Economic Growth and Development: Volume 11

This series is aimed at economist and financial economists worldwide and will provide an in-depth look at current global topics. Each volume in the series will focus on specialized topics for greater understanding of the chosen subject and provide a detailed discussion of emerging issues. The target audiences are professional researchers, graduate students, and policy makers. It will offer cutting-edge views on new horizons and deepen the understanding in these emerging topics.

Olivier de La Grandville is visiting professor in the Department of Management Science and Engineering at Stanford University, a position he has held since 1988. A professor of economics at the University of Geneva between l978 and 2007, he has also held visiting positions at the Massachusetts Institute of Technology, Ecole Polytechnique of Lausanne, University of Neuchâtel, University of Western Australia, and more recently at Frankfurt University.

A prominent headline in today's New York Times (January 29, 2011, p. B1) announces that “U.S. Economic Growth Bounces Back to Rate Seen Before Recession.” We know exactly what this means. Nevertheless the phrase irritates me, and I am not sure whether I am defending clarity and precision or merely being pedantic. The accompanying news story says that real GDP “grew at an annual rate of 3.2 percent in the fourth quarter” of 2010. So the recession gap between potential output and actual output narrowed a little. Most of that 3.2 percent increase in real aggregate output has in my (precise? pedantic?) mind little or nothing to do with economic growth. It represents an increase in aggregate demand, easily accommodated within existing capacity. The 3.2 percent might have been 6.2 percent, as in some other cyclical recoveries, and that would clearly have been an implausible “growth” rate. To be more specific, this increase in natural output was not the result of any favorable change in the determinants of long-run growth. Instead, it was the consequence of the Federal Reserve's unprecedented policy of asset purchaser and credit expansion for anti-cyclical reasons, along with some help from the last effects of earlier fiscal stimulus.

Among the good things that economic progress provides us is access to better health and longevity. The average life span in the advanced countries was of the order of 40 years in 1900; it is well over 70 a little more than a century later. It has also grown in less developed countries; as poor a country as Bangladesh has a life expectancy about 65. In fact it has been argued that inequality among countries in life expectancy is less than that in per capita income.

We use a new dataset on nonresource GDP to examine the impact of commodity price volatility on economic growth in a panel of up to 158 countries during the period 1970–2007. Our main finding is that commodity price volatility leads to a significant increase in nonresource GDP growth in democracies, but to no significant increase in autocracies. To explain this result, we show that increased commodity price volatility leads to a statistically significant and quantitatively large increase in net national saving in democracies. In autocracies, on the contrary, net national saving decreased significantly. Our results hold true when using indicators capturing the quality of economic institutions in lieu of indicators of political institutions.

This chapter investigates the determinants of the growth performance of Africa. I start by illustrating a broader research agenda that accounts not only for basic economic and demographic factors but also for the role of history and institutional development. After reporting results from standard growth regressions, I analyze the role of Africa's peculiar history, which has been marked by its colonization experience. Next, I discuss the potential growth impact of state fragility, a concept that reflects multiple facets of the dysfunctions that plague the continent. The last topic I address is the influence, in and out of Africa, of the slave trades. The chapter ends with critical conclusions and suggestions for further research.

This chapter advances a panel vector autoregressive/vector error correction model (PVAR/PVECM) framework for purposes of examining the sources and determinants of cross-country variations in macroeconomic performance using large cross-country data sets. Besides capturing the simultaneity of the potential determinants of cross-country variations in macroeconomic performance and carefully separating short- from long-run dynamics, the PVAR/PVECM framework advanced allows to capture a variety of other features typically present in cross-country macroeconomic data, including model heterogeneity and cross-sectional dependence. We use the PVAR/PVECM framework we advance to reexamine the dynamic interrelation between investment in physical capital and output growth. The empirical findings for an unbalanced panel of 90 countries over the time period from at most 1950 to 2000 suggest for most regions of the world surprisingly strong support for a long-run relationship between output and investment in physical capital that is in line with neoclassical growth theory. At the same time, the notion that there would be even a long-run (let alone short-run) causal relation between investment in physical capital and output (or vice versa) is strongly refuted. However, the size of the feedback from output growth to investment growth is estimated to strongly dominate the size of the feedback from investment growth to output growth.

Vintage capital growth models have been at the heart of growth theory in the 1960s. This research line collapsed in the late 1960s with the so-called embodiment controversy and the technical sophisitication of the vintage models. This chapter analyzes the astonishing revival of this literature in the 1990s. In particular, it outlines three methodological breakthroughs explaining this resurgence: a growth accounting revolution, taking advantage of the availability of new time series; an optimal control revolution, allowing to safely study vintage capital optimal growth models; and a vintage human capital revolution, along with the rise of economic demography, accounting for the vintage structure of human capital similarly to physical capital age structuring. The related literature is surveyed.

Economic development is the outcome of an interaction between creative intelligence and adaptive economizing. Inventors and innovators continually perturb the possibilities for production, consumption, and social organization. Adaptive economizing enables individuals to cope with changing conditions and take advantage of new opportunities. Any seemingly stable situation that emerges is temporary. The process as a whole evolves out-of-equilibrium.

