978-0133780581 Chapter 12 Lecture Note

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Chapter 12. Technological

Progress and Growth

I. MOTIVATING QUESTION

How does growth relate to technological progress, and what determines the rate

of technological progress?

In the long run, the growth of output per person output equals the rate of technological progress. Evidence

from the postwar growth experience of four rich economies coincides with this assertion. Most

technological progress results from research and development (R&D) carried out by firms. Economics

has relatively little to say about the translation of R&D effort into useful products. Economic analysis

does suggest some policies—e.g., patent protection—that provide incentives for R&D effort.

II. WHY THE ANSWER MATTERS

Rich countries want to maintain growth in their standards of living, and poor countries want desperately

to improve their standards of living. Chapter 11 ruled out the saving rate as a means to improve the

standard of living in the long run. What is left is the rate of technological progress. This chapter

confirms that the rate of technological progress is the only determinant of long-run growth. Since this

rate is not directly in the control of policymakers, it is critical to understand the determinants of the rate of

technological progress and to assess whether there are policy options available to improve growth. This

chapter focuses primarily on rich countries, although there is a short section on China and a brief

discussion of patent protection in poor countries. Chapter 13 examines the relationship between

institutions and growth, a topic of special relevance to poor countries.

III. KEY TOOLS, CONCEPTS, AND ASSUMPTIONS

1. Tools and Concepts

i. Effective worker is the number of workers (or the amount of labor) multiplied by the level of labor

productivity. In symbols, effective worker equals AN.

ii. Growth accounting and the Solow residual are described in an appendix to the chapter.

2. Assumptions

This chapter continues to assume a closed economy, but allows for growth of the labor force and

technological progress.

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IV. SUMMARY OF THE MATERIAL

1. Technological Progress and the Rate of Growth

Let the variable A denote the state of technology, and incorporate labor-augmenting technology into the

aggregate production function:

Y = F(K,AN). (12.1)

In Chapter 11, which used a production function with fixed technology, it was convenient to describe the

economy in terms of output per worker and capital per worker. In this chapter, which uses the production

function in equation (12.1), it is convenient to describe the economy in terms of output per effective

worker (Y/AN) and capital per effective worker (K/AN). With this new normalization, the analysis

proceeds as in Chapter 11.

The function F is assumed to exhibit constant returns to scale and therefore decreasing returns to each of

its arguments separately. Thus, it can be rewritten as

Y/AN = f(K/AN), (12.2)

where the function f has positive but decreasing returns to K/(AN).

With the government budget deficit set equal to zero, goods market equilibrium in a closed economy is

equivalent to I=S=sY, or expressed in terms of effective workers,

I/AN = sf(K/AN)

In the model of Chapter 11, with a constant labor force and no technological progress, the capital-labor

ratio reached a steady state when saving was just sufficient to replace capital depreciation. Since N was

fixed, K/N was constant when K was constant, i.e., when saving did no more than replace depreciated

capital. In this model, in order for K/(AN) to be constant, K must grow at the same rate as AN. These

assumptions imply that the level of investment needed to maintain a given level of output per effective

worker is given by

I = (+gA+gN)K. (12.3)

Where  is the depreciation rate of capital, gA represents the rate of technological progress, and gN

represents the population growth rate. This level of investment is sufficient to both to replace depreciated

capital, and to allow the capital stock to increase by (gA+gN)K.

Substituting equation (12.3) into equation (12.2) gives the steady-state equilibrium condition of

investment per effective worker:

I/AN = (+gA+gN)(K/AN)

The economy looks qualitatively similar to Figure 12-2. In steady state, Y/(AN) is constant, so output

grows at rate +gA+gN. Output per worker, however, grows at rate gA. An increase in the saving rate

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increases steady-state output per effective worker, but does not affect the steady-state growth rate of

output per effective worker which is affected by the rate of technological progress (See Figure 12-3).

2. The Determinants of Technological Progress

The model in this chapter establishes that long-run growth is determined by the rate of technological

progress, but takes this rate as given. What are the sources of technological progress? Technological

change is the product of research and development (R&D), most of which is conducted by firms in search

of increased profits. In general terms, R&D spending depends on the expected fertility of research (its

yield of new ideas and products) and the appropriability of the results of research.

Fertility depends on the successful interaction of basic research, applied research, and product

development. Appropriability depends in part on the nature of the research process.

