In this chapter, we discuss

the following :
ECONOMIC • Important concepts used to understand economic growth.

DEVELOPMENT • The economic growth theories.

• The structuralist approach to explain economic growth.
AC 2203
• The new growth theories.

Unit 3 • The Asian Miracle

Economic Growth and the Asian Experience • The Aspects of Economic Performance in Miracle
Economies
• The Policy Matrix and Econonic Performance in South Asia
• Convergence of Income

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Important Concepts in Components of Income and

Understanding Growth Output
• Components of Income and Output • Output or Income– is derived by combining various
• Total Factor Productivity factors of production
• Economic Efficiency • Factors of Production or Factor Inputs - land, labor
and capital.
• Technical Progress
• The production function – is a useful tool for
analyzing the process of economic growth. The
functional form:
𝒀 = 𝒇(𝑲, 𝑳)
• As labor and capital grow overtime, so will income.

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 The Law of Diminishing
Marginal Returns
• Diminishing marginal returns primarily looks at
• An economic concept that changes in variable inputs and is therefore a short-term
shows that there is a point metric. Variable inputs are easier to change in a short
where an increased level of time horizon when compared to fixed inputs.
inputs does not equal to an • Returns to scale is a measure focused on changing
equal increase level of fixed inputs and is therefore a long-term metric.
outputs. • A constant return to scale à an increase in input results in a
proportional increase in output.
• Governs the growth process. As • Increasing returns to scale à the output increases in a
each worker acquires more greater proportion than the increase in input.
capital, it follows that there will • Decreasing returns to scale à production variables are
increased by a certain percentage resulting in a less-than-
be diminishing returns to capital. proportional increase in output.
If process were to continue for a
long period of time, growth
would slow to zero.
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Total Factor Productivity Economies of Scale

• Pertains to the efficiency with which the inputs

are combined to produced the output and due
to:
• Greater economies of scale
• Better management, marketing or organizational
abilities
• Shifts in production from low productivity activities
to higher productivity activities with the same
amount of labor and capital
• Impact of technology which enables greater output
to be obtained with same capital and labor inputs.

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 Total Factor Productivity
• Suppose a country has a growth rate of income of 6% a
• 𝒀 = 𝒇(𝑲, 𝑳, 𝑨)à assumed that competitive conditions growth rate of capital (net of depreciation) of 10% and
exist in capital and labor markets and there is the capital share of income is 30%, labor share is 70%
constant returns to scale and labor grows at 1 %
• 𝒈 𝒀 =𝒈 𝑲 𝑾 𝑲 +𝒈 𝑳 𝑾 𝑳 +𝑨
• 0.06 =A + 0.30(0.10)+0.70(0.01)
• A=0.023
Weighted
Growth share of Growth Weighted
Efficiency • Assumptions:
rate of
capital rate of share of factor • Factors are paid the value of their marginal product and that
Income labor labor that the two factors, K and L, exhaust total output, in the
Growth rate sense that their coefficients add to one.
of capital • A constant returns to scale so that we do not allow for
(investment) output growth to exceed the rate of growth of labor and
capital
• Growth in income will be raised if the investment rate is
increased or if the labor force increases more rapidly.
The growth rate of income is equal to the growth rates of the capital Efficiency is assumed to be unchanged
and labor inputs weighted by their share to the national income.

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Economic Efficiency
The Production Possibility Frontier (PPF)
Technical Progress
• Economic Efficiency can take A curve depicting the best possible
place in the move toward best Natural changes in the Inputs ( K, L ) and the way they are
combination of goods that is produced organized to produce output can result to:
practice through better in an economy—best in the sense that
management and organization.
the combination utilizes all the • Embodied technical progress
available inputs efficiently and • Labor forces have tended to become more educated overtime
• Static Efficiency as more resources are spent on upgrading skills of the
• if firms move from inside the minimizes waste. existing labor force and also in educating the young.
production possibility frontier.
• one-time increase in income but • Result of innovation and invention
it would not arrest the tendency • Usually hard to get estimates of the capital stock as we tend
toward decreasing returns to rely on investment figures to measure the increment to
capital—do not tell much about amount new innovation or
• Dynamic Efficiency technology contained in this new capital.
• takes place when there is • Labor input is usually measured in terms of man hours or
economic growth and the scale man years worked.
of production increases ,
production shifts from low
productivity sector to a more
productive sector. • Diesembodied technical progress
• Results from innovations and • Applications in information and computer technology,
inventions which boosts TFP.
• Due to effective marketing and advances in industrial organization and management that
distribution arrangements, increased the level output but the amounts of inputs
sometimes from foreign outlets. remained fixed. (e.g Internet)

