CHAPTER

41
Tec echnical Change The Models of Technical Change
INTRODUCTION
The Harrod-Domar analysis is based on the assumption of fixed coefficients in production and thus gives rise to the famous knife-edge problem. The neoclassical models also treat technical progress exogenously. Kendrick, Kaldor, and Solow, among others, have been the most consistent critics of this approach who have tried to demonstrate the role of technological changes in the growth of an economy. Before discussing the models of technical change, we shall attempt the basis of these models as enshrined in the controversy over neutral and non-neutral technical change.

NEUTRAL AND NON-NEUTRAL TECHNICAL CHANGE

Technical change or progress consists of discovering new methods of production, developing new products and introducing new techniques. Technical change is synonymous with a change in the production function. When there is technical change, it leads to an increase in the productivity of labour and capital, assuming only two inputes. This is represented diagrammatically by a shift towards the origin and even a change in the slope of the isoquant. This signifies that more output can be produced either with the same inputs or with fewer inputs.

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A technical change is said to be neutral when it is neither capital-saving nor labour-saving. On the contrary, non-neutral technical change is either capital-saving or labour-saving. In the literature on growth economics, the two important definitions pertaining to neutral and nonneutral technical change are by Hicks and Harrod. HICKS NEUTRALITY According to Hicks, a technical change is neutral if the ratio of the marginal product of capital to that of labour remains unchanged at a constant capital-labour ratio. Hicks neutral technical change is explained in Fig. 1 by comparing points on two different production functions. The vertical axis measures output per man q(=Q/L where Q represents output and L labour inputs) and the horizontal axis measures the capital-labour ratio k(=K/L where K and L represent capital and labour inputs in physical units). OM measures the ratio between the marginal product of labour and capital. OP is the production function before the technical change and OP1 is the production function after the technical change. Taking the production function OP, the slope of the tangent MWA measures the marginal product of capital and OW measures the marginal product of labour. To prove that OM measures the ratio between the marginal product of labour and capital, take the triangle OWM. Since the slope of MW slows the marginal product of capital, say u, we can express it as

OW OW or OM = OM u Hence OM measures the ratio between the marginal product of labour (OW) and the marginal product of capital (u). Hicks-neutral technical progress requires that if technical change q shifts the production function upwards from OP to OP1, the ratios of the two marginal products must be the same on any vertical line P1 from the X-axis, like KB, where it passes through the production B functions at points A and B respectively. Again, for Hicks-neutral A technical progress, the condition is that the tangent MB on the higher P W1 production function OP1 must originate from point M to the left O, W like the tangent before the technical change. In Fig. 1 the tangent k MB on the production functions OP and OP1 originates from M. M O K When both the tangents MA and MB on the production functions Capital-Labour OP and OP1 originate from M, only then the ratios between the Ratio marginal products of labour and capital will be equal, i..e., the ratio Fig. 1 between the marginal product of labour and capital after the u=
OW1 OW technical progress, u = u , the ratio between the marginal 1 product of labour and capital before the technical progress. Hence, the ratio between the marginal product of labour and capital is equal at points A and B on the vertical line KB. We may conclude that as a result of Hicks-neutral technical progress, the output per head rises by AB but the capital-labour ratio (k) remains constant at OK. Thus Hicks-neutral technical change which represents a shift in the aggregate production function Q = F(K, L, t) can be expressed as: Q =A(t)F(K, L), where Q, K and L represent total output, and inputs of capital and labour respectively. A(t) is an Per Capita Output

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index of technical progress which measures cumulated effects of shifts overtime and is an increasing function of t. Under Hicks-neutral technical progress, the factor shares remain constant if factor proportions and relative remunerations of labour and capital are constant. In terms of our Fig. 1, it implies that between A and B if the slope of the production function OP1 at B is greater than the slope of the production function OP at A in the same proportion as the output KB is greater than output KA, then the technical progress is Hicks-neutral. This means that when the amount of capital is changed, the marginal product of capital (or the amount of profit per unit of capital) increases in the same proportion as total output. In other words, between A and B the proportion of total output which is paid out in profits and wages remains constant if technical progress is Hicksneutral. It is also the case when the elasticity of substitution between labour and capital is equal to unity. ITS CRITICISMS Hicks-neutrality has been criticised on the following grounds: First it is a rigid type of definition even when a large number of factors of production are involved. Second, the dependence of Hicks-neutrality on demand elasticities, and substitution elasticities makes it a cumbersome tool of analysis. Third, Harrod has criticised Hicks-neutrality because it is quite unrelated to the intrinsic character of the innovation itself such as the elasticity of demand for products and factors. Lastly, the Hicksian neutrality is built within the framework of static economic analysis.