We perform a comprehensive Monte Carlo simulation analysis of a variant of the nonstationary continuous-time stochastic growth model with Cobb–Douglas technology developed in Feicht and Stummer (2010), where for every (short-term, middle-term, long-term) time horizon the corresponding dynamic transitional sample path values were derived explicitly, that is, in closed form.

In particular, we study how much the outcoming (e.g., German empirical data adjusted) economy values are affected by changes of the involved economically meaningful parameters. Furthermore, we obtain realistically low savings rates, as well as a reasonably fast speed of recovery in situations where the abovementioned model economy is suddenly and considerably disturbed by a “crash” (macroeconomic disaster).

The aim of the chapter is twofold: (i) to propose a methodology to compute the growth rate volatility of an economy and (ii) to investigate the relationship between growth volatility and economic development through the lenses of the structural characteristics of an economy. We study a large cross-section of countries in the period 1970–2009, controlling for the stability of the estimates in two subperiods: 1970:1989 (Period I) and 1990:2009 (Period II). Our main findings are (i) the degree of trade openness has a destabilizing effect, while the degree of financial openness has not a significant effect; (ii) the size of the public sector displays a U-shaped relationship with growth volatility, but only in Period II; and (iii) the level of financial development has a negative effect on growth volatility, but only in Period I. Therefore, the dominant policy orientations in the recent decades contained emphasis on potential sources of instability, for example, on the increase in openness and on the reduction of the size of the public sector.

This chapter considers the lag structures of dynamic models in economics, arguing that the standard approach is too simple to capture the complexity of actual lag structures arising, for example, from production and investment decisions. It is argued that recent (1990s) developments in the the theory of functional differential equations provide a means to analyze models with generalized lag structures. The stability and asymptotic stability of two growth models with generalized lag structures are analyzed. The chapter's penultimate section includes a speculative discussion of time-varying parameters.

This chapter proposes a refined and updated measurement of the World's Economic Center of Gravity over the 1950–2008 period, based on historical data provided by Maddison (2010) and on the detailed grid data of the G-Econ (Nordhaus, 2006) database. The economic center of gravity is located in the vicinity of Iceland during the first three decades, and then heads strongly toward the East since 1980. Regarding geographic concentration, world production is less concentrated than population across the Earth's surface, and becomes even less so over time. A new decomposition technique is proposed, which suggests a structural break at the end of the 1970s. Measures of R&D activity, education expenditures and literacy as growth related indicators depict a spatial pattern that is consistent with the Eastern shift of the world economic center of gravity.

Multisector growth (MSG) models have a special aura that is shared with computable general equilibrium (CGE) models. Both of them, with their many sectors (industries and goods), are known as trying to convert Walrasian general equilibrium systems from an abstract economy representation into workable models with industrial structures changing as actually observed. Yet, they are plagued by severe problems. First, they are difficult subjects involving systems of nonlinear equations. Second, their prevalent numerical (algorithmic) methodology offers little in the way of showing a clear overall picture and understanding the plethora of numbers pouring out from model simulations. The great wood is not seen for all the trees. Hence, the main objective is to set out comparative static and dynamic systems for succinctly stating and explicitly solving MSG models. The Walrasian general equilibrium is completely stated by one equation and the multisector dynamics by one differential equation. Benchmark solutions are shown for three Constant Elasticity of Substitution (CES) parameter regimes of a 10-sector general equilibrium model.

In this chapter we review the recent and growing literature on medium-term growth patterns. This strand of research emerged from the realization that for most countries economic development is a highly unstable process; over a course of a few decades, a typical country enjoys periods of rapid growth as well episodes of stagnation and economic decline. This approach highlights the complex nature of growth and implies that studying transitions between periods of fast growth, stagnation, and collapse is essential for understanding the process of long run growth. We document recent efforts to characterize and study such growth transitions. We also update and extend some of our earlier research. Specifically, we use historical data from Maddison to confirm a link between political institutions and propensity to experience large swings in growth. We also study the role of institutions and macroeconomic policies, such as inflation, openness to trade, size of government, and real exchange rate overvaluation, in the context of growth transitions. We find surprisingly complex effects of some policies. For example, trade makes fast growth more likely but also increases the frequency of crises. The size of government reduces the likelihood of fast miracle-like growth while at the same time limiting the risk of stagnation. Moreover, these effects are nonlinear and dependent on the quality of institutions. We conclude by highlighting potentially promising areas for future research.

We employ various local generalizations of the Solow growth model that model parameter heterogeneity using human development at the beginning of the period with adult literacy rates and life expectancy at birth as a proxy. The model takes the form of a semiparametric varying coefficient model along the lines of Hastie and Tibshirani (1992). The empirical results show substantial parameter heterogeneity in the cross-country growth process, a finding that is consistent with the presence of multiple steady-state equilibria and the emergence of convergence clubs.

