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A short detour: How Economists Think About Economic Growth

A short detour: How Economists Think About Economic Growth. Topic 1: Structural Change Old and New National Graduate Institute For Policy Studies IDTP Fall 2012 John Page. The Basics . The production function: Y = A f(K,L,...) Where:

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A short detour: How Economists Think About Economic Growth

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  1. A short detour:How Economists Think About Economic Growth Topic 1: Structural Change Old and New National Graduate Institute For Policy Studies IDTP Fall 2012 John Page

  2. The Basics • The production function: Y = A f(K,L,...) Where: A is a “shift” parameter (why didn’t I just say technology?) K is capital L is labor • With some limiting assumptions we can also write it as: Y = A f(k,...) Where: A is a “shift” parameter y is output per worker k is capital per worker

  3. Economists are really pretty simple minded about growth • In the neo-classical world there are only two ways to raise output per worker • Accumulation: more capital (or other inputs) per worker • “Capital deepening” • Productivity Change: raising the “shift parameter” • “Technological change”?

  4. Accumulation and productivity change in the neo-classical model

  5. Accounting for Growth • A little algebra with the production function let’s us decompose the rate of growth into two components: dY/Y = dA/A + [FKK/Y] dK/K + [FLL/Y] dL/L • Or in words: the rate of growth in output is the sum of the rate of growth in the “shifter” plus the weighted sum of the rate of growth in capital and labor

  6. Accounting for Growth • OK, so what are the weights? • FK is the marginal product of capital • FL is the marginal product of labor • In a neoclassical world: • The marginal product of capital equals the rate of return • The marginal product of labor equals the wage • So the weights are the shares of labor and capital in total output • That’s convenient because we can get those from national accounts data

  7. Accounting for Growth • But, we can’t directly observe the shift parameter. • So, we find that as a residual: dA/A = dY/Y – [SK] dK/K – [SL] dL/L • How do we interpret the residual? • It’s called Total Factor Productivity (TFP) Change • Is it Technological change? Not entirely. • It also captures any “rearrangement” of production that raises output for the same bundle of inputs – Technical Efficiency Change • And of course is captures any errors in measurement and errors made by assuming that factor shares are the correct weights (what if factors are not paid their marginal product?)

  8. Productivity Change and Development Policy • TFP is a big deal in development policy • It varies across countries (and over time within countries) • It can be (and frequently is) negative • So it can’t simply be technological progress • It can be a very large share of total income growth • It’s a big deal because unlike accumulation it’s “free”. • Oh, and if it’s negative, it’s like trying to run up the down escalator.

  9. Accounting for Growth:Comparing China and India

  10. What has TFP got to do with Structuralism? • In developing countries different sectors have different levels and rates of change of TFP. • Economy-wide TFP is the weighted average of the individual sector’s TFP levels (and rates of change). • What if it were possible to use public policy to encourage the growth of sectors with high TFP or more rapid TFP growth rates? • And that brings us to the new structuralism!

  11. Accounting for Growth:Persistent differences across sectors in TFP

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