Growth Economics and Fund-raising in International Cooperation

1. GROWTH ECONOMICSand Fund-raising in international cooperationSECS-P01, CFU 9Economics for Developmentacademic year 2018-19 4. CLASSICAL THEORIES Roberto Pasca di Magliano Fondazione Roma Sapienza-Cooperazione Internazionale roberto.pasca@uniroma1.it

2. Economic Classical Theorists (XIX century) • Adam Smith (1723-1790) • David Ricardo (1772-1823) • Thomas Robert Malthus (1766-1834) • Karl Marx (1818-1883) Roberto Pasca di Magliano

3. Origins of Economics: the Liberalism of Adam Smith • The father of liberalism is considered Adam Smith who published in 1776 “The Wealth of Nations”, the birth of modern economics • Smith’s theories designed the modern economic thought by discovering the superiority of the free market over any other system • Among the many ideas put forward by Smith, one was particularly successful: the famous metaphor of the “invisible hand” THE INVISIBLE HAND • The metaphor of the invisible hand is the basis of the liberal view of the market economy • The market (as it is guided by an invisible hand), if left free to operate according to its own rational logic, produces an unexpected result that is also desirable at the same time: it maximizes the wealth of the entire society • Such result is reached automatically without any external intervention designed to pursue collective goals. Rather, the collective goal is reached thanks to the selfishness of individuals and the natural ‘contrast of interests’ Roberto Pasca di Magliano

4. Adam Smith and the divison of labour (I) An Enquiryinto the Nature and Causes of the Wealth of Nations (1776) open to an optimisticview of the development Major issues: • Division of labor The specialization and concentration of workers on their single subtasks leads to greater skills and greater productivity on their particular subtasks than it would be achieved by the same number of workers each carrying out the original broad task. • Specialization of laborallowsIncreasing of the laborproductivity + Increasingreturns to scale Advantages of the divison of labor: 1) improvement of the productive capacity of the workman  increases the quantity of the work he can perform; 2) saving the time commonly lost in passing from one sort of work to another; 3) sensibility on how much labor is facilitated by the application of proper machinery. Roberto Pasca di Magliano

5. Adam Smith and the divison of labour (II) • The division of labour is prevalent in industries to increase the productivity • In agriculture and mining, instead, productivity is decresing not only because the existence of the fixed factor (land) but also because the division of labour is not prevalent • The growth of the product depends on the investments and the capital accumulation through the time generated by industrial and agricultural profits, and the degree of specialization of labor. • Investments depend on svaing capacity I = f (S) • Division of labor determines the level of labor productivity, but the division of labor is limited by the size of the market, which in turn depends on the division of labor itself (interactive cumulative process): • “As it is the power of exchanging that gives occasion to the division of labour, so the extent of this division must always be limited by the extent of that power, or, in other words, by the extent of the market. When the market is very small, no person can have any encouragement to dedicate himself entirely to one employment, for want of the power to exchange all that surplus part of the produce of his own labour, which is over and above his own consumption, for such parts of the produce of other men's labour as he has occasion for” (Book I, Chapter III) Roberto Pasca di Magliano

6. Adam Smith and the increasing returns to scale (I) Agriculture • It produces essential surplus for industrial growth (supply side contribution)… but it is characterized by diminishing returns to scale • Technical progress in agriculture has a main role to increase yields. In fact, 18° century was a period when the agricultural revolution was spreading before the advent of the industrial revolution • Contribution from the demand side: the growth of the agricultural surplus allows the increase in demand for non-agricultural products that can be bought by exchanging the surplus generated from agriculture Size of the market • The market is limited as a result of trade restrictions and therefore the division of labor can not manifest all its benefits • Therefore, it support the need to free enterprise accompanied by free trade (laissez-faire and laissez-passé) inside and outside the system • Importance of agricultural exports for growth Roberto Pasca di Magliano

7. Adam Smith and the increasing returns to scale (II) • The engine of the model is the capital accumulation  coming from profits generated from industrial investments and from agricultural technical progress • As the capital stock grows (k), the rate of profit will inevitably decrease as a result of the competition between capitalists (profit seeking) and labourers (wage growth) • If the rate of profit falls, it reduces the incentive for investment • On the other hand, new investment opportunities are generated and the rate of profit may increase or decrease depending on whether the investments are made ​​in new or old technologies  Then the rate of profit may increase or decrease and there is no reason to think that we are moving towards a steady state or, worse, that it is inevitable (Malthus, Ricardo, Marx) • Smith's theories have had great influence, for example of Myrdal, Hirshman, Lewis and Kaldor Roberto Pasca di Magliano

8. Thomas Malthus (I) Roberto Pasca di Magliano

9. Thomas Malthus (II) • As growth occurs, the population rapidly increases and reduces the per-capita income • The rate of profit is being eroded by the growth of industry in agricultural prices, resulting from the increased demand and diminishing returns in agriculture, as well as an increase in costs • The innovative introduction must grow in line with the production capacity, which depends on investment. But there is no certainty that sufficient savings will grow to meet the investment needs • Per-capita income needed to satisfy the self-sufficient needs could be caught in a "trap equilibrium of low level” Pessimistic view of economic growth Roberto Pasca di Magliano

