2 11. Capital Formation, Investment Choice, Information Technology & Technical Progress Capital Formation & Technical Progress as Sources of Growth Components of the Residual Learning by Doing Growth as a Process of Increase in Inputs

3 11. Capital & Technology (Cont) The Cost of Technical Knowledge Research, Invention, Development, & Innovation Computers, Electronics, & Information Technology Investment Criteria Differences between Social & Private Benefit- Cost Calculations Shadow Prices

4 Total factor productivity Total factor productivity (TFP) Output per combined factor input. TFP growth is a measure of technical progress. TFP fell almost 1% yearly in the Soviet Union, Productivity growth “is almost everything... in the long run.” (Krugman) U.S., Canada, Japan, & Western Europe real growth in GNP per capita > 1% annually from mid-19 th century to 2000

5 Absorptive capacity absorptive capacity The ability of an economy to profitably utilize additional capital. This ability depends on the availability of complementary factors.

6 Sources of growth DCs & LDCs In West & Japan, econometric studies showed that capital per worker-hour explained less than half of output per worker-hour. In LDCs, capital per worker-hour explained more than half of output per worker-hour. Technical progress relatively important source of growth in DCs and capital accumulation relatively important in LDCs. Hicks: cannot surmise, though, that capital accumulation is of minor importance Many advances in knowledge are embodied in new capital

7 Residual or technical knowledge Denison & Addison: education, training, advances in knowledge, learning by experience, economies of scale, product variety, improved allocation of resources, reduction in age of capital, & decreases in time lag in applying knowledge Balogh & Streeten object to elevating residual, converting ignorance to knowledge

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9 Figure 11-1’s message Reinforces earlier econometric studies indicating capital contributed more than productivity to LDC GDP growth Sub-Saharan Africa & developing Europe and Central Asia (mostly transitional) had negative productivity growth World Bank expects productivity to contribute more than capital to growth in East Asia & Pacific,

10 Learning by doing

11 Learning by doing Technical change is a prolonged process based on experience and problem solving, that is, doing, using and interacting. Learning curve measures how much labor productivity increases with cumulative experience. U.S. Air Force engineers assume constant relative decline in labor per airframe as number produced increases (but not to infinity). Stiglitz – markets for information imperfect, with spillovers and public-goods character.

12 Inputs and technical knowledge Growth as process of increase in inputs: if human capital is an input them most of growth explained by increases in inputs (Schultz, Jorgenson, Griliches) Cost of technical knowledge: cost of search; efficiency of given technology varies from country to country; thus T (technology) in production function is not a constant

13 Research, invention, development & innovation Basic research Applied research Invention: Devising new methods & products. Innovation: Embodiment in commercial practice of a new idea or invention.

14 Research, invention, development & innovation (cont) Organized R&D (only a part of actual research & development) Monopolist appropriates large proportion of gains from R&D Advantages of “relative backwardness” and technological followership

15 Computers, electronics, & information & communications technology (ICT) Solow in 1987: “You can see the computer age everywhere but in the productivity statistics.” True for most major innovations (steam engine, railroad, electricity, computers) – substantial time lag between introduction and widespread diffusion.

16 Can ICT provide LDCs with short cut to prosperity by bypassing phases of development? (Pohjola 2001)

17 ICT & increased productivity David (2001): ICT requires three new directions to benefit productivity. 1/ availability of a growing range of purpose-built and task-specific information technologies (e.g. supermarket scanners and other data logging devices) 2/ networking capabilities and networked environment reconfiguring work organization. 3/ internet technology introduces a new class of organization-wide data processing applications.

