The Contributions of Endogenous Growth

Theory to the Analysis of

Development Problems: An Assessmentby

Pranab K. Bardhan

Presented By:

Muhammad Gulfam Arshed

Zulfiqar Ahmed

Malaika Abbas

Pranab K. Bardhan is an Indian

Economist.

EDUCATION

•He was educated at

Presidency College,

Kolkata and Cambridge

University, England.

PREVIOUS POSITIONS

• He had been at the faculty of

MIT, Indian Statistical Institute and

Delhi School of Economics before

joining Berkeley.

• He has been Visiting Professor at

Trinity College, Cambridge, St.

Catherine's College, Oxford, and

London School of Economics.

CURRENT POSITIONS

He is Professor of Graduate

School at the Department

of Economics at the

University of California,

Berkeley.

IntroductionWhat is endogenous growth theory ?

An economic theory which argues that economicgrowth is generated from within a system as adirect result of internal processes. Morespecifically, the theory notes that theenhancement of a nation's human capital willlead to economic growth by means of thedevelopment of new forms of technology andefficient and effective means of production.

• Endogenous growth theory holds thateconomic growth is primarily the result ofendogenous and not external forces.Endogenous growth theory holds thatinvestment in human capital, innovation, andknowledge are significant contributors toeconomic growth. The theory also focuses onpositive externalities and spillover effects of aknowledge-based economy which will lead toeconomic development.

• The growth theory influenced the theory of

economic development in several ways.

• The classical growth model of Smith, Ricardo

and Marx was often considered more suitable

for studying development problems than the

Solow-Swan neoclassical growth model.

• The distinguishing contributions of the new

growth theory that may be particularly useful

for understanding development problems.

• on the basis of uncertain cross-country

regressions and even more doubtful data

quality, that the lack of convergence in per

capita income growth rates across countries

negates the standard assumption of the

availability of the same technological

opportunities in all countries of the world is not

particularly earth-shaking from the point of

view of development economics.

Solow (1994) words,

"I do not find this a confidence-inspiring project. It seems altogether too vulnerable to bias from omitted variables, to reverse causation, and above all to the recurrent suspicion that the experiences of various national economies are not to be explained as if they represent different 'points' on some well-defined surface".

• Development economist plowing

through this literature gets hardly any

clue about the factors determining the

crucial international differences in

factor productivity growth.

• A much more substantive contribution

of the new growth theory is to

formalize endogenous technical

progress in terms of imperfect

competition framework in which

temporary monopoly power acts as a

motivating force for private innovators.

• Growth theory has now beenliberated from the confines of thecompetitive market framework ofearlier endogenous growth models inwhich dynamic externalities playedthe central role, even considering themodels of Kaldor who repeatedlyemphasized the importance ofimperfect competition in the contextof endogenous technical progress.

• The emphasis on new goods and the

fixed costs in introducing them

provides valuable new insights. The

major impact of this literature on

development theory has been in the

area of trade and technological

circulation in an international

economy.

TRADE AND

TECHNOLOGICAL DIFFUSION

INTRODUCTION

• East Asian development experience has shown a positive relationship between outward orientation and economic development.

• Whereas standard neo-classical theory does not provide any such general theorem on the effects of trade on the long-run growth rate.

• Results in the new literature show how economic integration in world market helps long-run growth by avoiding unnecessary duplication in R & D sector.

• Main theme of this research paper is to divert our attention on the serious non-convexities involved in the process of diffusion and adaptation of new goods and technologies in the developing countries

• These non-convexities are in the form of

1. R & D Sector

2. Intellectual Property Right (IPR)

3. Economies of scale associated with learning by doing

• We shall discuss each one in detail

R & D SECTOR

• World market competition gives incentives to

entrepreneurs of both countries to invent products that

are unique in world economy.

• Trade also helps transmission of useful ideas in

production engineering and information about changing

product patterns.

• On part of knowledge accumulation, it is quite obvious

that it is localized largely in the rich countries and is more

in access as compare to poor countries.

• So rich countries benefits more from limited available

knowledge so they capture a growing market share in the

total no. of differentiated products

• Whereas poor countries innovate less rapidly in long-run

because of the foreseeing capital loss

• Poor countries specialize in production rather than

research.

