labors who were excluded from
large enterprises to specialize in labor- intensive
production. furthermore, uneducated non
agriculture labor had only one option is enter
unskilled labor in SME.
• The wage rate in agriculture and SME move
together in fixable manner in response to
business fluctuations and large-scale industries
were characterized by downward rigidity.

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Technological Conditions of the Two Growth Patterns
❖shift in the regime of industrial technology from education.
visible to invisible technology ✓ German and USA established advanced
✓ in Phase II, establishment of scientific research education and research institutions with
and educational systems improvements in practical orientation. Japan quickly followed
industrial technology. This similar to Kuznets's this pattern and established engineering college.
'epochal innovation' characterizing his 'modern
✓ Education and research in the new 'invisible
economic growth'.
technology' regime, underlay the much larger
✓ In his view each epoch was characterized by its contribution of TFP relative to the contribution
own epochal innovation. of tangible capital to product growth in
✓ Kuznets considered the systematic application conventional growth accounting for Phase I than
of science the engine of modern economic for Phase II.
growth since the time of the Industrial
Revolution
✓ For the effective operation of new invisible
technologies of workers had to be changed and
give job training and developed formal

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The Shift in the Demand Structure
14
The Shift in the Demand Structure
• Changing the direction of technological
progress from facilitating the
replacement of tangible capital for labor
with the replacement of intangible
The effect of the capital with tangible capital.
shift in the
technology regime
• Changed from the tangible capital using
and labour-saving direction to the
intangible-capital-using and tangible-
capital-saving direction.
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 Viewpoint of Marx
• Technical progress in the early phase
of industrialization was orientated
towards replacing labour by capital
Example
• Drainage from coal mines was a major problem during
the Industrial Revolution in England. If the water had
been raised by manpower using buckets, the marginal size
of one extra bucket would have dropped sharply beyond
the number equal to the number of lifting crews, often
closer to zero. Therefore, profit-seeking entrepreneurs
would not have invested in the purchase of more than one • The tendency to use such capital and
bucket per worker.
• Suppose that a water-pump run by James Watt's steam
save labor appears to be a feature of
engine was invented, which could drain with only five early industrialization mechanization.
operators the same volume of water lifted by one hundred
workers with buckets. If this pump set costs equivalent to
one hundred buckets, the entrepreneur would have been
willing to invest up to twenty times more capital per
worker with no fear of decreasing marginal productivity. 16
Bias in technical progress
• With this bias in technical progress,
• Wage rate (w) • Rate of return
• Capital-labour ratio (K/L) to capital (r)
Effect of Demand Structure
Such labor-saving mechanization would
be effective for large-scale production of
standardized goods whose demand was
rapidly expanding in the early stages of
industrialization. Therefore per capita
incomes had been near subsistence level
for the majority of people.
So that the income
share of capital
(rK/Y) increased
However, as per capita income
continued to rise and people's
basic needs were satisfied,
demand tended to shift from
standardized to differentiated
products with less risky.
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 Behavior of New Regime
• Marginal productivity of human ability and knowledge rose sharply
relative to that of tangible capital
• The measured wage rates rose sharply relative to the rate of return to
tangible capital
As a result, So that the income
• Rate of return
• Wage rate (w) to capital (r) share of capital
• Capital-labour ratio (K/L) (rK/Y) decreased

➢ It must be true that increases in the labour wage rates in Phase II were also accelerated by deceleration
in the growth in labour supply owing to both a slow-down in population growth rates and increased
preference for leisure corresponding to per capita income rises. Yet, if the product demand structure
had remained the same, and human capital had not accumulated so fast in Phase II, the traditional
labour-saving and capital-using technical progress of the Phase I-type would have continued to
advance at a sufficiently rapid speed so that the effect of labour supply reduction could have been
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counteracted, resulting in no appreciable increase in the wage rate.
Productivity of shifting demand structure

