World Development, Vol. 18, No. 8, pp. 1057-1079, 1990. 0305s750)</90s3.00+0.

00
Printed in Great Britain. c 1990 Pergamon Press plc

Investment and Economic Growth

DENNiS ANDERSON*
University College, London and St. Anthony’s College, Oxford

Summary. - The paper revisits the old question, how much does investment contribute to economic
growth? Building on recent work of Maurice Scott, it suggests that the analysis of growth. in
developing as in the industrial countries, would benefit from a capital accumulation approach. In
the following analysis, economic growth is related to three variables, all greatly influenced by the
quality of economic policies: the rate of investment, the social rate of return to investment, and the
investment-induced returns to labor.

1. INTRODUCTION The advantage of reworking the approach to

This paper considers once again the role of
investment in economic growth and development.
Its aim is to derive an accounting relationship
between the rate of economic growth and variables
representing the rate, allocation and efficiency of
investment. Efficiency is measured by the social net
present value or social rate of return to investment.
The paper draws on earlier approaches to the
analysis of growth in three ways. First, it shows
that changes in output arising from technical pro-
gress turn out, in large measure, to be due to the
redeployment of labor brought about by invest-
ment in human and material resources; that is, they
can be attributed to investment. The paper draws
on vintage theories of investment-embodied tech-
nical progress to show how these gains from
redeployment can be linked to investment. Second,
turning to disembodied sources of technical pro-
gress, the paper shows that factors that appear
to change output in ways seemingly disconnected
from investment turn out to actually change it by
changing the outputs of new investments and
(especially important) of investments in place.
Again, the effect is to link output gains from tech-
nical progress to investment.
A corollary of these two extensions is that the
“residual” factor in economic growth is much
smaller than growth accounting studies commonly
find. Indeed, in a third extension, using an idea
of Maurice Scott,’ the residual is set to zero, by
definition of the accounting conventions used, on
the grounds that the effects of technical progress
on output are captured in the returns to investment
and the investment-induced returns to labor. The
accounting conventions used are those relating to
the social rate of return to investment.
growth accounting in these ways is that the econ-
omist’s tools for analyzing the allocative efficiency
of economic policies can be brought to bear on the
analysis of the effects of those policies on growth.
It leads to what Johnson (1964) once described
as “a generalized capital accumulation approach”
toward growth and development:
The growth of income that defines economic devel-
opment is necessarily the result of the accumulation
of capital, or of “investment”; but “investment” in
this context must be defined to include such diverse
activities as adding to material capital, increasing the
health, discipline, skill and education of the human
population, moving labor into more productive occu-
pations and locations, and applying existing know-
ledge or discovering and applying processes. All such
activities involve incurring costs, in the form of use
ofcurrent resources, and investment in them is worth-
while if the rate of return over the cost exceeds the
general rate of interest, or the capital value of the
*This paper was originally prepared while I was on leave
from the World Bank in 1986 at St. Anthony’s College.
Oxford. I am grateful to Hans Fuchs and Tariq Husain
for encouraging me to write up my ideas on the subject.
to the Bank for giving me the leave. and to the Fellows
and staff of St. Anthony’s for providing an exceedingly
pleasant and stimulating environment in which to under-
take research. I wish to thank Maurice Scott for gen-
erously sharing with me his ideas on the subject. Carl
Liedholm, Peter Kilby and Paul Streeten for their com-
ments and encouragement, and Ralph Turvey for raising
some thought-provoking points on earlier drafts. I should
also like to thank two anonymous referees whose com-
ments saved me from a potentially embarrassing mistake
and led to several other helpful revisions. The paper is
based on a World Bank Discussion Paper of a similar
title (Anderson, 1987). The usual disclaimers apply.

1057
1058 WORLD DEVELOPMENT

additional income they yield exceeds the cost of investment is determined by the point at which its
obtaining it. From the different perspective of plan- quasi rents become zero or negative on account of
ning, efficient development involves allocation of changes in relative prices. Its net present value is
investment resources according to priorities set by the the discounted value of its quasi rents, less the
relative rates-of return on alternative investments.
discounted value of actual investment expenditures
The paper benefits greatly from the work of (which may be incurred over several years for
Maurice Scott (1981, 1986, 1989). His recent book investments with long lead times). These defi-
on the subject is very important, and I hope will nitions and accounting procedures follow Scott
be influential. The following analysis departs from (1981, 1986), Salter (1960) and are also standard
his work in three respects; in each case, the aim is in social cost-benefit analysis.
constructive. First, it draws extensively on vintage Before deriving the relationship, it is necessary
theories of growth, of which Scott is critical (and to reconsider the effects of investment on the
which have long been dismissed, as well, as being redeployment of labor and thus on labor’s income.
“unimportant” by Denison [ 19641 and others). The These effects can be appreciable and tend to be
analysis shows that what was surely a major devel- underestimated by current methods of growth
opment in growth theory 30 years ago can benefit accounting. A reworking of the relationship so as
from Scott’s ideas, and moreover leads to inter- to reflect them better is the first task of this analysis.
esting results. Second, Scott uses the familiar
“quality adjustment” approach to estimate labor’s
contribution to growth, whereas below I raise (a) Inoestment and the redeployment of labor
questions (as have many others before me) about
its reliability. Third, to get the theory straight, Most growth accounting studies allow for the
Scott is more concerned with steady growth. My output and income gains from redeployment, but
aim is to relate the analysis to developing and only for broadly defined occupations, e.g., for the
industrial countries, whether or not growth is movement of workers from agriculture to industry,
steady, and whether or not the “stylized facts” of defined at the one-digit level. The practice is as
long-term growth apply. In this respect, my aim is follows.3 The labor force is grouped according to
to broaden the applicability of Scott’s own the occupations, educations and ages of its male
attempts to revive the investment approach to and female members. The contribution of the
growth. redeployment of labor to the growth of income is
Section 2 of the paper derives an aggregate then taken to be a weighted average of the rates of
accounting relationship, first for the case of purely change of the proportions of the labor force in
investment-embodied technical progress, and then each group, the weights being the average incomes
for embodied and (seemingly) disembodied sources of the labor force in each group divided by national
of technical progress together. Section 3 discusses income per worker. Then (i) if there is a net move-
how the relationship can be disaggregated and ment of workers from, say, agriculture to industry,
generalized in other ways. Section 4 uses the aggre- with wages being higher in industry, there is a
gate form to estimate the imputed returns to invest- rise in income attributable to the redeployment of
ment in various countries; the estimates serve to labor from agriculture to industry; (ii) if there is
illustrate the strength of the link between the alloc- an increase in the proportion of workers in the
ative efficiency of investment and growth. Section higher paid, better educated groups, there is a rise
5 reviews some points of departure between current in income attributable to redeployment associated
approaches to growth accounting and the with investment in education; (iii) if there is an
approach followed in this paper. Section 6 makes increase in their average age, such that a greater
some concluding remarks. proportion of workers are in the higher paid age
groups, there is a further rise attributable to the
increased experience of the labor force; and (iv) if
2. INVESTMENT, EFFICIENCY AND there is an increase in the proportion of women in
GROWTH: SOME AGGREGATE the labor force, the average contribution of the
RELATIONSHIPS quality of labor to the growth of income may
(according to such procedures) be estimated to fall,
To begin, a note on definitions and procedures: since women (within any particular education-age-
The following analysis uses the gross rather than occupation group) are paid less than men4
the net value of investment. Any provision to keep It is likely that a greater disaggregation of occu-
an investment in service up to the end of its econ- pational or industrial groupings would show the
omic lifetime is not regarded as depreciation but rate of redeployment of the labor force, and the
as maintenance, which in turn is considered part increased income derived from redeployment, to
of operating costs.2 The economic lifetime of an be significantly greater. For instance, in the course
 INVESTMENT AND ECONOMIC GROWTH 1059

