Lecture 5. STE’s growth record and technological progress

Lecture outline A first look at growth rates Total factor productivity (TFP) Types of economic growth (extensive vs. intensive growth) Another look at growth rates Reasons for low TFP growth Inequality

Annual per capita GNP growth Countries 1950-60 1970-75 1975-80 1980-85 Socialist countries 4.7 4.0 2.0 USSR 3.9 2.7 1.8 1.1 China 5.6 4.5 4.6 8.0 Market economies 3.7 2.95 2.6 1.3 USA 1.5 1.6 1.4 Socialist countries: Czechoslovakia, E. Germany, USSR, Poland, Hungary, Romania, Bulgaria, China; Market economies: USA, Canada, W. Germany, Denmark, Norway, Belgium, France, Netherlands, Japan, Austria, UK, Italy, Spain, Greece, Turkey, India

Total factor productivity Let 𝑙 ′ = 𝐿 𝑡+1 − 𝐿 𝑡 𝐿 𝑡 = growth rate of labor 𝑘 ′ = 𝐾 𝑡+1 − 𝐾 𝑡 𝐾 𝑡 = growth rate of capital and 𝑦 ′ = 𝑌 𝑡+1 − 𝑌 𝑡 𝑌 𝑡 = growth rate of GDP And let α=𝑤𝐿/𝑌 and 𝛽=𝑟𝐾/𝑌 be income shares of labor and capital in economy (𝑤=𝑤𝑎𝑔𝑒;𝑟=𝑐𝑜𝑠𝑡 𝑜𝑓 𝑐𝑎𝑝𝑖𝑡𝑎𝑙)

Total factor productivity (cont.) [YOU MAY SKIP THIS SLIDE] Assume that labor and capital are the only factors of production, i.e., 𝑌=𝑓(𝐿,𝐾)  𝑦 ′ = 𝑓 𝐿 𝐿 𝑌 𝑙 ′ + 𝑓 𝐾 𝐾 𝑌 𝑘 ′ In a competitive economy with constant returns to scale, 𝑤= 𝑓 𝐿 and 𝑟= 𝑓 𝐾  𝑦 ′ =𝛼 𝑙 ′ +𝛽𝑘′. Even if the economy is not competitive, this equation holds, with 𝛼= 𝑓 𝐿 𝐿 𝑌 , 𝛽= 𝑓 𝐾 𝐾 𝑌 , but we may no longer interpret 𝛼 and 𝛽 as income shares of capital and labor, although it is always true that 𝑦 ′ = 𝑠ℎ𝑎𝑟𝑒 𝑜𝑓 𝑙𝑎𝑏𝑜𝑟 𝑙 ′ + 𝑠ℎ𝑎𝑟𝑒 𝑜𝑓 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑘′ if income shares of labor and capital remain constant.

Total factor productivity (cont.) So, if only quantities of inputs change (and income shares remain constant), then 𝑦 ′ =𝛼 𝑙 ′ +𝛽𝑘′ (GDP growth = growth of combined inputs) If quality of inputs improves over time, 𝑌=𝑓 𝑔(𝑡),𝐾,𝐿 and 𝑦 ′ >𝛼 𝑙 ′ +𝛽𝑘′ TFP growth = 𝒚 ′ −(𝜶 𝒍 ′ +𝜷 𝒌 ′ )

Example Let 𝑌= 𝑒 𝛾𝑡 𝐾 𝛼 𝐿 1−𝛼 . Take logs of both sides (subscript 𝑡 is dropped): ln 𝑌 =𝛾𝑡+𝛼 ln 𝐾 + 1−𝛼 ln⁡(𝐿) Differentiate both sides with respect to 𝑡: 𝑦 ′ =𝛾+𝛼 𝑘 ′ + 1−𝛼 𝑙′ TFP growth = 𝑦 ′ −𝛼 𝑘 ′ − 1−𝛼 𝑙 ′ =𝛾 Issues: Are 𝛼 and other parameters constant over time? What is the shape of the production function 𝑌=𝑓 𝑔(𝑡),𝐾,𝐿 ? What does TFP represent?

