ECO105_LEC05 - Notes for Lecture 5: The Importance of...

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Unformatted text preview: Notes for Lecture 5: The Importance of Productivity Growth for a Market Economy [October 9,2007] Economic Concepts: labour productivity, total factor productivity, Cobb-Douglas production function, weights assigned for labour and for capital, Solow's rate of technological change, Hare's version of `Solow's Surprise', the residual, our degree of ignorance, Lipsey's Black Box; the contribution of labour to economic growth, the contribution of capital to economic growth, capital/labour ratios, Krugman's five ways to increase consumption per capita [GDP per capita], Hare's two additional ways to increase consumption per capita, personal [household] saving, consumption, exports, imports, government deficits, taxes, gains from trade and Easterly's version of Solow's Surprise. Central Theme Living -- Productivity Growth: The "Miracle" Behind Higher Standards of This lecture contained the following key points: a. the meaning and economic significance of labour productivity and, separately, factor productivity [both must be understood]; b. c. the outstanding results from Solow's model: Hare's version of Solow's Surprise; the relative importance of total factor productivity to labour productivity; of total d. labour productivity as a function of total factor productivity and of increases in the capital/labour ratio and the associated Solow diagram; e. the short-run abilities of a country to increase consumption per capita [GDP per capita]and their limitations; f. the long-run ability of a country to increase consumption per capita: the case of labour productivity growth; g. the theoretical relationship between labour productivity and higher real wages in a plant or an industry or the industrial sector; g. h. the statistical evidence supporting the previous relationship; Easterly's version of Solow's Surprise; 2 The Two Productivities: Labour Productivity and Total Factor Productivity Labour productivity represents the level of real output per person hour [and sometimes just per person]. The rate of growth of labour productivity is derived by taking the rate of growth of real output minus the rate of growth of labour input [usually in person hours]. Total factor productivity represents the contribution to the rate of growth of real output which is not accounted for by the contribution of labour and by the contribution of capital. The Cobb-Douglas Model Using The Aggregate Production Function In the simple aggregate production function, output is only a function of labour and capital as shown in a previous lecture. The contribution of labour is derived by taking the weight associated with labour times the growth rate for labour input, usually in person hours and the contribution for capital is similarly derived. The weight for labour and the weight for capital sum to one in this model. The weight for labour is taken as the percentage of labour income [total wages] to total factor income or net domestic income [defined in a preceding lecture] and the weight assigned to capital is the remaining factor income [mostly profits] as a percentage of total factor income. Thus the weights are represented as fractions [or percentages] and add to one [or as percentages to 100]. I n t h e si m p l e e c o n o