18 Contribution of ICT to GDP per- capita growth in the U.S. (not counting increased TFP of non- ICT sectors from ICT-facilitated work reorganization & knowledge spillovers percentage points yearly percentage points yearly percentage points yearly

19 Low-cost ICT improves... Allocative efficiency by minimizing input cost per output Technical efficiency by cutting costs by better access to factor and product markets (mobile phones reduce information costs) Economies of larger-scale production by breaking labor & capital constraints

20 Explosion of cellular phone technology India 56 million cellular phone users by end of 2004 Expected to reach > 130 million by 2008 Continued growth for many years Telecommunications deregulation in 1990s facilitated growth India, China, & other LDCs can leapfrog Western landline telephone technology

21 Sachs’ (2000) division of world  Technological innovators (Schumpeterian entrepreneurs, discussed in Chapter 12) Most of OECD plus Taiwan (15% of world’s population)  Technological adapters (Addison – LDCs’ imitation of DCs and increased education, major contributors to TFP) Mexico, Costa Rica, Argentina, Chile, Tunisia, South Africa, Israel, most of India, Singapore, Malaysia, Indonesia, Thailand, coastal China, Baltic states, Russia (near St. Petersberg), East- Central Europe (50% of world’s population)  Technologically excluded (rest of world)

22 With some exceptions (not all blue are innovators, much of India is adaptive, etc.), blue-colored (high-income) nations are technological innovators, red & green (middle-income) nations are adapters, & yellow (low-income) nations are excluded.

23 Rapid ICT growth Moore’s Law: doubling of computer capacity & halving of computer & software prices every 2 years. Pohjola: if auto technical progress were at the same rate as computer technical progress ( ), price of car today would be $5!

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26 ICT growth in Asia Half OECD ICT imports from non-OECD countries, primarily in Asia, but largely from multinational corporations with headquarters in OECD countries Innovators in Asia Cellular technology in Bangladesh benefits petty traders haggling with middlemen

27 Investment criteria Suppose society has a given amount of resources to invest Should society invest in steel, fertilizer, schools, computers, agricultural extension, or what? Maximizing a project’s labor intensity is not a sound investment criterion

28 Social benefit-cost analysis more comprehensive The net present value (V) of the stream of benefits and costs is calculated as V = B 0 – C 0 + (B 1 – C 1 )/ (1 + r) + (B 2 – C 2 )/(1 + r) (B T – C T )/(1 + r) T

29 where B is social benefits, C is social costs, r is the social discount rate, t is time, and T the life of the investment project.

30 In Table 11-2 (next slide), the present value of the net income stream from $1 million initial investment is higher for the sugar refinery than for the textile factory -

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32 Interest on capital... Reflects discount of future income relative to present income Capital invested now represents potential for higher income in the future $ in future is never worth today’s $

33 What discount rate to use? Current interest rate Or if distorted, choose a discount rate so that present value of net income stream is equal to the value of capital invested (Equation 11-1) With numerous projects, can pool risk Still, risk averse decision makers can place less value on probability distributions with substantial risk or wide dispersion around the mean

34 Differences between social & private benefit-cost calculations

35 Differences between social & private benefit-cost calculations External economies Distributional weights Indivisibilities Monopoly Saving & reinvestment Factor price distortions (corrected by using shadow prices

36 What should Dakha, Bangladesh authorities consider when building an underground railway?

37 What should Dakha, Bangladesh authorities consider when building an underground railway? Can estimate capital outlays as expect outlays to take place Net social benefits should > or = net social costs Benefits include not only total receipts but also externalities

38 External benefits & costs (not included in receipts)... Price people willing to pay for alternative transport (auto, taxi, bus, bicycle, & rickshaw) + time, comfort, & safety benefits – fare payments Environmental benefits (reduced pollution & congestion) & costs (disruption of neighborhoods, pollution & inconvenience of initial construction)

39 Shadow prices  Shadow prices: The adjustment of prices to take account of differences between social cost-benefit and private cost-benefit calculations.  Wouldn’t it be easier for LDC governments to change foreign exchange rates, interest rates, wages, and other prices to equilibrium prices than to use scarce personnel to calculate shadow prices in these markets?