HICKS NON-NEUTRAL TECHNICAL CHANGE

From the above definition of Hicks neutrality, we can also define labour-saving and capitalsaving non-neutral technical changes, which Joan Rohinson terms biased technical progress. LABOUR-SAVING TECHNICAL CHANGE A technical change is labour-saving if it raises the marginal product of capital relative to that of labour, at a constant capital-labour ratio. The given output would now require less labour relatively to capital. Technical change implies that a given output can be produced with fewer inputs of labour and capital than before so that the isoquant after the change (t1) shifts below the R original isoquant (t) in Figure 2. It depicts the case of labour-savA ing technical change where t is the isoquant before the technical progress and t1 after the technical progress. At the point B on the B t isoquant t1 less labour is required relatively to capital for a given t1 capital-labour ratio. This type of technical change is relatively labour-saving. If the amount of labour used is reduced absolutely O Capital and that of capital rises, then the technical change will be absolutely labour-saving and capital-using. Fig. 2 CAPITAL-SAVING TECHNICAL CHANGE A technical change is capital-saving if it raises the marginal product of labour relatively to capital at a constant capital-labour ratio. The given output will now require less capital relatively to labour. This is illustrated in Fig. 3 where at the point B on the isoquant t1 less capital is required Labour

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relatively to labour after the technical change for a given capital-labour ratio. This type of technical change is relatively capital-saving. If the amount of capital used is reduced absolutely and that of labour rises, the technical change is absolutely capitalsaving and labour-using. R The precise manner in which the relative and absolute amounts of labour and capital used will change as the result of the technical A change will depend upon the factor-elasticities of substitution and B product elasticities of demand. t Harrod Neutrality. The alternative definition of neutral technical t1 change is given by Harrod in his Towards a Dynamic Economics. O According to him, technical change is neutral if at a constant rate Capital of profit (or interest) the capital-output ratio also remains constant.1 Fig. 3 If the rate of profit remains constant after technical change but the capital-output ratio rises, then the technical change is labour-saving. On the other hand, if the capital-output ratio falls with technical change at a constant rate of profit, then the technical change is capital-saving. Harrod neutrality is explained with the help of Fig. 4 where capital per man (k) is measured along the X-axis and output per man (q) along the Y-axis. q OP is the production function before the technical change and OP1 is the production function after the technical R change. The capital-output ratio at point A on the production function OP is OK1/OY1 and at point B on the B G1 Y2 production function OP1 is OK2/OY2. Since the ray OR T1 P1 A G Y1 passes through both the points A and B, the capital-output T P ratios at these points are equal, i.e., OK1/OY1 = OK2/ OY2. Harrod-neutrality also requires that the rate of profit must remain constant along with a constant capital-output ratio k O K1 K2 after technical change. This means that the marginal productivity of capital (or rate of profit) must be the same Fig. 4 at points A and B on the production functions OP and OP1 respectively. This, in turn, requires that the slope of the production function OP at point A must equal the slope of the production function OP1 at point B. In other words, it means that the tangents at A and B must be parallel to each other. In the figure, the tangent TG at point A is parallel to the tangent T1G1 at B. Thus Harrod-neutral technical change, as shown by the shifting of the production function OP upwards to OP1, depicts the equality of the capital-output ratio at A and B as represented by the ray OR passing through them, and also the equality of the slopes of the tangents at A and B, thereby showing a constant rate of profit. Its Implications. There are certain implications of the Harrod neutrality. 1. Harrods definition of neutral technical change is superior to that of Hicks because it is applicable to a dynamic situation rather than to a static situation. As such, it forms an important part of the theory of economic growth because it uses the concept of the capital-output ratio which is indispensable in modern growth analysis. Assuming constant returns to scale, changes in the capital-output ratios can come about only through technical changes. 2. In Harrod-neutral technical change there is no direct reference to labour because it is
1. Harrod uses constant rate of interest while other economists have interpreted his definition in terms of constant rate of profit.

