Regional Regional EconomicsEconomics

Lecture 2Lecture 2

Sedef AkgüngörSedef Akgüngör

Perspectives on Perspectives on Economic GrowthEconomic Growth

GDP Growth in Turkey GDP Growth in Turkey (1968-2004) (in 1987 (1968-2004) (in 1987

constant prices)constant prices)GSYİH (1987 fiyatları ile)

0

20000

40000

60000

80000

100000

120000

140000

160000

Per Capita GDP Growth in Per Capita GDP Growth in Turkey (in 1987 constant Turkey (in 1987 constant

prices)prices)SAGP'na Göre Kişi Başına GSYİH

0

1.000

2.000

3.000

4.000

5.000

6.000

7.000

8.000

9.000

GDP Per Capita in EU-15 GDP Per Capita in EU-15 and Japanand Japan

Growth in Real GDPGrowth in Real GDP

Per Capita GDP IndexPer Capita GDP Index, 2002, 2002((EUEU25=100)25=100)

Most Developed 10 regions in Europe Least Developed 10 Regions in Europe

1 Inner London (UK) 315 1 Lubelskie (Polond) 32

2 Bruxelles-Capitale (Belgium) 235 2 Podkarpackie (Polond) 33

3 Lüksemburg 213 3 Warmińsko-Mazurskie (Polond) 34

4 Hamburg (Germany) 188 4 Podlaskie (Polond) 35

5 Île de France (France) 176 5 Świętokrzyskie (Polond) 36

6 Wien (Avusturia) 173 6 Észak Magyaroszág () 37

7 Berkshire, Buckinghamshire & Oxfordshire (UK)

162 7 Opolskie (Polonya) 37

8 Provincia Autonoma Bolzano (Italy)

160 8 Eszag-Alföld (Hungary) 38

9 Stockholm (Sweden) 158 9 Východné Slovensko (Slovakia) 39

10 Oberbayern (Germany) 158 10 Letonya 39

TR42 (Kocaeli, Bolu, Sakarya, Yalova, Düzce)

53 TRB2 (Bitlis, Hakkari, Muş, Van) 10

There have been dramatic changes in There have been dramatic changes in standards of material well being in the world.standards of material well being in the world.

During the period of 1000-1700, real income During the period of 1000-1700, real income per capita in W. Europe roughly tripled. per capita in W. Europe roughly tripled.

Between 1700-1750 annual growth rate rose to Between 1700-1750 annual growth rate rose to 0.4%.0.4%.

During the next century, it escalated to 1.2-During the next century, it escalated to 1.2-1.5% per year.1.5% per year.

As these transformations exolved, scholars As these transformations exolved, scholars sought with varying degrees of success to sought with varying degrees of success to understand what happened. What is the cause understand what happened. What is the cause of economic growth.of economic growth.

Classical Views of Classical Views of GrowthGrowth

Serious considerations on economic Serious considerations on economic growth began with the mercantalist growth began with the mercantalist economists. (William Petty, John Locke, economists. (William Petty, John Locke, Jean-Baptiste Colbert).Jean-Baptiste Colbert). Money as a source of national wealth (gold, Money as a source of national wealth (gold,

silver).silver). Export promotion.Export promotion. Adam Smith argued for free trade policies.Adam Smith argued for free trade policies. Pin Factory example. Adam Smith’s Pin Factory example. Adam Smith’s

observations on the impact of labor division on observations on the impact of labor division on labor productivity.labor productivity.

Ricardo and Malthus Wiews Ricardo and Malthus Wiews on Economic Growthon Economic Growth

Ricardo on law of diminishing Ricardo on law of diminishing returns.returns.

Malthus on population increase at a Malthus on population increase at a geometric rate. Increase more geometric rate. Increase more rapidly than land’s capacityrapidly than land’s capacity

Was Malthus Wrong?Was Malthus Wrong?

Complex mixture of increased Complex mixture of increased capital investment, as foreseen by capital investment, as foreseen by Ricaardo and Malthus, and Ricaardo and Malthus, and technological progress they failed to technological progress they failed to anticipate.anticipate.

Hayami and Ruttan contended that Hayami and Ruttan contended that both labor and capital productivity both labor and capital productivity have increased.have increased.

Neoclassical Growth Neoclassical Growth ModelsModels

Economic growth depend on Economic growth depend on increasing the stock of capital to increasing the stock of capital to keep pace with growth and labor keep pace with growth and labor force and technological force and technological improvements.improvements.

