model

Malthusian Model

Summary

Given the right circumstances human can breed at a prodigious rate but are limited by the scarcity of resources - particularly land and by rational 'fertility check'

Assumptions

Model/Theory

An increase in productivity or new land then there would be a shift outwards of top curve but not bottom

Malthus only argued moral restraint could lead to higher standards of living.

Predictions

  • Differences in technology will only result in differences in population size, not standard of living.

Evidence

  • Until recently the model does well for example, in AD 1000, the technologically advanced Chinese lived at roughly the same level of subsistence as the technologically backward Europeans.
  • Model does not apply at all for the last two centuries and in fact the reverse is true, the richest countries in the world have the lowest rates of population growth. Also land was replaced by capital as the key factor of production (and it is not constrained). 

Evaluation

Solow Model

Summary

Capital based model that can explain a lot of, although not all the differences between countries.

Assumptions

  1. Capital has five key characteristics: 1. It is productive 2. It is produced 3. It is limited (rival) 4. It can earn a return 5. It wears out (depreciates)
  2. Production function Y=F(K,L) where we assume constant returns to scale (i.e. F(zK,zL)=zF(K,L) & thus y=f(k) and we assume diminishing marginal product.
  3. Cobb Douglas Production function has an additional assumption where where α is capital's share of income where F(K,L)=AK^αL^(1-α) implies y=Ak^α. In a competitive economy factors of production will be paid their marginal products (i.e. wage=MPL, rent=MPK) and α=MPK*K/Y and 1-α=MPL*L/Y
  4. Constant quantity of labour, L (or at least exogenously determined population & growth rate).
  5. Constant production function i.e. no change in technology A
  6. Capital accumulation is modelled as Δk=i-d where i=γy and d=𝛿k means  Δk=γf(k)-𝛿k

Model/Theory

steady state.png

Steady state can be solved for as γf(k)=𝛿k

  • Kss increases with an increase in γ, or a decrease in 𝛿

ss=A(kss)^α

=A^(1/1-α)( γ/𝛿)^(α/(1-α))

Savings=government savings + private savings

Applications

Predictions

Convergence Towards the Steady State (Solow as a Theory of Relative Growth Rates)

  • If two countries have the same rate of investment but different levels of income, the country with lower income will have higher growth.

  • If two countries have the same level of income but different rates of investment, then the country with a higher rate of investment will have higher growth.

  • A country that raises its level of investment will experience an increase in its rate of income growth.

Evidence

  • Solow Model as a Theory of Income Differences is not very good (Figure 3.7).
  • Solow Model as a Theory of Relative Growth Rates - further away from steady state the fastest a country will grow.

Evaluation

  • Before the 19th century land was a more important factor of production than capital.
  • What matters are differences in the rate of investment, which depends upon the savings rate. Critics of the Solow Model argue the savings rate is endogenous and that people save more when they are rich rather than they are rich because they save more i.e. Solow doesn't explain why there are differences in investment rates.
  • 'Can't afford to save' argument doesn't work for countries just above subsistence. Although perhaps a broken savings line could potentially lead to multiple steady state equilibria.
  • Model doesn't explain long-term growth - as long-term steady state has no growth and shifts in savings rate are only temporary and finite.
  • If the model includes population growth than you can get capital dilution where   Δk=γf(k)-𝛿k-nk where again we can solve for yss=A(kss)^α. However the model, with only a 34% predicted difference, is insufficient to explain the large differences in gdp/capita that we see in the data.

Aspiration vs Authoritarianism

Summary

Aspirational Chinese will inevitably lead to the democratization of the Chinese government.

Assumptions

  • Government is so corrupt it is unable to transform itself and therefore will have transformation forced upon it. E.g. Xi Jin Ping's politburo is conservative.