• This is because they compete with differentiated products

through unskilled workers

• Which eventually leads them to reduction in profitability

of R & D sector in poor countries

Author has used a mathematical approach to show how labor devoted for R n D sector help increases the rate of growth of R & D sector

n′ = __l__

a/n

n = stock of cumulative knowledge capital

l = labor devote to R n D sector

n′ = innovation output of R n D sector

n′/n = rate of growth of R n D sector

In order to find out rate of growth of R n D (n′/n) we need to simplify the above eq.

n’ = __l__

a/n

n’ = l a/n

n’ = l x n/a

n’ = l x n

a

n’ = _l_

n a

n’ x a = l

n

n’ α l _________ (A)

n

• Thus the equation A shows that rate of growth of R n D sector is directly proportional to the labor devoted for R n D sector.

• A trade induced movement of labor away from R n D sector towards production will reduce the rate of growth and vice verse

• R n D sector in poor countries rely mostly on the

adaptation of the products and processes invented

abroad and to copying them.

• This kind of R n D sector (based on copying) is

usually so small that if poor countries reallocate their

fully employed resources either to or away from R n

D sector, it does not help them.

• In order to study the relationship between innovation in

rich countries and its imitation in poor countries:

• Grossman-Helpman has constructed a North-South

model.

• Assume that innovation takes place in North (developed

country) whereas South (LDC) imitates it

• They have concluded that imitating Northern products

discourages innovation in North in two ways

1. It reduces the duration of monopoly profits of the

innovators in North

2. It frees Northern labor to produce more of the as yet

uninitiated products and to conduct more R & D

• Since Southern firms are equipped with cheap labor they

keep on targeting Northern product for imitation rather

then to innovate

INTELLECTUAL PROPERTY RIGHTS

(IPR)

• Intellectual property rights (IPR) are the rights given to persons over the creations of their minds. They usually give the creator an exclusive right over the use of his/her creation for a certain period of time.

• IPR sometimes creates a divide between rich and poor countries in a way that

• Rich countries claims a tighter IPR regime expands the duration of monopoly of investors which encourages innovations and all countries benefit from this

• Whereas poor countries argue that increased monopoly

power of large companies in rich countries decreases their

profit margin which eventually ends up to their loss.

• Contrary to tighter IPR regime is lax patent protection

this regime makes a significant effect when it is applied to

those products that are particularly appropriate for poor

countries.

• Otherwise its disincentive effect is very small as compare

to the rate of innovation in rich countries

• To discuss the question of IPR, Helpman constructed a dynamic general-equilibrium model of innovation and imitation. He ends up to the following points

1. A tighter IPR regime increases the fraction of the total no. of products produced in rich countries (simply because of their monopoly power)

2. But it lowers the long-run rate of innovation of new products

3. In tighter IPR regime, by shifting production from lower wage country (Poor one) to higher wage country (Richer one) makes consumer in both countries worse off

• Multinational companies sometimes practice

“restrictive business” which is being neglected by the

advocators of tighter IPR regimes.

• It simply means that in rich countries MNC’s use

some other kinds of patents like pre-emptive patent or

sleeping patents that they seldom use in production

but are taken out to deter their competitors.

• Another possible way of floating technology from

rich country to poor country is the direct investment

by multinational enterprises.

• Author holds the view that poor countries does not take

proper benefit form the technology coming from direct

investment by MNC’s

• This is because of the lack of proper infrastructure in

poor countries

ECONOMIES OF SCALE ASSOCIATED WITH

LEARNING BY DOING

• In this sections author’s main objective is to show learning by doing increases the existing sectoral patterns in production of comparative advantage

• The models of learning as one proposed by Lucas shows that

• learning on narrowly defined products often shows high initial learning rate but declines over time as production increases

• He also suggests that in order to achieve sustained on-the-job learning workers and managers should continue to work on tasks that are new to them

• Stocky has developed a North-South trade model which is

based on product differentiation and international

differences in quality of labor.

• Assume that North produces high-quality product

whereas south produces low-quality goods.

• Now if human capital is acquired through learning by

doing free trade will:

• Increase the human capital accumulation in North and

will slow it down in South.

• It is quite obvious that a country with technological leads

tries to widen that lead overtime.

• It then also gives us the answer that why subsidizing

infant export industries then to import-substitute industry

sometimes promote more growth.

• This is because the opportunities for learning spillovers

into newer and more sophisticated goods are more in

export industries then in import-substitution industries

• East Asian Experience also shows that high level of skill

in labor force has facilitated them to achieve rapid growth

of exports which eventually enabled them to overcome

imperfections in the technology market.

CONCLUSION

• As per Romer (1994) New growth theory may not be new but it is about newness

• The new literature in some ways divert our attention to the problems of structural transformation and reallocation of resources from traditional to other sector.

• But the new growth theory focuses on the process of introduction of an ever-expanding set of new goods and technologies and large fixed cost usually associated with it.

3. Strategic complementarities and increasing returns

• The new growth theory focuses on understanding the economic forces underlying policies and technological progress which can influence the long run growth rate.