The aggregate production fuction lies at The aggregate production fuction lies at the heart of neoclassical growth models.the heart of neoclassical growth models.

In an economy in which there is no In an economy in which there is no technical progress, output is determined technical progress, output is determined entirely by capital and labour inputs. entirely by capital and labour inputs.

This relationship can be expressed in This relationship can be expressed in general form as follows:general form as follows:

Y= Y= F F (K,L)(K,L)

Where Where YY is real output, is real output, KK is the stock is the stock of capital and of capital and LL is the labour force. is the labour force.

A specific form of this general A specific form of this general relationship is provided by the well-relationship is provided by the well-known Cobb-Douglas production known Cobb-Douglas production function. Assuming constant returns to function. Assuming constant returns to scale, we have:scale, we have: 1.. LKAY

Output per worker will increase as each Output per worker will increase as each worker is provided with more capital worker is provided with more capital equipment- but the increase will be at a equipment- but the increase will be at a decreasing rate due to diminishing decreasing rate due to diminishing marginal returns.marginal returns.

What conclusions can be drawn so far?What conclusions can be drawn so far?

1. Output grows without limit as the 1. Output grows without limit as the supplies of capital and labour increasesupplies of capital and labour increase

2. Output per worker can increase only if 2. Output per worker can increase only if there is capital deeping (i.e. if the there is capital deeping (i.e. if the capital/labour ratio increases)capital/labour ratio increases)

3. When the capital/labour ratio reaches its 3. When the capital/labour ratio reaches its long-run equilibrium level, there will be no long-run equilibrium level, there will be no further increase in output per worker. further increase in output per worker.

More realism can be built into the More realism can be built into the neoclassical model by allowing for the neoclassical model by allowing for the effect of technical progress on output effect of technical progress on output growth. growth.

Solow’s contribution to the neoclassical Solow’s contribution to the neoclassical growth model: The most convenient way growth model: The most convenient way of allowing for technical progress is to of allowing for technical progress is to regard technical knowledge as an regard technical knowledge as an additional and separate element in the additional and separate element in the production function.production function.

Capital and labour are assumed to benefit Capital and labour are assumed to benefit equally from any technical progress that equally from any technical progress that may occur as in the following function:may occur as in the following function:

Y= F (A,K,L)Y= F (A,K,L)

Where A is technical knowledge. Where A is technical knowledge. Technical progress is said to be Technical progress is said to be disembodied in this model since it is disembodied in this model since it is independent of capital and labour inputs.independent of capital and labour inputs.

Thus, regional disparities in the Thus, regional disparities in the growth of output per worker are growth of output per worker are explained by regional differences in explained by regional differences in the rate of technical progress and by the rate of technical progress and by regional differences in the growth of regional differences in the growth of the capital/labour ratio.the capital/labour ratio.

REGION’S OUTPUT GROWTHREGION’S OUTPUT GROWTH

The neoclassical model identifies three The neoclassical model identifies three sources of output growth:sources of output growth:

1. The capital stock1. The capital stock

2. The labour force2. The labour force

3. Technology 3. Technology

A region’s output growth will A region’s output growth will therefore depend upon the growth therefore depend upon the growth rate three factors of production. rate three factors of production.

Why are the rates of growth of Why are the rates of growth of capital, labour and technology vary capital, labour and technology vary between regions.between regions.

A potentially important influence on A potentially important influence on regional growth disparities is inter-regional growth disparities is inter-regional factor migration. regional factor migration.

According to the neoclassical model, According to the neoclassical model, capital and labour will move to those capital and labour will move to those regions offering the highest rates of regions offering the highest rates of return. return.

Producers will search for the most Producers will search for the most profitable locations for their plant and profitable locations for their plant and machinery while workers will be machinery while workers will be attracted to those regions in which attracted to those regions in which wages are high. wages are high.

The neoclassical model assumes that The neoclassical model assumes that there are no impediments to factor there are no impediments to factor mobility between regions and that there mobility between regions and that there is perfect knowledge about factor prices is perfect knowledge about factor prices in all regions.in all regions.

Which factors may be expected to Which factors may be expected to influence the growth of capital, influence the growth of capital, labour and technology within any labour and technology within any individual region?individual region?

