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1
ITFD Growth and Development
LECTURE SLIDES SET 5
Professor Antonio Ciccone
2
III. Economic Growth with Human Capital and
Externalities
3
Outline
1. THE IMPORTANCE OF THE ROLE PLAYED BY CAPITAL IN PRODUCTION
2. A SIMPLE MODEL OF ENDOGENOUS GROWTH
3. EXTERNALITIES AND GROWTH
4. HUMAN CAPITAL AND GROWTH
4
1. THE IMPORTANCE OF THE ROLE PLAYED BY CAPITAL IN PRODUCTION
Let us return to the Solow model
• Savings a constant fraction s of income• Depreciation rate of capital is
• Population growth n• Rate of echnological progress a
5
PRODUCTION FUNCTION with DECREASING RETURNS TO CAPITAL
DECREASING RETURNS TO CAPITAL
CLOSE TO ZERO: STRONG DECREASING RETURNS
CLOSE TO UNITY: WEAK DECREASING RETURNS
1( , ) ( )F K L K AL
0 1
6
COBB-DOUGLAS PRODUCTION FUNCTION
1( )Y K AL
1 1 1( )MPK K AL k
(1 )MPK K MPK k
K MPK k MPK
7
k
MPK
STRONGDECREASING RETURNSTO CAPITAL
WEAKDECREASINGRETURNS
STRONG AND WEAK DECREASING RETURNS TO CAPITAL
8
Effect of savings rate on BGP income/capital under STRONG and WEAK decreasing
returns to capital
11,BGP t
BGPt t
K sk
A L n a
,
,
11
BGP t
BGP t
K ss K
• STRONG DECREASING RETURNS TO CAPITALSmall BGP effects of savings rate
• WEAK DECREASING RETURNS TO CAPITAL Large BGP effects of savings rate
9
1
BGPBGPs
y kn a
,
, 1BGP t
BGP t
Y ss Y
• STRONG DECREASING RETURNS TO CAPITALSmall BGP effects of savings rate
• WEAK DECREASING RETURNS TO CAPITAL Large BGP effects of savings rate
10
How much of international income differences explained by
“propensity of countries to accumulate”?
Depends on strength of decreasing returns to capital
11
Convergence to the BGP under WEAK and STRONG decreasing returns to capital
EQUILIBRIUM CAPITAL ACCUMULATION EQUATION
K sF(K , L) K
KK
sF(K , L)
K
12
( )K t
( , )F K Ls
K
*K
t
t
KK
CONVERGENCE UNDER STRONG DECREASING RETURNS TO CAPITAL
13
( )K t
( , )F K Ls
K
*K
t
t
KK
CONVERGENCE AND WEAK DECREASING RETURNS TO CAPITAL
14
INCOME CONVERGENCE EQUATION (CLOSE to balanced growth path)
(1 )( )(ln * ln )tt
t
ya n a y y
y
(1 )( ) ln *
(1 )( ) ln
t
t
t
ya n a y
y
n a y
growth between and
(determinants of BGP income)
convergence parameter ln(initial income)
t t T
f
15
Speed of convergence
• STRONG decreasing returns to capitalFAST convergence to BGP
• WEAK decreasing returns to capitalSLOW convergence to BGP
EMPIRICALLY, using cross-country data
16
REMEMBER THAT IN THE SOLOW MODEL
Elasticity of output with respect to capital
= Capital income share
= 1/3 (empirically)
=STRONG DECREASING RETURNS: Fast convergence to BGP
Small BGP level effects of savings rate
17
2. A SIMPLE MODEL OF ENDOGENOUS GROWTH
Return to the Solow model
• Savings a constant fraction s of income• Depreciation rate of capital is
• No population growth• No technological change
18
BUT BUT BUT NO DECREASING RETURNS TO CAPITAL(!)
Y AK
MPK A constant
where A is a CONSTANT
which implies
19
THIS PRODUCTION FUNCTION ALSO IMPLIES THAT
Elasticity of output with respect to capital
= Capital income share
• which is evidently in CONTRADICTION with empirical observation
• but let’s see where it leads us
1
20
EQUILIBRIUM CAPITAL ACCUMULATION EQUATION
K sAK K
K sA K
-- if sA>, CAPITAL per WORKER and therefore OUTPUT per WORKER grow forever, even if there is NO TECHNOLOGICAL PROGRESS
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( )K t
Y AK KsAK
PERPETUAL CAPITAL ACCUMULATION WITHOUT TECHNOLOGICAL CHANGE
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Is there a BALANCED GROWTH PATH?(path where all variables grow at constant rate)
tK sAK K
KsA
K
To growth rate of capital
From equilibrium accumulation equation
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To growth rate of output
Hence in this ENDOGENOUS GROWTH MODEL
1) long run growth in absence of technological progress
2) a higher savings rate means FASTER GROWTH IN the SHORT, MEDIUM, and LONG run
Y KsA
Y K
Y=AK
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Moreover,
- Implies that the growth rate of capital does NOT fall as economies accumulate capital
YY
sA
25
( )K t
Y AKs s sA
K K
t t
t t
K YK Y
GROWTH RATE OF CAPITAL (AND OUTPUT) STAYSCONSTANT IN TIME
same macro fundamentals (s,A,), same growth rate, no matter what initial conditions !!