of economic growth both the size distribution It is unlikely, however, that a greater dis-
and the composition of manufacturing activities aggregation of industries or of occupations, say
change appreciably over time - from a con- to the four of five digit level, would provide a
centration of employment in small-scale, cottage satisfactory estimate of the rate of redeployment
industries and workshops in food processing, tex- that takes place as a consequence of investment in
tiles, wearing apparel and light engineering, toward a growing economy. Workers of a given age and
a greater concentration on heavy engineering.‘The education may be redeployed by material invest-
earnings differentials between these activities for ment without changing their industry or occu-
workers of a given age and education are often pation - or even their firm or place of employ-
large, e.g. over a two or three to one range as ment. In agriculture, for example, changes from
between large and small firms in a given industry.6 rainfed to irrigated crops, from traditional to high-
It follows that an application of the above method yield, seed-fertilizer varieties, from the use of bull-
of analysis would attribute some (if not a large ocks to the use of tractors, all bring about a
share) of the observed increases of labor incomes redeployment of agricultural labor. often without
in manufacturing to redeployment within manu- changing the crop variety. In factories, labor may
facturing. Similar remarks can be made about be redeployed and retrained at regular intervals in
changes in the scale and composition of activities order to introduce new machines and new mana-
within agriculture (the transition from manual till- gerial methods with higher outputs per worker to
age to the use of draft animals, or changes in mech- produce essentially the same product. It is not
anization, crop varieties, land tenure systems, difficult to think of examples in other industries,
investment in irrigation, and so forth),’ commerce each being associated with a change in the nature
(e.g., changes in the types and scales of retailing, of work, economic output and ultimately in labor’s
wholesaling and banking activities), transport and income.
construction. Furthermore, each generation of the Since greater disaggregation will not work, let
labor force is continually redeploying itself us consider an alternative approach toward esti-
through the introduction of new, higher tech- mating the effects of investment on labor’s income,
nology industries and products in the indu- drawing on vintage theories of growth. To begin,
strialized countries, or through diversification of a “pure,” aggregate vintage model will be taken,
the industrial base in the developing countries. after which attempts will be made to generalize it.
Insofar as the new industries are associated with
higher productivity and earnings levels for workers
in a given age and education group, a redeploy- (b) A relationship for the case of embodied
ment of the labor force toward them will again technical progress
account for some - if not a large share - of
the observed increases of both labor’s income and Figure I shows a plot of output per worker
value added. against the numbers of workers deployed on vari-

-------7-;y&of&

/’ introduced
I” Y

Growth of wages on
- Investments Introduced in v

--CF.-----
-,
-‘(number depioyed new vIntageI
L” number of workers
employed an Y

Figure I. Vintage model: Emplqvment, producrivity, wages and quasi rents for successive vimoges
of investments.
1060 WORLD DEVELOPMENT
ous vintages of investments. It is drawn for the
case of steady growth, in which new vintages of
investment with higher outputs per worker are con-
tinuously redeploying workers from old vintages.
It is not difficult to consider other cases such as
dualistic growth shown in Figure 2.’ The steady
growth case, however, suffices for the purpose of
the present analysis. The construct used here fol-
lows Solow (1970).
Output per worker on the latest vintage, v, is
denoted by b,$“, where b is the rate of growth of
output per worker. On the oldest vintage still in
use, output per worker is b,eb’“-“‘, where n is the
economic lifetime of the investments. When a new
vintage is introduced it will have higher quasi rents.
If the labor force were fully employed, or if the
labor requirements of the new vintages exceeded
unemployment levels plus the number of new
entrants into the labor force, then labor would
have to be redeployed from existing investments.
As Solow explains, in any competitive economy,
or in any planned economy maximizing output per
worker, labor would be redeployed from the oldest
investments, which would be duly retired. Further,
in a competitive economy, wages would be bid up
to the point where the quasi rents of the oldest
(marginal) investments remaining in operation
were zero (or close to zero). That is, the output per
worker on the oldest investments determines the
wage rate, which rises whenever those investments
are displaced by, and labor is redeployed on, new
investments.
Now consider the question: what is the rate of
return to investment in a period of steady growth,
in which workers are being continually redeployed
blue cdded
(net of I
rnaintemnce)
per worker
Quos~ rents on
Value added
per worker In
I I new vmtoges
‘Lv (number of wakers employed in 14’ ,-,,,,. vlntqe
Figure 2. As in Figure 1, but wilh low rates of deployment of the labor force on new
(large shares of Iabor force on old vintages).
as just described, and real wages and real output
per worker are rising? It is defined as the discount
rate which equates the (gross) expenditures on new
investments with the present worth of the quasi
rents over the economic lifetime of the investments.
Let the annual output (value added) of investments
introduced in v be q,,. If we take exponential instead
of compound growth to simplify algebra, then
qC = E,b,e&‘, where E, denotes the number of wor-
kers deployed on the investments introduced in v.
The annual outputs of the investments, the growth
of wages, and the (declining) quasi rents are shown
as dotted lines on Figure 1 and correspond to a
stylized form (shown in the lower half of Figure 3)
of the costs of and returns to investments fre-
quently encountered in project analysis. The net
present value (NPV) of the outputs of these invest-
ments is thus given by:
o+n Cf”
NPV = qCe-Ir-u,dt_. W,,,e@-‘)dt - I,
s 1
(1)
where I, is the present value of the expenditures
on investments whose outputs first appear in v,
referred to the period v; r is the discount rate and
n is the average economic lifetime of the invest-
ments; as discussed above, n is defined by the time
when their quasi rents have declined to zero.
Denoting total economic output in v by Q”, and
the annual rate of investment in v by i, we also
have
Iv = iQ. (2)
(This expression is really an approximation
I’E, number employed on
invesfmenfs
 INVESTMENT AND ECONOMIC GROWTH 1061

Actual vorlottbns
I

mantenonce and
intermedlate rtputs

Economtc lifetime
L

Styhzed form of above

I
I,,~---_-_---
Grossoutput

Value odded
--_--_-

- Trne

Ii _______._
\
Expenditure on molntenance
G’expendhures and Intemwdlote inputs

Figure 3. Variations over time of costs, gross output, intermediate inputs, value added, wage bill
and quasi rents of an investment.

because the effects of lead times on the value of I, the outputs of investment are assumed to be con-
are ignored for the moment.) stant after they are brought into service. From
Total economic output in v is given by the sum equation (4), the net change in output equals the
of outputs from all investments being utilized in v, output from new investments minus the outputs of
i.e., by investments about to be retired. Since qC = Elb,eb”,
q.-qU_, can be written as q,(l -(E,._,,/E,.)e-““). If
Qr = ’ q,dt (3) the labor force, L,, is growing at a rate of c per
s ,.-!I year, and the rate of redeployment, EJL,., is
while the rate of change of output is obtained by constant, then the expression for q0-q41,_. further
differentiating equation (3) to give simplifies to q,,( 1 -e-g”), where g = (b+c) is the
rate of economic growth. This simplification is
dQc
-=
dL3 s ’ &Jr
r_,z.dt+qp-q,.-n = qr-ql._n

Note that dq,/dc = 0 in the present case because

(4)
used below since it reduces notation
affecting the analysis in any basic way.
To complete the above relationships,
without

note that
investments are retired once their quasi rents have
1062 WORLD
become zero, i.e., when
W,,,,” = 4c
For this equality to hold, we are also including the
opportunity cost of entrepreneurial labor in the
wage bill.
The above five expressions are sufficient for a
relationship between the allocative efficiency of
investment and the rate of economic growth to be
derived. Taking g to be the exponential rate of
growth and w to be the growth rate of wages,
noting that g = (l/Q,)(dQ,/dv), and using equa-
tions (2) (4) and (5) in equation (I), gives
NPV = (1 -e-“‘)/r-(e-“‘“-e-‘“)/(r-W)
-i(l --eAng)/g
In the pure vintage model sketched in Figure 1,
the growth rate of wages, w, equals the growth
rate of output per worker, b. However, the above
expression is applicable to a slightly more general
case where the two may be different, as they often
are in practice. In developing countries, real wages
frequently grow more slowly than output per
worker over long periods. It seems important to
allow for such possibilities.
To facilitate the interpretation of equation (6),
iedefine r to be the social rate of return and (by
definition of the latter) set the NPV = 0. Also, note
that the ratio of the second term to the first on the
right-hand side of equation (6) is the present value
of labor’s share in output; like the more familiar
quantity, labor’s share in current output, it would
seem to merit its own definition and notation in the
analysis. Denoting it by S, equation (6) becomes:
g = air/(l-S)
where u = (1 - e-“‘)/( 1 - eeng). Since CJdepends
on r and g, and S on r, any solution for g in terms
of i, r and S, or for r in terms g, i and S, has to be
obtained iteratively. It turns out (see Section 4)
that equation (6) is easier to work with in this
respect, e.g., by scanning a range of possible values
of r to find the value which makes NPV zero, as is
the practice in project analysis. However, since CJ
and S are fairly stable quantities, equation (7) is
easier to interpret.
Equation (7) indicates that investment’s con-
tribution to the growth of economic output is sig-
nificantly higher than growth accounting studies
usually find, because of its influence on the growth
of wages. This is the reason for the (1 -s) term in
the denominator. New investments not only gen-
erate annual returns of the order of the product
ir for the investors, but also raise real wages by
redeploying labor from one kind of activity to
another - more productive - kind. Recalling the
calculations of Cairncross (1961) Kuznets (1966)
DEVELOPMENT
and others, the effects of investment on growth
were usually estimated from the product ir. But the
(5) above result shows that they should be estimated
from ir times I/( 1- 5’). Since S is typically in the
range 0.6 to 0.75, the total effects of investments
on growth may be. in an economy redeploying its
labor in productive ways. of the order of 2.5 to 4.0
times the estimates of these early studies.’
It is reassuring to find that the relationships on
which equations (6) and (7) are based appeared in
a similar form in the growth literature nearly 30
years ago, in the growth model of Kaldor and
Mirrlees (196162) which evolved out of Kaldor’s
earlier work (Kaldor, 1957. 1961). As in the vintage
models of Solow discussed above. technical pro-
(6) gress is embodied in new investment; investments
are retired once their quasi rents have declined to
zero on account of the growth wages (as in equa-
tion 5 and Figure 3); the amount of labor available
for working on new investments is equal to the
growth of the working population plus the labor
released from obsolescent investments (as above)
and physically wasted equipment; wage growth is
linked (as above) to the rate of redeployment of
labor and the growth rate of productivity of new
investments. New investments take place so long
as the present value of expected quasi rents equals
or exceeds the costs of investments (as in equation
1). There is no residual account, since the effects
of technical progress appear in the returns to
investment and the returns to labor. It is puzzling
that the insights provided by vintage theory have
been so long ignored in the growth accounting
literature. even though Abramovitz (1962) raised
the issue with great clarity more than 25 years ago.
(7)
(c) Disembodied and embodied technical
progress together
The analysis has so far concentrated on a stan-
dard case of embodied technical progress. Now
consider the effects on the returns to investment
and growth of factors not embodied in new invest-
ment directly. Familiar examples are growth in
agriculture arising from improvements in hus-
bandry, and growth in industry and commerce
arising from improvements in organization and
reductions in managerial inefficiencies. Negative
examples might be the economic costs of bureau-
cratic and political harassment of public and pri-
vate enterprises, which affect not only the choice
and rate of investment (and thus the rate of
embodied technical progress) but how well invest-
ments in place work and are managed (and thus
the rate of disembodied technical progress). There
are also some cases in which increases in output
per worker, though seemingly disembodied from
 INVESTMENT AND ECONOMIC GROWTH 1063

