1. Life Impact | The University of Adelaide University of Papua New Guinea Economic Development Lecture 5: Growth Theories III

2. University of Papua New Guinea Slide 1 Lecture 5: Growth Theories III Michael Cornish Overview Endogenous Growth –Romer Model Contemporary Models –Coordination Failure –Multiple Equilibria –The Big Push –Kremer’s O-Ring Theory Recap: Growth Theories

3. University of Papua New Guinea Slide 2 Lecture 5: Growth Theories III Michael Cornish Endogenous Growth: An Introduction Decreasing returns to K –An assumption in Harrod Domar Growth Model, Lewis Theory of Development, Neoclassical Growth Model –Implies investment in K should occur wherever there is the least capital –True in long-run, but not always in short-run!

4. University of Papua New Guinea Slide 3 Lecture 5: Growth Theories III Michael Cornish Endogenous Growth: An Introduction Flaws in the Neoclassical Growth Model –Conditional convergence in long-run –Assuming technology is constant, any changes to income not caused by short-term shifts in K or L are ‘Solow Residuals’ –Why are Solow Residual so different across countries with similar levels of technology? –Trade and domestic market liberalisation often led to few gains to growth

5. University of Papua New Guinea Slide 4 Lecture 5: Growth Theories III Michael Cornish Endogenous Growth: The Theory Tried to explain the Solow Residuals Did not assume diminishing returns to K Reinforced central role of I, not just in physical K but also human K Looked at the role of externalities on returns to K No conditional convergence Market undersupplies human capital investment –Finally, a role for government!

6. University of Papua New Guinea Slide 5 Lecture 5: Growth Theories III Michael Cornish Endogenous Growth Romer Model –Firm-level: assumes each individual firm produces with constant returns to scale Y i = AK i α L i 1-α K̄ ß K̄ = economy-wide stock of capital (‘spillover effects’) ß = proportion of growth derived from K̄ –Economy level: assumes increasing returns to scale are possible Y = AK α+ß L 1-α

7. University of Papua New Guinea Slide 6 Lecture 5: Growth Theories III Michael Cornish Endogenous Growth Romer Model –Assume A constant, then ΔY/Y defined as: g – n = ß n / 1 – α – ß g = output growth rate n = population growth –Without increases in technology or K̄ ‘spillovers’ ( ß = 0), growth is equal to zero This matches the Neoclassical Growth Model!

8. University of Papua New Guinea Slide 7 Lecture 5: Growth Theories III Michael Cornish Endogenous Growth Criticisms –Little empirical support –Does not include inefficiencies from poor human capital and infrastructure, But why can’t ß take a negative value?

9. University of Papua New Guinea Slide 8 Lecture 5: Growth Theories III Michael Cornish Contemporary Growth Models Coordination Failure –Stresses existence of complementarities between necessary conditions for development –‘Getting everything right, at the same time’ –Communication problems, expectation mismatches –First movement costs –Specialisation and middlemen –A role for government?

10. University of Papua New Guinea Slide 9 Lecture 5: Growth Theories III Michael Cornish Multiple Equilibria

11. University of Papua New Guinea Slide 10 Lecture 5: Growth Theories III Michael Cornish Case Study: Latin American Time

12. University of Papua New Guinea Slide 11 Lecture 5: Growth Theories III Michael Cornish Contemporary Growth Models The ‘Big Push’ –Economy-wide effort to kick-start development, to get from low equilibrium to high equilibrium Industrialisation Inter-temporal effects Urbanisation Infrastructure Training –Super-entrepreneurs

13. University of Papua New Guinea Slide 12 Lecture 5: Growth Theories III Michael Cornish Contemporary Growth Models Kremer’s O-Ring Theory –Looks at firm-level –Assumes strong complementarities among inputs –Productive workers accrete

14. University of Papua New Guinea Slide 13 Lecture 5: Growth Theories III Michael Cornish Contemporary Growth Models Kremer’s O-Ring Theory –Conclusions When workers around you have higher skills, there is a greater incentive to acquire more skills yourself Alternatively, poverty traps can occur! Bottlenecks have a multiplying effect on other production, reducing the incentive to invest in skills because of the lower expected return

15. University of Papua New Guinea Slide 14 Lecture 5: Growth Theories III Michael Cornish Recap: Growth Theories Linear stages growth: primacy of savings and investment in facilitating capital formation and growth Structural change model: prescribes the transfer of resources from low productivity sectors – specifically, subsistence agriculture – to high-productivity modern sectors – the industrialised economy International dependence theory: political economy model with focus on effects of international and intra-national power imbalances on resource allocation Neoclassical growth theory: supremacy of the market as the engine of growth, technology is the way to beat growth constraints in the long-run Endogenous growth theory: prescribes a limited and prudential role for government in policies that promote ‘spillover’ effects, particularly centred on human capital formation, infrastructure, and research and development Contemporary growth models: Coordination Failure, Multiple Equilibria, Big Push, Kremer’s O-Ring Theory