1. Growth of capital stock:1. Growth of capital stock:

1.1. Investment by region’s residents. 1.1. Investment by region’s residents. Regional saving rate.Regional saving rate.

1.2. Net inflow of capital into region1.2. Net inflow of capital into region

Rate of return relative to rate of return Rate of return relative to rate of return in other regionsin other regions

2. Growth of labour force2. Growth of labour force

2.1. Net in-migration of workers2.1. Net in-migration of workers

Regional wage relative to wage rate in Regional wage relative to wage rate in other regionsother regions

2.2. Population growth2.2. Population growth

Birth rate and death rateBirth rate and death rate

3. Technical progress3. Technical progress

3.1. Inflow of technical knowledge from 3.1. Inflow of technical knowledge from other regionsother regions

3.2. Investment in R&D education3.2. Investment in R&D education

The Solow growth model argues that The Solow growth model argues that the growth in output per capita is driven the growth in output per capita is driven by the rate of technological progress.by the rate of technological progress.

Without technological progress there Without technological progress there

would be no growth in the long run. But would be no growth in the long run. But since the cause of technological since the cause of technological progress are not identified in the Solow progress are not identified in the Solow model, this means that the underlying model, this means that the underlying explanations of growth is not spelt out.explanations of growth is not spelt out.

Endogenous growth theory attempts to Endogenous growth theory attempts to overcome this deficiency in the Solow overcome this deficiency in the Solow model by providing an explanation of model by providing an explanation of the causes of technological progress.the causes of technological progress.

This extension to the neoclassical This extension to the neoclassical model is referred to as endogenous model is referred to as endogenous growth theory since it argues that growth theory since it argues that technological progress is itself technological progress is itself determined by the growth process.determined by the growth process.

Endogenous Growth Model as Endogenous Growth Model as an Extension to Neoclassical an Extension to Neoclassical

Growth ModelGrowth Model

Basically, entrepreneurs are looking Basically, entrepreneurs are looking for ways to make a profit and one for ways to make a profit and one way of doing this is to produce and way of doing this is to produce and sell new ideas. sell new ideas.

Since there is a profit incentive to Since there is a profit incentive to produce new ideas, this means that produce new ideas, this means that economic growth is endogenous. economic growth is endogenous.

The embodiment of technogical progress The embodiment of technogical progress in the newest capital goods is not only in the newest capital goods is not only way in which technology enters the way in which technology enters the production system. production system.

More recent developments of the More recent developments of the neoclassical model recognize the neoclassical model recognize the importance of human capital as a critical importance of human capital as a critical factor in determining the productive factor in determining the productive capacity of the economy.capacity of the economy.

Human capital is important for two reasons:Human capital is important for two reasons:

First, a region’s stock of human capital First, a region’s stock of human capital determines its ability to absorb and use new determines its ability to absorb and use new technology.technology.

As the stock of human capital increases, the As the stock of human capital increases, the economy will be more able to benefit from economy will be more able to benefit from technological developments, thereby technological developments, thereby expanding the economy’s productive expanding the economy’s productive capacity.capacity.

Hence, although technology may be Hence, although technology may be available everywhere, its efficient use available everywhere, its efficient use requires an appropriately skilled workforce.requires an appropriately skilled workforce.

Second, human capital is an important Second, human capital is an important ingredient in determining the ability of a ingredient in determining the ability of a region to generate its own technical region to generate its own technical progress.progress.

The capacity of a region to absorb or create The capacity of a region to absorb or create technical progress is not simply a matter of technical progress is not simply a matter of investing in physical or human capital. A investing in physical or human capital. A region’s capacity to absorb or create region’s capacity to absorb or create technical progress is determined by its technical progress is determined by its institutional environment.institutional environment.

The creation of technical progress is The creation of technical progress is determined by a collective learning process determined by a collective learning process within which many individuals interact and within which many individuals interact and exchange ideas and information, thereby exchange ideas and information, thereby providing a knowledge-rich environment.providing a knowledge-rich environment.

If such an environment exist, knowledge If such an environment exist, knowledge pases quickly from one economic agent to pases quickly from one economic agent to another , giving rise to the rapid creation another , giving rise to the rapid creation of a wide variety of new ideas.of a wide variety of new ideas.

There are therefore economies of scale There are therefore economies of scale to be gained from the geographical to be gained from the geographical concentration of large numbers of highly concentration of large numbers of highly educated people since their proximity to educated people since their proximity to each other results in a more rapid each other results in a more rapid transfer of knowledge and ideas. transfer of knowledge and ideas.

These ideas are then transformed into These ideas are then transformed into new products and new processes, new products and new processes, thereby raising labour productivity. thereby raising labour productivity.

This means that technical progress is not This means that technical progress is not simply an automatic outcome of simply an automatic outcome of investment in R&D, but requires an investment in R&D, but requires an institutional environment which is institutional environment which is conducive to the adoption and assimilation conducive to the adoption and assimilation of new ideas into the production system.of new ideas into the production system.