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 • GROWTH ACCOUNTING
• The shares of the different
factors of production are
• Vintage Production Functions–production assumed to be known and
functions which assume that has higher innate are not estimated as they
productivity than do capital investments in would be.
previous years.
• Cobb Douglas constant
• More highly trained and educated workers enter the elasticity of substitution or
workforce all the time and older workers retire.à variable elasticity of
these figures are not ordinarily used to construct a substitution model.
new labor series each year that reflects this higher • Assume that share of
embodiment of education and skill into the hours or labor and capital in the The shorthand method for
years worked national accounts are assessing technical
• Limitation: people unlike capital , can increase their marginal products of progress. It does not
these products of these
productivity during their lifetime. factors and are simply
requires calculating a
added to the factors production function, which
contributing to output. can often be complicated by
the lack of reliable
information on capital stock
and labor supply.

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Growth Theories
• Keynesian Theory
• Solow or Neo Classical Theory
• Power Balance Theory
• Structural Theory
• New Growth Theory

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 Keynesian Growth Theory Rostow’s Growth Model
• stresses the accumulation • American economic historian Walt W.
of capital Rostow.
• Growth in among countries • The transition from underdevelopment to
development can be described in terms
using these models could of a series of steps or stages through
easily diverge. The models which all countries must proceed.
do not explicitly consider • The advanced countries, it was argued,
the law of diminishing had all passed the stage of “takeoff into
returns to capital which self-sustaining growth,”
take effect as growth • The underdeveloped countries that were
proceed. still in either the traditional society or
• Rostow’s (1960) à stages of the “pre-conditions” stage had only to
growth model follow a certain set of rules of
development to take off in their turn into
• Harrod-Domar growth self-sustaining economic growth.
model (Harrod 1939, Domar 1946)

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Rostow’s 5 stages of growth The Harrod-Domar Model

• The economic mechanism by
which more investment leads to
more growth can be described
in terms of the Harrod-Domar
growth model.

• Often referred to as the “AK Roy F. Harrod and Evsey Domar

model” because it is based on a
linear production function with
output given by the capital stock
K times a constant, often
labelled A. In one form or
another, it has frequently been
applied to policy issues facing
developing countries, such as in
the two-gap and three-gap
models.

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 The Harrod-Domar Model
Net saving (S) is some proportion, s, of national income (Y) such that
The Harrod-Domar Model
we have the simple equation : (Eq.1)
𝑺 = 𝒔𝒀
Finally,because net national savings, S, must equal net investment. I we can write this
Net investment (I) is defined as the change in the capital stock, K, and equality as (Eq.4)
can be represented by ∆K such that : (Eq.2) 𝑺=𝑰
𝑰 = ∆𝑲
But from (Eq.1) we know that 𝑆 = 𝑠𝑌, and the (Eq. 2) and (Eq.3) we know that :
But because the total capital stock, K, bears a direct relationship to 𝑰 = ∆𝑲 = 𝒄∆𝒀
total national income or output, Y, as expressed by the capital-output
ratio, c, it follows that: It therefore follows that we can write the “identity” of saving equalling investment shown
by (Eq.4) as : (Eq.5)
𝑺 = 𝒔𝒀 = 𝒄∆𝒀 = ∆𝑲 = 𝑰
𝑲
=𝐜 Or simply as : (Eq.6)
𝒀 𝒔𝒀 = 𝒄∆𝒀
or,
∆𝑲 Dividing both sides of (Eq.6) by 𝑌 and then by 𝑐 we obtain: (Eq.7) as The simplified
=𝐜 version of the Harrod Domar Theory equation
∆𝒀 ∆𝑲 𝒔
=
∆𝒀 𝒄
Or finally, (Eq.3)
∆𝑌 𝑠𝐺
∆𝑲 = 𝒄∆𝒀 = = −δ
𝑌 𝑐
1/c is a measure of efficiency of capital accumulation 𝑠𝐺 is gross savings , δ is the rate of capital depreciation.