Model/Theory

Enabling factors

  • Chinese are becoming wealthier and want more incl. democracy/human rights.
  • Internet means news gets out and then is covered up afterwards, making the Party's role in censorship embarrassingly clear.
  • Chinese are looking for ideologies, something to belief in. Party fails to provide that.
  • Frustration over Party corruption and lack of meritocracy. Also growing inequality.

Evaluation

  • Are dissidents representative? Are they the pioneers of a new movement or an irrelevant fringe? Are western journalists looking for a story making something out of nothing?

Party wants strong supporters but weak rivals

Summary

The Communist Party plays a delicate game of power politics: benefiting from strong supporters but always wary against any potential rivals.

    Assumptions

    • Absence of a strong socialist ideology has meant the Party's power is based on an implicit bargain of 'you can get rich if we stay in charge' 
    • Party has adapted over time, becoming more hidden but still just as pervasive. Rather than bare threats, now the Party seduces.

    Theory/Model

    These major components of the Chinese government, society and economy need to be strong, but not too strong.

    1. SEOs
      • Benefits - Capitalism and free markets under Deng Xiaoping brought much prosperity. Foreign listings provided impetus for efficiency gains e.g. firing lots of workers (1993 - 76 million, 2003 - 28 million). SEOs chiefs incentivised with Party roles combined profitability of SEOs went from roughly zero to $140bn.
      • Threats - Post Tiananmen Party needed to take control of SEOs and make money. Rather than running the SEOs directly act like a board of governors hiring/firing executives. Less central planning at the provincial/city level offset by centralised financial system under Politburo members. Danger SEOs executives become too powerful, so they are rotated (e.g. in oil and aeroplanes) and made to compete for roles in the Party.
    2. Party jobs
      • Benefits - All major political, government, regulatory, SEO, legal, news and university and think tank jobs centralized under the 'Central Organisation Department, keeping control within the Party. Fierce competition for roles, where party officials are stress-tested in multiple rural jobs against statistics including economic growth, investment & quality of air etc. SEO roles are similar with 'musical chairs' resulting in clear comparisons and fierce competition.
      • Threats - Promotion is not a pure meritocracy with relations being crucial. Also strong incentives to be corrupt and extract money from local businesses. Party roles with all the attention/pressure are losing luster compared to company/provincial official roles where it's easy to get rich.
    3. Military (PLA)
      • Benefits -Party's victory in China was built on the military. Army can be used for international relations and controlling dissent internally (e.g. Tiananmen). In line with China becoming a net importer of oil in 1993 the PLA budget has risen every year since.
      • Threats - Soviet Union lost Cold War because of Arms race and because Westerners de-partied the Peoples' Liberation Army (PLA). Modern army has weaker ideological ties to the Party. No PLA man in Standing committee since 1992. Little trust of PLA with every military commander being monitored by a Party equivalent. Built Peoples' Armed Policy, 800,000 strong alternative to Army. Stale ideology and technical/professional career paths with no chance of political office has led to dissent over PLA's ties to the Party (rather than the nation).
    4. Provincial officials
      • Benefits - Decentralized system and dictatorial local officials allows policies to fit local conditions. Also results in extreme competition, each district becoming like a company promoting investment, with officials getting a share in the profits. Also allows policies to be tested before being rolled out across the country. Move towards centralization under Hu Jintao has kept power balance in check.
      • Threats - Competition has led to inefficient investing with China's 50% of GDP rate of investment yielding only a few more percentage points of growth than India's 25%. Also, move towards centralization and larger Beijing fiscal budgets has led to short-termist sale of land by local officials and corruption. Now 3,000 local party bosses are educated by politburo members in Beijing and kept in check by local journalists and bloggers (something that wouldn't be tolerated of senior Beijing officials). However as with Sanlu and the baby milk officials with both political and corporate roles can lead to skewed incentives.
    5. Entrepreneurs
      • Benefits - Since 2002 entrepreneurs have been invited into the Party to keep them wedded to the Party system. Companies compete to recruit retired party officials to gain access and strengthen ties to the prevailing governmental system.
      • Threats - Post Tiananmen private sector was reigned in, same with labour unions. Obviously entrepreneurs represents a dangerous, independent power base. Party has offset this with 'Party sleeper cells' which are usually ignored but in times of crisis can be called into action. Companies that actively defy and compete against the state like Tieban are crushed.
    6. Legal
      • Benefits -  The Party investigates criminal activity first before being handed over to the legal system. Re: corruption 1. law is a method for removing political rivals 2. outrageous illegality that threatens system. Corruption actual helps provide the system with stability building relationships and incentives to maintain the status quo. No longer able to execute etc. Party still has the power's of detention/persuasion.
      • Threats - The threat to party members is minimized by the fact that an official can only be investigated if an official of higher rank orders it (i.e. they supervise themselves). Separation of powers with law courts separate from the Party could be a threat to corrupt senior party members and even the system itself. Therefore major scandals like the Sanlu baby milk poisoning are quickly and severely dealt with to satisfy public dissatisfaction.
    7. Propaganda
      • Benefits - Rewriting history and controlling the media can strengthen the legitimacy of the Party but only as long as it doesn't go too far. 
      • Threats - The internet and globalisation, particularly foreign sources of news means its harder to dominate the conversation with Party propaganda.