direct investment, require it in significant amounts (see equation 4) leads to the following expression
indirectly. Public investment in agricultural ex- for the rate of change of output:
tension services to improve husbandry and facili-
tate the dissemination of the results of scientific
research would be one example. lo One of the two
main effects of such indirect investments, however,
(-1
dQt
dt
= d. Qr +q,, -qt mm., (11)

is to raise the returns of investments already in But qL’P-ql-_n.l.can be written as q,,(l-(E,._,/

place (the other being to raise the returns to new EL,)e-@++ ), which again suggests the approxi-
investments) such that output per worker, b, exp mation qol.- q,.-n.r = q,,,( 1 -eeg”), assuming that
(6~) in the preceding notation, is no longer constant the rate of redeployment is approximately constant
after t’, but may rise (or fall, if managerial problems over time.
or bureaucratic harassment become worse). Out- Substituting equation (9) into equation (8) and
put per worker is not therefore fully defined by integrating, substituting for q,.t from equation
(embodied in) the investment at the time it takes (11) in the resulting expression, noting that
place. g = (l/Q,.)(dQ,./dt)and taking Z, = iQ, (we are con-
Such sources of growth increase the quasi rents tinuing to ignore lead times for the moment), leads
and thus the returns to both present and future to
investments. Changes in quasi rents might also g = air/(1-S)+d[l -ai/(l -s)] (12)
affect the deployment of labor on various vintages
of investments and thus real wages, as is apparent To compare this result with that of the “pure”
if a general upward shift of the curve of output per vintage case, denote the values of g, r and s in the
worker is considered in Figures 1 and 2. The effects latter case by the subscript 1, and in the present
might be quitecomplicated depending on the inci- case by the subscript 2. The difference in the rates
dence of the efficiency improvements on the vari- of growth in the two cases is d:
ous vintages of investments. But suppose outputs 92 =g,+d (13)
per worker increase at a rate of d per year on each
vintage of investment, with qt, being the output in where g, = air,/( 1 -S,), while g2 is given by equa-
year t of investments in the amount of IV com- tion (12) with the subscripts 2 attached to r and S.
missioned in year D (t > ~1). As before, let S be the It follows that, comparing equations (12) and (13),
present value of labor’s share in output. Then by d=r,-r,(l-S,)/(l-S,) (14)
definition of the rate of return,
2: r2-r,
,‘+?I

I, = (1 -s) -<l-V,& assuming Sz u S,.