10. David Ricardo (I) Principles of Political Economy and Taxation(1817) • As a result of diminishingreturns in agriculture the economicsystemwillinevitablyreach a «steady state withoutgrowth»; • As in Smith, growthdepends on capital accumulation, whichdepends on profitsreinvestment • Profits are sacrificed by subsistencewages and payment of rents to landlords, whichtend to grow due to the increase in agriculturalprices, to diminishingreturns and growth of the marginalcosts (non productivelands); • Theory of distribution: incomeisdistributedamong the main social classes -> rentiers/ capitalists/ workers Roberto Pasca di Magliano

11. David Ricardo (II) Roberto Pasca di Magliano

12. David Ricardo (III) • With employmentequal to L, and a totalproductequal to ORZL, rentisdetermined by the differencebetween the averageproduct and the marginallabor (PRZY) • The subsistencewages are set at OWXL • Profits are equal to the differencebetween the averageyield and more wages (WPYX) • Profits are disappearingas the averageproductisdecreasingwhile the subsistencewages are obviously strong • In equilibrium, the rate of profit isequal in agriculture and in industry, since the rate of profit in agriculturedecreases, the capital move to industry, causing a decline in the rate of profit in industry • Profits in industrytendto decreasebecausewages in terms of foodincrease for livelihoods • Butaccording to Ricardo (unlike Malthus), there are no problems of effectivedemandbecause (aswilllatersay J.B. Say) supplygrowthcreatesitsowndemand Roberto Pasca di Magliano

13. David Ricardo (IV) • Profits are engine of growth investmentsensure the accumulation of capital; • There are no limits on the accumulationuntil the returnis positive • Due to the wageincreasing in industry the profitabilityisgoing to decrease and the systemwillreach the steady state • Anyfactorthatreduces the accumulationanticipates steady state • So he wascontrary to taxes, tariffs on production, aswellasduties on imports, especially of food • He was in favour of the campaign for the abolition of the CornLaws • Butiffoodpricesremainlow, wages do not rise and generates the steady state Indeedthese are erroneousassumptionsas Ricardo assumes the decreasing of the averageproduct in industry - > erroneousas he didnotconsider the role of technical progress! Roberto Pasca di Magliano

14. Karl Marx (I) DasKapital (1867)  the collapse of capitalism • Like allclassics, he believesthat the rate of return on capital isgoing to reduce as the economy grows, butClassicsprovidedifferentmotivations: • According to Smith competitionbetweencapitalists; • Ricardo itdepends on the reduction in yields in agriculture and the reduction in profitsforced in wages (up to the increase in agriculturalprices) Marx the limit to growthisnot the steady state but the rise in the organiccomposition of capital (seebelow). AcordingMarx the heart of the capitalistsystemconsists in the process of capital accumulation: D-M-D in the cycle of money>-commodity-> increase of money. Roberto Pasca di Magliano

15. Karl Marx (II) Labortheory of value • surplus valuegenerated in the exchangebetweenlabor and capital • Market value vs. use-value Marxists argue that the value of goods should be calculated in terms of the amount of labor that are used in their production. Conventional economics does not agree -> labour takes value whatever it will be paid in the market place! Roberto Pasca di Magliano

16. Karl Marx (III) The quantity D (MONEY) isused in: • C, means of production, constant capital. Itdoesnot generate surplus; ittransmitsitsvalueunchanged to the good production; • V, labor(variable capital) produces surplus (surplus workday on time sociallynecessary to produce subsistence) generates surplus (surplus product over wagegoods)  surplus value(through the sale of surplus production). Roberto Pasca di Magliano

17. Karl Marx (IV) • The value of a commodity isgiven by the amount of work emboded in it: c + v + s. • s / v: rate of surplus value, and 'the relationshipbetween surplus and variable capital  ismeasuring the degree of exploitation of labor • c / v: organiccomposition of capital, and the ratio of constant capital and variable capital. • The rate of profit isgiven by the ratio between the quantity of laborembodied in the built-in surplus and total capital: r = s / (c + v) = (s / v) / (1 + c / v) • risall the greaterasgreateris the rate of exploitation and therefore the loweris the organiccomposition of capital. • Marx argues that a rising organic composition of capital is a necessary effect of capital accumulation and competition in the sphere of production, at least in the long term. This means that the share of constant capital in the total capital outlay increases, and that labor input per product unit declines. Roberto Pasca di Magliano

18. Karl Marx (V) Cyclicalcrisis • Capital accumulationreduces the reservearmy of labor(workers)  the wageincreases by reducings / v • Capitalistsreact by substituting capital for labor the army of unemployedworkersisreconstitutedbutnot be able to consumegoodsproduced by  overproductioncrisis (lack of effectivedemand in the field of consumer goods). Finalcrisis • Competitionamongcapitalistsleads to adopt new techniques capital-intensive risingorganiccomposition of capital. • The positive effect of s / v of technical progress incorporatedintoconstant capital isnotenough to offset the increase in c / v falling rate of profit! Roberto Pasca di Magliano