26
MAIN RESULTS:
• perpetual accumulation-driven growth: capital accumulation alone can be the “engine of economic growth”
• savings rate has long-run growth effects: an increase in the savings rate increases the growth rate of capital and output forever
27
Endogenous growth and convergence
The AK model has two interesting features:
(A) a poor economy will NOT achieve the income per capita of a rich economy even if has the same macro fundamentals
(B) holding deep parameters or macro fundamentals constant as economies become richer, growth does not slow down
are these two linked? NO!
28
tK
Ys
K
t
t
KK
Endogenous growth model where GROWTH RATE OF CAPITAL FALLS IN TIME
29
Endogenous growth and convergence
(A) a poor economy will NOT achieve the income per capita of a rich economy even if has the same macro fundamentals
(B) holding deep parameters or macro fundamentals constant as economies become richer, growth MAY STILL slow down
30
The problem with the AK model?
• Capital share too large
• Back to the Solow model?
-- externalities
-- human capital
31
3. EXTERNALITIES AND ENDOGENOUS GROWTH
In the Solow model we have• perfect competition• no externalities
As a result
which we said was around
YMPK r
K
( )" " CAPITAL INCOME SHARE
Y K r KK Y Y
13
32
Why ?
Because the RESULTS of INVESTMENT are assumed to be
– EXCLUDABLE (only the INVESTOR benefits directly)
But sometimes investments by one particular firm yields results that are
– NON-EXCLUDABLE
– NON-RIVAL
CAPITAL INCOME SHAREY KK Y
33
Rivalry and excludability
EXCLUDABLE? YES NO
YES --Banana for personal consumption --Truck for production
-- Crowded highway in Germany -- Sun light
RIVAL?
NO -- NON-crowded highway in Italy (for pay) -- PAY TV
--Car design --New form of organization for production
34
What if investment has a non-rival, non excludable element?
PRIVATE
Yr
K
(SOCIAL)ECONOMY WIDE
Yr
K
1CAPITAL INCOME SHARE=
3Y KK Y
Externalities: real world has SLOWER convergence than Solow model, but not as slow as in endogenous growth model
35
Non-excludability, non-rivalry in the Solow model?
• Technological progress!
• But fell from heaven; or to put it differently COMES WITH THE PASSAGE OF TIME, not with investment
36
The Solow model with externalities
• Capital income share reflects the internal return to capital
• Elasticity of aggregate output wrt to capital reflects the social return to capital (private plus external return)
37
Solow model with externalities
1( , ) ( )f f f fF K L K EL
where f is an index for firms: f=1,…,N
E Ak
where A grows at rate a; and there are positive externalities to aggregate capital accumulation if and only if > 0
38
Solve:
• Optimal behavior of each firm (rental of capital and labor)
• Aggregate production as a function of aggregate inputs (capital and labor)
• Solow and non-Solow dynamics
39
4. HUMAN CAPITAL AND ENDOGENOUS GROWTH
In the Solow model we have
• perfect competition
• no externalities
• only ONE TYPE OF CAPITAL: PHYSICAL CAPITAL
As a result
CAPITAL INCOME SHAREY KK Y
40
But what about HUMAN CAPITAL?
What is human capital?
• knowledge in people that makes them more productive
In many ways similar to physical capital
• first INVEST (go to school; get some training) • then GET A RETURN (higher wage)
41
1CAPITAL INCOME SHARE=
3Y BroadCapital
BroadCapital Y
Human capital (like capital externalities):
• real world has SLOWER convergence than Solow model, but not as slow as in endogenous growth model
• capital and savings explains more of international differences in income than in the Solow model
42
Level and growth effects of HC
• Level effect of HC: more HC raises output (“neoclassical view of HC”)
• Growth effect: human capital may determine the rate of technological progress:
may affect growth rate in BGP
or have transitional growth effects only
43
Growth effects of HC (A)
• Lucas, JME, 1988: human capital can produce output or “technology”:
,
, " ",
,
( )c t
c t LEARNINGc t c
c t
Aa h HC
A
increasing HC allocated to learning may therefore increase the BGP growth rate(the downside is that output is reduced in the short and medium run)
44
“Growth” effects of HC (B)
Nelson and Phelps, AER, 1966
, ,,
,
( ) frontier t c tc t c
frontier t
A Aa h HC
A
, ,c t frontier ta a
,,
,
( ) 1 c tfrontier t c
frontier t
Aa h HC
A
1
( )frontierc
frontier c
aA
A h HC
BGP:
45
Empirical work on link between human capital and growth
46
The human capital “level” effect
47
48
49
50
FROM ELASTICITIES to AGGREGATE RATES OF RETURNTO SCHOOLING
Much of the aggregate work estimates:
1% increase in average years of schoolingincome per capita growth(?)