• The shift from the Marx to the Kuznets pattern can be explained,
Visible technology Shift Invisible technology
regime regime

Standardized product Differentiated product

• Both shifts together increased the rate of

technical progress and also changed the bias
in technical progress from the tangible-
capital-using to the intangible-capital-using
direction.
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Schooling and economic growth
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 Schooling and economic growth
➢ School education contribute to economic growth
through increase in the income earning capability.
➢ more important may be its contribution to 'advances in
knowledge'
➢ National income growth accounted for by
the growth of formal education.
➢ School education should be externalized.
➢ In terms of both the large magnitude of formal
education's contribution to economic growth and the
➢ high rate of return to society,

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The time lag between investment in formal
education and realization of its outcomes

• Usually takes a long time

• Insignificant correlation between increases in the average number of years of
schooling and GDP growth rates across countries
• By giving the high future discount rate in poor economies a question will come.

22
• If returns to investment in education are so
low in the short run, is it appropriate to
allocate a large share of affordable
investment to education, especially to
advanced education?

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• Japan began rapid catching up in school education with the USA soon after the MeijiRestoration in
1868 that transformed the feudal order to the modern nation state.
• average schooling in Japan rose from 1.3 years in 1890, which was only 20 per cent of that in the
USA, to 5.6 years or 62 per cent of the US level in 1930.
• Before world war?
Physical capital stock in Japan increased significantly
• After world war?
• Japan's capital-labour ratio relative to the US ratio rose very fast from 17 per cent to nearly 90 per
cent in 2000. 24
• During the post-war period, the level of education in Japan continued to approach
the US level but its speed was rather slow with the Japan-USA gap in education
closed by only about ten percentage points.
Why was the gap between Japan and USA in per capita GDP not reduced
significantly before the war?
• physical capital is bound to face sharp decreasing returns unless supported by
parallel increases in human capital
• improved skills and knowledge created from education will not contribute much to
productivity growth, unless appropriately combined with physical capital.

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Increasing returns and the endogenous growth model

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Increasing returns and the endogenous growth model
• In Denison’s growth the effect of scale of economies were arbitrarily assumed and
residuals were simply supposed to reflect the effects of advances in knowledge.
• An attempt to incorporate these mechanisms into theory is the ‘Endogenous Growth
Model’ pioneered by Paul Romer (1986) and Robert Lucas (1988).
• The endogenous growth model tries to explain the mechanism of how new knowledge
is created through economic activities.
• Basic assumption is that new knowledge to improve economic production accumulates
bit by bit through the effects of individual firms to design and construct more efficient
machines and factories in their investment activities in addition to public sector
investments in education and research.
• Further, it is assumed that a certain useful knowledge created by a firm sooner or later
becomes usable by other firms, despite the firm's efforts to prevent other firms from
using it by such means as patenting. This reflects the very nature of knowledge as a
public good that makes exclusion of the others from its use inherently difficult.
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• It follows that the productive efficiency of a firm is considered to increase parallel
with concurrent increases in total capital and knowledge in the economy.
• Characteristics of the endogenous growth model based on these assumptions can
most easily be understood in comparison with the neoclassical growth model
explained using the Cobb-Douglas production function.

❖ First, the production function of the i-th firm is specified as,

𝛽
𝑌𝑖 = 𝐸𝐿𝑖 𝛼 𝐾𝑖  Equation 1

𝑌𝑖 → Output
𝐿𝑖 → Labor
𝐾𝑖 → Capital
𝐸 → Efficiency of labor
• This specification assumes technological progress to be 'labor-augmenting' in
the sense that technological progress works to increase the efficiency of labor
alone without affecting the efficiency of capital.

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 ❖ The assumption that the efficiency of labor in the i-th firm does not
depend on the knowledge produced from this particular firm's investment
activities but on the total knowledge produced from all the firms'
investment activities can be represented by,
𝐸 = 𝑎𝐾  Equation 2

• where a is a constant determining the parallel relationship between the total

stock of capital (K) and the average efficiency of labor (E) in the economy.