If it is believed that a new discovery will quickly lead to a better discovery by another firm, the ability to

profit from the results of research is limited. Appropriability also depends on the degree of patent

protection afforded to the inventors of new products. Patent protection allows the inventor of a product to

enjoy a monopoly on its sale for a time, and thus offers an incentive for research effort. On the other

hand, patent protection makes it more expensive for society to benefit from the introduction of new

products, since these products are likely be sold at prices above their marginal cost of production. By and

large, rich countries, where most inventions occur, have stronger patent laws than poor countries, where

technological progress depends on the adaptation of foreign technologies by domestic firms.

A box in the text examines the relationship between management practices and growth. A study by Bloom

and Van Reenen (2010) discovered that firm performance differed among similar size firms using the

same technology. They attributed the performance difference to good management practices. In other

words, firms outperformed peers by adopting and implementing good management practices.

3. Institutions, Technological Progress, and Growth

Growth rates differ significantly among countries. While many factors contribute to these differences

many economists increasingly point to institutions as the fundamental reason why many poor countries

remain poor. By institutions, economists generally mean the procedures and traditions in place to protect

private property rights.

These procedures and traditions span a wide range, including areas as diverse as the degree of corruption

in the political system, the efficiency and fairness of the court system, and patent and anti-trust law and

enforcement, among many others. The complexity and scope of the arrangements required to protect

property rights in a modern economy make it difficult for poor countries to build these institutions. This

observation means that there is also reverse causality: poor institutions may lead to low GDP per person,

but low GDP per person may also lead to poor institutions.

The protection of property rights is a primary driver of growth because individuals and firms that believe

wealth will be expropriated have little incentive to work and create. In contrast, countries that protect

property rights provide incentive for hard work and creativity. Figure 12-5 shows the high correlation

between property rights and GDP per person.

A text box highlights North Korea and South Korea which provide a case study in property rights. Prior to

1953 Korea was a single country with no physical differences in population or resources, in other words a

very homogenous country. After 1953 the country was divided into North Korea (limited property rights

and central planning) and South Korea (protection of property rights and capitalism). A substantial

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divergence in per capita GDP now exists after 60+ years. South Koreans have per capita GDPs that are

more than 6 times greater than North Korean per capita GDPs. The difference is due to the differences in

institutions. See the text box on page 254.

4. The Facts of Growth Revisited

Having incorporated technological progress in the growth model, the text compares measures of

technological progress with output growth for France, Japan, the United Kingdom, and the United States.

An appendix describes the Solow growth accounting methodology used to calculate the technological

progress measures.

There are two conclusions about postwar growth in the four economies studied. First, the rates of growth

of output per worker have been very close to the rates of technological progress, a fact that suggests that

the four economies are on a balanced growth path. Second, convergence among these four economies has

occurred because the poorest of any pair of countries in 1950 has had a faster rate of technological

progress since then. This result extends beyond the four countries analyzed in this chapter. In general,

convergence among OECD countries has arisen largely because the poorer the country in 1950, the faster

has been the rate of technological progress since then. Note that these conclusions do not mean that

capital accumulation has been irrelevant. Sustaining a balanced growth path requires ongoing capital

accumulation.

The text also looks at growth in China since 1980, and again finds—subject to the limitations of the data

—that growth of output per worker has been approximately the same as the rate of technological progress,

i.e., about 7.5-8%. This result suggests that China is also on a balanced growth path. For China,

maintaining this path with such a high rate of growth has required a substantial amount of investment.

Using equation (12.3) and dividing by output, the text calculates that China has required investment of

about 34% of GDP to sustain its growth path.

China has achieved rapid technological progress through two strategies. First, workers have been

reallocated from occupations in the countryside to more productive ones in cities. Second, China has

encouraged foreign direct investment and joint ventures, which allow Chinese firms to learn from more

productive foreign firms and to import technologies.

V. PEDAGOGY

It is worthwhile to reinforce the distinction between technological progress and productivity growth. In

terms of the production function used in this chapter, technological progress is an increase in the

parameter A. Productivity growth is an increase in output per worker. In steady state, the rate of

technological progress equals the rate of productivity growth.

VI. EXTENSIONS

The notion that technological progress applies only to the labor input in the production function may seem

arbitrary to students. Instructors could point out that under the Cobb-Douglas production function,

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Y=AKaN1-a, the assignment of the technology parameter is a mere convenience, since the production

function can be rewritten as Y= Ka(N)1-a, where A1/(1-a).

VII. OBSERVATIONS

The finding that the saving rate has no effect on the steady-state growth rate depends on the assumption

that the size of the capital stock has no effect on technological progress. This assumption might not be

true for human capital. For example, it is possible that an increase in investment in education geared

toward basic research could lead to an increase in the rate of technological progress.

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