qr, e (8)
Hence the contribution to growth of factors not
directly embodied in investment can be measured
Using the previous notation, the value of qc is by their effects on the returns to investment - in
now given by the present case, by the change in the returns to
investment. Substituting for rz from equation (14)
into equation (12) leads to:
The first term inside the exponent indicates that
g2 = air,/(l -S,)+aid/(l -SJ
new investment may capture the managerial and
other such efficiency improvements as well, while +d[l -ai/(l -S?)] (15)
the second term represents the effects of such The first term on the right-hand side of equation
improvements on the investment’s output after it (15) represents the rate of economic growth due to
has been commissioned. Since qv, represents the factors embodied in investments at the time they
output of investments commissioned in L‘in their are brought into service. The second term,
first year of service (2,) it simplifies notation to aid(1 -Sz), represents the effects on growth of
rewrite the last expression as managerial and other such sources of efficiency
improvement being captured by new investments.
(9) Note that it can be written approximately as
Total output in r, Q,, is then given by ai(r2 - r ,)/(1 - SJ, so that not only is there a gain
in terms of the returns to investment, measured by
Q, = 1 q,, dt’
J, = I -n
(10)
ai(r, - r ,), but a gain arising from the influences of
disembodied sources of economic growth on the
growth of labor’s income as well (as we would
The variable q,, has the same form as equation expect if we consider an upward shift of curves
(9) with obvious changes in notation. Substituting representing outputs per worker in Figures 1 and
equation (9) into equation (IO). and differentiating 2); hence the appearance of (1 - S2) in the denomi-
1064 WORLD DEVELOPMENT
nator of this term. The third term, d (the full
growth effect of disembodied factors) minus the
second represents the effects on output of efficiency
improvements to investments in place.
The effects of efficiency improvements not
directly embodied in investment may be quite
large, since they apply here to the entire capital
stock. If such improvements were confined to a
smaller share of the capita1 stock (as they often are
in practice) the effects would be smaller. But the
underlying conclusion would remain the same.
Improvements in managerial and other sources of
efficiency seemingly not embodied in investment
directly can nevertheless be viewed as influencing
growth by influencing the returns to existing and
new investments, and cannot accomplish much
without them. Their economic desirability can also
be assessed using a standard measure of economic
efficiency, the social rate of return to investment.
(d) The rate of profit analogue and the capital
output ratio
Consider the accounting identity Q = pK+ wL,
where p is the rate of profit, K capital stock, wL.
the wage bill and Q value added. Then if wages
ch>nge with investment:
@Q/Q) = p~+UlQ)kTw~)l=ld~
The second term on the right-hand side represents
the effects of investment on real wages; it becomes
gS if, drawing on the results of vintage theory, we
argue that it is investment which maintains labor’s
share in output at some level S*. The expression
then reduces to g = pi/( 1 - S*), the rate of profit
analogue of equation (7). The incremental capital/
output ratio also follows readily from the above
and is (1 - S)/ar if we are working in terms of the
rate of return, and (1 - Q/p in terms of the rate of
profit. Since neither the rate of profit, nor (recalling
Streeten, (1972)) the incremental capital/output
ratio provides a satisfactory basis for the analysis
of investment decisions and their effects on output,
it is generally preferable to work with the rate of
return.
3. SOME GENERALIZATIONS AND A
MORE DISAGGREGATED RELATIONSHIP
In the analysis in Section 2, the cost and revenue
streams associated with investment have a simple
form, with the yearly value added by an investment
being assumed constant over its economic lifetime
in the pure investment-embodied case, or changing
at a steady rate of d per year with changes in
managerial efficiency and other influences not
initially embodied in investment. The only changes
in prices considered were those of labor relative
to other inputs and outputs together, while the
changes in labor costs were also assumed to take
a simple exponential form. The assumptions were
depicted graphically in the lower half of Figure
3. They were obviously restrictive assumptions,
which might be relaxed as follows:
(a) The value added each year by an investment
may change over economic cycles, or with
weather, political shocks, and other ran-
dom factors.
(b) Value added may also change over time
with “learning-by-doing” and with the
experience of the labor force working on
the new vintages of investments.
(c) Investments often have long lead times.
(d) Maintenance costs generally rise as the
investments age. leading to a decline in
quasi rents even if labor costs remain
unchanged.
(e) Finally, relative prices of outputs and
inputs may change with innovation,
changes in terms of trade, and scarcities in
the supply of certain factor inputs.
In general, and after smoothing out random and
cyclical factors, the outputs and costs of an invest-
ment may look more like the form shown in the
upper half of Figure 3 than in the stylized form
below it.
It is apparent that once one begins to allow for
such realities, explicit algebraic relations between
the growth of output, investment, and the returns
to investment (including the returns of labor)
become more difficult to derive. But two points can
be fairly made. First, when we are considering
how the rate and efficiency of investment influence
growth, the principle of comparing the present
value of the change in output associated with
investment with the present value of the investment
and labor costs of producing the change remains
applicable. The computational difficulties of esti-
mating the returns to investment and labor from
data on output, investment and wages are sig-
nificantly increased, but the basic accounting ident-
ity for the rate of return or NPV of investment
remains a valid starting point for analysis. Second,
it is still useful to know how the averages of the
various quantities of interest (i, g. r and 5’) relate
to each other in more complicated situations, and
how they might be estimated.
In a separate paper, ’ ’ I have attempted to show
that the aggregate relationships derived in Section
2 may hold for the periods over which growth
 INVESTMENT AND ECONOMIC
performance is usually studied (typically IO-20
years). The approach is to divide the outputs
of investments of vintage tr into two parts,
qc,= &.+u,;,, where IV is their mean output over
the period of interest and u,.,(? 2 v) is the deviation
of the actual output from the mean. The variable
u,, may be negative in the early years of an invest-
ment as output gradually builds to full capacity
levels; negative in later years, as maintenance prob-
lems increase and the investment is gradually
worked shorter hours until being taken out of ser-
vice; positive or negative at other times on account
of business cycles, random factors, and so forth;
rise or fall if there are any systematic improvements
or deteriorations in the efficiency with which the
investment is managed and operated; and rise or
fall with relative changes in factor and product
prices. By definition of 41, and u,,, the integral of
the latter over sufficiently long periods is small; the
approximation that its discounted value over such
periods is small is also used (which helps to simplify
rate-of-return identities like equation (8)). An
expression similar to equation (7) then emerges,
with the variables g, i, 6, r and S being replaced
by their average values, namely
Equation (16) raises issues regarding the aver-
aging process itself, the lead times of investments,
the calculation of 3, and disaggregation.
First, using averages does not preclude analysis
of the numerous events which may influence an
investment’s output over its lifetime. The value of
&+u,, = qt, in general cannot exceed the capacity
output of an investment, which means that the
larger is u, the smaller the average output 4., the
smaller the average quasi rents, the smaller the
rates of return to investment and thus the smaller
the contribution of investment to the growth of
output. In other words, the transitory factors rep-
resented by u,, exert their influence on growth
through their influences on quasi rents. This pro-
cess affects the average returns to investment and
may also affect the rate of investment and labor’s
share in output. The division of a particular vintage
of investment’s contribution to output into tran-
sient and average terms is in any case only the
simplest of several ways of expressing qr,.
Lead times of investments are a second factor
which the analysis has neglected thus far. Lead
times vary greatly with the kind of investments,
from a few weeks or months for machinery and
equipment, to one to seven years or more for fac-
tories, power plants, physical infrastructure, and
irrigation works. Investments in such areas as agri-
cultural extension and research may need lead
times of more than IO years. Thus investments
GROWTH 1065
taking place in u do not affect output until IJ to U+ 1
years later (depending on when they were begun in
the period ~1-1 to v), where I is the lead time
of the investments, while the output of activities
started up in L’originates from investments taking
place over the period r-1 to c. Lead times raise the
discounted costs of investment (if the discounted
values are referred to period P), or alternatively
lower the discounted benefits (if the discounted
values are referred to the time when investment
activities begin, r-I). Taking the former case, we
can define the proportionate effects on costs by a
term L,, where
a,e-*‘-“dt, and a,dt = 1
Here, a, represents the profile of investment expen-
ditures, such as that depicted in Figure 3. In this
case, and again taking an average value of L,.,
equation (17) becomes
Q = 6itF/(l-3) (17)
Third, turning to the calculation of 3, the main
difference between this variable and the more fam-
iliar quantity, labor’s share in current output
(denoted by s*), is that the effects of discounting
are to give the present value of labor’s share in the
(present value of) output a lower weight toward
the end of an investment’s lifetime, when labor’s
share in output is high (see Figure 3). Thus 3 is
generally lower than s*, though not appreciably
(because output is discounted as well as wages).
The procedures for calculating .!? from data on
wages (or on s*) follow straightforwardly from
discounted cash flow formulae (see Table 1). When
wages are constant, S equals S*.
Finally, turning to disaggregated forms of equa-
tion (16), the rate-of-return accounting identity is
applicable to any investment. Denoting each
investment activity by j, the disaggregated form of
equation (16) is readily shown to be
g = ‘1 ff,L,l;,i//(1 - 3,) (18)
where the I;, represents the average share of invest-
ment in activity j over the period 0 to T.” This
relationship does not rest on any particular
assumptions as to the number of investment activi-
ties or sectors. The composition of such activities
or sectors within the group defined by j = I.. .J
can be thought of as changing over time. with old
sectors beoming a zero subgroup of J once they
are obsolete, and new sectors having been a zero
subgroup before their appearance.
1066 WORLD DEVELOPMENT
4. IMPUTED AVERAGE RATES OF
RETURN TO INVESTMENT FOR SOME
COUNTRIES
The following exercise uses the aggregate
relationships derived in Sections 2 and 3 to impute
the rates of return to investment from data on g, i
and S for some developing and industrial
countries. The aims are to determine whether
approach gives estimates of r consistent with pro-
ject experience and, second, to show how the three
variables, i, S and r relate to the rate of economic
growth in practice. The estimates of r are based on
the NPV form of equation (17): ’ 3
NPV = (1 -e-“‘)/r-(em”‘“-em’“)/(r-w)
-i(l -e-g”)/g(l +r)Li2 (19)
where L represents the average lead time of invest-
ment. The procedure is to scan a range of r and
find the value which makes NPV zero.
Estimated average rates of return to investment
using this equation are presented for 19 countries
in Table I. The period considered is 196&8 1. The
countries were chosen to give a broad sample in
ttrms of development, rates of growth and region.
There are five African, three Middle Eastern, five
Asian, three Latin American and three indu-
strialized countries in the sample; three of the coun-
tries are also major oil exporters (Saudi Arabia,
Mexico and Nigeria).
Two estimates of r are presented in the table, a
low estimate (in column lo), and a high estimate
(in column 11). Also shown (in column 12) is the
effect on r, for the developing countries, of includ-
ing current expenditures on health and education
in the rate of investment. Let us first consider the
reasons behind the low and high estimates of r.
Data on g, i, c (the labor force growth rate) and
b = (g-c), the labor productivity growth rate, are
shown in the first four columns. An attempt was
also made to construct an index for the growth rate
of real wages (which include the imputed wages of
entrepreneurial labor). Published data relevant for
the estimate of this variable (and for labor’s share
in output) are surprisingly scarce or, when avail-
able, are generally unreliable for developing coun-
tries. The main difficulty in using these data is that
large proportions of the labor force are either self-
employed or family workers for whom it is difficult
to impute a wage rate, given the diversity of activi-
ties involved. Only India among the countries listed
explicitly adjusts for this factor. Typically 3&50%
of the labor force is self-employed or household
workers in Latin American and Asian countries,
and 70-90% in Africa, as compared to around
10% for the industrialized countries.
Given these uncertainties, the approach taken
was to estimate a lower and an upper limit for r.
The lower limit was obtained by setting w = b,
the rate of growth of average output per worker,
shown in column (4). It is considered a lower limit
because real wages have probably grown more
slowly than average output per worker in most of
the developing countries shown, on account of a
concentration of investment away from the tra-
ditional sector. The situations in these countries
tend to vary between those depicted in Figures I
and 2, and are unlikely to fit Figure 1, in which
b = n’. A high value for n’ (and thus for labor’s
share in output) naturally lowers the value of r for
given values of g and i; a low value for w raises the
value of r.
The upper limit for r corresponds to the case
where S = S*, labor’s share in current output, and
a value of S* based on output per worker in agri-
culture less an allowance for operating surplus per
worker (in agriculture). Thus it is based on the
relation:
NPV=O=
(1 --S*)(l -e-“‘)/r -i(l -e-““)/g(l +r)L*2 (20)
Let us comment further on the estimates of S*.
For six of the countries listed, the operating surplus
of unincorporated enterprises (OSUE) is itemized
in the national accounts, as are the wage labor
bills of government and nongovernment activities.
Hence, using the following definitions:
W, = government wage bill as a proportion of
(national) value added;
W, = nongovernment wage bill also as a pro-
portion of value added;
V, = value added by nongovernment activi-
ties as a proportion of (national) value
added; V, = I- WY;
S,* = share of labor in V,; and
OSUE = Operating surplus of unincorporated
enterprises as a proportion of (national)
value added. Then:
s* = w,+s,*v,;
S,,* V,, = W,+ S,,* OSUE, assuming labor’s share
in output is the same in the unin-
corporated as in the incorporated
sector. Hence, on this assumption,
S* = W,,+ W,,/(l -OSUE/V,,).
The calculations of S* using this procedure are
shown in column (5) of Table 1; the background
data and worksheet are provided in Table 2.
For 13 of the countries listed no information is
published in the sources cited on OSUE, though
data are available on W, and IV,. Hence an attempt
was made to proceed by rewriting the accounting
 INVESTMENT AND ECONOMIC
identity for the nongovernment sector as follows:
.s,*v, = w”+s,*(v”- w,/S”*) (21)
Since W,, in equation (21) is the share of wage
labor in value added, it follows that (V, - W,/.S,*)
represents value added by non-wage labor (as a
proportion of national value added). The problem
at hand, given that W, and V, are known, is to
determine what this quantity might be. S* would
then follow as before from the identity
S* = W,+ .S,* V,,. Several ways of estimating the
value added by non-wage labor were tried, of
which the following expression gives a fairly con-
servative estimate: Va(NSE/Na), where Va is the
value added in agriculture as a proportion
national value added, NSE is the number of self-
employed and household workers in the economy,
and Na is the number of agricultural workers. This
estimate is conservative because NSE includes a
significant fraction of nonagricultural workers
whose value added per worker, though higher than
in agriculture, is costed at (VaiNa) in the analysis.
That the proportion of household workers is
greater in agriculture (one-half to two-thirds
NSE in agriculture) than in nonagricultural acti-
vities (around a quarter, the rest being proprietors)
also leads to a downward bias in the resulting
estimate of S*.
The calculations of S* using this procedure are
shown in column (6) of Table 1, the background
data again being provided in Table 2. Comparing
the results in this column with those shown in
column (5) for countries for which data on OSUE
were available. it can be seen that the cor-
respondence is generally quite good. Also shown
in column (7) is an estimate of S* from the vintage
model discussed in Section 2 assuming M’= 6. This
estimate was made solely to begin the iterations to
find r when using equation (2); it shows, however,
when comparing the results with those in column
(8) that the approximation S = S* is not a bad
one in an economy where wages are growing in
step with output per worker, but will generally
overestimate the influence of investment on labor’s
income where M:< b, as we would expect.
The values of g, c, b and c used are those sum-
marized in the World Tables published by the
World Bank. Assumptions were needed about the
average economic lead times and lifetimes of
investment. The values used were five years for the
sub-Saharan African countries listed, four years
for the other developing countries, and three years
for the industrialized countries. The values of n
used range from 15 years for the countries with
high growth rates per worker, to 30 years for the
slow-growth countries, the shorter lifetimes in the
high-growth cases being considered more likely on
the grounds that the rates of retirement of invest-
GROWTH 1067
ments and the rates of redeployment of labor
would both be higher.
The values of g shown in the table relate to the
growth of GDP at factor cost, and of i to gross
investment. No adjustments to these figures were
made to allow for depreciation. When deriving
the relationships discussed in Section 2 and 3, the
change in output was formulated as the derivative
(with respect to L.)of the integral of the outputs of
all investments in service in ~7,introduced over the
period r-n to r; a negative component of the
change in output thus appeared in the resulting
expression, arising from the shift in the lower limit
of the integral from r-n to v+dzl-n. This com-
of ponent represented the effects on output of the
retirement of investments with zero quasi rents. In
addition, the finite life of the investments leads to
the appearance of the capita1 recovery factor in
expressions like equations (I 9) and (20). To deduct
official estimates of depreciation from both the
GDP and the investment series thus would be to
double count costs. I4
Before turning to the results, a comment might
of be added on investment in health and education.
The national accounts data cover physical invest-
ment only, including physical investment in health
and education services and in the training of the
labor force. But in developing countries most
recurrent expenditures on health, education, train-
ing and agricultural extension have the effect of
improving the quality (i.e. productivity) of the
labor force, as opposed maintaining the quality
intact. At least for the developing countries, there-
fore, such expenditures ought to be included in the
investment cost stream. This adjustment was made
in the results shown in column (I 2) of Table 1. The
general effect is to lower the returns by a factor of
1.1 to 1.3, depending on the size of such expen-
ditures in relation to investment.
Turning to the results shown in columns (IO) and
(I I), it is apparent that the captial accumulation
approach to growth followed in this paper does
not lead to anomalously high rates of return to
investment. For the three industrialized countries
the estimated average rates of return vary between
4.6% (United Kingdon) up to 7.6% (Japan). For
the developing countries, the estimates vary from
being negative (Ghana) to l2-16% for the high-
growth countries.
The results indicate that what is important for
growth is neither a high rate of investment in and
of itself, nor simply high social yields from invest-
ment, but rather the product of the two, with g
being approximately equal to 3(ir). Savings and
investment are emphasized by the approach, but
so are savings wisely invested - with the rewards,
in terms of growth, being appreciable indeed. Fig-
ure 4 illustrates this point graphically by plotting
 Table 1.Imputed averaqe rates of return to investment in selected countries, 1960-41