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The Solow (Neoclassical) Model

The Harrod-Domar Model • Stress the neoclassical economic
principle that factors of production
should be paid the value of their qExposition of the Solow neoclassical
marginal products. growth model uses an aggregate
• To grow, economies must save and invest • 1>c expresses the efficiency with
a certain proportion of their GDP. • The law of diminishing returns can production function in which
which capital is utilised. operate and there is mobility of
• The more they can save and invest, the • The lower (more efficient) the value factors to seek their highest return.
faster they can grow. of c that an economy can attain, the 𝒀 = 𝑲𝜶 (𝑨𝑳)𝟏#𝜶
• Solow-Swan (1956) model
• But the actual rate at which they can greater the output that can be gained
grow for any level of saving and • These models show a convergence in where Y is gross domestic product, K is
from additional investment. growth among countries and also
investment—how much additional the stock of capital (which may include
output can be had from an additional • In other words, the rate of growth imply that there will be a slowdown human capital as well as physical
unit of investment—can be measured by depends as much upon the efficiency in growth in the absence of technical
the inverse of the capital-output ratio, c, progress as a result of diminishing capital), L is labor, and A represents the
with which investment is used as the returns
because this inverse, 1>c, is simply the productivity of labor, which grows at an
output-capital or output-investment amount of capital invested. Beyond exogenous rate.
ratio. these factors, growth depends • The model implies that economies
will converge to the same level of 𝜶 represents the elasticity of output
• It follows that multiplying the rate of fundamentally on technological income per worker “conditionally”— with respect to capital (the percentage
new investment, s = I>Y, by its progress, that is, other things equal,
particularly savings rates, increase in GDP resulting from a 1%
productivity, 1>c, will give the rate by • Net savings ratio Savings expressed
which national income or GDP will depreciation, labor force growth, and increase in human and physical capital).
as a proportion of disposable income productivity.
increase.
over some period of time.

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 The Solow (Neoclassical)
Model

25 26

27 28
 • What happens in the Solow The Power Balance Theory
neoclassical growth model if
we increase the rate of • North-South issues (poor—Southern
savings, s? economies), (rich industrial —
Northern economies).
• The poor countries export raw
materials to industrial countries in
• A temporary increase in the exchange for industrial goods.
rate of output growth is • Terms of Trade (price of raw
material vis-à-vis manufactured
realised as we increase k by goods) deteriorate overtime.
raising the rate of savings. • Asserts that the poor countries have
We return to the original to export more and more raw
materials in order to keep from
steady-state growth rate slipping backward.à Development
retards.
later, though at a higher level
• Assumes that when incomes are
of output per worker in each low, savings tend to be low.
later year. • Because of poverty, high productivity
is hard to achieve or to improve
productivity. ( Vicious cycle of
poverty )

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The Structuralist Approach The Structuralist Approach

• Models of economic growth as a process of shifts in • The Lewis-Fei—Ranis Model
resources among sectors
• It tries to explain how the process of
• Stresses rigidities that hinder the shift in resources industrialization takes place and how inefficiencies
and it studies how the shift in output among different
sectors takes place over time as development can arise.
progresses. • Comprise of two sectors model:
• A systematic shift in output that has been observed • modern sector –primarily based in the cities, high
in the process of development in the industrial productivity and pays higher wages
countries and developing countries • traditional sector – the countryside, has low capital
• In structuralist view, manufacturing is the source of accumulation and low labor skill, low productivity and
rapid growth ( Chenery and Syrquin, 1975) à earning capabilities.
technological advancements are made or copied • Labor moves from the countryside to the city to
from the other countries. take advantage of wage differentials
• Service sector cannot keep up in the fast growth in
the productivity in the manufacturing sector.

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 New Growth Theory –
New Growth Theories
Human Capital
• Developed by economists who were dissatisfied • Assume of 2 types of saving economy :
with the Solow-Swan(1956) model. • Traditional form of saving for investment in
physical capital
• These models try to endogenize technical progress • Saving in human capital through education and
and make use of assumptions of increasing returns training.
to scale and positive externalities.
• These assumptions contrast sharply with Neo Classical • We assume that population growth rate is
model which stresses diminishing marginal returns and zero and ignore unskilled labor which does not
slowdown of growth to a steady state. benefit from education ( Cobb Douglas Production
function in per capita )
𝑦 = 𝑘) + ℎ(*+))
ℎ à human capital

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• A proportion of output is assumed to be saved in •