Regional disparities therefore occur in Regional disparities therefore occur in technical progress because the technical progress because the institutional environment varies between institutional environment varies between regions.regions.

In other words, some regions are In other words, some regions are more capable of using and producing more capable of using and producing technical progress than others.technical progress than others.

The regions which are knowledge-rich The regions which are knowledge-rich and which have relatively large and which have relatively large quantities of human capital will quantities of human capital will specialize in creative activities such as specialize in creative activities such as R&D, scientific research institutions R&D, scientific research institutions and high-level service activitiesand high-level service activities

Such regions will generate new ideas which Such regions will generate new ideas which add to the region’s technical knowledge which add to the region’s technical knowledge which will be transformed into new products and will be transformed into new products and new methods of production. new methods of production.

Conversely, regions that are less well endowed Conversely, regions that are less well endowed with human capital will specialize in routine with human capital will specialize in routine activities which rely on technical know-how activities which rely on technical know-how embodied in the capital equipment available embodied in the capital equipment available globally. Such regions will depend heavily globally. Such regions will depend heavily upon being cost competitive in world markets.upon being cost competitive in world markets.

This modern variant of the neoclassical This modern variant of the neoclassical model therefore explains why regional model therefore explains why regional disparities in economic development can disparities in economic development can and do persist, even in the long run.and do persist, even in the long run.

The primary reason for long-term The primary reason for long-term persistence is that some regions are persistence is that some regions are more able to generate their own more able to generate their own technical change.technical change.

Knowledge-rich regions with an institutional Knowledge-rich regions with an institutional environment conducive to the creation and environment conducive to the creation and transmission of new ideas will have a transmission of new ideas will have a continuning advantage over less well-endowed continuning advantage over less well-endowed regions which depend far more on acquiring regions which depend far more on acquiring technical change through purchasing capital technical change through purchasing capital equipment from other regions. equipment from other regions.

Less well-endowed regions have no alternative Less well-endowed regions have no alternative but to rely on exogenously embodied but to rely on exogenously embodied technology since they are not capable of technology since they are not capable of producing their ownproducing their own

What Determines Labor What Determines Labor Productivity?Productivity?

Output/Labour RatioOutput/Labour Ratio

1.Capital/labour ratio1.Capital/labour ratio 2.Technology embodied in capital 2.Technology embodied in capital

stockstock

Investment in new capitalInvestment in new capital

Regional savingRegional saving

Output/Labour RatioOutput/Labour Ratio

3. Endogenous technical progress: R&D 3. Endogenous technical progress: R&D spendingspending

3.1.Creation and transmission of new ideas3.1.Creation and transmission of new ideas 3.1.1. Social and economic networks in 3.1.1. Social and economic networks in

region: transmission between individualsregion: transmission between individuals 3.1.2. Public and private investment in 3.1.2. Public and private investment in

educationeducation

Output/Labour RatioOutput/Labour Ratio

4.Human capital4.Human capital

Per Capita GDP IndexPer Capita GDP Index, 2002, 2002((EUEU25=100)25=100)

Most Developed 10 regions in Europe Least Developed 10 Regions in Europe

1 Inner London (UK) 315 1 Lubelskie (Polond) 32

2 Bruxelles-Capitale (Belgium) 235 2 Podkarpackie (Polond) 33

3 Lüksemburg 213 3 Warmińsko-Mazurskie (Polond) 34

4 Hamburg (Germany) 188 4 Podlaskie (Polond) 35

5 Île de France (France) 176 5 Świętokrzyskie (Polond) 36

6 Wien (Avusturia) 173 6 Észak Magyaroszág () 37

7 Berkshire, Buckinghamshire & Oxfordshire (UK)

162 7 Opolskie (Polonya) 37

8 Provincia Autonoma Bolzano (Italy)

160 8 Eszag-Alföld (Hungary) 38

9 Stockholm (Sweden) 158 9 Východné Slovensko (Slovakia) 39

10 Oberbayern (Germany) 158 10 Letonya 39

TR42 (Kocaeli, Bolu, Sakarya, Yalova, Düzce)

53 TRB2 (Bitlis, Hakkari, Muş, Van) 10

DiscussionDiscussion

Based on what we have discussed in Based on what we have discussed in the class, relate what you see in the the class, relate what you see in the tables to the theoretical models of tables to the theoretical models of economic growth and development.economic growth and development.

In your point of view, what explains In your point of view, what explains regional disparities?regional disparities?