Fall Semester 09-10 Akila Weerapana

Lecture 14: The Role of Technology in Economic Growth

I. INTRODUCTION
In the last lecture we discussed the importance of labor and capital for economic growth. We showed that the growth experience for much of human history represents what we could model with a production function that had labor alone. The end result is an economy in which population growth and output growth come to a halt over time. This outcome can be improved upon by introducing capital to the model. Increases in capital boost the economy in the short run and stimulate a brief period of economic growth. However, those eects die out over time unless capital in increased continually. Even if we were to increase capital continually, we would run into diminishing returns, which in turn would imply that sustained economic growth would NOT be possible on the strength of capital and labor accumulation alone. In todays lecture, we will wrap up our analysis on how best to increase the economys productive capacity, this time by focusing on technology. We will rst dene what economists call technology. Then we discuss the special importance of technology in fostering growth and address policy issues on how to achieve faster technological progress.

II. WHAT IS TECHNOLOGY, AND WHY IS IT IMPORTANT?

Economists dene technology as ideas, or knowledge, that help us produce output from inputs. Having more technology means being able to produce more output with a given amount of inputs. Technology can take many shapes: it can be engineering discoveries like the invention of the airplane or the light-bulb, basic knowledge like calculus, service concepts like the all-in-one shopping of Wal-Mart or the multiplex movie theater or production concepts like assembly line production. Technology is also important because regular inputs are characterized by diminishing returns: the more of an input we use, holding others constant, the less output each additional unit is able to produce. However, since the same idea is available to the entire economy, we do not run into diminishing returns with technology. Technology turns out to have a very important role to play in overcoming the limitations imposed by diminishing returns to labor and capital.At many points in history, prophecies of doom have been announced based on the idea that scarcities in one input or another (land, oil, people) will bring economic growth to a grinding halt. These prophecies have been disproven so far mostly because of technological progress: we have learned to produce more with less of the scarce inputs, thus reducing the dangers posed by the niteness of available resources.

 The best way to think of how important technology is, is to consider a simple example of two countries, Brainland and Brawnland, that have both grown at 5% a year for the last ve years. Brawnland can attribute 4% of its growth to increased inputs and 1% to better use of inputs. Brainland can attribute 4% of its growth to better use of inputs and 1% to increased inputs. Which country is likely to continue to enjoy high growth in the future? Economic analysis suggests that Brainland is more likely to continue to enjoy faster growth. Why? Brawnland is going to run into hurdles because it will nd it dicult to continue to achieve more economic growth by adding inputs. This can occur for a couple of reasons 1. For example, if Brawnland started out with a large pool of underutilized labor resources then it can increase the number of workers for a while: it can bring the unemployed and those not in the labor force back into employment. However, after a while they would have increased the labor force as much as possible and will not be able to get gains that way. 2. Even if the input has no inherent limitations on the quantity (e.g. capital), the productive use of that input may be reduced because of diminishing returns. For example, if one of the factors (labor) is limited, adding more and more capital will soon lose its effectiveness because diminishing returns will set in. Additional units of capital will cease to be as productive because of the absence of other complementary inputs like labor. 3. Given the niteness of resources, the country that is continually coming up with better ways to use those resources is likely to be better o than the country relying exclusively on more inputs being available. In other words, more productive countries are able to sustain rates of growth for longer.

III. THE PRODUCTION OF TECHNOLOGY

In order to understand the special nature of technology, we need to understand the underlying economics. Typically, we classify economic goods along two dimensions: rivalry and excludability. Excludability The degree of excludability of a good is the extent to which the owner can restrict access to the product to those who pay for the privilege of using the product. Non-excludable goods often tend to have spillovers of costs or benets that are not captured by the producer (owner) of the good; these are also known as externalities. If these externalities are positive then the good is under-produced by the market; government intervention to increase production may be necessary (public goods). Alternatively, the externalities may be negative so that the good is over-produced by the market (tragedy of the commons); government intervention to restrict production may be necessary. Rivalry

 A rival good is a good that when used by one person, cannot be used by another person. Several people can simultaneously use a non-rival good; use by one does not preclude its use by another. The basic nature of non-rival goods implies that a lot of time and money must be spent to come up with the product but once it is created the good becomes relatively easy to replicate. A few examples are given in the table below. EXCLUDABLE RIVAL MP3 player Pencil Computer keyboard Fish in the ocean Grazing on Federal land A swing in a public park NON-RIVAL Satellite TV Computer software Movie theater National defense A reworks show Calculus

