Trade and Economic

Development
Bob Koopman
Theories of Economic Growth and Development
Lecture 2
MINT002
In this class class….
• We discuss the theories that underpin economic thinking around economic
growth.
• A seemingly simple thing turns out to be difficult to build a good economic model to explain.
• We will quickly see the main elements of the historical evolution of those
theories and then quickly focus on simplified versions (essentially stick figure
representations) of production functions and production possibility frontiers to
explore how to organize our thinking around what turns out to be a complex
issue.
• We will then discuss how some of the aspects of even these simple analytical
approaches can highlight the intersection of economic growth and development
– often around the modern concept of endogenous growth.
• Finally we will discuss how to incorporate things like climate related externalities
that have not been well modeled historically. Will adding these dimensions help?
• But first some reminders from last class…
Some measures of long-term economic
growth
And an estimate
of the
composition of
the global
economy…
And global poverty?
Production functions…
• Simple aggregate production function – in a few minutes we will make this
more complex…
• Y (t) = F[K(t), L(t)] – Total output in an economy is produced by variable inputs
available capital and labor.

• Sector production function

• Yi(t) = Fi [Ki(t), Li(t)], where i represents all sectors, summing over i
would give us aggregate Y above.
• Summing Ki(t) and Li(t) across all sectors cannot exceed total K and L available to the
economy.
More complex production functions and
optimization in the economy…
• Accounting for improvements in “factor productivity”
• Y (t) = A(t)*F[K(t), L(t)] – aggregate level – what productivity boost seems to explain changes in amount of Y that cannot be explained
by changes in amounts of K and L?
• Y(t) = A(t)*F[b*K(t), c*L(t)] – perhaps there are aggregate productivity boosts, and factor specific productivity boosts?
• Y(t) = A(t)*F[b*K(t), c*L(t), I(t)] – better intermediate goods can raise output, and there can be a parameter d added to estimate that
factor specific productivity boost.
• There is also a need to look at these expressions at the sector (i) level.
• This can go on and we can write very complicated expressions.
• In economic theory we set up optimization problems – looking for the various combinations of the optimal
allocations of inputs to output (perhaps cost minimization – minimum use of inputs to get maximum output)
• We can then ask what is the optimal combination of production of various goods to meet consumer
preferences – maximizing utility subject to income constraints.
• General equilibrium? Households provide K and L to Firms. When firms are cost minimizing and households
are utility maximizing we find a general equilibrium optimal output and consumption levels.
• Adding other countries and viewing global K and L as constraints we can then allow countries to interact
(trade, FDI, movement of people and knowledge) and we have typically seen that this creates the “most
growth”….but there are winners and losers.
Helpman – the Mystery of Economic Growth
• Four major themes
• 1. Accumulation of capital (K) and labor (L – particularly human capital – greater capabilities)
• 2. Total factor productivity – ways to make K and L (and actually also intermediate goods)
increase output without using greater quantities of them – this is often a way economists
capture increases in knowhow/knowledge.
• 3. Interdependence – growth in one country can be/is affected by growth in other countries.
Items in 1 and 2 have over the centuries crossed borders, particularly elements of 2,
knowledge/knowhow. But also K – FDI. Movement of L has historically occurred – migration,
but that is also often subject to much greater “control.”
• Next class will spend more time on the trade/interdependence aspect
• 4. The role of economic and political (and cultural?) institutions play a role in creating the
“incentive” environment for countries to both accumulate and innovate..
• The models summarized in the previous slide can do a reasonably good job with
1, 2 and 3. Harder with 4. And much depends on what we include and how we
specify those models.
Production possibility frontiers (ppfs)
• Now we need to think about how to allocate K and L (and other
factors) across sectors in an economy to see what are the possible
combinations of output that could be produced.
• https://www.econgraphs.org/graphs/micro/equilibrium/general_equi
librium/ppf_and_production_functions -what happens when we
reallocate resources between sectors and move “along” a ppf.
 Simplified Example of Growth and Production
Possibility Frontiers

Capital Goods

1. Economic growth when a

country is operating below
capacity – more of both capital
and consumer goods are made
available as the economy
B moves from point A to point B
K2
A
K1

C1 C2
Consumer Goods
Capital Goods
Growth and Production Possibility Frontiers

2. Country operating at full

B capacity but discovers new
K2 resources or find ways of
A improving the efficiency of
existing resources, for example,
K1 education of the population to
improve the quality of human
capital.