Labour

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entirely based on the relationship between capital and output. Still, capital-labour ratio and output-labour ratio may change without technical change. But with a constant capital-output ratio, Harrod-neutral technical change will not by itself change the capital-labour ratio. However, a Harrod-neutral innovation may raise the productivity of all types of labour engaged in making and operating machines in exactly the same proportion as the output from these machines. In other words, it means that under Harrod neutrality the rise in the output per machine would be in the same proportion as the rise in the output per man. 3. Another implication of the Harrod neutrality is with regard to the distribution of factor shares in national output. Under Harrod-neutral technical change the shares of capital and labour in national output are constant if the capital-output ratio and the rate of profit are constant at A and B in Fig. 4. We may also say that when labour and capital are producing a product and there is Harrod-neutral technical change, it would raise the wages and profits of both, proportionately to the increase in output. In this context, the assumption of a constant capitaloutput ratio implies that the capital stock and the labour force grow at the same rate. It is then that the incomes of the capitalists would grow at the same speed at which the wages of the workers rise. If a technical change is capital-saving in Harrods sense, this will raise the share of labour in national output and reduce that of capitalists, given a constant rate of interest. On the other hand, a labour-saving technical change will reduce the share of labour in national output and increase that of capitalists, with a constant rate of interest. OTHER VIEWS Harrod neutrality can be shown also in the form of a production function as Q = F[K, A(t)L] Here Q is a function F of K and A(t)L which means that the given constant returns to scale on equal proportionate rise in capital (K) and in effective labour units [A( t) L] must lead to an equal proportionate rise in national output (Q). With the rate of interest being constant, the efficiency of labour increases in the whole economy. With population growth, there is an increase in the number of men at work; Harrod-neutral technical progress increases the amount of work each man can do. The result is that, both with population growth and with Harrodneutral technical progress, the GNP rises at a given rate. The difference is that, with Harrodneutral technical progress, income per head (real wage per head) increases; with population growth it remains the same. As Joan Robinson and Uzawa have shown, on the strict definition, Harrod-neutral technical progress raises income at the same rate whatever the (constant) level of the capital-output ratio. It is this rate which measures technical progress. This formulation of Harrod neutrality has been described as pure labour augmenting technical progress. Solow2 has, however, shown that Harrod neutrality can be purely capital augmenting technical progress with the production function. Q= F[A (t)K, L] Here A(t), the index of technical progress, has been prefixed to K instead of to L, unlike as in the labour augmentation case. Economists have shown on the basis of Joan Robinsons3 analysis that technical progress is both Hicks-neutral and Harrod-neutral if the elasticity of substitution between labour and capital is unity and there is no change in the distribution of income. There is neutral technical change in Hicks sense if with given labour force capital remains unchanged and the distribution of income
2. R.M. Solow, Capital Theory and the Rate of Interest, 1963. 3. J. Robinson, The Classification of Inventions, Review of Economic Studies, February 1938.

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is the same. It is Harrod neutral if with given labour force, capital increases in the same proportion as national output and the distribution of income is the same. We examine briefly the extent to which these concepts of neutrality have been used by economists in building models of technical change with particular reference to Solows contribution.

DISEMBODIED AND EMBODIED TECHNICAL CHANGE

Technical change may be disembodied or embodied DISEMBODIED TECHNICAL CHANGE MODEL In 1956 Abramovitz wrote the first paper followed by Kendrick and Solow in an attempt to measure the contribution of technical change to economic growth4. They treated technical change as disembodied. Disembodied technical change is purely organisational which permits more output to be produced from unchanged inputs, without any new investment. Disembodied technical change refers to any kind of shift in the production function that leaves the balance between capital ailed labour undisturbed in the long run. The production function for such technical change is Q = F(K, L; t) . . . (1) where Q represents output, and K and L represent capital and labour inputs, and t represents technical change. Taking Hicks-neutral technical change as the basis, Solow postulated the production function in the special form as Q=A(t)F(K, L) ... (2) where A (t) is an index of technical progress which indicates about a steady continuous upward shift in the production function. Such a production function implies that technical progress is organisational in the sense that its effect on productivity does not require any change in the quantity of the inputs. Existing inputs are improved or used more effectively. They just shift the production function up through time. Now differentiate equation (2) totally with respect to time t and divide by Q, & & & & Q A F K F L = +A . +A . K Q L Q Q A where dots indicate time derivates. Solow uses his equation to bring about the relative share of different factor inputs. Productivity of capital can be shown by writing equation (3) in elasticity form, & & & Q A F K K = +A . . Q A K Q K or
& & F K Q A . = + A K Q Q A