    Predictions

    • Despite western expectations of a gradual weakening of the Communist Party with globalisation/capitalism etc. the Party is actually becoming more assertive and powerful internationally. E.g. pre-Crisis Westerners were teaching the Chinese about governance, post-Crisis they were asking for money.
    • The Party is simultaneously evolving and decaying. Unclear what the future holds.
    • Previous predictions of decline e.g. WTO membership would lead to Western multinationals destroying inefficient SEOs or a rising middle class would call for democracy or inequality would lead to discontent or even corruption would break apart the Party have proven unfounded.

    Evidence

    Evaluation

    Financial Structure

    Reference

    Chapter V - Financial Structure & Economic Development

    Summary

     

    Assumptions

    Theory/Model

    Bank-based: better at reducing the market frictions related to short-run lower risk well collateralized projects

    Security markets are better at financing more innovative, longer-run and higher risk projects that rely on more intangible inputs like human capital.

    Four views on banks vs. markets

    1. Financial-structure-irrelevancy view: what matters is the interest rate and which projects have positive net return. Only financial depth, not structure, matters. A variation of this determines that financial depth is a function of the legal system. However, assumptions about perfect information between investors and managers ('hidden action' and 'hidden information') don't hold.
    2. Bank-base view says in early stages of development, banks are better than markets because powerful banks can make up for weak legal and accounting systems and frail institutions. 
    3. Markets-based view argues that diversification and risk management are only possible in stock markets. Also they promote competition whereas banks extract large rents for information-gathering costs which reduces the incentives to undertake risky projects (particularly as debt doesn't benefit from the upside).
    4. Structural view argues that banks and markets offer distinctly differ services that are, at different stages of development better suited or worst suited to a country. At early stages of development small regional banks work best, at later stages large established capital markets.

    Application

    Evidence

    Financial systems are more developed in developed countries. And stock markets in higher-income countries are more active and efficient than banks which tend to  be more common when the country lacks good accounting, low levels of corruption, strong legal system.

    Although previous efforts found no relationship between financial structure and economic development for the average country, when the level of development is taken into account a difference emerges (Demirguc-Kunt, Feyan and Levine 2011). Crucially as countries become richer their sensitivity to bank development decreases but their sensitivity to securities markets increases (note only use OECD countries). Furthermore, the financial structure gap, the difference between the ideal financial structure for a given level of development and the actual financial structure, has a negative relationship with economic activity.

     

    Evaluation

    New Structural Economics

    Summary

    New Structural Economics uses markets as the mechanism for resource allocation but government plays a role in coordinating investments and compensating first movers.

