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This may also provide some insight on why the European powers sought to gain ever-larger colonial empires in the later 19 th Century.

A principal problem with this classical production function was that it could not explain the sources of productivity growth, or its dynamics, over time. More specifically, this function had no place for innovation . Finally, and most importantly, there was no role for human capital.

(2)A more useful Production Function: In his pioneering work in the theory of “endogenous growth,” Paul Romer of Stanford University extended the Model of Robert Solow of MIT to incorporate innovation into the formal theory of economic growth. There is considerable debate as to how far his model makes growth endogenous. Romer’s Model brought innovation and R&D to the forefront. Previously, these factors were treated in a most unsatisfactory manner as in the “residual” term of the Solow model. We can write:

(2) Y = F t (L, P, K, H, I) + Z

Here the new terms are (I), devoting innovation and H, standing for human capital . K now stands for physical capital only. The subscript t in F t indicates the technology function F that maps inputs into output changes over time t due to the dynamics of innovation and technological change. The rate of growth dY/dt in such a model will be the total derivative dF t (o)/dt . The letter (Z) is the residual. This, in turn, will be a complex function showing how changes in the five variables ( L , P , K , H and I ) and I translate into a change in output Y over time.

While this was an advance in thinking, it is not sufficient. This model still falls short of what is needed, namely a model that explains how two different economies possessing the same values of

the independent variables L , P , K , H and I can have completely different growth rates dY/dt .

That is, there must be additional variables missing from (2) (Romer’s approach) that cause

the four independent variables to be transformed differently into different growth rates of output.

A Much Better Production Function: Traditional growth theory along the lines sketched above has been a branch of “economics proper.” Political, legal, and sociological factors were usually not included in the models of economists who work in this field. This situation is changing rapidly. Recent research has shown that the true determinants of economic output and growth include not only the five independent variables appearing in (2) , but a host of other quite different variables, including the incentive structure in the economy. These include such institutional features as the quality of the legal system (e.g., the efficiencies of government regulation, the quality of the educational system), the average and marginal rates of taxation, the extent of leverage (debt) that accumulates in the economy, the extent of private and public sector corruption, the degree of compliance with the tax code, the incentives to retire early versus late, the penalties for excess pollution, the incentives to have few or many children, the regulation of immigration, the level of public safely, and the protection of property rights. These factors play no role in models like (1) or (2) above.

(3)Incentive Structure Effects on Growth: Taken together, these variables define the incentive structure within which economic activity is carried out in an economy. Think of the incentive structure of a society as the collection of all “sticks and carrots” (penalties and rewards) influencing the decisions of all agents as they decide what to produce or not to produce. If top tax rates are 90% (as they were from 1945-69), agents will probably stay in bed or go on long vacations or hire legions of expensive lawyers to help avoid taxes. If tax rates are 20%, they will probably work harder and hire fewer lawyers. As a result of the role of incentive structures, citizens in two essentially identical economies (i.e., economies possessing identical values of the land, workforce, capital, and innovation variables in (2) above) will experience very divergent rates in growth in output and living standards. This will be due to differences in the incentive effects of tax rates, regulatory burdens legal provisions such as sanctity of contract, property rights, etc. To incorporate these factors, we need more general growth mode, as in (3).

(3) Y = F t (L, P, H, K, I, IS) + e

Y = f t (L, P, H, K, I, IS) + e

where IS denotes the incentive structure of the economy may have evolved by design or by accident. Equation (3) , furnishes a more general framework that can, in principle, explain what fuels growth rates in several type of economies. It helps to explain growth in economies that conform perfectly to classical textbook assumptions and that grow in accord with equation (2) . It also helps to explain stages of growth in Nations such as China between 1950 and 2010. During the period 1950-1963, we noted that there was only modest growth. From 1963-1980, during the Cultural Revolution due to nationwide economic and social disruption China had negative growth. But after 1982, China experienced an astonishing 10% growth rate thereafter. Classical growth theory cannot explain such phenomena at all, whereas variations in the incentive structure can. This is the advantage of model (3) over (2) .

