Regional Economics

1. Regional Economics Lecture 2 Sedef Akgüngör

2. Perspectives on Economic Growth

3. GDP Growth in Turkey (1968-2004) (in 1987 constant prices)

4. Per Capita GDP Growth in Turkey (in 1987 constant prices)

5. GDP Per Capita in EU-15 and Japan

6. Growth in Real GDP

8. Per Capita GDP Index, 2002(EU25=100)

9. There have been dramatic changes in standards of material well being in the world. • During the period of 1000-1700, real income per capita in W. Europe roughly tripled. • Between 1700-1750 annual growth rate rose to 0.4%. • During the next century, it escalated to 1.2-1.5% per year. • As these transformations exolved, scholars sought with varying degrees of success to understand what happened. What is the cause of economic growth.

10. Classical Views of Growth • Serious considerations on economic growth began with the mercantalist economists. (William Petty, John Locke, Jean-Baptiste Colbert). • Money as a source of national wealth (gold, silver). • Export promotion. • Adam Smith argued for free trade policies. • Pin Factory example. Adam Smith’s observations on the impact of labor division on labor productivity.

11. Ricardo and Malthus Wiews on Economic Growth • Ricardo on law of diminishing returns. • Malthus on population increase at a geometric rate. Increase more rapidly than land’s capacity

12. Was Malthus Wrong? • Complex mixture of increased capital investment, as foreseen by Ricaardo and Malthus, and technological progress they failed to anticipate. • Hayami and Ruttan contended that both labor and capital productivity have increased.

13. Neoclassical Growth Models • Economic growth depend on increasing the stock of capital to keep pace with growth and labor force and technological improvements.

14. The aggregate production fuction lies at the heart of neoclassical growth models. • In an economy in which there is no technical progress, output is determined entirely by capital and labour inputs. • This relationship can be expressed in general form as follows: • Y= F (K,L)

15. Where Y is real output, K is the stock of capital and L is the labour force. • A specific form of this general relationship is provided by the well-known Cobb-Douglas production function. Assuming constant returns to scale, we have:

16. Output per worker will increase as each worker is provided with more capital equipment- but the increase will be at a decreasing rate due to diminishing marginal returns.

17. What conclusions can be drawn so far? • 1. Output grows without limit as the supplies of capital and labour increase • 2. Output per worker can increase only if there is capital deeping (i.e. if the capital/labour ratio increases) • 3. When the capital/labour ratio reaches its long-run equilibrium level, there will be no further increase in output per worker.

18. More realism can be built into the neoclassical model by allowing for the effect of technical progress on output growth. • Solow’s contribution to the neoclassical growth model: The most convenient way of allowing for technical progress is to regard technical knowledge as an additional and separate element in the production function.

19. Capital and labour are assumed to benefit equally from any technical progress that may occur as in the following function: • Y= F (A,K,L) • Where A is technical knowledge. Technical progress is said to be disembodied in this model since it is independent of capital and labour inputs.

20. Thus, regional disparities in the growth of output per worker are explained by regional differences in the rate of technical progress and by regional differences in the growth of the capital/labour ratio.

21. REGION’S OUTPUT GROWTH • The neoclassical model identifies three sources of output growth: • 1. The capital stock • 2. The labour force • 3. Technology

22. A region’s output growth will therefore depend upon the growth rate three factors of production. • Why are the rates of growth of capital, labour and technology vary between regions.

23. A potentially important influence on regional growth disparities is inter-regional factor migration. • According to the neoclassical model, capital and labour will move to those regions offering the highest rates of return.

24. Producers will search for the most profitable locations for their plant and machinery while workers will be attracted to those regions in which wages are high. • The neoclassical model assumes that there are no impediments to factor mobility between regions and that there is perfect knowledge about factor prices in all regions.

25. Which factors may be expected to influence the growth of capital, labour and technology within any individual region?