    Assumptions

    • Economic structure = f(factor endowment structure)
    • Endowments are given but changeable = factor endowments (resources, labour, capital) and infrastructure (soft and hard). 
    • Economic development is a point along the continuum from a low-income agrarian economy to a high income post-industrialized economy (not a dichotomy of poor vs rich).
    • Market is needed for capital allocation according to comparative advantage (so relative factor prices = relative factor abundance).
    • Backwardness advantage = developing countries can borrow and adapt existing technologies rather than having to invent them themselves.
    • Increased risks to firms with industrial upgrading as they face product and technology risk in addition to managerial risk

    Model/Theory

    • Sustained development = f(changes in factor endowments, technological progress).
    • Optimal industrial structure = Comparative Advantage Following (CAF)

    CAF maximise economy's competitiveness, economic surplus and therefore the fastest possible capital accumulation and upgrading of endowment structure. 

    However need government to 

    1. Coordinate investments in improvements in infrastructure.
    2. Compensate information externalities of first movers about where comparative advantage is.

    Applications

    Growth Identification & Facilitation Framework (GIFF) is a guide to help policymakers facilitate structural change.

    1. Government can identify the list of tradeable goods and services that have been produced for about 20 years in dynamically growing countries with similar endowment structures about roughly 2x their GDP/capita.
    2. Among the industries in that list, give priority to private firms that have already entered and try to identify 1. the obstacles to improving the quality of their products 2. barriers that limit the entry of other private firms. E.g. Hausmann's Growth Diagnostic Framework or Duflo's RCE.
    3. For completely new industries encourage firms from example countries to move and take advantage of lower labour costs.
    4. Should also encourage other successful firms.
    5. Improve infrastructure and business environment with industrial parks or export processing zones, rather than whole economy.
    6. Provide limited compensation to domestic pioneer firms or foreign investors e.g. corporate income tax holiday, direct credits or priority access to foreign reserves.

     

    Predictions

    Every developing country can grow at 8% for several decades.

    Evidence

    • Other schools of economic development have failed because 2/3 of low income countries in 1960 failed to reach middle income in 2009 and those in middle income have stayed the same or regressed.
    • Bulk of empirical work (McMillan & Rodrik 2011) shows difference between Asia and Latin America and Africa is due to the contribution of structural change to overall labour productivity.

    Evaluation

    • Anne Krueger asks how would government sectors be chosen without leading to the same corruption/protection problems of previous structural efforts? Also asks whether need tech changes and industrial upgrading from the beginning.
    • Dani Rodrik agrees that developing and developed countries are structurally different and agrees that market incentives are good but says that Lin argues for a CAD form of CAF development.
    • Stiglitz agrees with new structural approach but argues there are more market failures and that comparative advantage is often endogenous. Stiglitz argues that key is knowledge and human capital and transition to a learning society.
    • Ha Joon-Chang argues that first there isn't perfect factor mobility so there are losers from trade liberalization, second capital is discrete and industry-specific, third you can only learn-by-doing with different levels of technology, fourth there are many successful examples of countries like Korea and Japan significantly deviating from its CAF and succeeding.

    Laissez-faire growth economics

    Summary

    Laissez-faire economics failed to deliver economic growth to poor countries

    Assumptions

    • Market is best allocation mechanism
    • Diminishing returns to capital
    • Technology was exogenous so in endogenous growth models, technology modelled as non-rivalrous (but partially excludability) therefore not a pure public good.

    Theory/Model

    Solow model & Endogenous growth models

    Application

    Predictions

    Conditional convergence, assuming diminishing returns to capital, implied poor economies with lower k (=K/L) compared to its long-term steady state will grow faster.

    Evidence

    Evaluation

    To include technology, endogenous growth theories assumed technology is non-rivalrous but partially excludability  however Yifu Lin despite partial excludability, not sufficient to mean the market will provide a socially optimum level. Therefore need government intervention.

    Washington Consensus

    Summary

    Washington consensus argued for an astructural approach focused on liberalization, privatization and stabilization of markets.