Formally:increase y
yelasticity=
increase in SS
51
Something that is easier to interpret intuitively would be:
1 YEAR increase in average years of schoolingincome per capita growth(?)
*
increase yy
Aggr. Return= Sincrease in S
S
52
Elasticity Aggr. Return
0.1 1.25%
0.2 2.5%
0.3 3.75%
0.4 5%
0.5 6.25%
0.7 8.75%
1 12%
1.2 15%
53
54
55
56
HUMAN CAPITAL QUALITY
57
58
59
60
61
62
Human capital externalitiesMoretti, AER 2004
63
Estimatingexternalities:
PLANT
INDUSTRY
CITY
-- does output IN THE PLANT(controlling for inputs in plant and industry)INCREASE with THE SHARE OF COLLEGE WORKERSoutside of INDUSTRY but inside CITY?
64
Estimating equation:
65
Data:
66
Benchmark results:
67
68
Physical capital externalities?
69
70
Human capital “growth” effect: a cautionary note
71
Goal and problems
• Is there an effect of the level of human capita at t on future growth rates?
• Literature has regressed growth on initial levels of human capital.
• ISSUES:-- Is it really the initial stock of HC? Otherwise
endogeneity problem. See Bils and Klenow AER, 2001.
-- Anything that increase the productivity of human capital will produce the correlation above!
72
HUMAN CAPITAL AND INTERNATIONAL SPECIALIZATION
73
Human Capital Accumulation Aggregate Income Growth(?)
Difficulties to test at country level:
• limited number of countries• countries with rapid HC accumulation “look good” in many other dimensions• (expected) income growth could be driving HC accumulation
74
Human Capital Accumulation Income Growth
If there is international trade, this should come about partly through shifts towards more HC-intensive sectors.
75
LOW HC Industry
HIGH HC Industry
TEST: BOTTOM CELL SHOULD BE GREATER THAN TOP CELL
LOW HC GROWTH Country
G(LOW industry, LOW GROWTH country)
G(HIGH industry, LOW GROWTH country)
G(HIGH,LOW HC GROWTH)-G(LOW,LOW HC GROWTH)
HIGH HC GROWTH Country
G(LOW industry, HIGH GROWTH country)
G(HIGH industry, HIGH GROWTH country)
G(HIGH,HIGH HC GROWTH)-G(LOW,HIGH HC GROWTH)
“HC-growth effect”
76
,1980 90
,1980( )
(Initial Industry Share, Finance, PropRights)
sc c s
s c
y
HC
Other
Estimating STRATEGY
FIRST: ESTIMATE
77
SECOND: ASK
Is the estimated elasticity greater for HUMAN CAPITALINTENSIVE INDUSTRIES?
ESTIMATEDELASTICITY
YEARS OF SCHOOLINGIN INDUSTRY (US say)
78
US average years of schooling of employees in industry
Industry SCH Industry SCH
Drugs 13.45 Pottery 11.09
Office, computing 13.40 Tobacco 11.00
Transportation equipment 12.86 Food products 10.93
Basic chemicals excl. fertilizers 12.79 Furniture 10.59
Radio 12.55Wood
Products 10.54
Printing and Publishing 12.54 Textile 10.38
Industrial chemicals 12.42 Spinning 10.21
Professional goods 12.22 Footwear 10.14
Chemicals 12.15 Apparel 10.04
Electric machinery 12.01
79
Figure: Schooling-Growth and Growth: Basic
311
313
314
321
322323324
331 332
341
342
352
353
354
355
356
361
362369
371372 381
382
383
384
385
390
3211
3411
3511
3513
3522 3825
3832
3841 3843
1011
1213
14In
dust
ry H
C In
tens
ity H
CIN
T(S
CH
)
.04 .06 .08 .1 .12Estimated Coefficient on Change in Schooling (1990-1970)
80
Figure: Schooling-Growth and Growth: With Controls
311
313
314
321
322323324
331 332
341
342
352
353
355
356
361
362369
371372 381
382
383
384
385
390
3211
3411
3511
3513
3522 3825
3832
3841 3843
1011
1213
14In
dust
ry H
C In
tens
ity H
CIN
T(S
CH
)
-.02 0 .02 .04 .06Estimated Coefficient on Change in Schooling (1990-1970)
81
IS THE EFFECT STRONGER IN OPEN ECONOMIES?
82
IS THE EFFECT THERE given income levels andgrowth?