❖ By substituting aK for E in equation 1 and dividing both sides by 𝐿𝑖 the

following relation can be derived:
𝛽
𝑦𝑖 = 𝐴𝐾 𝛼 𝑘𝑖  Equation 3
𝑌𝑖 𝐾𝑖
𝑦𝑖 → ൗ𝐿𝑖 𝑘𝑖 → ൗ𝐿𝑖
𝐴 → 𝑎𝛼

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 ❖ Using the definition that k = K/L, equation 3 is expressed as,
𝛽
𝑦𝑖 = 𝐴𝐿𝛼 𝑘 𝛼 𝑘𝑖  Equation 4

❖ Further, it can be assumed that at the long-run competitive equilibrium all

the firms achieve the same optimality in the allocation of resources,
implying that 𝑘𝑖 = 𝑘 and 𝑦𝑖 = 𝑦. With this assumption equation 4 can be
transformed to,
𝑦 = 𝐴𝐿𝛼 k  Equation 5
• Under the condition that population remains constant, AL is constant, so that
equation 5 is formally equivalent to the production function used in the Harrod-
Domar model. Therefore, for constant population, the marginal productivity of
capital remains constant for the whole range of k, implying that both k and y
continue to increase indefinitely.

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❖ Equation 5 can be rewritten as,
𝑌
= 𝐴𝐿𝛼  Equation 6
𝐾
• which expresses the relationship that population growth results in reduction in the
capital-output ratio. The above equation may be considered to represent the
possibility that the growth of population improves the efficiency of capital,
because increased population means an increase in the number of agents who may
invent new ideas useful for production.
• In that sense, equation 6 gives an optimistic perspective on the sustainable
development of the world economy under continued population growth.
• In the Harrod-Domar model capital (1C) includes only physical or tangible capital,
whereas K in the endogenous growth model includes both tangible and intangible
capital.

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• The endogenous growth model be similar to the Marx model in the assumption
that capital accumulation and technological progress are inseparably related.
• It also shares the common assumption with Friedrich List that activities in one
firm have positive externalities to result in industrywide scale economies.
• This model could be considered a return to Adam Smith in the thesis that capital
accumulation results in improvements in economic efficiency by promoting
division of labor.
• However, it is hazardous to conclude that economic growth can be achieved by
capital accumulation alone, even if capital includes both tangible and intangible
capital.

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▫ Schumpeter and centrally planned economies

Can investment activities lead to

technological advancement and scale
economies?

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• Centrally planned economies such as the former Soviet Union were unable to sustain economic growth.
• former socialist economies invested heavily in education and research.
✓ For example, the ratio of expenditure for scientific research and development to national income in the
Soviet Union during the 1960s and 1970s exceeded 4%, significantly higher than the 2% to 3% in
advanced market economies.
• The Soviet Union was able to compete with the USA in the advancement of space technology in the 1960s
and 1970s.
• Contributions of TFP(Total Factor Productivity) to the growth of the Soviet economy were relatively low and
declined over time.
• These observations suggest that investment in education and research is necessary but not sufficient (for the
shift from Marx to the Kuznets pattern).

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What then is the
sufficient condition?

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 According to the Theory of Economic Development ([1912] 1961) by Joseph Schumpeter (1883-1950),
• Schumpeter considered 'innovation' the engine of development in a capitalist economy.
• Innovation is not scientific discovery and invention, but the process by which new ideas are utilized by
entrepreneurs to create a new combination of production resources to increase their profit.
• Innovations can take various forms such as,

Innovation forms Example

(l) the introduction of a new good or a new quality of
good
(2) the introduction of a new method of production
(3) the opening of a new market
(l) the introduction of the transistor to replace the vacuum
tube
(2) development of a low-cost mass production system
for transistors,
(3) exploitation of overseas market for transistors

(4) the conquest of a new source of supply of raw
materials
(5) the designing of the new organization of any industry
(4) utilization of new materials such as silicon
(5) organizational developments such as industrial parks
and venture capital markets (such as NASDAQ in the
USA)

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• According to Schumpeter, in the absence of innovation, competition in the market will eventually
eliminate excess profits from all the economic sectors and bring the economy to a stationary state at the
long-run equilibrium which equates revenue and cost (average cost curve =the market price).

