INTERNATIONAL ECONOMIC

ENVIRONMENT

ECONOMIC GROWTH II
(ALONSO (2019): LECCIONES SOBRE ECONOMÍA MUNDIAL, CHAPTER 4)

Jorge Pena
CUNEF
Curso 2019/2020
Jorge.penaizquierdo@cunef.edu
Outline

1 Endogenous growth
2 Growth and structural change
3 Innovation and growth
4 Human capital
5 Economic convergence
1 Endogenous growth

• In the Solow model, growth of per capita income depends on

the capital-labor ratio and the rate of technical progress. But,
what generates technological progress?
• A new approach is to explain growth from endogenous
factors.
• To put it briefly, these theories set out to find a factor that:
1. is generated by the growth process itself;
2. be able to boost economic dynamics; and
3. is not subject to diminishing marginal returns.
• Knowledge is identified as the sought factor, whether it is
materialized in goods and productive processes (innovation),
or in people (human capital).
2 Structural change and growth

a) SUPPLY SIDE
• Based on the composition of the product (GDP) of an economy is the
sum of the productions of the three basic sectors: agriculture,
industry and services.
• Empirical evidence reveals that there are statistical regularities that
relate the levels of development with the composition of the product.
• In particular, it is observed that the participation of the agricultural
sector decreases continuously as the level of income per capita of the
countries increases.
• On the other hand, industrial participation shows an inverted U-
shape, with higher values in intermediate-level countries.
• Finally, it is the services sector that is most clearly favored by the
growth of income.
• All this reveals the path that an economy follows in its growth
process, which first goes through a phase of industrialization - as it
reaches the first stages of development -, and then outsourcing later
- upon reaching the stage of maturity.
2 Structural change and growth

a) SUPPLY SIDE
• Once these basic guidelines have been identified, one can ask about
their explanatory causes.
• In a closed economy, the demand of a certain sector depends on its
relative prices (with respect to the rest of the sectors), national
income (which determines the purchasing power of consumers) and
the corresponding price and income elasticities.
• Thus, it is expected that a fall in the relative prices of the sector i will
cause an increase in its sales and, therefore, in its weight in the total
production, the opposite being the case in the alternative sector j. In
turn, the evolution of prices will be negatively related to relative
productivity gains: the higher these are, the lower the relative prices
will be and, therefore, the greater the demand and the weight of this
sector in total production.
• The composition of the demand changes with the level of income: at
low levels of income consumers have a greater preference for
essential goods (mainly related to food), while, as such income
grows and immediate needs are met, its demand is directed to
industrial goods and services.
2 Structural change and growth

b) DEMAND SIDE
• GDP is also the sum of private consumption, investment, public
consumption and foreign sales and purchases (the latter with a
negative sign),
• There is a relationship between the level of development and the
constituents of the demand.
• As the level of income increases, there is a reduction in private
consumption.
• It could be said that the poorer the country in question, the greater
the proportion of the income that is dedicated to basic consumption
to meet vital needs, leaving less room for investment or public
spending.
• In return, a higher level of development leads to an increase in
public consumption, reflecting the increasing importance of collective
actions in the economy as the level of income increases:
development of the welfare state or greater relevance of public
goods, among others.
2 Structural change and growth

b) DEMAND SIDE
• In terms of foreign trade, it should be noted that in the lower income
countries there is a significant gap between the weights of exports
and imports, tending to equalize both as the level of development
increases.
• As with the changes in the productive offer, the structural change in
demand finds one of its main determinants in the composition of
social preferences. This is the case in the growth of public
consumption, whose income elasticity seems to be superior to unity,
since a higher level of development is usually accompanied by a
greater presence of the State in the economy.
2 Structural change and growth

c) STRUCTURAL CHANGE AS A DETERMINANT OF GROWTH

• the increase in the weight of the industrial and service sectors, in
addition to being an effect of growth, has been a promoting factor,
since productivity in these sectors exceeds that corresponding to the
primary sector.
• On the contrary, once a high level of development is reached, the
effect of structural change on total growth is much lower, given that
it is the service sector that gains prominence and in this sector
productivity gains are normally lower than in the industry.
• Structural change can also influence growth from a demand
perspective, if the structural change implies an increase in the
savings rate as the income level increases, the development itself
will enter into a virtuous circle, because as income increases, savings
and investment will increase, which, to in turn, it will promote an
increase in income.
2 Structural change and growth

c) STRUCTURAL CHANGE AS A DETERMINANT OF GROWTH

• In the other hand, the specialization that leads to international trade
promotes higher levels of income per capita, since resources are
shifted to those sectors where their relative efficiency is higher. This
effect is exhausted in time, once the new specialization is reached.
However, if, in addition, it is considered that international trade
constitutes a path for international diffusion of technology, then
openness to international exchanges can be a sustained source of
growth.
3 Innovation and growth