    Assumptions

    • Government failure was crucial to failure of Keynesian Development Economics.
    • Rational Expectations.

    Theory/Model

    Rational expectations refuted government's structural role in monetary, fiscal and trade policy. Instead the focus was on the 'right price', stable market environments, strengthening institutions and building human capital.

    Predictions

    Evidence

    • Justin Yifu Lin argues that Washington Consensus, despite being promoted by mulitlateral institutions is 'at best controversial.'.

    Evaluation

    Keynesian Development Economics

    Summary

    Post WW2 development economics focused on structural change towards modern advanced industries through government intervention.

    Assumptions

    • Structural change is key to economic development.
    • Keynesian macroeconomic foundation.
    • Dirigiste dogma.
    • Rosenstein-Rodan (1943) suggested modern methods only > traditional at scale o/w not worth paying higher wages. Scale itself depended upon on size of market therefore if countries didn't develop at scale they could be trapped in poverty.
    • Worsening terms-of-trade from exporting primary commodities to manufacturing economies
    • Failure to develop capital industries is exogenously determined by structural rigidities (monopolies), labour's perverse response to price signals and or the immobility of factors.

    Theory/Model

    Government intervention to facilitate structural change through import substitution by: 

    • Exchange controls
    • Quantitative restrictions on imports

    Application

    According to Yifu Lin Comparative Advantage Defying (CAD) development and the protection of nonviable industries typically lead to:

    1. Increase in the price of imports and import-substituting goods relative to the world price and distortions in incentives and economically inefficient consumption.
    2. Fragmentation of markets and therefore too many small-scale goods.
    3. Decreased competition from foreign firms and support for the monopoly power of domestic firms - which were run by politically well connected owners
    4. Opportunities for rents and corruption which raised input and transaction costs.

    Predictions

    Evidence

    • Justin Yifu Lin argues that other schools of economic development have failed because 2/3 of low income countries in 1960 failed to reach middle income in 2009 and those in middle income have stayed the same or regressed.
    • Keynesian theories decline with stagflation, Latin American debt crisis and collapse of the socialist planning systems in the 1980s

    Evaluation

    China's Hundred Year Marathon

    Summary

    The Chinese government's secret plan to replace the US as the world's leading hegemonic power by 2049, 100 years after the founding of the People's Republic of China.

    Assumptions

    1. US Engagement has not/will not bring complete cooperation.
    2. China is not on the road to democracy.
    3. China is not a fragile flower.
    4. China does not want to be like the US.
    5. Chinese hawks (鹰派) are strong, Chinese moderates are weak.

    Theory/Model

    The Chinese government has been actively employing the Warring States period 'Strategic lessons' to restore China to the top of the geopolitical hierarchy by 2049.

    1. Induce complacency to avoid alerting your opponent.
    2. Manipulate your opponent's advisers.
    3. Be patient - for decades, or longer - to achieve victory.
    4. Steal your opponent's ideas and technology for strategic purposes.
    5. Military might is not the critical factor for winning a long-term competition.
    6. Recognize that the hegemon will take extreme, even reckless action to retain its dominant position.
    7. Never lose sight of shi.
    8. Establish and employ metrics for measuring your status relative to other potential challengers.
    9. Always be vigilant to avoid being encircled or deceived by others.

    Predictions

    In 2049 China, with GDP 3x US, will dominate a unipolar world (or potentially a duel polar with US or tripolar with India and US).

    1. China will harmonize dissent on the internet.
    2. China will continue to oppose democratization.
    3. China will form alliances with America's adversaries.
    4. China will export the airpocalypse
    5. China's growth strategy involves significant pollution and contamination.
    6. Cancer Villages
    7. Cheater's win - China will unleash national champions.
    8. China will increasingly undermine the UN and WTO
    9. China will proliferate weapons for profit.

    Evidence

     

    Evaluation

    US's counter to Hundred Year Marathon

    Summary

    The US's decline and China's rise can be thwarted only if US first recognizes what is really going on, that China is running its Hundred Year Marathon.