Once we know how a particular IS variable impacts growth, and why , we may begin to understand which particular values of the IS variables are most supportive with strong growth. As we discuss later in this book, once policy- makers understand that taxes on consumption are much more efficient than taxes on labor because of their relative incentive effects, countries might consider adopting a tax code tilted towards consumption on the basis that it is “incentive structure compatible with optimal growth,” whereas taxes on payrolls are not. We may note at this point that over 150 nations now have ventral government taxes bases primarily on consumption: the value-added tax.

Selecting a Growth Rate: There is a second property that incentive structure variables have in common: IS variables are almost always policy variables chosen by governments, in contrast to classical land and labor variables that are usually exogenous and “taken as given.” Importantly, since IS variables are chosen, IS variables can be changed as a matter of policy, just as they were so spectacularly in China when Deng Xiaoping said in 1978, “It’s okay to go get rich!” After further reforms, the growth process there took off in 1982 and remained strong though 2014.

By contrast countries can be said to be “stuck” with a pathological incentive structure, and, by extension, with low growth. Greece over the period 2008-2014 has been the poster child for this incentive structure. We might conclude that the highly diverse growth rates that have been observed in history have themselves been chosen to a certain extent via their governments’ choice of incentive structures.

Analogously, countries can choose growth rates in the future. We now understand what polices are compatible with growth, and which are not.

Questions & Answers

are nano particles real
Missy Reply
Hello, if I study Physics teacher in bachelor, can I study Nanotechnology in master?
Lale Reply
no can't
where we get a research paper on Nano chemistry....?
Maira Reply
nanopartical of organic/inorganic / physical chemistry , pdf / thesis / review
what are the products of Nano chemistry?
Maira Reply
There are lots of products of nano chemistry... Like nano coatings.....carbon fiber.. And lots of others..
Even nanotechnology is pretty much all about chemistry... Its the chemistry on quantum or atomic level
no nanotechnology is also a part of physics and maths it requires angle formulas and some pressure regarding concepts
Preparation and Applications of Nanomaterial for Drug Delivery
Hafiz Reply
Application of nanotechnology in medicine
has a lot of application modern world
what is variations in raman spectra for nanomaterials
Jyoti Reply
ya I also want to know the raman spectra
I only see partial conversation and what's the question here!
Crow Reply
what about nanotechnology for water purification
RAW Reply
please someone correct me if I'm wrong but I think one can use nanoparticles, specially silver nanoparticles for water treatment.
yes that's correct
I think
Nasa has use it in the 60's, copper as water purification in the moon travel.
nanocopper obvius
what is the stm
Brian Reply
is there industrial application of fullrenes. What is the method to prepare fullrene on large scale.?
industrial application...? mmm I think on the medical side as drug carrier, but you should go deeper on your research, I may be wrong
How we are making nano material?
what is a peer
What is meant by 'nano scale'?
What is STMs full form?
scanning tunneling microscope
how nano science is used for hydrophobicity
Do u think that Graphene and Fullrene fiber can be used to make Air Plane body structure the lightest and strongest. Rafiq
what is differents between GO and RGO?
what is simplest way to understand the applications of nano robots used to detect the cancer affected cell of human body.? How this robot is carried to required site of body cell.? what will be the carrier material and how can be detected that correct delivery of drug is done Rafiq
analytical skills graphene is prepared to kill any type viruses .
Any one who tell me about Preparation and application of Nanomaterial for drug Delivery
what is Nano technology ?
Bob Reply
write examples of Nano molecule?
The nanotechnology is as new science, to scale nanometric
nanotechnology is the study, desing, synthesis, manipulation and application of materials and functional systems through control of matter at nanoscale
Is there any normative that regulates the use of silver nanoparticles?
Damian Reply
what king of growth are you checking .?
how did you get the value of 2000N.What calculations are needed to arrive at it
Smarajit Reply
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Source:  OpenStax, Economic development for the 21st century. OpenStax CNX. Jun 05, 2015 Download for free at http://legacy.cnx.org/content/col11747/1.12
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