SOME ECONOMIC MUSINGS

How Does TFP Growth Fuel Development

Some observers have estimated that the increase in the growth of total factor productivity in the U.S. was 0.8 percent in the late 1990’s. They have attributed that growth to the effect of new technologies, or to the development of a new knowledge based society.

How important is that? It seems that for millennia, many societies saw little if any growth in per capita GDP. Say you have a growth of 0.2 percent per year; then per capita GDP will increase by about 5 percent per quarter century, 22 percent per century. If, however, you increase the rate of growth of per capita GDP to one percent per year, the improvement will be 27 percent per 25 years, 168 percent per century. With an annual rate of improvement of 1.8 percent per year, growth is more than 50 percent per 25 years, 485 percent per century. The miracle of compounding makes the difference.

If one extends the analysis to 200 years, a period comparable to that from the beginning of the industrial revolution until now, the differences are even more extreme. Growing at 0.2 percent per year, one sees 49 percent improvement in per capita GDP in 200 years; at one percent per annum, one sees 624 percent overall improvement; at 1.8 percent per year, 3,381 percent improvement in overall per capita GDP.

Note that even if the acceleration of TFP is transitory, the long term effect can be quite significant. If for example, one increases the growth rate from one percent per year to 1.8 percent per year for a decade at the beginning of every half century, the growth over two centuries goes from 624 percent to 885 percent. Thus growth effects from improved technology and knowledge can be large if compounded over long periods of time, and indeed could be large enough to alone account for much of the economic difference between rich and poor countries that has developed over the last couple of centuries.

Can Poor Countries Catch Up All at Once?

When I worked as a health planner decades ago, U.S. health economists were very concerned with the effects of the introduction of Medicaid and Medicare. Basically the legislation had made a lot more money available to buy health services because of the subsidies for services for the poor and elderly. The construction of new health facilities and the training of new health workers took longer than the increase in financial availability. Indeed, there were forces that limited the rate of production of trained doctors and nurses. If demand increases faster than supply, prices tend to go up, and that was what happened in the U.S. health sector. Some, perhaps a lot, of the subsidies that were intended to make health care more affordable for the poor and elderly, resulted in higher costs of health care for all, increased income for key health professionals, and increased returns to investments in health facilities.

I wonder what the absorptive capacity of developing nations is for increases in funding of research and experimental development, scientific and technological education, and information and communications infrastructure. Will efforts to encourage the development of knowledge economies in poor countries lead to inflationary pressures in their knowledge systems?