NON-EXCLUDABLE

New technology can be thought of as new ideas that enable us to produce more output with the same amount of inputs. In the classication outlined above, ideas are non-rival: the use of an idea by one does not preclude the use of an idea by another. The degree of excludability varies: some ideas like calculus are non excludable. Other ideas like satellite TV broadcasts, or the process for making Coca-Cola are mostly excludable. A third category of ideas: software programs, books, etc. are only excludable if the proper legal safeguards are in place. This is the primary dierence between technology and other inputs. While most other inputs are rival in nature, technology is non-rival in nature; many producers can use the same idea to produce more output. Having established the importance of technology, we focus on coming up with policies that can encourage more technological progress. This requires us to understand how technology is produced in the economy. Sometimes a new technology is a completely innocent byproduct of another activity. However, the more likely scenario is that technology is the result of a systematic search to nd new and better ways of doing things. Research by Upjohn chemists to nd hepatitis drugs, research by GM engineers to nd more fuel-ecient electronic engines etc. The excludability of the good becomes important; otherwise the person doing the up front expenditure on developing the product may not be able to extract the benets because competitors enter the cheap reproduction stage. Because some ideas are non-excludable: the owner of the good may not be able to charge people for its use. When we combine the non-excludability with the non-rivalry we see that people may be reluctant to invest the upfront money necessary to create an idea. Without a subsidy or a system of property rights to the idea researchers will not develop the idea because after they incur the xed cost, others can enter the market and charge much lower prices for their goods. As a result, in order to entice researchers to come up with ideas, especially ideas that are not excludable, we need to either

a) Subsidize xed costs (grants from the government) b) Set up property rights (patents, copyrights) The government can also play a role by setting up a good system of secondary and higher education, thus allowing companies to hire scientists and engineers who they can provide resources to generate new ideas. Similarly, companies may concentrate only on doing R&D for products that benet their own industry. Yet there is a lot of basic scientic research that has benets for a wide variety of industries; government funding of research in universities and colleges have helped produce several such ideas like the Internet. So in sum, we can encourage technology to develop at a faster rate by 1. Set up a system of patents and copyrights to encourage research on ideas that are inherently non-excludable. 2. Provide research grants and subsidies to rms that encourage in research that will always be non-excludable (basic scientic research in universities) 3. Better education and training of scientists and engineers.

IV. HOW DO WE MEASURE TECHNOLOGY?

In practice measuring technology is dicult, which in turn makes calculating how much of a countrys growth rates are driven by technology be a challenge. What economists resort to is an exercise where we try to subtract out the contribution of economic growth attributable to more inputs from overall economic growth and call the remainder, growth attributable to more technology. TFP Growth = GDP growth - (Labor Driven Growth + Capital Driven Growth) This type of decomposition of economic growth is known as Growth Accounting; rst described by Robert Solow, a Professor of Economics at MIT, who won a Nobel Prize for his work on economic growth. Growth accounting can provide powerful insights into the future of an economy. Perhaps the most famous application of growth accounting is to understand the background behind the economic crisis that hit East Asia in 1997. A series of papers by Alwyn Young decomposed growth in these East Asian countries using good primary sources of data. Young separated the growth in these countries into growth from capital and labor accumulation, and growth from technology. Young showed that these East Asian countries made remarkable progress in the following areas: labor force participation, educational attainment, and investment in physical capital. However, the growth rate of technology was relatively small for all of these countries. So Young speculated that, despite the stellar record of performance that these countries had displayed over the last 30 years, that they would not be able to continue to grow very fast in the future.

 His ideas were essentially grounded on the idea that long run growth rate was closely related to the growth rate of technology; the idea that technology was the engine of growth. While adding inputs could bring short run improvements in growth rates: it seems unlikely that the improvements could be long-term. Lots of controversy surrounding the analysis in the paper when it rst came out. However, there are many positive lessons to be learned from the East Asian countries. Many countries need to gure out how to accumulate factors like investment and improve educational attainment. However, it is important to realize that once gains on the input accumulation front have been made, then countries should focus attention on improving the level of technological progress in order to sustain economic growth for a long period of time. CRUDE GROWTH ACCOUNTING EXERCISE SELECTED EAST ASIAN COUNTRIES (1966-1990) Hong Kong Singapore South Korea Taiwan GDP Growth 7.30% 8.50% 8.50% 8.60% GDP Per Capita Growth 5.70% 6.60% 6.90% 6.80% GDP Per Worker Growth 4.70% 4.00% 5.70% 5.50% LF Participation 38% 49% 27% 51% 27% 36% 28% 37% Investment/GDP 30% 30% 10% 41% 8% 40% 9% 21% No Schooling 19% 6% 55% 0% 31% 6% 17% 4% Primary School Only 54% 23% 28% 34% 42% 19% 57% 28% Secondary School 27% 71% 16% 66% 27% 75% 26% 68%