m i c g r o w t h m o d e l, d is c u s s e d i n a n e a rli e r l e c t u r e , t h e r a t e o f g r o w t h o f t o t a l o u t p u t [i n d u strial s e ct o r G D P o r c o u n tr y G D P ] is t o tall y a c c o u n te d f o r b y t h e s u m o f t h e c o n tri b u ti o n s o f l a b o u r a n d c a p it a l. Stu th e gro id e c a p d e n ts a r e a d v is e d t h a t, i t w o ter m s: th e rate of w th. In th e ta bles in n tifie d . S i m ila rl y , t h e r ital t o e c o n o m ic. n m gro th e e is o st o w th R e a c o nf f th e re a din g s, of th e la b o ur din g s, stu d e nts u sio n b et w e e n th e for s h th e re is c e a o uld rate o fte n n d th e b e cl of c a p c o nfu sio n [ c o n tri b u ti o e ar w hic h ital f o r m ati a n n of o n d i m pre cisio n] b et w of la b o ur to e c o n o th ese t w o c o n c e pt a n d t h e c o n tri b u ti o e e n m ic s is n if T h e S olo w M o d el a n d H are s S olo w s S u r p ris e ' ' ` ' T h e s u r p risin g m e ss a g e d eriv e d in th e S olo w m o d el is still th e f o c u s o f e c o n o m ic re s e arc h to d a y: al m o st fifty y e ars after its initial p re s e ntatio n. S o l o w u s e d t h e b a si c g r o w t h m o d e l, a s d is c u s s e d a b o v e . T h e r a t e o f g r o w t h o f t h e l a b o u r f o r c e [i n p e r s o n h o u r s ] w a s 1 . 5 % a n d t h e r ate o f g r o w t h o f c a p ital w a s 3 % . T h e w ei g h ts w e r e 7 5 % f o r la b o u r a n d 2 5 % f o r c a p ital [ o r 3 / 4 f o r la b o u r a n d 1 / 4 f o r c a p ital]. S o l o w p u b lis h e d t h e r e s u lts o f h is C o b b - D o u g la s g r o w t h m o d el f o r t h e i n d u strial s e ct o r i n t h e U n ite d States b et w e e n 1 9 0 9 a n d 1 9 4 9 in th e 1 9 5 6. 3 O n t h e b a sis o f t h is i n p u t, t h e e x p e c t e d r a t e o f g r o w t h o f r e a l o u t p u t i n t h e S o l o w 1.9 % p er a n n u m . m o d el w o uld b e H o w e v e r, t h e a ct u al r ate o f e c o n o m ic g r o w t h f o r t h e i n d u strial s e ct o r o f t h e U n ite d S tate s f o r t h e a s s e s s m e n t p e ri o d w a s d ete r m i n e d i n d e p e n d e n tl y at 3 . 5 % . T h u s, 1 . 6 % [ 3 . 5 % m i n u s 1 . 9 % ] o f t h e c o n tri b u ti o n t o e c o n o m ic g r o w t h i n t h e i n d u strial s e ct o r w a s u n e x p l a i n e d i n t h is g r o w t h m o d e l. In pr a n gr H are s inte o p o r t 'o n o f i d c a u se d a o w th w hic h r p r etati o n , th e e c o n o c o n ti n u i n c o n ti n u e s t h is h a s b e e n i d e n tifie d a s S o l o w s s u r p ris e. H o w c o u l d s u c h a c o n si d e r a b le m i c g r o w t h r a t e b e u n e x p l a i n e d ?' T h i s r e s u l t s h o c k e d t h e e c o n o m i c s w o r l d g flo w o f re s e arc h into th e b a sis f o r this u n e x plain e d s o u rc e o f e c o n o m ic to d a y. total e c o n o m ic gro w th in th e U .S. d it t h e r e s i d u a l i. e ., w h a t i s l e ft t e r m i n e d `. A b r a 'm o v i t z c a l l e d t h e to b e u n d erta k e n to u n d ersta n d th e e y c a ll e d t h e r e si d u a l, a B l a c k B o x , c o u l d n o t b e o b s e r v e d d ir e ctl y . S o l o w c alle d t h is d iff e r e n c e, w h ic h r e p r e s e n te d a b o u t 4 5 % o f t h e i n d u strial s e ct o r, t h e r a t e o f t e c h n o l o g i c a l c h