1. Lecture 5. STE’s growth record and technological progress

2. 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

3. Annual per capita GNP growth
Countries
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

4. 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)

5. 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.

6. 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 ′ )

7. 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?

8. 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

9. 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

10. 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

11. More on GDP and TFP growth
USSR (annual growth rates):
PC GDP : 1.1
TFP :
Household
consumption : 2.3

12. China’s growth PC GDP annual growth rates: 1960-65 - 2.5%% % % %
TFP growth: : -0.7
: 3.8

13. 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)

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

15. x

16. Lorenz curve

17. 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

18. Decile ratio= 90𝑡ℎ 𝑝𝑒𝑟𝑐𝑒𝑛𝑡𝑖𝑙𝑒 10𝑡ℎ 𝑝𝑒𝑟𝑐𝑒𝑛𝑡𝑖𝑙𝑒

19. 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

20. 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)

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

22. 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

23. 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