The Copernican Revolution in the Study of Economic Growth
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Transcript of The Copernican Revolution in the Study of Economic Growth
The Copernican Revolution in the Study of Economic Growth
John Ross (Chongyang Institute for Financial Studies, Renmin University of China)G20 China Kickoff Meeting -14 December 2015)
Present policy in many countries is based on boosting TFP growth – why this won’t work
A ‘Copernican revolution’- measurement and observation typically play a revolutionary role in science
• Science states that if the facts and a theory do not coincide it is the theory that has to be abandoned not the facts
• When Galileo turned the newly invented telescope on Jupiter and saw its moons the earth centred theories of the universe collapsed
• Darwin’s observations in the Galapagos Islands and Latin America led to the theory of evolution: "such facts undermine the stability of Species“, "one species does change into another"
From the 1950s-1990s there was a contradiction between the theory of economic growth and the facts of
economic growth
• A theory of economic growth said that growth was primarily due to Total Factor Productivity (TFP) – Solow (1957)
• The facts of rapidly growing economies, above all in Asia, showed rapidly growing economies were dominated by factor accumulation of capital and labour – Young (1995)
• The prediction was therefore that the Asian economies would drastically slow down – Krugman (1994)
• The facts were that they didn’t!
• Science demands that where facts and theory don’t coincide the theory has to change not the facts
Solow’s quantitative errors in the original growth accounting framework
• The well known problem TFP is calculated as a residual – a ‘measure of our ignorance’- Abramovitz (1956)
• An omission from the growth accounting framework
• Did not include intermediate products
• Errors with the growth accounting framework
• Did not control for changes in quality of labour
• Did not control for changes in the quality of capital inputs
• Therefore an erroneous conclusion – TFP was the main source of economic growth
The steps to the official revolution in the measurement of the driving forces of economic growth
Study of the causes of economic growth over the long term
The work of Maddison
• Already by the 1970s Maddison had demonstrated via study of long term economic growth that fixed investment was the decisive ‘factor of production’ in economic development and he extended this in later studies.
• Maddison’s analysis of why the US attained first place among economies. ‘The rate of US domestic investment was nearly twice the US level for the sixty year period 1890-1950. Its level of capital stock per person employed was twice as high as that of the UK in 1890, and its overwhelming advantage in this respect over all other countries continued until the early 1980s. ‘ (Maddison 1991)
Conclusion of the study of long term trends in economic growth
The historical rise in the proportion of investment in GDP – England/UK
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
1680 1720 1760 1800 1840 1880 1920 1960 2000
Gross Domestic Fixed Capital Formation% of GDP
UK
The historical rise in the proportion of investment in GDP – United States
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
1680 1720 1760 1800 1840 1880 1920 1960 2000
Gross Domestic Fixed Capital Formation% of GDP
UK
US
The historical rise in the proportion of investment in GDP – West Germany
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
1680 1720 1760 1800 1840 1880 1920 1960 2000
Gross Domestic Fixed Capital Formation% of GDP
UK
US
Germany
The historical rise in the proportion of investment in GDP - Japan
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
1680 1720 1760 1800 1840 1880 1920 1960 2000
Gross Domestic Fixed Capital Formation% of GDP
UK
US
Germany
Japan
The historical rise in the proportion of investment in GDP – the ‘Asian Tiger Economies’
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
1680 1720 1760 1800 1840 1880 1920 1960 2000
Gross Domestic Fixed Capital Formation% of GDP
UK
US
Germany
Japan
South Korea
The historical rise in the proportion of investment in GDP - China
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
1680 1720 1760 1800 1840 1880 1920 1960 2000
Gross Domestic Fixed Capital Formation% of GDP
UK
US
Germany
Japan
South Korea
China
The historical rise in the proportion of investment in GDP - India
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
1680 1720 1760 1800 1840 1880 1920 1960 2000
Gross Domestic Fixed Capital Formation% of GDP
UK
US
Germany
Japan
South Korea
China
India
The historical rise in the proportion of investment in GDP - Vietnam
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
1680 1720 1760 1800 1840 1880 1920 1960 2000
Gross Domestic Fixed Capital Formation% of GDP
UK
US
Germany
Japan
South Korea
China
India
Vietnam
Why Asia grew so fast - world distribution of rates of fixed investment
Source: World Bank
Development of statistical methods for study of economic growth over the short term
The work of Jorgenson and the official change in the US/UN/OECD methods of calculation of factors in
economic growth
On basis of work of Jorgenson at Harvard University and collaborators
• 1979 Panel to Review Productivity Statistics of the National Research Council, chaired by Albert Rees.
• 1983 US Bureau of Labor Statistics (BLS) adopts constant quality index of capital input
• 1994 BLS adopts constant quality index of labour input as well
• 2001 OECD adopts written Measuring Productivity
• 2007 UN incorporates price and quantity of capital services into the revision of the System of National Accounts (SNA)
• 2009 OECD manual Measuring Capital.
