GY300 Reading Week 2 (LT)

http://www.jstor.org.gate3.library.lse.ac.uk/stable/pdf/3990260.pdf

• Ignore Stylized Fact 3 completely.

• You can skim Stylized Fact 4, but it's not important for the course material (we
will not be discussing this in class).
• Ignore the section on level accounting (starting on page 187)

“What have we learned from a decade of empirical research on growth? It's Not Factor
Accumulation: Stylized Facts and Growth Models”

William Easterly and Ross Levine

Five stylized facts of economic growth:

1 The “residual” (TFP) rather than factor accumulation accounts for most of the
income and growth differences across countries
2 Income diverges over the long run
3 Factor accumulation is persistent while growth is not, and the growth path of
countries exhibits remarkable variation
4 Economic activity is highly concentrated, with all factors of production flowing to the
richest areas
5 National policies are closely associated with long run economic growth rates.

Facts do not support models with diminishing return, constant returns to scale, some
fixed factors of production, or an emphasis on factor accumulation.

Study does not argue that factor accumulation is unimportant in general or deny that it is
critically important for some countries as specific junctures.

Something else
• Growing body of research suggests that after physical and human capital
accumulation, TFP accounts for the bulk of cross-country differences in level of
growth rate of GDP

• What accounts for cross-country growth differences?

• What accounts for growth differences over time?
Overwhelmingly the answer is TFP not factor accumulation.

Stylized FACT- It’s not factor accumulation, its TOTAL FACTOR PRODUCTIVITY
TFP is the portion of output not explained by the inputs used in production, as such its level is
determined by how efficiently and intensely the inputs the inputs are utilized in production.
• Models of TFP focus variously on technological change, impediments to adopting
new technologies, externalities, sectoral development or cost reductions.
• Considers three questions
o What part of the countries growth rate is accounted for by factor
accumulation and TFP growth?
 o What part of cross-country differences in economic growth rates is
accounted for by cross-country differences in growth rates of factor
accumulation and TFP?
o What part of the intertemporal difference in economic growth rates is
accounted for by time-series differences in growth rates of factor
accumulation and TFP?
Organizing principle of growth accounting is the Cobb-Douglas aggregate production
function:

Y= Income
A= technological progress
K = Physical capital stock per person
N = number of units of labour input per person
Alpha= a production function parameter=to the share of capital income in national output
under perfect competition

Consider a hypothetical country with a growth rate of output per person of 2%, growth in
capital per capita of 3%, growth in human capital of 0, and capitals share of national income
of 40% (Alpha =0.4) – in this example TFP = 0.8%, and therefore TFP growth accounts for
40% of output growth in the country (0.8/2)

• It is important to account for changes in the quality of labour and capital – if growth
accountants fail to consider improvements in the quality of labour inputs due to
improved education and health they would assign these improvements to TFP growth.
• TFP growth accounts for about half of output growth in OECD countries – variation is
greater among Latin American countries, with an average of 30%
o Young (1995) argues that factor accumulation was a key component of the
growth miracle in some East Asian economies.
• In an extension of Young (1995), Klenow and Rodriguez-Clare (1997a) show that factor
accumulation plays the crucial role only in Singapore (a small city-state) but in none of
the other East Asian miracle economies. In addition, the share attributed to capital
accumulation may be exaggerated because it does not take into account how much TFP
growth induces capital accumulation

 There is enormous cross-country variation in the fraction of growth accounted for by

capital and TFP growth. In the average country, considering only physical capital
accumulation, TFP growth accounts for about 60 percent of growth in output per work
 There are large differences across countries in the relationship between capital
accumulation and growth. For example, Costa Rica, Ecuador, Peru, and Syria all saw real
per capita GDP fall by more than 1 percent a year, while real per capita capital stocks
grew by more than 1 percent a year and educational attainment was rising. Clearly,
these factor injections were not being used productivity. Albeit unrepresentative, these
cases illustrate the shortcoming of focusing too heavily on factor accumulation
 In the average country, TFP growth still accounts for more than half of growth in output
per worker
 o Data suggests that a weak and sometimes inverse relationship between
improvement in educational attainment of the labour force and growth of output
per worker growth

Benhabib and Spiegel (1994) and Pritchett (2001), using cross-country data on
economic growth rates, show that increases in human capital resulting from
improvements in educational attainment have not positively affected the growth in
output per worker (perhaps because of a mismatch between education and the skills
needed for activities that generate social returns)

Disagreement however- Krueger and Lindahl (1999)- measurement error accounts

for the failure to find relation between growth per capita and human capital
accumulation. Haunushek and Kimko 2000- quality of education is strongly linked
with economic growth.

Growth accounting has several limitations. It is mechanical procedure and using it to

elucidate a casual story is dangerous. E.g. Solows (!956) model, if tech progression grows at
the exogenously given steady state rate x, then y and k growth at the steady rate x too. too.
Growth account- ing will, therefore, attribute ax of output growth to capital growth, yielding
the conclusion that a times 100 percent of growth is due to physical capital accumulation

…..