Types of growth Assuming that TFP represents innovation: Low TFP growth  extensive growth High TFP growth  intensive growth Limits of extensive growth: Labor and land cannot grow fast  diminishing marginal returns Large amount of capital  high depreciation

Total factor productivity (1950-60) Countries Growth of L (i.e.,𝑙′) Growth of K (i.e., 𝑘′) Combined inputs growth TFP growth Socialist countries 0.8 4.2 1.7 3.5 USSR 1.2 9.4 3.4 2.4 (1.7) Market economies 0.9 4.7 1.8 3.0 USA 1.4 3.6 1.3 Socialist countries: Czechoslovakia, E. Germany, USSR, Poland, Hungary, Romania, Bulgaria, China; Market economies: USA, Canada, W. Germany, Denmark, Norway, Belgium, France, Netherlands, Japan, Austria, UK, Italy, Spain, Greece, Turkey, India

Factor productivity (1960-85) Countries Growth of L (i.e.,𝑙′) Growth of K (i.e., 𝑘′) Combined inputs growth TFP growth Socialist countries 0.8 5.1 2.1 0.9 USSR 1.3 7.3 2.8 Market economies 4.7 1.9 1.8 USA 2.0 3.3 2.4 0.7 Socialist countries: Czechoslovakia, E. Germany, USSR, Poland, Hungary, Romania, Bulgaria, China; Market economies: USA, Canada, W. Germany, Denmark, Norway, Belgium, France, Netherlands, Japan, Austria, UK, Italy, Spain, Greece, Turkey, India

More on GDP and TFP growth USSR (annual growth rates): PC GDP 1980-85: 1.1 TFP 1980-85: -0.5 Household consumption 1970-80: 2.3

China’s growth PC GDP annual growth rates: 1960-65 - 2.5% 1960-65 - 2.5% 1965-70 - 4.0% 1975-80 - 4.6% 1980-85 - 8.0% TFP growth: 1953-78: -0.7 1979-94: 3.8

Reasons for slowdown in the USSR and other E. European economies Increasing complexity of the economy Lower oil revenues of the USSR Increasing burden of military expenditures Second economy growth Calcified bureaucracy (rent-seeking ↑) How was China different? (more decentralized along regional lines, planning was not as tight and comprehensive, leaving room for local initiatives; genuine reforms started in 1979)

Income distribution Measures of income inequality Lorenz curve Gini coefficient Decile ratio

x

Lorenz curve

Gini coefficient The Gini coefficient is the ratio of the area between the diagonal and the Lorenz curve to the area under the diagonal Gini = 0  perfectly equal distribution Gini = 1  most unequal distribution

Decile ratio= 90𝑡ℎ 𝑝𝑒𝑟𝑐𝑒𝑛𝑡𝑖𝑙𝑒 10𝑡ℎ 𝑝𝑒𝑟𝑐𝑒𝑛𝑡𝑖𝑙𝑒

Income inequality in selected countries (late 1980’s, ex. USA) Country Gini Coefficient Decile Ratio Czechoslovakia 20.1 2.44 Poland 26.8 3.31 USSR 28.9 3.53 UK 29.7 3.79 USA (1997) 37.5 5.64

Income distribution in STE’s vs. market economies (theory) Capital ownership - allocation of capital income in STE’s - capital ownership in ME’s Progressive income taxation An alternative measure of welfare: (PC GDP)*(1-Gini coefficient)

Hard to measure factors Informal economy Access to goods in short supply Subsidies (housing, etc.) Unrepresentative nature of surveys in STE’s

Other problems with centrally planned economies Structural distortions: - overdeveloped heavy industry and construction; small service sector; - prevalence of large firms and relatively few medium and small firms; - little competition among enterprises Distorted investment decisions No enterprise closures Excessive vertical integration of enterprises Soft budget constraint Large and growing foreign debt “Wrong” type of entrepreneurship Corruption

Did the STE’s have to reform? Look back at the reasons for the slowdown in growth; they were going to slow down the economy further The system’s legitimacy was based on high growth Lots of other problems Improvement in communications that facilitated comparison with other countries