GROWTH AND ASIAN

EXPERIENCE
Important Concepts for Understanding Growth
1. Components of Income and Output
 Output is derived by combining various factors of production, which include
land, capital, and labor.

 The production function is a useful tool for analyzing the process of economic
growth. A production function relates the inputs of the production process,
such as labor (L) and capital (K), to the output/income (Y) from the process.

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1. Components of Income and Output (cont)

This relationship can be stated in a number of ways. A general function (/)

without any functional form can be stated as
Y=f(K,L). (3.1)

As labor and capital grow over time, so will income. What are some of the
attributes of this relationship?

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 1. Components of Income and Output (cont)
 To a large extent, the law of diminishing returns governs the
growth process.
 As each worker acquires more capital, it follows that there would
be diminishing returns to that capital. If this process were to
continue for a long enough period, growth would slow to zero.

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1. Components of Income and Output (cont)

 To summarize, at any level of capital and labor inputs, there will be an

associated level of output. When the output increases at the same rate as the
inputs, we refer to the production function as having constant returns to scale.
This means that in Equation 3.1, we could multiply each input by some
constant and the output would increase by that constant amount.

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 1. Components of Income and Output (cont)

In what follows, we will explore various aspects of the production function and
technology that can change the relationship.
Example: researchers have studied the rate of increase in labor, capital, and output. The
evidence from these studies suggests that output increases more rapidly than Inputs.

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1. Components of Income and Output (cont)

 If technology were fixed, this would imply that there would be increasing
returns to scale, that it, that output would increase faster than inputs.

 However, as technology has changed, we have to interpret the difference

between input and output growth in a slightly different way.

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1. Components of Income and Output (cont)
 The size of the labor force will increase over time as a lagged consequence of
the natural increase in population

 The capital stock will also increase as a result of investment.

While it depends on how these factors are combined and the shape of the production
function, increase in labor and capital will result in an increase of output and income.

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2. Total Factor Productivity
By investigating the rate of growth of labor and capital together with income and output,
economists have observed that there is some growth in output that is unaccounted
for by the growth of labor and capital in the standard production functions, even when
adjustments are made in the quality of the labor and capital inputs. In some cases, this
discrepancy or residual is quite large, this residual has been called total factor
productivity (TFP), or multifactor productivity,term A.

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2. Total Factor Productivity (cont)
 TFP pertains to the efficiency with which the inputs are combined to produce
output.
 These efficiency gains can be due to a number of factors:
i. including greater economies of scale,
ii. better management,
iii. marketing or organizational abilities,
iv. shifts in production from low productivity activities to higher productvity activities with
the same amount of labor and capital,
v. or the impact of new technology which enables greater output to be obtained with the same
capital and labor inputs

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2. Total Factor Productivity (cont)
If we call this TFP or multifactor productivity, term A, and denote capital
and labor by K and L respectively, then the production function can be
rewritten as follows;

Y=f(K,L,A). (3.2)

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2. Total Factor Productivity (cont)

Equation 3.2 is a general expression. Often, economists assume that

competitive conditions exist in capital and labor markets and there are
constant returns to scale. If this is the case, then we can show that the growth
rate of income is equal to the growth rates of the capital and labor inputs
weighted by their shares in national income:

5(y)=g(K) W(K)+g(L) W(L) + A, (3.3)

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2. Total Factor Productivity (cont)

g(Y)=g(K) W(K)+g(L) W(L) + A, (3.3)

where g(Y) is the growth rate of income, g(K) is the growth rate of capital
(investment), g(L) is the growth rate of labor, and W(K) and W(L) are the
weighted shares of capital and labor in the economy.

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 2. Total Factor Productivity (cont)

Working through an example, suppose a country has a growth rate of income of 6

percent, a growth rate of capital (net of depreciation) of 10 percent, and capital’s
share of income is 30-percent, labor’s share is 70 percent and labor grows at 1
percent, then the sum of the terms on the right-hand side, apart from A, will be
0.06 = A+ 0.3(0.10)+ 0.7(0.01).

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 2. Total Factor Productivity (cont)

0.06 = A+ 0.3(0.10)+ 0.7(0.01).

0.06= A +0.03 + 0.007
0.06= A + 0.037
0.06- 0.037= A

A= 0. 023

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3. Economic Efficiency
The Production Possibility Frontier (PPF) is a curve depicting
the best possible combination of goods that is produced in an
economy- best in a sense that the combination utilizes all the
available inputs efficiently and minimize waste.

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3. Economic Efficiency (cont.)

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3. Economic Efficiency (cont.)

Static efficiency - is concerned with the most efficient combination of

existing resources at a given point in time.

Dynamic efficiency- This is concerned about the development of better

technology and working practices which improve the efficiency of production
over a period of time.

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 4.Technical Progress
As noted above, there are two kinds of technical progress or innovation that
can be achieved by an economy;

Embodied technical progress has to do with the changing nature of the inputs
into the production process. These would include more highly skilled and
computer-literate workers, or less stressed and more congenial workers, or the
installation of new innovations in capital equipment.