Effect on I F;
Labor Labor’s share in output S*% PV of Rate of return, r% (col. 1I)
force Labor -_.--. labor’s --- of including g
Growth Rate of growth productivity Using Using share in Rate of Using Using health and $
rate investment rate growth rate Accounts equation vintage output profit equation equation education 6
Country 9% i% C% b% data* (21) model? S%$ r*%§ (19) (20) expenditures11 2

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) z
4
Ghana 0.9 IO.5 2.0 -1.1 >lOOI -- > IOOf -1.7 _** -**
Cdte d’lvoire 7.1 22.2 4.0 3.1 64 67 69 68 9.g 9.1 9.3 8.2
Kenya 5.8 21.5 2.8 3.0 59 67 71 70 7.8 7.8 8.7 7.1
Nigeria 3.8 20.8 I.9 1.9 - 52 74 71 5.1 5.5 9.6 8.7
Sierra Leone 2.8 13.6 1.3 I.5 - 52 78 75 4.5 6.7 12.6 I I.0

Egypt 6.2 21.3 2.1 4.1 -- 57 71 58 10.8 12.4 12.7 Il.6

Turkey 5.7 20.9 1.8 3.9 - 57 66 60 9.7 II.6 12.5 10.2
Saudi Arabia 10.1 20.1 3.3 6.8 - 35 55 40 22.5 21.4 25.9 ma.

India 3.6 19.6 I.6 2.0 71 77 71 68 5.3 6.7 4.2 4.1

Sri Lanka 4.5 19.0 2.1 2.4 - 69 71 68 6.8 8.4 8.0 7.4

Korea (Republic of) 8.8 26.3 2.9 5.9 60 61 60 58 13.3 12.9 11.8 10.8
Philippines 5.7 24.4 3.4 - 58 68 67 7.5 7.8 10.4 8.7
Thailand 7.8 24.3 ::; 5.3 52 44 64 61 II.6 II.9 17.6 15.8
Brazil 6.6 22. I 3.2 3.4 53 67 65 9.7 10.3 14.0 13.5
Colombia 5.4 22.0 3.1 2.3 16 13 71 70 7.0 1.3 6.4 6.1
Mexico 7.0 23.2 3.1 3.9 45 63 61 11.0 11.5 15.9 14.5

Japan 7.5 34.7 1.6 5.9 74 68 61 61 8.4 7.6 5.2 -

United Kingdom 2.3 18.3 0.4 1.9 75 75 74 71 3.3 5.5 4.3
llnited States 3.6 19.0 1.6 2.0 71 70 76 74 4.6 5.8 6.9
___._._ ___~
Sources: values of 9. i and c are taken from World Bank (1983). Estimates of S* are derived from the data presented in Table 2.
The values of n and L were assumed to be as follows: L = five years for the African countries, four years for other developing countries, and three years for the
industrialized countries; n = 30 years for the slow-growth countries (where the rate of “turnover” of investment is low) with output per worker growth rates, b, of less
than 2% per year; 25 years for countries with h in the range 2 3%; 20 years for countries with b in the range 3-5%; and 15 years when b > 5% per year.
*Using the relation S* = W,,/(I -OSLJE/V,)+ W,, where W, is the share of nongovernment wages, W, of government wages and OSUE of the operating surplus of
unincorporated enterprises in value added. V, = (I - W,). Data on W,, I+‘, and OSUE are provided in Table 2.
tFor the pure vintage model that generates equations (6) and (7) in Section 2, the value of S* is given by:

S* = @/c)(e-“-e~v’)/(l -e-““). LZ
fThe ratio of the second term to the first in equation (19). evaluated at the equalizing discount rate (T, shown in column IO), assuming w = h.
Or* = (1 - S’)g/i. T
1li.e.. current expenditures on health and education, since investment expenditures on these items are already included in the figures for investment. Health and education
expenditures are also tabulated in the above source and vary from l-.5% of GDP. To obtain the estimates in column (12), column (I I) is multiplied by I/( I +current 2
health and education expenditures per unit of GDP). The exercise was not done for the industrialized countries.
TValues of S* and S > 100% are feasible for a period if capital stock and inventories are being consumed (as happened in Ghana in the 1970s). R
**No feasible value exists because the benefit and cost streams are both negative. The analysis thus works with the rate of profit instead, as a proxy, shown in column 0
(9).
B
i;
 8
Table 2. Worksheets for estimates of labor’s share in current output in the 1960s and 1970s
E
Value added % Labor
Split of W between in force Fz
Wages as government and nongovernment agriculture in Labor force S* from Estimates of S* from accounts data Fz
% of GDP as % GDP Agriculture self-employed equation (21) s
country W W,% W”% Va% Na% NSE% S% * OSUE as % GDP s*t s
;;;
(1) (2) (3) (4) (5) (6) (7) (8) (9)
3
Ghana 84 8 76 53 58 73 >I00
Cote d’lvoire 43 II 32 35 81 89 67 35 62
Kenya 40 10 30 40 80 85 67 353 56
Nigeria 27 5 22 40 60 76 525
Sierra Leone 29 8 21 38 70 89 52

Egypt 47 1011 37 30 55 36 57
Turkey 31 10 21 32 45 70 57
Saudi Arabia 15 6 9 - 35ll

India** 77 - 77**
Sri Lanka 47 4 43 32 55 56 69

Korea, (Republic of) 39 5 34 28 45 60 61 36 58

Philippines 36 6 30 28 50 71 58
Thailand 28 4 24 35 78 85 44 48 50
Brazil (45)tt 8 (37) 14 40 45 (53)
Colombia 44 7 37 33 35 43 73 43 72
Mexico 40 8 32 12 40 38 45

Japan 60 5 55 7 22 36 68 18 72
United Kingdom 68 6 62 2 3 14 75 9 74
United States 69 13 53 3 4 IO 70 8 70

Sources: W, I+‘, and W, are obtained from the UN, Yearbooks of Ndonal Accounts Starisrics and are rough averages. The Operating Surplus of Unincorporated
Enterprises (OSUE) shown in column (8) was taken from the same source. Note that the values of W, W, and W, and OSUE are expressed as percentages of GDP at
factor cost. Va and Na are tabulated in World Bank (1983). Data on NSE are published by the ILO, (various years), but for some countries were only available for one
or two years in the period; estimates of NSE are approximate, and based on spotty data.
*I.e., S* = Wg+ W./(l -x). where x = (Va.NSE)/( V,Na).
tAs estimated from S* = W,+ W,/( I -OSUE/V,). 2
$For Kenya, OSUE is taken to be the sum of the output of the “semi-monetary” sector plus the marketed production of small farms and businesses. See Hazlewood 3
(1979), chapters 3, and 5 for data.
§For the non-oil economy, S* is about 70%. 3
/IA nominal figure, taken for this exercise (Egypt does not publish estimates of W,).
IAssuming S* is 60% for the non-oil sector of economy, which accounted for about 45% of value added, on average, over the period, and dividing the nongovernment 2
wage bill (W,) between the oil and non-oil sectors in the ratio (I-0.45) to (0.45). The value of S* is then W,+O.SSW,+O.6 x 0.45 = 35% (rounded).
**Indian statistics estimate labor’s share in current output directly, “including part of net operating surplus of unincorporated enterprises which cannot be separated
Z
from income on own account.
ttAgain, a nominal figure taken for this exercise, since W is not published in the sources cited. An analysis of wages in Brazil is to be found in PfetTermann and Webb #
(1979). 0
1072 WORLD DEVELOPMENT

II-

IO - 0 +

-9 -
+ 0

f”-
0 +
e + 0
o+ 0 +
;’ 0 +
E _
8” +o
08 o++”
‘ij5-
30
+ High value of R
&I-
+8e + 0 LOW VclLue of R
3-
0 +
+o
2-

I -

I I I I I
200 loo 300 500
Rate of Investment times the rate of return (ir )
Figure 4. Economic growth us investment times its yield.

the product i. r against g. The high and low esti- (1957), is to estimate a production function of the
mates of r discussed above are identified separately form Q = A exp &f) F(K,L), where A exp (&,r)
in the figure so as to show the effects of the uncer- represents the technical progress, or the “resi-
tainties (regarding the treatment of labor’s share) dual”) and A is a constant. From this,
on the results; the uncertainties are not small, but
also not such as to obscure the rule just stated. 9 = @7,+(J --)g,+g, (22)
Regrettably, the data on labor’s share are not good whereg,g, andg, are the rates ofgrowth of output.
enough for a third element to be investigated, capital and labor (in person hours), tl = pK/Q is
which is that high growth rates might also be ach- capital’s share in output, and (I --3~) = M,L/Q is
ieved with higher returns to labor than many devel- labor’s share in output. ” The other approach is to
oping countries have achieved in the past. This work with the “fundamental accounting identity”
subject has been examined extensively elsewhere (Jorgenson and Griliches, (1967) in which the total
however, ” and, broadly speaking, we might value of outputs equals the total value of inputs,
amend the opening statement of this paragraph or, at an aggregate level, Q = pK+ wL. If Q, K, \t
and conclude that what matters for growth is the (wage rates) and L are changing over time, then,
product of three variables: the rate of investment. from this identity,
the returns to investment, and the investment-
induced returns to labor. 9 = ag, f(J -~)g1_+(l-~)g. (23)
where g,, is the rate of growth of real wages.
Comparing equations (22) and (23). g,, =
5. RELATION TO CURRENT (1 -x)9,*; hence most of the attempts to explain
APPROACHES TO GROWTH or whittle down the residual since Solow’s article
ACCOUNTING have amounted to accounting for the growth
of real wages - associated, for instance. with
Growth accounting studies generally work with changes in the educational, age (experience), and
the rate of profit, p. rather than the rate of return. skill compositions of the labor force, and with the
To simplify algebra and to make comparisons, the redeployment of labor from low to higher wage
following analysis uses the rate of profit analogues sectors, as described in Section 2. The rate of
of the relationships derived earlier. growth of labor’s income is usually divided into
Assessments of the contribution of investment four parts: changes in the number of employed
to growth have been based on two essentially equi- people. in their hours of work. in their educational
valent approaches. ” The first, following Solow levels. and in their occupations or sectors of work.
 INVESTMENT AND ECONOMIC GROWTH 1073

