WEEK 5 - Economic Growth II (Solow Model with technology and human capital)

Question 1

What are some examples of Technological Progress?

Answer 1

US Farm sector productivity nearly tripled from 1950 to 2009.
The real price of computer power has fallen an average of 30% per year over the past three decades.

Question 2

What does the basic solow model lack?

Answer 2

Production technology held constant (at 1)

Income per capita constant in steady state

Question 3

How do we show technological progress in the solow model?

Answer 3

g = ΔE/E

Where E is labour efficiency

Question 4

How do we rewrite the production function to include labour efficiency?

Answer 4

y = F(K,LxE)

Where:
K is total capital
(LxE) is number of effective workers
- Hence increases in labour efficiency have same effect on output as increases in labour force

Question 5

What are the new notations in the Solow Model adding in technological progress?

Answer 5

y = Y/LE = Output per effective worker
k = K/LE = Capital per effective worker

Production function per effective worker:
y = f(k)

Saving and investment per effective worker:
sy = sf(k)

Question 6

What is the break even investment considering technological progress?

Answer 6

(δ + n + g)k = Break even investment
(Amount of investment necessary to keep k constant)

Consists of:

• δk to replace depreciating capital
• nk to provide capital for new workers
• gk to provide capital

SEE GRAPH IN NOTES

Question 7

What are the steady state growth rates in the Solow Model with tech progress?

Answer 7

Capital per effective worker
k = K/(LxE)
Steady state growth rate: 0

Output per effective worker
y = Y/(LxE)
Steady state growth rate: 0

Output per worker
(Y/L) = y x E
Steady state growth rate: g

Total Output
Y = y x E x L
Steady state growth rate:
n +g

Question 8

How do we find the Golden Rule with technological progress?

Answer 8

To find Golden Rule capital stock, express c* in terms of k*
c* = y* - i*
= f(k) - (δ + n + g)k

c* maximised when
MPK = δ + n + g

OR

MPK - δ = n + g

Question 9

What does Solow model’s steady state exhibit?

Answer 9

Exhibits balanced growth (many variables grow at same rate)

• Solow model predicts Y/L and K/L grow at the same rate (g), so K/Y should be constant
• Solow model predicts real wage grows at same rate as Y/L, while real rental price is constant.

Question 10

What does the Solow model predict?

Answer 10

Conditional convergence
(countries converge to their own steady states, which are determined by saving, population growth, and education (e.g. we have to consider human capital))

Question 11

Why is income per capita lower in some countries than others?

Answer 11

1. Differences in capital (physical or human) per worker
2. Differences in the efficiency of production (the height of the production function)

Studies:
- countries with higher capital (physical or human) per worker also tend to have higher production efficiency

Question 12

What are some of the empirics of production efficiency and free trade?

Answer 12

Sachs and Warner classify countries as either “open” or “closed.” Among the developed nations classified as “open,” the average annual growth rate was 2.3%.
Among developed nations classified as “closed,” the growth rate was only 0.7% per year.
The average growth rate for “open” developing nations was 4.5%.
The average growth rate for “closed” developing countries was only 0.7%.

Question 13

How do Frankel and Romer determine the causation of differing econ growth in countries?

Answer 13

Some nations trade less because they are farther from other nations, or landlocked.
Such geographical differences are correlated with trade but not with other determinants of income.
Hence, they can be used to isolate the impact of trade on income.

Findings: increasing trade/GDP by 2% causes GDP per capita to rise 1%, other things equal.

Question 14

What are some policy issues?

Answer 14

Are we saving enough? Or too much?

What policies might change the saving rate?

How should we allocate our investment between privately owned physical capital, public infrastructure, and “human capital”?

How do a country’s institutions affect production efficiency and capital accumulation?

What policies might encourage faster technological progress?

Question 15

How do we evaluate the rate of saving?

Answer 15

Using golden rule to determine whether UK saving rate and capital stock too high or low

Need to compare
(MPK - δ) to (n+g)

Question 16

What are the results of the rate of saving?