a n g e. D o m a r c alle o v e r a fte r t h e c o n tri b u ti o n s o f la b o u r a n d c a p ital h a d b e e n d e resid u al o ur d e gre e of ig n ora n c e sin c e th ere w as a lot of rese arc h s o u r c e s ` f e c o n o m i c g r o w t h c o n t 'i n e d w i t h i n t h e r e s i d u a l . L i p s o a i n w h i c h i t i s n o t k n o w n w h a t i s i n c l u d e d w i t h i n t `h e B o x ' s i n c e i t ` ' T o d a y , t h e c o n tri b u ti o n t o e c o n o m ic g r o w t h w h ic h is n o t e x p lai n e d b y t h e s u m o f t h e c o n tri b u ti o n s o f la b o u r a n d c a p ital is d e fi n e d a s t h e r a t e o f g r o w t h o f t o t a l f a c t o r p r o d u c ti v it y [ T F P ^ ]. I n 1 9 5 6 , t h e m a g n it u d e o f t h e r ate o f g r o w t h o f t o tal f a ct o r p r o d u cti v it y c o n stit u te d a n e c o n o m ic m y ste r y a n d a n u m b e r o f e c o n o m ists s et o u t t o e x p lai n t h is m y ste r y . T h is r e s e a r c h c o n ti n u e s t o d a y a s t w o n e w m aj o r b o o k s h a v e b e e n p u b lis h e d w it h i n t h e la st t h r e e y e a r s o n t h is t o p ic. T h e I m p o rta n c e o f L a b o u r P r o d u cti v it y t o T o tal F a ct o r P r o d u cti v it y i n S o l o w s A n al y sis ' T h e r ate o f g r o w t h o f la b o u r p r o d u cti v it y i n S o l o w s w o r k w a s 2 . 0 % p e r a n n u m . T h is is d e ri v e d b y t a k i n g t h e r a t e o f g r o w t h o f o u t p u t [ 3 . 5 % ] m i n u s t h 'e r a t e o f g r o w t h o f t h e l a b o u r f o r c e [ 1 . 5 % ] . T h e rate of gro w th of T F P w as ta k e n a b o v e as 1.6 % . T h erefore, th e gro w th rate of total fa ctor p r o d u cti v it y a c c o u n te d f o r 8 0 % [ 1 . 6 % o v e r 2 . 0 % ] o f t h e g r o w t h r ate o f la b o u r p r o d u cti v it y . I n s u m m ar y, S olo w ' s rate o f te c h n olo gic al c h a n g e is th e sin gle m o st i m p o rta nt f o rc e in d eter m inin g b oth th e rate o f e c o n o m ic g r o w th a n d th e rate o f g r o w th o f la b o u r p r o d u ctivity. 4 T h e r e m ai n i n g 2 0 % s h a r e o f la b o u r p r o d u cti v it y g r o w t h w a s a c c o u n te d f o r b y h i g h e r c a p ital-la b o u r r a ti o s i n t h e i n d u s tri a l s e c t o r i. e ., w h e n w o r k e r s a r e s u p p li e d w it h m o r e p o w e r f u l m a c h i n e r y t h r o u g h t h e a s s e s s m e n t p e ri o d t h e y w ill p r o d u c e m o r e r e al o u t p u t p e r p e r s o n h o u r. D u ri n g t h e le ct u r e t h e t w o c a u s e s o f i n c r e a s e d la b o u r p r o d u cti v it y [ T F P a n d i n c r e a s e d c a p ital-la b o u r r ati o s ] w e r e s h o w n i n a d ia g r a m i n itiate d b y S o l o w t o h el p i n te r p r et t h e s e r e s u lts. T h is d ia g r a m m a y b e h el p f u l f o r st u d e n ts t o e x p lai n S o l o w s r e s u lts. ' T h e D o u b le I n te r p r etati o n o f S o l o w s S u r p ris e ' ` ' I n t h e R e a d i n g s, E a ste rl y h a s p r o v i d e d a s e c o n d d e fi n iti o n o f S o l o w s s u r p ris e th e ' r a t i o , w o u ld n o t i n c r e a si n g l e v e ls o f i n v e st m e n t, w h i c h w o r k t o i n c r e a s e t h e c a p it a l-l a b o u r c o n ti n u a ll y str o n g i n c r e a s e s i n o u t p u t p e r w o r k e r b e c a