Letting N denote the number of workers, H their (I- r)gL* +gy*, where go* is a new residual, vari-
hours of work, and for simplicity taking H to be ously termed total factor productivity (TFP), out-
the same for all categories of worker. put growth due to advances in knowledge, or
technical progress (TP). It is apparent that, from
WL = NH~e,~s,,w,, (24) this definition of gL*. TFP or TP is the fifth term
J I
on the right-hand side of equation (25) multiplied
where e, is the proportion of the total labor force by (1 -c(); i.e., and substituting for NH/wL
(in worker hours) in education group i with from equation (24),
Ze, = I; wi/ denotes the wages of workers of edu-
cation i in occupation or sector i; and sii is the TFPorTP =
share of workers with education i in sectorj, with
Z/s,, = I. Differentiating, omitting second-order
terms, and dividing by wL,
1 d(wL) 1 dN 1 dH That is, TFP or TP is the sum of the wage growth
-.p = N.X + H’Z (quantityinputs) rates of labor within the various educational and
WL dt
occupational groups, weighted by the shares of
NH de, each group in value added.
+ wL c dr c sbwij (quality adjustments)
I Expressions (25) and (26) reveal three points of
I
departure between current approaches to growth
+ gx e, c we% (gains from redeployment) accounting and the capital accumulation approach
t I to growth: the treatment of technical progress; the
NH dw, (wage growth ostensibly analysis of economic efficiency; and the com-
+ wL, c e, Isof without quality change plementarities among physical investment, human
1 I or redeployment) (25) investment and the deployment of labor.
As regards the treatment of technical progress,
where wL/NHis the average wage per worker hour. terms like equation (26) have been left in labor’s
The first three terms on the right-hand side of account in the present analysis (as the expression
equation (25) follow Jorgenson and Griliches suggests they should be) when imputing the returns
(1967) and Grilliches (1970) except that I have also to investment from growth rates of output and
disaggregated by sector to identify redeployment wages. They have also been left in when suggesting
effects on labor’s income. The first four terms on how growth rates of output might be estimated
the right-hand side are similar to those in the dis- from assumptions about the rates of invest-
aggregated study of Nishimizu and Hulten (1978). ment, the returns to investment, the deployment of
Considering each term in turn, the first two rep- labor, and the rates of growth of wages. In other
resent changes in quantity inputs, and the third words, following Scott (1981, 1986), no “residual
the familiar quality adjustments for changes in the account” is kept open to represent the effects on
educational composition of the labor force. The growth of TP. The residual is zero, by definition
fourth represents the effects on labor’s income of of the accounting convention used (the social rate
shifts in the sectoral or occupational composition of return convention), and the effects of TP on
of (each education group of) the labor force. The output are reflected in the returns to labor and the
fifth represents wage growth over time of labor returns to investment.
within given educational and sectoral or occu- In adopting this convention, the intention is not
pational categories. As indicated, this term repre- to suggest that TP is unimportant or that its role
sents wage growth ostensibly without changes in in economic growth would be “catastrophically
the quality of labor, and also without redeploy- reduced” if the residual (as it is usually estimated)
ment, because these two effects are intended to be were small or zero, as Kennedy and Thirlwall
measured by the third and fourth terms; in prac- (1972) suggested it would be in reference to Jorg-
tice, however, both quality changes and redeploy- enson and Griliches (1967). Rather, technical pro-
ment may be appreciable within any i,jgroup even gress, in the generic sense, is give a greater role by
if, as discussed in Section 2, one is working at quite the capital accumulation approach: its con-
high levels of disaggregation, so that significant tribution can be seen as being closer to the early
quality changes and redeployment effects may be estimates of Abramovitz, Solow, Kuznets and
unintentionally included in the fifth term. others, in which it was estimated to account for
Growth accounting studies generally estimate around 90% of output growth as opposed to the
the first four terms on the right-hand side of 3650% figures later suggested by the growth
equation (25) to obtain an estimate of the rate of accounting procedures just discussed.
growth of the quality-and deployment - adjusted Consider again, for instance, the relation
labor force. Denote this by gL*. Then g = ag,+ g = uir/(l -S), and suppose that new techniques
1074 WORLD
with higher outputs per worker were not intro-
duced - neither through new investment nor
through improvements to investments in place. Let
the value of g.in these circumstances be g,. Since
this would be a static economy with constant real
wages and output levels, the present value of
labor’s share in output would equal labor’s share
in current output, so that S = (1 -a). Also, the
lifetimes of the investments would be large, assum-
ing maintenance is uridertaken as required, and so
u = 1. Hence g, = air/(l-S) = ir+(l -a)g,. But
ir = ug,, so that g,, which under the preceding
conditions falls to gL, can be written as g, =
ag,+(l -cZ)g,.‘* This means that without new
techniques and the redeployment of labor to utilize
them, the growth rate of output collapses to a rate
corresponding to the quantity inputs of labor and
capital only. (The accounting identities derived in
this paper thus fit this special case of no TP.) Hence
the difference between such an economy and an
economy in which technical progress is taking
place is given by (recalling equation 22 above),
g, = g-Ugk--(l -a)gL = oir/(l -g-g,
Hence the capital accumulation approach to
growth (as I have attempted to interpret it in this
paper), measures the “fruits” of technical progress
( ga) in terms of their effects on the returns to labor
and to capital. ’ 9
This result raises the issue, long noted by Deni-
son, that a small or zero contribution of TFP to
growth can be correct “onZy, if.. . procedures have
the effect of reclassifying.. a contribution of out-
put per unit input to an input contribution.“”
In a much cited critique of Jorgenson and Gri-
liches (1967), Denison concludes that
there is an advantage in matching growth sources
with the reasons that income changes, and I have tried
to adhere to this principle in my own work.
In particular, confusion and misinterpretation
avoided if the contribution of capital is identified
with changes in income that result from investment,
and the contribution of advances in knowledge is
identified with changes in income that result from ad-
vances in technical and managerial knowledge. and
that can be altered by changing the state of know-
ledge. Confusion is hard to avoid if the consequences
of advances in knowledge are classified as contribu-
tions of capital.*’
These remarks indicate the second point of
departure between the capital accumulation ap-
proach to growth and current approaches. which
relates to the measurement and analysis of eco-
nomic efficiency. It seems reasonable that, if the
economist is seeking to determine how perceived
efficiencies or inefficiencies in economic policies
affect the rate of economic growth. it is necessary,
DEVELOPMENT
in the social as in the physical sciences, to compare
outputs with inputs directly. This is the basic case
for comparing the value of output changes with
the costs of achieving them using the economist’s
measure of economic efficiency. the social rate of
return or NPV of investment. Its use does not
preclude the analysis of the various causal factors
to which Denison refers, such as the relative con-
tributions of physical and human capital to the
growth of output - though such contributions
need to be assessed in terms of their total rather
than their partial effects on output, as discussed
below.
Instead, use of NPV raises additional questions,
such as are expenditures on physical and human
investment, and the policies which bear on the
rate and composition of such expenditures, being
applied efficiently to the task’of rasing output? Is
there too little investment in raising the quality
of labor given the technologies available and the
amount of physical investment taking place? Con-
versely, is there too little physical investment to
fruitfully employ increasingly educated and skilled
workers capable, if they had the tools at their dis-
posal, of raising the output of investment? In
addressing these and other such questions, it is
necessary to compare outputs with inputs, specifi-
cally, the present value of output changes with the
present value of the investment and rising real
labor costs of achieving changes. The labor costs
would be estimated at prevailing real wage rates
over the periods in question, and would include
allowances for real wage growth uithin well-
defined educational and occupational groups (the
fifth term in equation (25) as well as for real wage
growth arising from redeployment or changes in
the quality of labor (the third and fourth terms).
Thus all five terms on the right-hand side of equa-
tion (25) are relevant. Together they represent the
rising opportunity costs of labor. It seems impor-
are tant for an economy, if it is to raise real wages as
well as real output, to assess its policies in terms of
their capacity to generate positive quasi rents in
the presence of rising real wages.
If one must allow for the full costs of labor in
the analysis of how economic policies affect
growth, and not just the quality - and occu-
pation ~ adjusted costs of labor (the first four
terms on the right-hand side of equation (25) the
following question arises: is there any purpose in
separating out the effects of education and
redeployment on real wages from those within nar-
rowly defined educational and occupational
groups?
The position here is that the analysis of the con-
tribution of education to growth should surely not
end with the estimation of terms like the third and
fourth on the right-hand side of equation (25). It
 INVESTMENT AND ECONOMIC GROWTH I075