& K K

or

& & & Q A K = +a Q A K

...(4)

4. M. Abramovitz, Resources and Output Trends in the United States since 1870, A.E.R., May 1956; J.W. Kendrick, Productivity Trends: Capital and Labour, R.E.S., August 1956; R.M. Solow, Technical Change and the Aggregate Production Function, R.E.S., August 1957.

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Similarly, the rate of output growth per labour can be shown by writing equation (3) in elasticity form. & & & Q A F L L = +A . . Q A L Q L or
& & Q A F L = + A . Q A L Q

& L L

or

& & & Q A L = +b Q A L

...(5)

Now a and b are the production elasticities of capital and labour respectively. Assuming linear homogeneous production function, then a+b=1 or b = (1 a) From equations (4) and (5), we have the Solow fundamental equation of the model. & & & & Q A K L = + a + (1 b) ...(6) K L Q A In disembodied technical progress, capital is assumed as homogeneous and technical progress flows down from the outside (economy). Productivity depends upon the amount of capital stock and not on its age. Disembodied technical progress improves the productivity of all factors of production or those of a particular kind already existing. All disembodied technical progress is capital-augmenting in which existing capital is, by one means or another, made more productive. To explain disembodied technical progress diagrammatically, assume a per capita (per worker) production function that shifts up through time. Dividing the production function (2) through by L, we have

Q K = A(t ) f L L In Figure 5, the per capita production function A(t)0 f(K/L) shifts up through time at the rate to A (t)1(f(K/ L) and A(t)2 f(K/L) with disembodied technical progress in capital and labour, when output per head increases A(t)2 f(K/L) with a given percentage increase in the capital/labour A(t)1 f(K/L) ratio. It shows that technical progress is capitalA(t)0 f(K/L) augmenting. Relying on the United States time series where capital and output grew at approximately the same rate, Solow proceeded to focus on the rate of technical change. By using data on the share of capital and labour and the O Capital-Labour Ratio rates of growth of capital per head and output per head, the contribution of the residual is obtained after Fig. 5 calculating the contribution of capital. This residual is attributed to technical progress. Solow came to the conclusion that during 1909-49 the average growth rate of output per head in the United States could be attributed 12.5 per cent to the increase in capital per worker and the residual 87.5 per cent to technical change.
Output-Labour Ratio