u s e d i m i n is h i n g r e t u r n s t o c a p it a l. t h a t t h e st o c k o f l a b o u r is g i v e n , t h e n e q u a l i n c r e m e n ts i n i n v e st m e n t, g i v e n a fi x e d s u p p l y w o u l d g e n e r ate s m alle r a n d s m alle r i n c r e a s e s i n la b o u r p r o d u cti v it y . T h is is t h e s a m e o n i n p u t m o d el w h ic h w a s a n al y z e d d u ri n g t h e le ct u r e o n M alt h u s, w h e r e la n d w a s fi x e d a w a s v a ria b le. H e r e, a g ai n , la b o u r is fi x e d a n d c a p ital is v a ria b le. E a ste rl y h a s als o d o n e a j o b o f e x p lai n i n g t h e s e r e s u lts i n w h at h e c alls S o l o w s s u r p ris e. ' S olo w in cre a pro d u f u n cti fa ct th at all o w f o r A ss u m e o f la b o u r, e v aria ble n d la b o ur m asterful i n d ic ate d t h at w h at a c c o u n te d f o r str o n g i n c r e a s e s i n la b o u r p r o d u cti v it y w a s n o t i n v e st m e n t s es th e m s elv es, b ut rath er te c h n olo gic al c h a n g e w hic h le d to lar g e in cre as es in la b o u r cti v it y . I n t h e d ia g r a m , t h is is r e p r e s e n te d b y a n u p w a r d s h ift i n t h e a g g r e g ate p r o d u cti o n o n. T o d a y s S tatistic al E v i d e n c e ' T h e le ct u r e p r e s e n tati o n i n cl u d e d m e a n i n g f u l d ata o n f a ct o r p r o d u cti v it y , s o m e o f w h ic h is i n cl u d e d i n th e re a din g s. L e c t u r e 6 w ill e x a m i n e t h e c a u s e s o f e c o n o m ic g r o w t h i n g r e ate r d etail a n d L e c t u r e 7 w ill e x a m i n e t h e c a u s e s f o r e c o n o m ic g r o w t h a n d p r o d u cti v it y sl o w d o w n a fte r 1 9 7 3 . K r u g m a n s M e s s a g e o n t h e I m p o rta n c e o f I n c r e a si n g L a b o u r P r o d u cti v it y is e x p lai n e d i n t h e ' A g e of D i m inis h e d E x p e ctatio n s. I n this a n aly sis, K r u g m a n is th e m e ss e n g er [ n ot th e o rigin ato r] o n th e i m p o rta n c e o f risin g la b o u r p r o d u cti v it y . 5 K r u g m a n p re s e nts o n e o f th e m o st p o w erf ul state m e nts in e c o n o m ic s: P r o d u cti v it y [la b o u r p r o d u cti v it y ] is n t e v e r y t h i n g "v e r y t h i n g . ' e b u t i n t h e l o n g r u n it is al m o st A c o u n tr y s a b ilit y t o i m p r o v e its sta n d a r d o f li v i n g [ c o n s u m p ti o n / G D P p e r c a p ita ] o v e r ti m e d e p e n d s a'm o s t e n ti r e l y o n it s a b ilit y t o r a i s e it s o u t p u t p e r w o r k e r. l " T h e R e a din g p res e nte d b y B a u m ol re-e n f o rc es th e K r u g m a n m ess a g es. C o n v e r si o n B et w e e n H i g h e r L a b o u r P r o d u cti v it y a n d H i g h e r W a g e R ate s A s e x p lai n e d d u ri n g t h e le ct u r e, t h e m e a n s t h r o u g h w h ic h h i g h e r la b o u r p r o d u cti v it y w o u l d g e n e r ate h i g h e r r e al w a g e r ate s is n o t c o n tai n e d w it h i n t h e K r u g m a n r e a d i n g . W h e n t h e r e is h i g h e r l a b o u r p r o d u c ti v it y i n a p l a n t, t h e n t h e r e is a H o w e v e r, t h is li n k a g e f o ll o w s. u nio n/e m plo y e e d e m a n d f o r hig h er re al w a g e s d u rin g th e n e xt e m plo y e e-e m plo y er b ar g ainin g s e ssio n. If a w o r k e r w e r e