We introduce a formula for the optimal savings rate in an economy driven by an investment policy reflecting competitive equilibrium. The reasonable numbers generated by the formula should be of help not only to assess our present situation but also to prepare our future. Moreover, this chapter provides two theorems correcting a widely held belief in economic growth theory, namely that a steady state defined by income per person growing at the labor-augmenting rate can be asymptotically reached only if technical progress is labor-augmenting. We finally show that the magnitudes of the optimal savings rates are highly robust to very different, S-shaped evolutions of population and technology. The chapter closes with a daring conjecture.

We examine the two-level nested constant elasticity of substitution production function where both capital and labor are disaggregated in two classes. We propose a normalized system estimation method to retrieve estimates of the inter- and intra-class elasticities of substitution and factor-augmenting technical progress coefficients. The system is estimated for US data for the 1963–2006 period. Our findings reveal that skilled and unskilled labor classes are gross substitutes, capital structures and equipment are gross complements, and aggregate capital and aggregate labor are gross complements with an elasticity of substitution close to 0.5. We discuss the implications of our findings and methodology for the analysis of the causes of the increase in the skill premium and, by implication, inequality in a growing economy.

The famous Uzawa (1961) balanced growth theorem has exercised a tyranny of sorts over macroeconomics for decades. It is the prime reason why researchers use Cobb–Douglas production functions and abstract from considering movements in factor shares. Others have had to recourse to complex explanations for long-run labor augmentation in technical progress. In this chapter, we discuss the issues arising from this problem and propose a way of achieving balanced growth with a short-run production function where the elasticity of factor substitution is less than one, and capital augmenting technology shocks can be permanent. We do so by allowing firms to choose the relative reliance on capital in the production technology and introducing a suitable modification of the production function. We also provide some model simulations in the context of a simple deterministic neoclassical growth model.

This chapter develops a neoclassical growth model of illegal immigration with imperfect substitutability between native and immigrant workers in production. We investigate analytically and/or numerically the effects of illegal immigration on the average capital stock in the host economy as well as on the wage, income, and asset holdings of native workers. Our findings indicate that the effects of an increase in illegal immigration on the average levels of capital, consumption, and income are positive. Moreover, by employing the normalization technique (e.g., Klump & de La Grandville, 2000), we examine the effects of a change in the elasticity of substitution between immigrant workers and natives for any given immigration ratio. These effects are in general ambiguous, because of the presence of two opposing forces: the efficiency and the distribution effects. Finally, we extend the model by separating the domestic workers into skilled and unskilled and study the impact on distribution of income and wealth. We show that illegal immigration may not necessarily make the distribution of wealth more unequal and unskilled labor worse off. This is because the end results depend on the elasticities of substitution between different types of labor. Thus, assuming erroneously that immigrants and natives are perfect substitutes could lead to results that are not only overestimated but also of the wrong sign.

The vintage model of capital accumulation predicts that technical progress depends on the installation of new capital equipment. In this chapter it is found that investment raises labor productivity in the G7 countries and Australia. This finding implies that the decline in investment during the global financial crisis will have a long lasting detrimental effect on labor productivity and hence wages.

I present a model where firms and workers set wages above the market-clearing level. Unemployment is thus generated by their exercise of market power. Because both the labor and product markets are imperfectly competitive, market power in the labor market interacts with market power in the product market. This interaction sheds new light on the effects of policy interventions on unemployment and growth. For example, labor market reforms that reduce labor costs reduce unemployment and boost growth because they expand the scale of the economy and generate more competition in the product market.

In this chapter we present a continuous time model with reversible abatement capital in order to analyze the effects of environmental policies on the value of the firm and investment decisions. We show that the effects depend on what sort of future policy are implemented. We focus on investment effects of changes in corrective taxes to control the use of polluting inputs, and subsidies to promote abatement investment. We show that (1) while taxes have a depressive effect on capital accumulation, subsidies boost investment; (2) the impact of these policies on the value of the firm is ambiguous. This latter result has important empirical implications insofar as investment are based on the average value of the firm rather than the (unobservable) marginal value.

This chapter examines the implications of introducing “robot capital goods” in a one-sector optimal growth model, assuming a high elasticity of substitution between workers and robots. The growth path will either converge to a steady state, or involve endogenous growth without scale effects. In the latter case, the optimal growth rate of output per worker will converge to a positive number that depends on both technological and preference parameter. Moreover, the rate of growth could be increased permanently by subsidizing saving.

The relative size of the State in industrialized economies has increased dramatically during the past century giving rise to legitimate fears that such a trend might end up having an adverse impact on growth. This chapter explores the relationship between the development of government activities and economic growth. It starts by evoking problems related to the measurement of the public sector before reviewing statistical evidence on the long-term growth of the share of the State in the economy. It then provides a number of explanations for this phenomenon including those pertaining to the functioning of the political system itself thereby pointing toward inefficiencies. The next step is to explore the principal avenues along which government interventions can positively or negatively interfere with the growth potential of the economy. It turns out that while public expenditures – especially those responding to market failures – tend to be favorable to growth, most taxes are growth-hindering. The final part of the chapter singles out some pitfalls in the empirical investigation of this relationship. The conjecture is that the nonlinear and possibly endogenous nature of the hypothesized nexus can explain the lack of consensus in empirical studies conducted so far.