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4.Technical Progress (cont.)
Disembodied technical progress, on the other hand, relates to
the way factors are combined together in the workplace, such as
management or organizational innovations. This type of
technical progress would be contained in the residual.

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4.Technical Progress (cont.)
Practically, it is unlikely that all the embodied technical progress will be
captured in the measures of labor and capital.
 it is hard to get good estimates of the capital stock as we tend to rely on
investment figures to measure the increment to capital. (figures are
measured in a monetary unit )
 labor input is usually measured in terms of man-hours or man-years
worked.

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Growth Theories
Growth Theories
There are a number of theories on how the process of economic development
takes place. A very broad interpretation of these theories could consider five
alternative approaches;

1. KEYNESIAN THEORY These models stress the accumulation of capital.

They include Rostows (1960) stages of growth model and the Harrod-Domar
growth model (see Harrod, 1939; and Domar, 1946).

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KEYNESIAN THEORY (cont.)
The models do not explicitly consider the law of diminishing returns to capital
which can take effect as growth proceeds. In this sense, they are not particularly
realistic.

2. SOLOW OR NEOCLASSICAL THEORY These models stress the

neoclassical economic principle that factors of production should be paid the
value of their marginal products.

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 SOLOW OR NEOCLASSICAL THEORY

In these models, the law of diminishing returns can operate and there is mobUity
of factors to seek their highest return These models have all been developed on
the basis of the Solow-Swan (1956) model.

3.POWER-BALANCETHEORY These models stress internationl power balance

as an important factor in development, including the terms and patterns of trade
which tend to

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POWER-BALANCETHEORY (cont)

keep some countries poor while other get richer. In one sense, the
international poer balance model can be considered as subclass of the
neoclassical model where there is lack of factor mobility in international
trade.

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STRUCTURALTHEORY

4. STRUCTURAL THEORY These models emphasize the shifts in

resources between different sectors on the supply side.

These theories discuss the transition from labor-intensive agriculture, which

relies on traditional, low-productivity farming techniques, to modern, high-
productivity industries which have benefited from innovation and more
intensive use of capital and technology.

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NEW GROWTH THEORY

NEW GROWTH THEORY The most recent growth theories, simply called
“new growth theories,” try to endogenize technical progress and make use of
assumptions of increasing returns to scale and positive externalities. These
assumptions contrast sharply with the neoclassrcal model which stresses
diminishing returns and a slowdown of growth to a steady-state rate.

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The Asian Growth Miracles
The Asian Growth Miracles

The pace of economic growth and structural change in marrv Asian

countries m the past thirty to forty years ranks as one of the most
outstanding fearures of recent world economic history. It has been termed
the “Asian growth miracle”

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The Asian Growth Miracles (cont.)

Why have the Asian economies flourished whilst other developing countries
and regions have not?

 Incomes in developing Asia have grown much faster for a sustained

period of time—up to four decades—than they have anywhere else in the
world.

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The Asian Growth Miracles (cont)

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 The Asian Growth Miracles (cont)
In analyzing the growth experience of the “miracle” economies, it is important to
distinguish the policy environment that existed during the early stage of the
economic takeoff to sustained high growth and the economic performance that
resulted from the mix of policies. To do this, it is useful to describe the dynamics
of the growth process that resulted in such outstanding growth performance.

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 The Asian Growth Miracles (cont)

One of the common threads of these policies was that there was
initial protection of these industires through a combination of
import restrictions and tarrifs so that resources would be allocated
to them by the private sector in anticipation of profit potential.

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The Asian Growth Miracles (cont)

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The Role of Technology
Technology also played a crucial role as the “miracle” economies moved to
higher levels of income and development. Growth in income is a function of
the growth in inputs and the TFP residual and this residual is largely a
function of improvements in technology.

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The Role of Technology (cont.)

The developing economies in Asia have been able to access new technology in
three major ways;

1. buying it from foreign companies under license

2. by copying it without license;and

3. by entering into jpoin venture and importing has been through foreign
direct investment.

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Role of Education
Historically, the role of capital and savings to facilate equipment
purchase has been stresses as the primary engine of economic
growth. However, number of economist have recently stresses
the importance of education .

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Role of Education
Robert Lucas (1991), Mankiw and Romer (1992) suggests that
education is even more important than physical capital raising the
rate growth. Lucas argued that by contnuously shifting to products
requiring higer skills, the Asian economies were able to raise
productivity at a very rapid rate.

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Role of Education (cont.)

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Role of Education (cont.)

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Role of Education (cont.)
 The comparisons with other developing countries do not show that the educational
attainment is Asian economies was significantly higher than that of other
developing countries.

 This ;eads to the conclusion that education has to be taken together with labor-
market flexibility and the mix if skills developed to deal rapidly changing
production schedule.

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END

Thank you