Stylized fact 2 – Divergence, Not Convergence, is the big story

 Over the long run – there has been divergence big time (Pritchett, 1997)
o Richest countries in 1820 subsequently grew faster than the poorest
o Ratio of richest: poorest went from 6:1 (1820) to 70:1 (1992)
o Prior to industrial revolution – the difference between the richest and
poorest countries was probably 2:1 – therefore big story over the past 200-
300 years is one of massive divergence in the levels of income per capita
between rich and poor.
 Absolute divergence continued over past 30 years – not as dramatically as before –
while China and India performed well – growth has diverged
 Data on table 5- underestimates because data lacking from low and middle income
countries for 1990s but not for high-income – bias towards convergence
o Easterly (2001) found that the bottom half of countries ordered by per capita
income in 1980 registered 0 per capita growth over 1980-98 – while the top
half continued to register positive growth
 Kremer (1993) and Ades and Glaeser (1999) have found absolute divergence in the
majority of closed developing economies, suggesting an "'extent of the market"
effect on growth in closed economies

Stylized fact number 5- policy matters

  Empirical literature on national policies and economic growth is huge. There is
considerable disagreement about which policies are most strongly linked with
economic growth.
o Some focus on openness to international trade
o Fiscal policy
o Financial development
o Macroeconomic policies
All of these find that some indicator of national policy is strongly linked with
economic growth, confirming the argument made by Levine and Renelt (1992)
Most empirical assessments of the growth-policy relation is plagued by three shortcomings
 Most don’t confront endogeneity – studies frequently assume that many of the
regressor are exogenous and focus only on the potential endogeneity of one variable
of interest. Therefore, failure to confront causality – biased assessments
 Traditional cross-country growth regressors may suffer from omitted variable bias –
cross-country growth regressions may omit an important country specific effect and
thereby produce biased coefficient estimates
 Almost all cross-country regressions included lagged real per capita GDP as a
regressor. Because the dependent variable is the growth rate of real per capita GDP,
this specification may produce biased coefficient estimates.
The Growth of Nations
Author(s): N. Gregory Mankiw, Edmund S. Phelps and Paul M. Romer

http://www.jstor.org.gate3.library.lse.ac.uk/stable/pdf/2534576.pdf

 Average income in the world’s richest countries are >10x worlds poorest countries
 Long-run growth is now widely viewed to be at least as important as short-run
fluctuations.
Goal is to assess what we know about economic growth.

Textbook Neoclassical Theory

 When discussing what we know about growth- neoclassical model is the natural
place to start
 Robert Solow provided most basis version of the neoclassical theory of growth.
Centre piece is the production function – Y=F(K,AL)
o Y is output, K is capital, L is labour, L is a measure of technology, AL can be
seen as the labour force measured in efficiency units
 Neoclassical model emphasized how growth arises from the accumulation of capital.
The capital stock per efficiency unit k, evolves according to…
Predictions
 One strength despite simplicity is that it has many predictions
o In the long run- the economy approaches a steady state that is independent
of initial conditions
o Stead-state level of income depends on the rate of saving and population
growth – the higher the rate of saving, the higher the SS level of income PP.
the higher the rate of population growth the lower the SS level of income PP
o SS rate of growth income PP depends only on the rate of technological
progress; it doesn’t depend on the rates of saving or growth
o In SS, the capital stock grows at the same rate as income so the capital to
income ratio is constant
o In the SS – Marginal product of capital is constant, whereas the marginal
product of labour grows at the rate of technological progress

Household Behaviour
 So Far I have followed Solow’s rendition of the neoclassical model in treating the
saving rate as an exogenous parameter- this is extremely useful – Allows to abstract
from household behaviour in order to highlight the roles of capital accumulation,
population growth, and technological progress. – concentrate on the production side
of the model
 If you want a household behaviour analysis – choose from
o Paul Samuelson AND Peter diamond – Model the economy as composed of a
series of overlapping generations, each with a finite lifetime
 The economy can accumulate too much capital.
 Government debt can alter the saving rate and the capital stock
o Frank Ramsey, David Cass, and Tjailing Koopmans – Model the economy with
a singly, infinitely lived representative consumer.
 Never choose an allocation of resources that is dynamically inefficient
  Ricardian equivalence holds, and so government debt does not crowd
out capital
Both models reach a steady state with a constant saving rate.
Theoretical objections
 One might reject the model on the grounds that it does not, in the end, shed light on
economic growth
 Neoclassicals assumption of constant, exogenous technological change need not be
a problem – even with this assumption the model predicts that different countries
will reach stead-state levels of income per person, depending on their rates of saving
and population growth – it predicts that countries will have different rates of growth,
depending on each countries initial deviation from its own steady sate therefore the
assumption of constant, exogenous technological change does not preclude
addressing many of the central issues of growth theory.
 For neoclassical to explain international variation in growth requires the assumption
that different countries use roughly the same production function at a given point in
time- which is ridiculous – In poor countries farmers use shovels, where in rich they
use machines – common sense – however author says that it shouldn’t be taken
literally,

Three Problems for Neoclassical Growth Theory

Come under stack in recent years as providing an empirically inadequate theory of growth.
1. The magnitude of international difference
 Suppose that all economies were in their steady states – neoclassical model predicts
that different countries should have different levels of income per person,
depending on the various parameters that determine the steady state.
o
2. The Rate of Convergence

o
3. Rates of Return

o

A New view of Capital

The key role of the capital share

Capital with externalities

Human capital

Theories of Endogenous Growth

The Basic Model

Empirical studies of Economic Growth