* +,- .*(+0
= 𝑠. 𝑟 -.2 𝑎𝑛𝑑
either of the two forms. *(+)
3 +,- .3(+0
• 𝑘 𝑡 + 1 + 𝑘 𝑡 = 𝑠𝑦 𝑡 , 𝑎𝑛𝑑 • = 𝑞. 𝑟 .2
3(+)
• ℎ 𝑡 + 1 + ℎ 𝑡 = 𝑞𝑦 𝑡
• Dividing above equations with 𝑘(𝑡) and ℎ(𝑡)
𝑠 à proportion of output devoted to capital obtain the rates at which physical and human
investments capital grows
𝑞à the proportion of output devoted to human • In the long run, the ratio of human capital to
capital. physical capital is constant 𝑟.
The equations above suggest that the growth in the
economy is fuelled by the savings rate (𝑠) as well • These give us the the growth rate of physical
as the propensity to invest in human capital. and human capital

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 • All the variables must grow at the same rate
• Since these two growth rates are the same in in the long run. The long run growth rate G can
the long run ( so that the ratio 𝑟 is constant ), be derived from either growth rate equation :
equate both right side terms and obtain the 𝐺 = 𝑠 2 𝑞-.2
relationship.
𝑞 • Above equation is suspiciously looks like Cobb
𝑟= Douglas function
𝑠
• This implies that the larger the ratio of saving • There maybe broad constant returns to
in the form of human capital to physical physical and human capital combined.
capital, the larger the value of this ratio in the
long run. • Savings rate and the human capital formation
rate, s and q

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The Asian Growth Miracle

The First Primary Factor: Importance of
The Asian Growth Miracle Outward-Looking Policies and the Emphasis on
Exports and Foreign Direct Investment

• The term “Asian Growth Miracle” was due to the • Economies of East Asia and Southeast Asia started the
incomes in developing Asia have grown much faster industrialization process by developing import-
for the sustained period of time—up to four decades— substituting industries. ( natural complements to
than elsewhere in the world.
agricultural baseà food processing, textile, apparel
• Quibria (2002), grouped the explanations for the and footwear )
Asian “miracle” ( primary to secondary ) factors.
• Japan led the way beginning right after the World War • “Bootstrap”Development, was popularly believed that
II. the developing countries would need a large inflows of
development assistance to supplement domestic
• NIEs( Newly Industrialized Economies ) such as saving in order to accomplish this transformation of
(Singapore, Korea, Hongkong, Taiwan) in the 1960s
production structure.
• Indonesia, Malaysia, Thailand Southeast Asian
countries and China followed in the 1970s. • The theory was that developing countries had
comparative advantage in primary products and so they
should export these products.

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 • The transformation to labor intensive
industrialization à exports à supported by inflow
of foreign direct investments.
• In the Southeast Asian countries of Malaysia, the
Philippines and Thailand, the initial emphasis was • accelerated the movement of labor-intensive
on agriculture-based exports such as rubber, industries on offshore.
sugar, coconut and palm oil products, and textile • The Role of Technology
fabrics such as silk. • Growth in income is a function of growth in inputs and
• One of the common threads of these policies: the TFP residual, and this residual is largely a functions
• Initial protection of industries (import restrictions and of improvements in technology.
tariffs) • Foreign Technology
• Taxes à as percentage of exports and importsà • NIEs used foreign technology but mostly on license.
understates the degree of protection
• Japan and Korea did not encourage FDIs à they sent missions
• Average tariff rates à may overstate the degree of overseas to learn about the most up-to-date technologies and
protection à trade occurs in products that are taxed at the copied it.
low rates.
• R&D spendingà adopt overseas technologyà efficiency

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The Asian Growth Miracle

Second Principal Factor: Macroeconomic
Policies and the Role of the Government

• Governments supported this market led • Government intervention :

development through : • à in the industrial and financial sectors was
• the pursuit of prudent fiscal and monetary policies heavy in Japan, Korea and Singapore.
• low inflation environment
• Emphasis on human resource development • à Moderate in Malaysia and Taiwan
• Provision of physical and social infrastructure • à Relatively weak in Hongkong and Thailand
• Management of a legal framework essential for • à In Philippines and Sri Lanka, policy
market system to work smoothly. environments were similar to the most
successful economies but growth was slowed
by political uncertainty and domestic unrest.

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 The Asian Growth Miracle
Third Principal Factor: Education, Labor-
Force Growth and Labor Productivity

• The effectivity in achieving broad economic • Labor Productivity increased rapidly as did
stability, export promotion and and tariff total productivity is due to:
reduction and a neutral position toward • The increase in the amount of capital per worker
agriculture combined with outward-looking as a result of rapid investment growth and
policies that attracted foreign investment and technological transfer.
technology transfer were more important than • High level of investment given to educating the
specific industrial, financial and trade policies workforce à that makes Asia with very literate
workforce that make them highly adaptable to
in stimulating growth. changes
• High population growth particularly in labor force
was the source of economic development.

