Development, Growth, and Structural Change

1. Development, Growth, and Structural Change Lecture 1: How Economists Think About Growth and Development National Graduate Institute For Policy Studies IDTP Fall 2013 John Page

2. What is Development? • An economist’s answer: Rising per capita income • What makes this appropriate? • Grounded in microeconomic theory • Measures “in principle” the goods and services available to a “representative’ individual in society • Comparable across countries • What are some limitations? • Comparing income across countries (purchasing power) • How representative is the “representative” individual (income distribution) • A lot is left out

3. Accelerating Economic Progress

4. Has Been Led by Developing Economies

5. A Cautionary Tale:Even the BRICS Will Not Have Caught Up by 2050

6. What is Development? • The International Community’s Answer (MDGs): Poverty reduction and human development • What makes this appropriate? • “Linked” to income growth but more “human centered” • Politically more appealing • Comparable across countries • What are some limitations • Problems of measurement and comparability • Imposes a “value judgment” (why only the poor?) • A lot is left out

7. Progress Toward the MDGs

8. A Cautionary Tale: Progress at the Country Level Is Uneven

9. What is Development? • A post “Arab Spring” answer: “good” jobs • What makes this appropriate? • “Linked” to both growth and poverty reduction • A political imperative (youth unemployment) • Comparable across countries • What are some limitations? • Problems of measurement and comparability • Imposes a “value judgment” (what’s a good job?) • A lot is left out

10. Total and Youth Unemployment 2008 MOR TUN 30 JOR EGY 25 SYR 20 Youth Unemployment Rate ECA 15 LAC HIC SSA 10 SAS EAP 5 4 6 8 10 12 14 Total Unemployment Rate A Political Imperative:Unemployment and the Arab Spring

11. A Cautionary Tale:Africa’s Fastest Growing Economies are Creating Too Few Jobs

12. What is Development? • An influential economist-philosopher’s answer (Sen): Increased “capability” of the individual to function in society • What makes this appropriate? • Intellectually appealing (even to economists) • Linked to income, poverty and employment • Also reflects powerlessness or lack of political freedoms • What are some limitations? • Very difficult to measure (proxies are income, poverty, etc.) • Imposes a value judgment (what capabilities matter?) • Comparisons are “impossible”

13. Why Sen May Be Right: Income Growth and Perceived Well Being in Tunisia and Egypt

14. Why Start With Growth? • Income growth per capita remains the single most used indicator of economic policy success • Growth is a necessary, but not sufficient, prerequisite for poverty reduction, employment growth, and the expansion of capabilities • Economic size and success are important in geopolitics

15. How Economists Think About Growth:The Basics • The production function: Y = A f(K,L,...) Where: A is a “shift” parameter (why didn’t I just say technology?) K is capital L is labor • With some limiting assumptions we can also write it as: y = A f(k,...) Where: A is a “shift” parameter y is output per worker k is capital per worker • Notice that y is the economists definition of development!

16. Economists are really pretty simple minded about growth • In the neo-classical world there are only two ways to raise output per worker • Accumulation: more capital (or other inputs) per worker • “Capital deepening” • Productivity Change: raising the “shift parameter” • “Technological change”?

17. Accumulation and productivity change in the neo-classical model

18. Accounting for Growth • A little algebra with the production function let’s us decompose the rate of growth into two components: dY/Y = dA/A + [FKK/Y] dK/K + [FLL/Y] dL/L • Or in words: the rate of growth in output is the sum of the rate of growth in the “shifter” plus the weighted sum of the rate of growth in capital and labor

19. Accounting for Growth • What are the weights? • FK is the marginal product of capital • FL is the marginal product of labor • In a neoclassical world: • The marginal product of capital equals the rate of return • The marginal product of labor equals the wage • So the weights are the shares of labor and capital in total output • That’s convenient because we can get those from national accounts data

20. Accounting for Growth • But, we can’t directly observe the shift parameter. • So, we find that as a residual: dA/A = dY/Y – [SK] dK/K – [SL] dL/L • How do we interpret the residual? • It’s called Total Factor Productivity (TFP) Change • Is it Technological change? Not entirely. • It also captures any “rearrangement” of production that raises output for the same bundle of inputs – Technical Efficiency Change • And of course it captures any errors in measurement and errors made by assuming that factor shares are the correct weights (what if factors are not paid their marginal product?)

21. Productivity Change and Development Policy • TFP is a big deal in development policy • It varies across countries (and over time within countries) • It can be (and frequently is) negative • So it can’t simply be technological progress • It can be a very large share of total income growth • It’s a big deal because unlike accumulation it’s “free”. • And if it’s negative, it’s like trying to run up the down escalator.

22. Accounting for Growth:Comparing China and India