Answer 16

If (MPK - δ) > (n+g), then below Golden rule steady state and should increase s

If (MPK-δ)< (n +g), then above the golden rule steady state and should reduce s

Question 17

What 3 facts do we use to evaluating the savings rate of the UK?

Answer 17

1. k = 2.5y
   (Capital stock about 2.5 times one year’s GDP)
2. δk = 0.1y
   About 10% of GDP used to replace depreciating capital

3.MPK x k = 0.3y
Capital income about 30% of GDP

Question 18

How do we calculate the UK’s rate of saving?

Answer 18

k = 2.5y
δk = 0.1y
MPK x k = 0.3y

To determine δ, divide 2 by 1:
δk/k = 0.1y/2.5y = δ = 0.1/2.5 = 0.04

To determine MPK, divide 3 by 1:
MPK x k/k = 0.3y/2.5y = MPK = 0.3/2.5 = 0.12

Hence, MPK - δ = 0.12 - 0.04 = 0.08

Question 19

What is the overall evaluation of the UK’s saving rate?

Answer 19

MPK - δ = 0.08

UK real GDP grows 2.5%/yr
so n+g = 0.025

So,
MPK - δ = 0.08>0.025= n+g

So below golden rule steady state

Question 20

What policies do we have to increase the saving rate?

Answer 20

Reduce the government budget deficit (or increase the budget surplus)

Increase incentives for private saving:
-reduce capital gains tax, corporate income tax, inheritance tax as they discourage saving

• replace income tax by consumption tax
• expand tax incentives for savings through retirement pension funds and other retirement savings accounts (such as ISAs)

Question 21

What are the differing type of capital?

Answer 21

• Private capital stock
• Public Infrastructure
• Human Capital: Knowledge and skills worker accquire via education

Where in Solow model only one

Question 22

What are the 2 ways we can allocate the economy’s investment?

Answer 22

1. Equalize tax treatment of all types of capital in all industries, then let the market allocate investment to the type with the highest marginal product.
2. INDUSTRIAL POLICY: Govt should actively encourage investment in capital of certain types or in certain industries, because they may have positive externalities (by-products) that private investors don’t consider.

Question 23

What are the possible problems with industrial policy?

Answer 23

Does the gov’t have the ability to “pick winners” (choose industries with the highest return to capital or biggest externalities)?

Would politics (e.g. campaign contributions) rather than economics influence which industries get preferential treatment?

Question 24

What is one of the solutions to policy issues?

Answer 24

Establishing the right institutions:
Creating the right institutions is important for ensuring that resources are allocated to their best use.

Examples:
Legal institutions, to protect property rights.

Capital markets, to help financial capital flow to the best investment projects.

A corruption-free government, to promote competition, enforce contracts, etc.

Question 25

How do we encourage technological progress?

Answer 25

Patent laws:
encourage innovation by granting temporary monopolies to inventors of new products

Tax incentives for R&D

Grants to fund research at universities

Industrial policy: encourage specific industries that are key for rapid tech. progress (subject to the preceding concerns)

Question 26

What are some explanations about the world slowdown? (PT 1)`

Answer 26

Measurement problems
Increases in productivity not fully measured.
But: Why would measurement problems be worse after 1972 than before?

Oil prices
Oil shocks occurred about when productivity slowdown began.
But: Then why didn’t productivity speed up when oil prices fell in the mid-1980s?

Question 27

What are some explanations about the world slowdown? (PT 2)`

Answer 27

Worker quality
1970s - large influx of new entrants into labour force (baby boomers, women).
New workers are less productive than experienced workers.

The depletion of ideas
Perhaps the slow growth of 1972-1995 is normal and the true anomaly was the rapid growth from 1948-1972.

Question 28

What did Schumpeter mean when he said economic growth is like creative destruction?

Answer 28

to describe displacements resulting from technological progress: the introduction of a new product is good for consumers but often bad for incumbent producers, who may be forced out of the market.
Examples:
Luddites (1811–12)