Therefore official transformation in the official method of calculation of national accounts
The factual results of the ‘Copernican Revolution’
• Solow’s ‘finding’ that TFP was the main factor in economic growth was simply based on wrong methods of measurement
• The order of importance of factors of production, proceeding from the most important to the least important is
(i) Intermediate products
(ii) Capital investment
(iii) Labour inputs
(iv) TFP
Intermediate products
Intermediate products - Jorgenson’s findings on the US
US – Sources of Output GrowthGDP
Growth TFP Labour Capital
Intermediate
inputs
Average annual change
1977-2000
(median) 2.7%
1985-19952.4% 0.3% 1.0% 1.2%
1996-20004.3% 0.9% 1.3% 2.1%
2000-20062.8% 1.0% 0.3% 1.4%
Source: Calculated from (Jorgenson and Vu, 2007) Table 2 and (Jorgenson, Mun
and Stiroh 2005) Table 4.8
Intermediate products - the conclusion for Asian economies
• For South Korea, Hak K. Pyo, Keun-Hee Rhee and BongchanHa found regarding material intermediate inputs: ‘The relative magnitude of contribution to output growth is in the order of: material, capital, labour, TFP then energy.’
• For Taiwan Province of China, analysing 26 sectors in 1981-99, Chi-Yuan Liang found regarding intermediate material inputs: ‘Material input is the biggest contributor to output growth in all sectors during 1981-99, except… seven’.
• For mainland China, Ren and Sun found that in the period 1981-2000, subdivided into 1984-88, 1988-94 and 1994-2000: ‘Intermediate input growth is the primary source of output growth in most industries.’
The ‘Solow factors’ of production
The ‘Solow factors’ of production
2.9%
1.6%
0.8%0.5%
4.3%
2.5%
1.2%
0.6%
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
4.0%
4.5%
GDP Capital Labour TFP
Sources of GDP Growth 1992-2014Average annual % increase for advanced and development
economies
AdvancedEconomies
DevelopingEconomies
Source: Calculated from The Conference Board. The Conference Board Total Economy Database 2015
‘Solow factors’ of production in developing economies
Capital60%
TFP10%
Labour Quantity
27%
Labour Quality3%
% Contribution to Growth in Developing Economies 1992-2014
Capital
TFP
Labour Quantity
Labour Quality
Source: Calculated from The Conference Board. 2015. The Conference Board Total Economy Database, May 2015
‘Solow factors’ of production in advanced economies
Capital63%
TFP10%
Labour Quantity
15%
Labour Quality11%
% Contribution to Growth in Advanced Economies 1992-2014
Capital
TFP
Labour Quantity
Labour Quality
Source: Calculated from The Conference Board. The Conference Board Total Economy Database 2015
Large economies are more dominated by capital investment than small ones
Average Contributions to GDP Growth 1992-2014
% of
World
GDP1 Annual % growth
% contribution to GDP
growth
Economic groups2 GDP Capital Labour TFP Capital Labour TFP
All economies 94 3.6 2.1 1.0 0.5 61 29 10
20 largest
economies 75 3.2 2.1 0.8 0.4 67 24 9
G7 32 1.6 1.0 0.4 0.2 69 17 14
Smaller economies3 19 3.7 2.1 1.1 0.6 60 30 10
Correlation to GDP growth
- R2
All economies .44 .27 .18
20 largest
economies .78 .19 .33
G7 .86 .86 .04
Smaller economies .35 .31 .15Starting year adopted as the earliest available data for Russia, however a control calculation from 1990 excluding Russia shows no significant difference
in pattern.1 Calculated in World Bank current dollar PPPs 2 Groups ranked by World Bank current dollar PPPs3 All economies excluding the 20 largest economies
Source: Calculated from The Conference Board Total Economy Database™, May 2015
For a detailed study specifically of the Asian economies see Vu (2013)
So n light of the development or more accurate methods of measurement now no contradiction of the facts and
economic theory!
But the policy that economic development can primarily be driven by TFP has to be abandoned
Or to put it simply Solow quantification was wrong and it is necessary for economic policy and theory to
understand this and its implications
Works cited
• Abramovitz, M. (1956), “Resource and Output Trends in the United States since 1870,” American Economic Review, V. 46: 5-23.
• Jorgenson, D. W. (2009). Introduction to The Economics of Productivity. In D. W. Jorgenson (Ed.), The Economics of Productivity (pp. ix-xxviii). Cheltenham, UK: Edward Elgar.
• Jorgenson, D.W., Mun S. Ho, Stiroh K.J. (2005), Growth of U.S. Industries and Investments in Information Technology and Higher Education : http://www.nber.org/chapters/c10627
• Jorgenson, D. W. & Vu, K. M. (2007). Information Technology and the World Growth Resurgence, German Economic Review, Volume 8, Issue 2, pages 125–145, May 2007
• Krugman, P. (1994). The Myth of Asia's Miracle. Foreign Affairs, 73(6), 62-78.
• Maddison, A. (1991). Dynamic Forces in Capitalist Development. Oxford, UK: Oxford University Press.
• Solow, R. M. (1957, August). Technical change and the Aggregate Production Function. Review of Economics and Statistics(3), 312-320.
• Vu, K. M. (2013). The Dynamics of Economic Growth - Policy Insights from Comparative Analyses in Asia. Cheltenham, UK and Northampton, M.A., US: Edward Elgar.
• Young, A. (1995, August). The tyranny of numbers: confronting the statistical reality of the East Asian growth experience. Quarterly Journal of Economics, 110, 641-680.