t o p r o d u c e s a y 4 % m o r e r e al o u t p u t p e r h o u r, t h e n m a n a g e m e n t c a n p a y w o r k e rs 4 % m o r e p e r h o u r, irr e s p e cti v e o f t h e c a u s e o f t h is h i g h e r la b o u r p r o d u cti v it y a n d u n it c o sts o f p r o d u cti o n w o u l d b e u n c h a n g e d . C o m p a n i e s w o u l d a ls o a c h i e v e h i g h e r r a t e s o f p r o fits. In th e le ctur le v els of la b o n e-to - o n e b w a g e in cre as e, e o ur asis e in vid e n c e w as prese nte d th at p r o d u cti v it y d i d a ct u all y le a . T h e e vid e n c e w as th at a in d u strial c o u ntrie s f o r th e p in th e d to h n x % erio d s le a din g in d u strial c o u ntrie s, sin c e 1 9 5 0, hig h er i g h e r r e al w a g e r ate s. T h e r elati o n s h i p w a s o n a i n la b o u r p r o d u cti v it y le d t o a n x % le v el o f r e al stu die d. K ru g m a n s Fiv e W a y s ' I n K r u g m a n s c o n tri b u ti o n , h e lists fi v e w a y s i n w h ic h d e fi n e d e c o n o m ic a cti v itie s c o u l d r ais e r e al p e r ' 6 c a p ita c o n s u m p ti o n le v els [ G D P /c a p ita le v els ] i n a n i n d u strial c o u n tr y . I n t h e f o ll o w i n g f o u r w a y s, a s e x p lai n e d d u ri n g t h e le ct u r e, a o n c e - o n l y c o n tri b u ti o n c o u l d all o w f o r a n i n c r e a s e i n r e al c o n s u m p ti o n p e r c a p ita: a. b. a h i g h e r p r o p o rti o n o f t h e la b o u r f o r c e h a s j o b s; a c o n v e r si o n o f h o u s e h o l d [ p e r s o n al] s a v i n g s t o c o n s u m p ti o n ; { N ote: plu s tra p aid to sa vin g. L e cture c. d. dis p o sa ble in c n sfer p a y m e nt g o v e r n m e n t. T h e s e d isti n s 1 7 to 1 9 } o m e for s fro m g D is p o sa cti o n s w t h e f a m il o v ern m e n ble in c o m ill b e d e v y is d efin e d to in t [ e . g ., u n e m p l o y e is t o tall y d i v i d e elo p e d d u rin g th e clu d e fa ctor in m e nt in s ura n c e d b et w e e n c o n s le ctu re s erie s c o m e [ m p a y m e n u m p ti o n o n m a cr o stl y w ts] less a n d p er o e c o n o a g es] ta x es s o n al m ics: a n in cre a s e in e x p o rt p ric e s; w h ile t h e le v el o f e x p o rts is h el d a n in cre a s e in c h e a p c o n s u m er g o o d s w hic h are i m p o rte d c o n st a n t. In li m H o b e w h e a c h of th e it e d i. e ., it w e v e r, a s e re p e ate d. ic h h o u se h o p re c e din g c as es, re al c o uld o c c ur o nly fo x plain e d in th e le ctur F or e x a m ple, th ere is l d s c o u l d s w itc h fr o m c o n s u m p ti o n p e r c a p ita c o u l d i n c r e a s e, b r a c e rtai n p e ri o d o f ti m e a s w a s d is c u e a n d i n K r u g m a n s v o l u m e, t h r o u g h ti m a l i m i t t o w h i c h m 'o r e p o t e n t i a l w o r k e r s c p e r s o n al s a v i n g s t o c o n s u m p ti o n . ut e a sse d e th e o uld c h d u se b e o p ti o n rin g th e v e nts e m plo y w o uld b e e le cture. c o uld n ot e d a n d to T h e o n l y w a y i n w h ic h , t h r o u g h ti m e, c o n s u m p ti o n p e r c a p ita [ G D P p e r c a p ita ] c o u l d b e i n c r e a s e d is t h r o u g h i n c r e a s e s i n la b o u r p r o d u cti v it y w h ic h d e p e n d p ri m a ril y u p o n te c h n o l o g ic al i m p r o v e m e n ts a n d i n n o v ati o n . T e c h n o l o g ic al i m p r o v e m e n ts c a n al w a y s b e m a d e d e c a d e b y d e c a d e a n d l o n g i n t o th e future. 