• Innovation is a multidimensional process that can affect products or

production processes.
• Product innovation involves the development of a new good or
variety, which broadens the range of available goods and improves
the quality of existing ones;
• Depending on the type of activity involved in the technological
improvement process, in turn, a distinction is made between
research, development and innovation (R + D + i).
• Research involves the generation of new knowledge. The
development uses existing knowledge to produce new materials,
devices, products, services, process design, production systems or
improvements. Finally, innovation refers to obtaining in the
production of results, methods, organization or external relations
substantially different from those that already exist.
3 Innovation and growth

• The theory of endogenous growth opened the possibility, however, to

consider monopolistic competition markets, where the innovator obtains a
reward for his effort through the monopoly position obtained by the company
that applies that innovation. As the technological effort improves productivity
and drives growth, this improvement in income allows encouraging new
technological progress, creating the basis for a circular relationship between
growth and innovation.
• The emphasis on technology as the main engine of growth and productivity
has motivated countries to try to implement policies to support R & D & I.
• Empirical evidence reveals that not all countries are in the same conditions to
generate and benefit from new technologies. Poor countries are affected not
only by their reduced capacities to generate their own technology
(innovating), but also to absorb the technology developed by others. For this
last process to take place, it is necessary that the countries have trained
human resources, a productive apparatus in accordance with the technical
needs of the new goods, a domestic investigation to undertake the processes
of adaptation and development of the new technology, thus as of institutions
and policies that favor macroeconomic stability and the business investment
climate.
4 Human capital

• Human capital, in a broad sense, can be defined as the sum of the innate
abilities that an individual has and the qualifications and knowledge that he
acquires throughout his life, through a process in which multiple factors
intervene: education Formal, intergenerational transmission of knowledge,
work experience and personal contacts.
• Modern growth theories consider human capital as complementary to
technical progress and a clear generator of positive externalities. For this
reason, it is a fundamental productive factor of present and future growth,
which can allow increasingly aging societies to maintain their standard of
living, despite having a scarcer active population.
• The theory considers a certain threshold of human capital necessary not only
to generate its own technology, but also to absorb and implement the
imported technology. In addition, education trains citizens, making them
more responsible and aware of their role as social actors, while modulating
the behavior of individuals and enriching societies. By its particular nature,
human capital is attributed partial characteristics of public good, in whose
promotion the State has an unquestionable role.
4 Human capital

• This type of measurement leads to new and

interesting conclusions about the effect of human
capital on economic conditions, among which the
following can be highlighted:
a. schooling is a necessary but not sufficient condition to improve
the economic conditions of a country;
b. global differences between developed and developing countries
are expressed more in quality than in the amount of human
capital;
c. the impact of educational quality on growth is more evident and
stronger than that due to quantity;
d. this impact, especially in the context of developing countries, is
reinforced by the "quality" of the institutional framework, and
among its various dimensions, with the degree of openness and
security of property rights.
5 Economic convergence

• The analysis of the relationship between the per capita

product of the developing regions with respect to that of the
leading region allows us to discard that, at least with a
general character, there has been, throughout the century,
any tendency towards convergence.
• For convergence to exist, it is a necessary (although not
sufficient) condition that countries that depart from a lower
level of development maintain higher GDP growth rates than
those of the richest countries.
• there has been significant convergence within: Western
Europe, New Western Countries and Japan. Thus, when the
sample refers to the richest countries, there seems to be
evidence of a perceptible process of economic convergence.
Something that, however, is not possible to generalize to all
countries.
5 Economic convergence

• This result is consistent with Solow's theory, which suggests

that economies should converge to their level of growth in
equilibrium (or steady state). This steady state depends, on
certain parameters of the economy, such as the savings rate,
population growth and technical progress rate.
• It is expected, therefore, that convergence is registered
between economies that have, at least in these three areas,
similar parameters; but not necessarily among the rest.
• This assumption coincides with the fact that convergence
occurs between economies, such as those mentioned, which
have more homogeneous parameters; and that, however, it is
not observed when the sample is enlarged, welcoming a more
heterogeneous group of countries.