• Hence it is not directly concerned with the older question of development theory: how underdevelopment often tends to persist and how does a poor country get out of a poverty trap?

• The recent formalizations and explorations of dynamic externalities has been to revive interest in the older question.

• One idea that was particularly prominent was that of how coordination of investments across sectors is essential for industrialization.

• It has been emphasized that when domestic markets are small, simultaneous expansion of many sectors can be self-sustaining through mutual demand support, even if by itself no sector can break even.

• In an open economy where an industry faces the world market, the size of the domestic market cannot plausibly limit the adoption of increasing returns technologies.

• Such objections usually underestimate how the size of the domestic market matters even in an open-economy.

• The idea of intersectoral complementarities in investment can be reformulated for an open economy with tradeable final outputs, but where jointly used infrastructure and other non-traded support services and specialized inputs are crucial for the production and distribution of the final goods.

• In the case of shared infrastructure each industrializing firm that uses it contributes to the large fixed cost of building it and thus indirectly helps other users and hence makes their industrialization more likely.

• The infrastructure will make money on its first-period investment if the economy industrializes, but will incur a large loss if no industrialization takes place and there are no users of its services.

• Thus the infrastructure is not built lest an insufficient number of firms industrialize and this in turn ensures that firms do not make the large-scale investments needed to industrialize. This is an underdevelopment trap caused by a coordination failure.

• The tradeable final goods require these non-traded intermediate inputs and services readily available in close proximity.

• The domestic availability of a wide variety of such specialized inputs enhances the productive efficiency of the manufacturing sector, but the extent of input specialization is limited by the extent of the market.

• In such a situation the economy may get stuck in an equilibrium where the division of labor in the input producing sector is shallow and the final goods production remains confined to the use of low-productivity techniques that do not require a wide variety of inputs.

• Such is the example of Pakistan agriculture and public sector hence the over-employment and limited skills.

• The task of development policy here is to compensate for an historical handicap either by trade policy or a policy of subsidization of fixed costs or of other ways of encouraging appropriate linkages between the finals goods sector and the intermediate inputs sector.

• Therefore the coordination of investments between sectors is the key, and the role of expectations and self-fulfilling prophecy become more important.

• The task of development policy is to coordinate expectations around high investment.

• The relative importance of the past and expected future depends on parameters of the economy like the discount rate and the speed of adjustment.

• The idea of strategic complementarities between sectors generated by increasing returns was so central to the development economics of the 1950's.

• Yet it lost much of its intellectual force because at the policy level the difficulties of aggregate coordination were underestimated particularly at the existing levels of administrative capacity and political coherence in the developing countries, and the incentive and organizational issues of micromanagement of capital were underappreciated.

• From the policy point of view it underestimates the difficulty of identifying the few sectors and locations where the spillover effects may be large and particularly difficult to internalize.

• It is sometimes overlooked that learning is often highly localized and project-specific.

• The extent of spillovers depends crucially on the nature of competition that the policy environment promotes and its interaction with the nature of the physical, social and organizational infrastructure in the country.

• Another by-product of the recent formalizations of market size, increasing returns and imperfect competition has been in the area of economic geography, where exists the problem of urban concentration and uneven regional development in the developing countries.

• The pattern of urban growth and regional inequality are shaped by a tension between centripetal forces that tend to pull population and production into agglomerations and the centrifugal forces that tend to break up such agglomerations. Just like Lahore is thought to be our one of the major hub.

• On the one hand, firms want to locate close to the large market provided by other firms' workers, and workers want to live close to the supply of goods provided by other firms; on the other hand, commuting costs and urban land rent tend to generate diseconomies of city size.

• The new emphasis on fixed costs and nonconvexities in the process of introduction of new goods and technologies is important.

• These fixed costs actually go much beyond the ordinary set-up costs in starting new economic activities: particularly in a developing country they encompass massive costs of collective action in building new economic institutions and political coalitions and in breaking the deadlock of serving interests

Conclusion • These models help us to explain why countries experience different growth

rates and how economic integration in world market helps long-run growthby avoiding unnecessary duplication in R & D sector.

• Helps us to see the other side of coin where we can prevent diminishing returns to capital through R n D and technological advancements.

• East Asian Experience also shows that high level of skill in labor force has facilitated them to achieve rapid growth of exports which eventually enabled them to overcome imperfections in the technology market.

• It limits the applicability of these models in country to country comparison because it ignores the institutional structures, imperfect capital and goods markets.

• Plus it is difficult to observe and internalize spillover effects when it is mostly project based and subject to specifics.