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Its Criticisms. Disembodied technical change has been criticised on the following grounds: 1. These conclusions tended to undermine the role of investment in contrast to technical change in the growth process. In the words of Phelps, The results of this approach produced a wave of investment pessimism. Whereas, according to Rosenberg, They provoked a wide response on the part of economists wakened, as it were, from their dogmatic slumber, They became sceptical about such a large size of the residual. As Abramovitz admitted, It is a measure of our ignorance. Griliches observed that the residual approach is not of much use in understanding the growth process because it is based on the concept of a production function which is not very useful if it is not a stable production function and if there are very large unexplained shifts in it. 2. Critics further pointed out that the residual approach tended to ignore other influences like improvements in the quality of labour due to education, etc. 3. This approach is based on the unrealistic assumptions of perfect competition, constant returns to scale and complete homogeneity of the capital stock. Therefore, Denison, Kendrick, Griliches and others tried to quantify and break down the residual into further components. They contended that the residual was not a catch-all and that changes in output were due to changes in the quantities and qualities of inputs, in economies of scale and advances in knowledge rather than the result of technical change, assuming a stable production function. EMBODIED TECHNICAL CHANGE MODEL-VINTAGE APPROACH In an alternative model entitled Investment and Technical Progress (1960), Solow himself modified the residual approach based on disembodied technical change in which capital stock is regarded as homogeneous and technical change floats down from the outside. Embodied technical progress improves the productivity of only new machines built in any period as compared with machines built in the previous period. But it does not increase the productivity of machines already in existence. Thus new machines are more productive than old machines. Capital stock consists of machines of different vintages, i.e., built at different dates. Assumptions. This model assumes that: (a) capital stock consists of machines of different vintages i.e., built at different dates; (b) new machines are more productive than machines of older vintage; (c) technical change proceeds at some given proportional rate; (d) technical change affects only new machines; (e) all technical progress is uniform; (f) machines embody all the latest knowledge at the time of construction but do not share in any subsequent improvements in technology; (g) only gross investment in new machines is considered in the model; (h) and the production function is linear homogeneous of the Cobb-Douglas type. The Model. Given these assumptions, under capital-embodied technical progress, capital stock is not treated as homogeneous. In other words, technical progress is embodied in new machines which cannot be applied to existing machines. Machines embody the latest technology on their date of construction. Therefore, machines built at different dates are qualitatively dissimilar and a separate production function is needed for machines built in each vintage. Total output is the sum of output of all machines of different vintages in use. The production function is linear homogeneous. It consists of two time variables: (1) the variable t for time in usual sense; and (2) the variable v for dates of machines in use at time t. Such a capital-embodied production function is Qt = F (Jt, Lt) where J denotes technologically advanced machines, also known as capital jelly. The variable J is the aggregate stock of capital with each machine weighted by a technical progress factor. Machines of smaller vintages (small vs) receive a smaller weight than new machines (with large Vs). Thus J can be written as

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v

Jt =

Cvt (1 + c)
v=0

where Cvt denotes the number of machines of vintages v still in operation in time t v. The oldest machine in time t has v = 0. The technical growth factor is c which represents a constant growth rate per year. (1 + c)v represents the adjustment of technical progress that converts each machine of vintage Cvt into equivalent units of technologically advanced machine, J. Now the growth rate of output is determined by the growth rates of inputs, J and L, & & & Q = JJ + LL

& & & where Q = (dQ/dt)/Q, J = (dJ/dt)J, and L = (dL/dt)L. J and L are the elasticities of output with respect to J and L inputs respectively. Its Appraisal. Unlike the model of disembodied technical change in which the capital stock is assumed to be completely homogeneous, in the model of embodied technical change new machines are better than old machines and technological progress is embodied in the new machines. In the former approach, capital-labour ratios change at all times along the CobbDouglas production function. But in the latter approach, once a machine is constructed it has fixed labour requirements. In other words, each machine is designed to be worked with a given crew of men and the size of the crew cannot thereafter be changed. In the terminology of Johansen, this model is said to have ex ante substitutability between labour and capital and ex post fixed coefficients or no ex post substitutability. Or, in the words of Phelps, it is a putty clay model-putty ex ante and clay ex post. On the other hand, the model of disembodied technical change is one of ex ante and ex post substitutability or a putty-putty model. Its Limitations. There are certain limitations of the embodied approach to technical change. 1. It fails to consider the influence of wage expectations on machine construction. Infact, an investor forms expectations of wage rates extending into the future before constructing a machine. In that case the real wage rate will not equal the marginal productivity of labour on the machine of a given vintage and type, but it will equal the average output per man on the least efficient machine in use. 2. The model is based on assumption of perfect competition and hence it fails to consider factor market imperfections. 3. The model assumes that machines depreciate exponentially. But, as pointed out by Stiglitz, this may be a reasonable assumption for telephone poles but not for most machines. 4. The entire model is based on the hypothesis that machines are of different types and new machines are better than old machines. But it does not treat capital-in-general which has come to be known as the aggregation of capital stock. 5. Another assumption on which this model is based relates to fixed labour requirements. This is unrealistic for an economy with a higher output per man which may have a lower capital-labour ratio. 6. This model concentrates only on technological progress as embodied in new machines and ignores the problems of inducing innovations through the process of learning and investment in research. Conclusion. Despite these weaknesses, unlike disembodied technical progress in which the capital stock is assumed to be completely homogeneous, in embodied technical progress new machines are better than old machines and technological progress is embodied in the new machines. In the former approach, capital-labour ratios change at all times along the production function. But in the latter approach, once a machine is constructed it has fixed labour requirements.