C1 C2
Consumer Goods
 Growth and Production Possibility Frontiers
Capital Goods

3. Disproportionate shift in PPF

caused by investment in resources
suitable for producing certain types of
B goods – for example, investment
A from overseas may generate growth
K2 in the production of consumer goods
K1 as opposed to capital goods – is such
investment of long term benefit to a
developing country?

C1 C2
Consumer Goods
 Growth and Production Possibility Frontiers
Capital Goods

4. Disproportionate shift in PPF as a

K2 B result of investment in resources that

favour generation of capital goods –
may not initially seem to have major
impact on the standard of living of the

K1 A country but may have long term

benefits in enabling more sustainable
long term growth.

C1 C2
Consumer Goods
Opportunity Cost of Growth
Capital Goods
Any
Production
attempt toPossibility
increase the
Frontier:
basis for wealth
generation – by producing more capital goods
Assume initial output levels of C1 consumer
that need to be used for such wealth
goods and K1 capital goods – where C1
generation – will mean a reduction in the
K2 barely represents the essentials of life in a
number of consumer goods available (the
developing country – clean water, food,
opportunity cost). Such a reduction can be
shelter, etc.
very damaging to a country already suffering
a lack of basic essentials.

Gain
Opportunity cost of K2 – K1 capital goods
is C1 – C2 consumer goods sacrificed.

K1

Sacrifice

C2 C1 Consumer Goods
So we face trade-offs – how to reconcile?
• We face basic “opportunity cost” challenges…
• But… good news in a sense…we have broken through Malthusian
constraints through productivity growth…
• But challenges remain around deeper understanding of the
mechanisms and how they interact, work together, or create tensions.
• AND GROWTH ALONE IS NOT DEVELOPMENT.
• In some cases growth may be bad for “development”
• Externalities – things markets don’t internalize and capture remain a major challenge
• Some factors may not allow for, or very easily allow for, “productivity”
boosting effects.
• What are some of these trade-offs?
Some Benefits Some Costs
• Increases in economic growth should enable more of everything to be • Economic growth can bring with it costs:
produced • Not all income distributed equally
• Increases possibility of providing consumer goods for all • Wealth often in the hands of a few
• More consumer goods, etc. could be equated with an increase in living • ‘Trickle down’ does not always seem
standards to work in practice
• Wealth generated may eventually ‘trickle down’ to those who are poor by • Corruption may reduce redistribution effects
means of income distribution – taxes and benefits, etc.
• Growth funded in part by spending
• Improved standards of living associated with increase in the availability of on weapons which do not benefit
luxury goods: the population as a whole
– TVs
– Fridges and freezers • Environmental problems
– Swimming pools, etc . • Expansion and growth brings with it the problems of pollution – often
• In addition: developing countries do not have the infrastructure to cope with the
waste generated nor
– Infrastructure – roads, rail, energy, water, communication networks the legislation or regulation
– Health and education provision to influence those
• All associated with a ‘decent’ standard of living who produce it.
• Welfare associated with well-being: • Negative Externalities
• Welfare is improved by the provision of support services for those not • Pollution – dumping
necessarily able to help themselves – often on the margins of society. of hazardous waste
Welfare includes:
• Environmental degradation – over farming reduces productivity of the soil,
• Pensions deforestation, damage
• Benefits – sickness, disability, etc. to eco-systems and reduction in biodiversity
• Support – maternity, holidays, • Non-renewable resources – finite resources
• Housing
• Infrastructure – homes for the elderly
• Such welfare provision often funded through income redistribution - taxes
Where to next?
• Growth and development within a country is complex
• How does growth occur? What are the mechanisms>
• Is growth the same as development? Not necessarily, but it has appeared to be some sort of
pre-condition.

• What happens when we connect countries and now growth is “interconnected”?

Next class.
• Mechanisms have some similarity – how to optimize resource allocation to get most output,
but now thinking about different resource productivities and allocations across countries.
• But positive spillovers from know how/knowledge and flow of factors across borders is
important over time.
• Again, but also more “global commons” problems. Externalities generated in other places
impact localities (btw – happens within countries also!)
• Cooperation within country for growth and development challenging
• Cooperation across countries for growth and development probably more challenging.
• Bretton Woods institutions – IMF/WBG/(GATT/WTO)