7 H a r e s A d d iti o n al S h o rt R u n O p ti o n s ' D u ri n g t h e le ct u r e, t w o a d d iti o n al m e a n s w e r e d e fi n e d t h r o u g h w h ic h a c o u n tr y c o u l d , i n t h e s h o rt r u n , i n c r e a s e c o n s u m p ti o n p e r c a p ita w e r e i d e n tifie d . H o w e v e r, t h e s e t w o a d d iti o n al o p ti o n s a r e als o o n c e - o n l y o r s h o rt-r u n o p ti o n s. Fin al C o m m e nts O n e p ri m q u a n tit y o th e e c o n o c o n s u m er ary f re m ic g o o p urp o se al c o n s u sta n d ar d s a n d s of t m p ti d of ervic h e e c o n o m ic s y ste m in m ark et e c o n o m ies is to g e n erate in cre ases in th e o n p e r c a p ita o v e r ti m e b y e a c h w o r k e r o r p e r f a m il y . W h e n this o c c u rs, li v i n g i s i n c r e a s e d i. e ., h o u s e h o l d s c a n p u r c h a s e a g r e a t e r q u a n tit y o f es. T h e a bility o f a c o u ntr y to a c hie v e hig h er p er c a pita in c o m e s d e p e n d s e ntirely, in th e lo n g r u n, o n in cre a s e s in la b o u r p r o d u ctivity. S o l o w s r e s u lts s h o w t h at m u c h o f e c o n o m ic g r o w t h is a c c o u n te d f o r b y i n c r e a s e s i n t o tal f a ct o r p r o d u 't i v i t y , w h i c h a r i s e s p r i m a r i l y w h e n t e c h n o l o g i c a l c h a n g e o c c u r s . c F u rt h e r, t o tal f a ct o r p r o d u c ti v it y a c c o u n ts f o r a b o u t 8 0 % o f t h e g r o w t h o f l a b o u r p r o d u c ti v it y i n S o l o w s m o d e l. ' T h e m e s s a g e is si m p le a n d i m p o rta n t: in o r d er to in cre a s e its sta n d ar d o f livin g [i.e., in cre a s e re al p er c a pita G D P ], th e n a c o u ntr y [a n y c o u ntr y ] m u st cre ate in cre a s e s in la b o u r p r o d u ctivity. A s w ill b e d e v elo p e d in L e ctu re 6, th e p ri m ar y s o u rc e b e hin d la b o u r p r o d u ctivity are in cre a s e s is te c h n olo gic al c h a n g e. W h at b et w e e n hig h e hig h er le v els e d u c ati o n a n d If la b o ur p o ssible. s p urs e c o n re v e n u e w e d u c ati o n , w ill r la b of ta infra als o b e d e v o u r p r o d u cti x re v e n u e, str u ctu re] o f elo p v it y , w hic g o v e d in hig h e h c a n ern m e f u t u r e le ct u r e s [ p a rtic u la rl y L e c t u r e 2 4 ]is t h e r elati o n s h i p r sta n d a r d s o f li v i n g [ a s a b o v e ]; h i g h e r i n d u strial p r o fits a n d a c c o m m o d a t e s o c i a l s p e n d i n g p ri o riti e s [ e . g ., h e a lt h c a r e , nts. e n u n in e x c o it y sig p a n n v er c o st: nific d its g e n c e sin c e a nt in c s o cial m a y pro d re ase s p e n n ot b u cti v it s in ta din g o x n e y p r o d u cti v it y H o w e v e r, t h o m ic gro w th, hic h c o uld p u th e e n vir o n m d o e s n o t i n c r e a s e s u fficie n tl y i n a c o u n tr y , t h e c o u n tr y w o u l d als o f a c e a n a d d iti o n al o p p o rt a sl u g g is h r ate o f p r o d u cti v it y g r o w t h n o t b ri n g t str o n g r e str ai n ts o n t h e a b ilit y o f a c o u n tr y t o e nt a n d e c o n o m ic in fra str u ctu re. ...
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