seems likely, as Bowman (1980) suggested, that of recruitment to the civil service and business man-
the approach significantly understates education’s agement..
contribution to growth in many ways. Blaug (1976) He notes the waste involved in “not planning for
has noted several ambiguities in the assumptions the required complementarities, and pushing edu-
and evidence underlying human capital theory. cation too far.. .r’24 In general, it is the joint
In addition, the returns to human investment so returns to human and material investment that are
estimated are necessarily based on the derived important for growth. In Sections 2 and 3. an
demands for various qualities of labor and assume attempt was made to allow for interdependence by
that the complementary physical investments are considering the joint returns to physical and human
in place; they are higher than the joint returns investment, and by considering the effects of these
to human and physical investment except in the (joint) investments on the returns to labor, as well
special case where they equal the marginal cost of as on the returns to investment itself.
capital. ** Then there are the problems of dis-
aggregation discussed in Section 2(a) and of the
human and material investment requirements of
raising labor productivity within even narrowly 6. CONCLUSIONS
defined sectors.
Regarding the complementarities between The above analysis sought to show how a coun-
physical and human investment, and also between try’s rate of economic growth can be expressed in
physical investment and the redeployment of terms of variables representing the size and quality
labor, it seems important to recognize that it is of its investment portfolio. The size of the portfolio
the total rather than the partial changes that are is determined by the rate and its quality by the
relevant for identifying changes in income that allocative efficiency of investment. The principal
result from investment. The redeployment of labor relationships derived were based on an accounting
from rural to urban areas, for example, requires identity for the social rate of return to investment.
appreciable human and physical investment in In this identity the present values of output
urban areas; investment is also needed in rural increases arising from economic investments were
areas where agricultural output per worker must compared with the present values of the costs of
be raised to meet the rising food demands of urban achieving them. The underlying aim was to arrive
areas, when the size of the agriculture labor force at a means for analyzing how the efficiency of
is in relative or absolute decline. The redeployment economic policies affects the rate of economic
of labor from small-scale to large-scale industries growth.
or from lower- to higher-technology industries as The analysis departs in several respects from the
industrialization proceeds similarly requires physi- methods followed in a number of growth account-
cal as well as human investment. As Nelson (1973) ing studies over the past 30 years, in which
remarked, in the absence of investment in new investment’s contribution to growth was estimated
technologies “educated workers would be doing to be small. Following the lead of Maurice Scott,
nothing different than uneducated workers and the analysis suggests instead that when efficiently
would not be more productive,” and it can be applied to the task of raising output, investment
misleading to suggest what education did or might accounts for most of a country’s growth. Con-
contribute to growth without reference to the versely, when inefficiently applied, it accounts for
physical investments (and the policies that bear on most of a country’s decline or stagnation. Much
them) required to employ the educated workers emphasis was placed on the product of the rate of
fruitfully. In several papers, Nelson has com- investment and the social rate of return. But these
mented on the way “growth accounting tables . . were not the only variables emphasized, since the
repress interdependence” between physical and rates and choices of investments have appreciable
human investment. *’ effects on the ways in which labor is deployed and
Streeten (1970) has similarly drawn our atten- redeployed in an economy. Most growth account-
tion to the dangers of neglecting the comp- ing studies significantly underestimate these effects
lementaries among education, material investment both in “positive” instances, when labor is re-
and economic policy. He comments that in devel- deployed productively, and in “negative” instances
oping countries: when it is not. Finally, the analysis did not follow
The isolation of “educational” expenditure (in
the common practice of placing the benefits of
growth accounting studies) may distract attention technical progress in a residual account, separate
from the urgent need. not only to select the right type from those accounts representing the returns to
of education, but also to combine it with the provision labor and the returns to investment; in practice,
of better seeds. drainage and fertilisers, with improve- and once the total effects of investment on output
ments in transport and birth control, with a reform are considered, the benefits must appear in one or
1076 WORLD DEVELOPMENT
the other of the latter two accounts. Again fol-
lowing Scott’s lead, it was argued that a residual
account is not needed and that its closure might
greatly facilitate the analysis of the influence of
economic policy on growth.
Reworking growth accounting relationships in
this way need not rest on assumptions about the
“stylized facts” of growth. Indeed, departures from
them - such as increases or decreases in the rates
of investment, in the social returns to investment,
and in labor’s share in output - are highlighted by
the approach. In this respect, the approach seems
especially relevant to the circumstances of the
developing countries. Furthermore, it need not
concern itself only with the long-run aspects of
development, since the cumulative effects of (for
instance) business cycles, changes in terms of trade,
NOTES
1. Scott (1981, 1986, and 1989).
2. Methods of estimating depreciation in national as
in private accounts generally bear no relation to what
determines actual maintenance requirements, and may
lead to a double counting of costs (see Section 4). The
costs of maintenance include: (a) the costs of establishing
maintenance workshops, equipment and machines (rou-
tinely included in an industry’s investment expenditure
streams); (b) the costs of labor; (c) spare parts and
materials; and (d) the “down times” of the machines
and factories being maintained (reflected in the observed
values of output).
3. A fuller discussion appears in Section 5. The fol-
lowing paragraphs draw on Grilliches (1970).
4. Schulz (1970) questioned this last view of women’s
contribution to the growth of economic output drawing
attention to the “troublesome omission” of investment
in females and by them in the upbringing of children.
5. See Hoselitz (19S9, 1968), Staley and Morse (1965).
Banerji (1978) and Anderson (1982). On small-scale
industries, see also Chuta and Liedholm (1985).
6. See Shinohara (1968) on wage differentials between
large and small firms in Japan.
7. See Johnston and Kilby (1975).
8. See Anderson (1987) for a discussion of this case,
and also the analysis of Stewart (1977).
9. Both Cairncross and Kuznets were careful to qual-
ify their conclusions about the apparently small con-
tribution of investment to growth. Thus Kuznets (1966.
p. 85) notes that “the low proportions of growth in per
capita product allocated to increased output of man-
hours and capital do not mean that the absence of such an
input would have resulted in only a small proportionate
political shocks, and even droughts may be exam-
ined through their effects on the variables dis-
cussed - on the rate and composition of invest-
ment, on the social returns to new investments
and to investments in place, on the deployment of
labor, and on real wage rates. A full discussion
of the applications of the analysis to developing
countries was beyond the scope of the paper. But
one general conclusion is likely to emerge from
further analysis. It is that wise policies toward
investment in a country’s physical and human
resources are likely to be thrice blest: they would
raise the rate of investment, the social returns to
investment, and the investment-induced returns to
labor. It is the three together which represent the
total effects of investment, and of the policies that
bear on it.
loss.. The lines of the relationship between absolute
increases in population, labor force and capital on the
one hand, and growth in per capita product on the other,
are numerous and far reaching.. in ways that make it
dificult, if not impossible, to establish the correct partial
effects of increases in inputs of man hours and capital on
growth of per capita product.”
I noted in the introduction that Scott (1981, 1986)
was critical of vintage theory. His problem is with the
assumption that exogenous technical proress affects
growth like “manna from heaven” and that: “later vin-
tages of capital goods are better than earlier ones just
because they are later, so that their efficiency is purely a
matter of time and nothing to do with investment or the
yield of investment itself. In vintage theory this is pre-
cisely what is assumed to happen, but it is wildly implaus-
ible. It implies, for example, that if no investment had
taken place anywhere in the world between 1881 and
198 1 we would have been able to build jet aeroplanes and
electric computers despite this century of stagnation.”
Actually, vintage theory assumes growth is possible onI>
i/new investments embodying higher outputs per worker
are in fact taking place. Also, as I hope the above analysis
shows, the investments have to have positive yields. While
it would be desirable to treat technical progress endogen-
ously (and Scott’s book takes us a long way in this direc-
tion) it does not undermine the ideas of technical progress
being embodied in investment.
IO. These expenditures are routinely treated as invrst-
ment in the analysis of agricultural projects. See Gittinger
(1982) and Baum and Tolbert (1985).
Ii. Anderson (1987), Part 111.
12. Anderson (1987), Part 111.
13. The averaging symbols used in Section 3 have been
omitted to simplify notation.
 INVESTMENT AND ECONOMIC GROWTH 1077

14. Another way of making the same point is to note 19. c.f. the growth model suggested by Eltis (1973. ch.
that the investment cost term in expressions like (6) and 6) in which he proposed putting g0 = a+ bi, where n and
(20) can bc written as: b are parameters. If b is rewritten as ar/( 1 -s) to allow
for the efficiency of investment, and also for the effects

c’ iQ.@‘dr/Q,F
of TP on labor’s income. and o = gL, a similar model
follows from the above analysis.

(neglecting the costs of lead-times), where Q0 is value 20. Denison (1969) p. 26. Both in earlier papers and
added at f = 0. The numerator of this expression equals since he has also dismissed the “embodied question” as
capital stock in seroice, so that capital stock no longer in being unimportant, and thus further delinked the gains
service is excluded. from technical progress from investment. See Denison
(1964) in reference to Solow (1957, 1963). As Kennedy
15. On agriculture, see Johnston and Kilby (1975) and and Thirlwall (1972, p. 138) observed, he considered the
Mellor (1976); on industry, Little, Scitovsky and Scott effects of new vintages of investments on output to work
(1970),Myint(l971,Chapter 14),Balassa(l971),Stewart only through the average age of capital stock and ignored
(1977) and Ranis (1973). The IL0 mission’s report on point that the average vintage of investment progresses
the Phillipines, led by Ranis, gives a wide-ranging review by about one year each year; if the newer vintages indeed
of the evidence for both agriculture and industry: IL0 reflect investments with higher outputs per worker, sig-
(1974). nificant growth may arise whether the average age of the
capital stock rises or falls. See also Abramovitz (1962).
Balogh and Streeten (1963). and Currie (1986).
16. The literature on the subject is huge, and one necess-
arily must start with the papers and books of those who 21. Denison (1969). p. 27.
have reviewed it; e.g., Nelson (1981) Binswanger and
Ruttan (1978), Kennedy and Thirlwall(1972), Hahn and 22. Letting subscripts f and h denote physical and
Matthews (1967). and the readings in Sen (1970) and human investment respectively, the cost of capital (mea-
Stiglitz and Uzawa (1969). For historical and cross-coun- sured as a rate of profit) be pc, the incremental output
try comparisons see Kuznets ‘(1966); for a review of less incremental labor cost be (Q - wL) and incremental
material and a study on Japan see Nishimizu and Jorg- investments be I, then the joint rate of profit p = (Q - wL)/
enson (1978) and Denison and Chung (1976); on US (I,+&,) whereas the derived rates of profit are
estimates, Denison (1962 and 1964); on US and Europe, P,= ~~Q--W--b~,ll4 and ph = KQ-W-JP~I/L In
Denison (1967). A review is also provided in Maurice general p,, and p, are both greater than p unless p,, and
Scott’s (1989) book on growth. The preceding list is p, = pc-. from which p = p< also. Thus rates of return or
unavoidably selective, since this paper is not a review; profit estimated from derived demand schedules can give
but the references cited in the papers of these authors misleadingly high impressions as to the rates of return to
together provide a comprehensive bibliography. particular factors; for estimating the optimum “balance”
of investments, the returns so-estimated give consistent
results, but for estimating their contributions to growth
17. Scale economies are not discussed below. it is their joint returns which are important.

18. The first term follows from ir = r(l/Q)(dK/dt), 23. See e.g. his review article (Nelson, 1981) and his
which can be rewritten as (rK/Q)(I/K)(dK/dr) = czgr. discussion of a paper by Kuznets (Nelson, 1984).
The second term can be obtained as follows: S = S*
under the present circumstances (as just shown) 24. Streeten (1970) provides a lucid critique of the
and S = wL/Q, with w(dL./dr) = S(dQ/dt) also. Hence interpretations (or misinterpretations) of the residual in
(w’L/Q)gr = (1 -a)gr = (l--a)g,. growth accounting. See also Balogh and Streeten (1963).

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