    Assumptions

    China is pursuing its Hundred Year Marathon

    Model/Theory

    Steps for America:

    1. Recognize the problem
    2. Keep track of your gifts (to China)
    3. Measure competitiveness
    4. Develop a competitiveness strategy
    5. Find common ground at home (against China)
    6. Build vertical coalitions of nations
    7. Protect political dissidents
    8. Stand up to anti-american competitive conduct.
    9. Identify and shame polluters
    10. Expose corruption and censorship.
    11. Support prodemocracy reformers
    12. Monitor and influence the debates between China's hawks and reformers.

    US should be careful of three intellectual traps:

    1. Premature fear of China's rise.
    2. Fail to appreciate that China does plan to replace the US.
    3. US policymakers have historically helped China's hawks, so do not want to admit that was a mistake.

    Predictions

    Evidence

    Evaluation

    Chinese Mercantalism

    Summary

    Chinese economic strategy involves significant and planned government intervention, particularly as relates to SOEs and mercantilism rather than competitive markets and free trade.

    Assumptions

    1. Peak Oil Theory that there will be a massive fight for resources as price increases.
      • Mercantalism = The theory and system of political economy prevailing in Europe after the decline of feudalism, based on nationalpolicies of accumulating bullion, establishing colonies and a merchant marine, and developing industry and mining to attain a favorable balance of trade.
    2. China has a grand strategy of economic growth rather than just 'muddling through'.

    Theory/Model

    Despite the narrative to the contrary, China has copied, what it deems was America's path to development:

    1. Protection of domestic market
    2. Financial subsidies of domestic companies
    3. Export promotion
    4. Stealing technology
    5. Enforcement of antitrust measures
    6. System of securities regulation
    7. Government led mergers.

    And used the advice of the World Bank to focus on SOEs where 50 of the Global Fortune 500 and developing 'national champions' because:

    1. SOEs have helped China's strategy of mercantalism and undercutting Western competition.
    2. SOEs provide a role and justification for the political dominance of the Chinese Communist Party
    3. Major industries, important for China's economic and national security, need to be government controlled.
    4. SOEs encourage indigenous innovation reducing the reliance on foreign technologies.
    5. Avoid post-Soviet mistake of selling state industries for pennies on the dollar.
    6. SOEs selling abroad can disrupt foreign telecommunications, manufacturing, logistics etc.

    Policy of 'going out' (走出去):

    1. Internationalization of RMB to replace US dollar as global reserve currency
    2. Bottom-fishing - buying foreign companies at low prices (funded by State banks with little need for ROI).

    Predictions

    Evidence

    Evaluation

    Solow Model

    Countries only differ from one another along one single dimension: capital/worker.

    Assumptions

    • Production function is the same.
      • Labour is constant.

      Equations

    • Δk=γf(k)-δk where i=γy (i.e. fraction of gdp invested) and d=δk (which is the fraction of depreciation)
    • Steady states
      • γ_ss=A(k_ss)^α=A^(1/1-α)(γ/δ)^(α/(1-α))

    capital = f(investment)=f(savings)=f(poverty?

    Evaluation

    • Theory of income differences - taken alone, and assuming similar technology levels, Solow model has only limited explanatory power with a correlation of 0.17.
    • Why investment differ? Although international flows matter, savings matter more.

    Implications

    • Theory of relative growth rates - convergence to steady state (at a decreasing rate)
      1. 2 countries have same γ but different y, country with lower y will have higher growth.
      2. 2 countries have same y but different γ then higher γ higher growth
      3. If a country increases its level of investment it will increase its rate of income growth.

    GDP=f(L,K,t)

    GDP=function(inputs, productivity)

    GDP=function(capital, labour, technology, efficiency)

    Gives us a production function with diminishing marginal returns

    Capital =function(investment*) 

    where investment is determined by the savings level.