INAF U8145: Advanced Economic Development Lecture 4: Endogenous Growth Theory, Increasing Returns and Poverty Traps Prof. Eric Verhoogen Spring 2021 Outline 1. Motivation 2. Multiple Equilibria 3. Adding Human Capital 4. Learning by Doing 5. Deliberate Technical Progress 6. Network Complementarities 7. Organizational Barriers to Technology Adoption I Lack of absolute convergence. (See ps1). I Lack of investment flows from rich to poor countries. (See Lucas (1990) and Banerjee and Duflo (2005).) I Countries that initially appear to be very similar that subsequently experience very different growth paths. I South Korea vs. Philippines example, from Lucas (1993). 1. Motivation I Solow model, although elegant, is difficult to reconcile with key features of the data: I Lack of investment flows from rich to poor countries. (See Lucas (1990) and Banerjee and Duflo (2005).) I Countries that initially appear to be very similar that subsequently experience very different growth paths. I South Korea vs. Philippines example, from Lucas (1993). 1. Motivation I Solow model, although elegant, is difficult to reconcile with key features of the data: I Lack of absolute convergence. (See ps1). I Countries that initially appear to be very similar that subsequently experience very different growth paths. I South Korea vs. Philippines example, from Lucas (1993). 1. Motivation I Solow model, although elegant, is difficult to reconcile with key features of the data: I Lack of absolute convergence. (See ps1). I Lack of investment flows from rich to poor countries. (See Lucas (1990) and Banerjee and Duflo (2005).) 1. Motivation I Solow model, although elegant, is difficult to reconcile with key features of the data: I Lack of absolute convergence. (See ps1). I Lack of investment flows from rich to poor countries. (See Lucas (1990) and Banerjee and Duflo (2005).) I Countries that initially appear to be very similar that subsequently experience very different growth paths. I South Korea vs. Philippines example, from Lucas (1993). 1. Motivation (cont.) Korea Philippines Average real GDP/capita (PPP conversion) in 1960 1570.89 2022.29 Total population in 1960 (millions) 25.25 27.56 Percentage of income saved in 1963 10.96 16.81 Value-added in agriculture as a percentage of GDP in 1960 36.35 25.65 Value-added in industry as a percentage of GDP in 1960 20.28 27.63 Percentage of population living in urban areas in 1960 27.71 30.30 Adult illiteracy rate in 1970 13.20 18.17 Gross enrollment rate for primary school in 1970 103.41 108.28 Gross enrollment rate for secondary school in 1970 41.61 45.81 Percentage primary products in exports 80.32 95.26 I Source: Penn World Tables and World Bank World Development Indicators 10 9.5 9 1. Motivation (cont.) Korea, Rep. 8.5 Philippines log GDP/cap. (PPP) 8 7.5 7 60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 0 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 2 year I Generally, an equilibrium is a situation from which, once reached, there is no tendency to deviate. I A Nash equilibrium is an equilibrium in which all agents are doing what is optimal, given the behavior of the other agents. I A stable equilibrium is an equilibrium from which there is no tendency to deviate, even in the presence of small shocks moving the economy away from the equilbrium. I Digression: some definitions 2. Multiple Equilibria I Big idea of endogenous growth literature: there may be multiple equilibria. I Generally, an equilibrium is a situation from which, once reached, there is no tendency to deviate. I A Nash equilibrium is an equilibrium in which all agents are doing what is optimal, given the behavior of the other agents. I A stable equilibrium is an equilibrium from which there is no tendency to deviate, even in the presence of small shocks moving the economy away from the equilbrium. 2. Multiple Equilibria I Big idea of endogenous growth literature: there may be multiple equilibria. I Digression: some definitions I A Nash equilibrium is an equilibrium in which all agents are doing what is optimal, given the behavior of the other agents. I A stable equilibrium is an equilibrium from which there is no tendency to deviate, even in the presence of small shocks moving the economy away from the equilbrium. 2. Multiple Equilibria I Big idea of endogenous growth literature: there may be multiple equilibria. I Digression: some definitions I Generally, an equilibrium is a situation from which, once reached, there is no tendency to deviate. I A stable equilibrium is an equilibrium from which there is no tendency to deviate, even in the presence of small shocks moving the economy away from the equilbrium. 