26. 1. Growth of capital stock: • 1.1. Investment by region’s residents. Regional saving rate. • 1.2. Net inflow of capital into region Rate of return relative to rate of return in other regions

27. 2. Growth of labour force • 2.1. Net in-migration of workers Regional wage relative to wage rate in other regions • 2.2. Population growth Birth rate and death rate

28. 3. Technical progress • 3.1. Inflow of technical knowledge from other regions • 3.2. Investment in R&D education

29. The Solow growth model argues that the growth in output per capita is driven by the rate of technological progress. • Without technological progress there would be no growth in the long run. But since the cause of technological progress are not identified in the Solow model, this means that the underlying explanations of growth is not spelt out.

30. Endogenous Growth Model as an Extension to Neoclassical Growth Model • Endogenous growth theory attempts to overcome this deficiency in the Solow model by providing an explanation of the causes of technological progress. • This extension to the neoclassical model is referred to as endogenous growth theory since it argues that technological progress is itself determined by the growth process.

31. Basically, entrepreneurs are looking for ways to make a profit and one way of doing this is to produce and sell new ideas. • Since there is a profit incentive to produce new ideas, this means that economic growth is endogenous.

32. The embodiment of technogical progress in the newest capital goods is not only way in which technology enters the production system. • More recent developments of the neoclassical model recognize the importance of human capital as a critical factor in determining the productive capacity of the economy.

33. Human capital is important for two reasons: • First, a region’s stock of human capital determines its ability to absorb and use new technology. • As the stock of human capital increases, the economy will be more able to benefit from technological developments, thereby expanding the economy’s productive capacity. • Hence, although technology may be available everywhere, its efficient use requires an appropriately skilled workforce.

34. Second, human capital is an important ingredient in determining the ability of a region to generate its own technical progress. • The capacity of a region to absorb or create technical progress is not simply a matter of investing in physical or human capital. A region’s capacity to absorb or create technical progress is determined by its institutional environment.

35. The creation of technical progress is determined by a collective learning process within which many individuals interact and exchange ideas and information, thereby providing a knowledge-rich environment. • If such an environment exist, knowledge pases quickly from one economic agent to another , giving rise to the rapid creation of a wide variety of new ideas.

36. There are therefore economies of scale to be gained from the geographical concentration of large numbers of highly educated people since their proximity to each other results in a more rapid transfer of knowledge and ideas. • These ideas are then transformed into new products and new processes, thereby raising labour productivity.

37. This means that technical progress is not simply an automatic outcome of investment in R&D, but requires an institutional environment which is conducive to the adoption and assimilation of new ideas into the production system. • Regional disparities therefore occur in technical progress because the institutional environment varies between regions.

38. In other words, some regions are more capable of using and producing technical progress than others. • The regions which are knowledge-rich and which have relatively large quantities of human capital will specialize in creative activities such as R&D, scientific research institutions and high-level service activities

39. Such regions will generate new ideas which add to the region’s technical knowledge which will be transformed into new products and new methods of production. • Conversely, regions that are less well endowed with human capital will specialize in routine activities which rely on technical know-how embodied in the capital equipment available globally. Such regions will depend heavily upon being cost competitive in world markets.

40. This modern variant of the neoclassical model therefore explains why regional disparities in economic development can and do persist, even in the long run. • The primary reason for long-term persistence is that some regions are more able to generate their own technical change.

41. Knowledge-rich regions with an institutional environment conducive to the creation and transmission of new ideas will have a continuning advantage over less well-endowed regions which depend far more on acquiring technical change through purchasing capital equipment from other regions. • Less well-endowed regions have no alternative but to rely on exogenously embodied technology since they are not capable of producing their own

42. What Determines Labor Productivity? • Output/Labour Ratio • 1.Capital/labour ratio • 2.Technology embodied in capital stock Investment in new capital Regional saving

43. Output/Labour Ratio 3. Endogenous technical progress: R&D spending • 3.1.Creation and transmission of new ideas • 3.1.1. Social and economic networks in region: transmission between individuals • 3.1.2. Public and private investment in education

44. Output/Labour Ratio • 4.Human capital

46. Per Capita GDP Index, 2002(EU25=100)

47. Discussion • Based on what we have discussed in the class, relate what you see in the tables to the theoretical models of economic growth and development. • In your point of view, what explains regional disparities?