DEVELOPMENT ECONOMICS

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DEVELOPMENT ECONOMICS

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DEVELOPMENT ECONOMICS

Sponsored by a Grant TÁMOP-4.1.2-08/2/A/KMR-2009-0041 Course Material Developed by Department of Economics,

Faculty of Social Sciences, Eötvös Loránd University Budapest (ELTE) Department of Economics, Eötvös Loránd University Budapest

Institute of Economics, Hungarian Academy of Sciences Balassi Kiadó, Budapest

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DEVELOPMENT ECONOMICS

Author: Katalin Szilágyi

Supervised by Katalin Szilágyi January 2011

ELTE Faculty of Social Sciences, Department of Economics

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DEVELOPMENT ECONOMICS

Week 3

Endogenous growth theory

Katalin Szilágyi

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Introduction

• Proximate causes of growth:

• Capital

• Labor (population)

• Technology

• Exogenous growth theory: mechanics of growth explained with proximate causes

• Cross-sectional and/or time-series

differences in growth performance are assumed

• Sources of growth are unclear (exogenous)

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Introduction

• Some empirical difficulties with exogenous growth theory

• Lack of (unconditional) cross-country convergence (Barro)

• Lack of capital flows from rich to poor

countries (Lucas)

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Outline

1. Human capital and endogenous growth

2. Technology and growth

• Innovation and R&D

• Diffusion of technology

3. Role of history: complementarities

and development traps

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1.Human capital and

endogenous growth

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1.Factors of production

• Fixed and flexible

• Flexible: can be accumulated (supply is endogenous)

• Fixed: cannot be deliberately

accumulated (supply is exogenous)

• Solow: labor is fixed (exogenous),

capital is flexible (endogenous)

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Human capital and growth

• Heterogeneity in human capital

• Labor force = educated + uneducated

• Difference: level of human capital (productivity)

• Total labor force (population) is exogenous, but the structure is not

• Being educated (human capital formation) is a result of a deliberate decision

(endogenous)

• Two flexible factors of production: physical and human capital

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Model with human capital

• Two inputs: physical (k) and human capital (h)

• Cobb–Douglas technology:

y = k^αh^{1- α}

• Assumption: n = δ = 0

• Accumulation of physical capital:

k_t+1 – k_t = sy_t

• Accumulation of human capital:

h_t+1 – h_t = qy_t

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Model with human capital

• Long run equilibrium:

h/k = q/s

• Ration of h to k depends on accumulation rates

• Growth:

capital physical

to capital human

of ratio run

long the

means where

) és (

) ( )

1 , (

) (

) ( )

1

( ₁

r

s r q t qr

h

t h t

sr h t

k

t k t

k

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Model with human capital

• Long-run growth depends on:

• Saving rate

• Accumulation of human capital

• Technology

• Initial differences in income persist!

• Long-run growth rates (↔ steady state levels) are the identical in countries with the same

characteristics

• Decisions about factor accumulation

(saving/education) have long-run consequences for growth

• Not just level shifts (Solow)

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Model with human capital

• Constant return to scale in the two flexible inputs

• With diminishing marginal products separately

• Marginal product of capital (Lucas paradox): not just the scarcity of physical capital

• MPK(k,h) depends on h as well!

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Model with human capital

• Cross-country convergence and divergence

• Conditional convergence after controlling for differences in human capital. Ceteris paribus: poor countries grow faster.

• Conditional divergence after controlling for differences in initial income. Ceteris

paribus: countries with more human capital grow faster.

• Rich countries tend to have more human capital→ two effects cancel out, no visible convergence.

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2.Technology and growth

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Technology

• Solow: long-run growth only through improvement in technology

• Improvement in technology

• Deliberate and calculated: innovation

• Models of individual optimisation

• Not necessarily deliberate and calculated:

diffusion

• Models of externalities

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Model of innovation

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Innovation

• Decision: channeling human capital (H)

directly into production (u) or to R&D (1-u)

• Dilemma: consumption now or later

• Production function:

Y

_t

= E

_t^γ

K

_t^α

(u

_t

H)

^1-α

• Accumulation of knowledge („know-how”):

(E

_t

- E

_t-1

) / E

_t

= a(1 - u

_t

)H

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Model of innovation

• Long-run growth is due to (endogous) accumulation of knowledge

• Depends on the level of human capital and on ratio of labor employed in R&D

• Protection of intellectual property rights is key

• Temporary monopolies are efficient

• Models of innovation are not compatible

with the idea of perfect competition (Romer, Grossman–Helpman)

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Model of technology

diffusion

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Diffusion of technology

• Individual decisions of human capital formation and innovation have external benefits (Romer)

• From an individual’s point of view:

technology is given (exogenous) Y

_t

= E

_t

K

_t^α

H

_t^1-α

• From the aggregate point of view:

technology is endogenous

E

_t

= a(K

_t

*)

^β

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Externalities

• Increasing returns in the aggregate of flexible inputs

• Still diminishing returns from the individual’s point of view

• Growth per capita is increasing

• Externality: PMB and SMB diverge

• PMB < SMB: disaggregated allocation

is suboptimal

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Complementarity

• Complementarity

• Action by one agent generates incentives for other agents

• Examples:

• If others go to college, I go as well.

• If everybody uses Microsoft, I will use it as well.

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3.Complementarities and

development traps

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