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The Asian Growth Miracle

Fourth Principal Factor: Labor Market
Flexibility

• According to ILO (International Labor • Regulations raise the cost of labor, diminish
Organization) the “miracle” economies are employment, and reduce flexibility of firms to
among the most flexible in the developing fire and hire.
world.
• While there are disagreements about the • Miracle economies were able to achieve rapid
desirability and extent of market interventions growth in real wages without protective labor
in the labor market that deal with safety, legislation
health, norms for compensation, and child • e.g. Korea when they joined OECD (Organization for
labor, there is little doubt that excessive labor Economic Cooperation and Development) in 1990s
market regulations have a negative impact on did not have a minimum wage policy until 1988.
economic development and growth

47 48
 The Secondary Factors: • B. Importance of Sector Policies
• Agriculture Sector Policies
• As industrialization proceeds à tendency to pursue policies that
• A. Difference in Initial Conditions favor industrial sector at the expense of the agriculture sector.
• The successful East Asian economies differed from • Taxing export agricultural products à not sustainable long-term
strategy à eventual strangulation, reduction of growth output,
other developing countries of Asia in 1960s, stagnation of the rural economy.
• Green Revolutionà instrumental in raising rural incomes.
• 1) successful countries were by led by and large
endowed than others in Asia in terms of the quality • Industrial Sector Policies
of their human resources. • ”industrial policy” in the context of the development of miracle
economies is taken to mean government policies that were
designed to promote particular sectors à capital-intensive
• 2) income, wealth and land were also evenly industries.
distributed in these Asian countries in early 1960s • Subsidized credit à promotes industries compete effectively
than they were in other Asian countries. international markets
• In Malaysia à push for heavy industry in 1980s and high
technology in 1990s
• In Thailand, policies were not guided by a strategy of picking
winners and have often marked by patronage and rent-seeking

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Aspects of Economic Performance in

the “Miracle” Economies
• Increased Productivity
• High Growth • Efficiency with which resources were used also
Rates of contributed significantly growth in Asian nations.
Savings and • Sarel (1997), shows that average rate of
productivity growth in the 1980s and early 1970-
Investment 1985
• Rates of • Bosworth and Collins (1996), found a “U-shaped”
saving and pattern of productivity growth in 3 periods: 1960-
investment 1973,1973-1 984, and 1984-1994.
increased • Young (1992,1995), and Kim and Lau (1994) found
dramatically out that although TFP figures in Asia is not as
in many high as industrial countries but their estimates
countries in for TFP remain that high.
Asia.

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 The Policy Matrix and
Economic Performance in
South Asia
• Growth in South Asia was considerably • The educational attainment of the workforce in South
slower than the ”miracle” economies Asia was much lower than the miracle economies such
during the postwar period. The reasons as (Hongkong and Singapore).
were: • Macroeconomic policies in South Asia were generally
• Not generally open to trade and to the inflow of stable—inflation rates were not high and variable and
foreign direct investment. government deficits were not excessive, except in early
• Sachs and Warner (1995), developed an openness 1990sàfiscal crisis.
index none of the South Asian economies were
open during the postwar period apart from Sri • Industrial policies were adopted that gave subsidies to
Lanka and Nepal in 1992. several industries but these policies were generally
unsuccessful in promoting rapid growth, neither in
• Inflexibility of labor markets even though there
were high levels of unemployment. exports nor in achieving economic efficiency.
• Global Competitiveness Index Report 1998 à
ranked high in the quality of its labor force but
lower in terms labor flexibility.

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Convergence of Income
• ABSOLUTE CONVERGENCE
• CONDITIONAL CONVERGENCE
• The hypothesis that poor countries tend to
• various parameters are allowed to change
grow faster per capita than rich countries-– between different countries or groups of countries.
without conditioning on any other • If savings rates, depreciation rates and population
characteristic of the economies. growth rates differ among countries, level of
• Solow model says, income may differ, although Solow theory would
still predict that there would be convergence in
• All economies will converge to the same level of
per capita capital and per capita income growth rate of income.
irrespective of where they started out. This would
be true even with technical progress, since 𝜋
technical progress coefficient is assumed to be
constant across countries.

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