• Once this mechanism of incessant creation of innovations stops, the economy will no longer be
capitalist but would be transformed into a non-capitalist economy.

• The entrepreneurs who undertake innovation are the economic agents who bear the risk of seeking
excess profit.

• An entrepreneur would have the ability to perceive profitable innovation opportunities, and the
courage to shoulder risk, but need not be a 'capitalist' himself also the required funds could be obtained
by credit from banks.
➢ Thus, the inflation caused by a bank's credit creation depresses consumption that results in 'forced
savings' and, thereby, transfer of resources from consumers to entrepreneurs for their investment in
innovations.
• Through innovation that savings needed for investment can be mobilized.

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• The greater the risk an entrepreneur
has to bear, the faster it will fall once
the new good or new method he has
introduced is successful.
• When other entrepreneurs emulate
this new business, the number of
those ‘followers’ to the innovator
increases, then the product price
goes down and the input price goes
up. ( then excess profit would
continue to decrease until the point
at which the trough of the new
product's average cost curve is equal
to its market price).
• In centrally planned economies,
➢ There is a mechanism of mobilizing entrepreneurs'
efforts for innovations of high social demand.
➢ The major incentive scheme for enhancing work
efforts was to set quantitative targets on output to be
produced at various levels.
➢ This incentive scheme promoted managers' and
workers' efforts to procure as much capital and other
inputs to achieve quantitative output targets
➢ Unlike private entrepreneurs in market economies,
who are penalized by a loss of customers when their
products are of low quality, state enterprises under
state procurement and distribution were subject to no
such penalty.
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Viewed from Schumpeter’s theory,
➢ Decay in centrally planned economies,
which culminated in their collapse in the
1980s is strong evidence in support of the
hypothesis that investment in scientific
education and research is a necessity, but is
not a sufficient condition to accelerate
technological progress.

➢ One important condition for the promotion

of innovation within the framework of the
market economy is the establishment of a
patent system and other means for the
protection of intellectual property rights.

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Institutional conditions of
borrowing technology

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• A major source of technological progress for developing economies is the importation of advanced
technologies from developed economies.
• Gerschenkron (1962) observed a tendency in the history of industrialization in Europe for late starters
to achieve higher rates of industrial growth because of their advantage in borrowing advanced
technologies from early starters.
• At the beginning of industrialization,
➢ Capital requirements were larger for late starters introducing advanced technology of high capital
intensity from abroad.
➢ To meet this requirement, the development of financial institutions became necessary to mobilize
savings from a wide range of citizens.
➢ France develop a ‘Credit Mobilier’-which accepted savings from a wide range of citizens for
lending to industrialists for their fixed capital investment.
➢ In Germany large banks were developed in 'universal bank’ - engaging in all financial transactions
from bill discounting to long-term loans for fixed capital investment as well as issuance and
brokering of bonds and stocks
• Economic backwardness creates an opportunity for faster growth but the actual catch-up depends on a
nation's ability or 'social capability to exploit this opportunity (Abramovitz, 1986)
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 Thank You!
Registration Numbers Name

2018MS8010 Balasuriya B.L.L.N.

2018MS8264 Madushan D.M.S.
2018MS8268 Maheshika W.P.S.
2018MS8271 Malepathirana D.M.W.

2018MS8274 Manchanayake M.D.N.

2018MS8298 Navodanie M.W.D.

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