2. Multiple Equilibria I Big idea of endogenous growth literature: there may be multiple equilibria. I Digression: some definitions I Generally, an equilibrium is a situation from which, once reached, there is no tendency to deviate. I A Nash equilibrium is an equilibrium in which all agents are doing what is optimal, given the behavior of the other agents. 2. Multiple Equilibria I Big idea of endogenous growth literature: there may be multiple equilibria. I Digression: some definitions I Generally, an equilibrium is a situation from which, once reached, there is no tendency to deviate. I A Nash equilibrium is an equilibrium in which all agents are doing what is optimal, given the behavior of the other agents. I A stable equilibrium is an equilibrium from which there is no tendency to deviate, even in the presence of small shocks moving the economy away from the equilbrium. 2. Multiple Equilibria (cont.) I Increasing returns can generate multiple equilibria. [Draw a Solow-type diagram, but with an S-shaped f (k) curve and three equilibria, an unstable one in the middle at k∗∗ and two stable ones on the ends (at k∗and k∗∗∗).] Suppose marginal returns to capital are decreasing initially, then increasing, then decreasing again. Note that increasing returns refer to the convex part of the curve. In that region, @2f =@k2 > 0. Key point: if the economy is bumped once to the right of k∗∗ it will naturally evolve toward k∗∗∗. Region [−∞; k∗∗) is the basin of attraction of the lower equilibrium, region (k∗∗; 1] is the basin of attraction of the higher one. I Low-level equilibrium may represent a poverty trap. I Market processes will not generate shift to higher-level equilibrium. I Multiple equilibria may provide a rationale for government intervention: I A one-time intervention can push economy from low-level equilibrium into \basin of attraction" of high-level equilibrium. I No subsequent intervention is required. 2. Multiple Equilibria (cont.) I In presence of multiple equilibria, history matters. Where you start out affects where you end up. I This is not true in Solow model, even when countries differ in their exogenous parameters. I Multiple equilibria may provide a rationale for government intervention: I A one-time intervention can push economy from low-level equilibrium into \basin of attraction" of high-level equilibrium. I No subsequent intervention is required. 2. Multiple Equilibria (cont.) I In presence of multiple equilibria, history matters. Where you start out affects where you end up. I This is not true in Solow model, even when countries differ in their exogenous parameters. I Low-level equilibrium may represent a poverty trap. I Market processes will not generate shift to higher-level equilibrium. 2. Multiple Equilibria (cont.) I In presence of multiple equilibria, history matters. Where you start out affects where you end up. I This is not true in Solow model, even when countries differ in their exogenous parameters. I Low-level equilibrium may represent a poverty trap. I Market processes will not generate shift to higher-level equilibrium. I Multiple equilibria may provide a rationale for government intervention: I A one-time intervention can push economy from low-level equilibrium into \basin of attraction" of high-level equilibrium. I No subsequent intervention is required. I Human capital (e.g. schooling, skill, health) is presumed to be accumulated like physical capital, but is embodied in people. I Suppose that human capital raises productivity of physical capital and labor: Y = AK αPβHγ @Y MPK = = αAK α−1PβHγ @K @2Y > 0 @K@H I If countries accumulate H at the same time that they accumulate K, then MPK may not decline; it may even increase. 3. Adding Human Capital I One factor that may offset the tendency of the marginal return to capital to diminish: human capital (Lucas, 1988, 1990). I Suppose that human capital raises productivity of physical capital and labor: Y = AK αPβHγ @Y MPK = = αAK α−1PβHγ @K @2Y > 0 @K@H I If countries accumulate H at the same time that they accumulate K, then MPK may not decline; it may even increase. 3. Adding Human Capital I One factor that may offset the tendency of the marginal return to capital to diminish: human capital (Lucas, 1988, 1990). I Human capital (e.g. schooling, skill, health) is presumed to be accumulated like physical capital, but is embodied in people. I If countries accumulate H at the same time that they accumulate K, then MPK may not decline; it may even increase. 3. Adding Human Capital I One factor that may offset the tendency of the marginal return to capital to diminish: human capital (Lucas, 1988, 1990).