Weekend reading links

1. Tao Liu and Qiujie Shi have a paper on the Chinese hukou system, the registration permit given to urban migrants which helps them avail social and welfare benefits in the city. They point to two less-discussed issues - the localized (or city-specific) application requirements and evaluation criteria of the hukou transfer, and the inconsistencies and discrepancies between the stated requirements and real criteria.

In the context of their study of hukou practice of Beijing, they point to the state eligibility requirements,

The first one is regarding education. Before 2009, many documents issued by the Beijing Municipal Human Resources and Social Security Bureau stated that a bachelor’s degree was required to apply for a Beijing hukou. This requirement was then raised to a master’s degree in 2009... Second, it is advantageous to work in a sector that contributes towards the development of Beijing’s economy (and)... contributing to Beijing’s core priorities... The third guideline centres on residence. To guarantee that local hukou go to settlers rather than movers, a certain period of residence is always mandatory.

And their findings about the hukou system works in practice,

Decisive factors include having a university education, working in a key occupation, living in Beijing for more than five years and being located in a village. Migrants who best meet the city’s needs are also prioritized. In order to maintain its role as China’s political centre, the capital of a socialist country, the national centre for science and technology and economic centre for northern China, Beijing has a vested interest in attracting the best talent and to balance development across the municipality. As such, who is eligible for and who should be granted hukou are both decided locally in order to best meet the city’s core objectives. Eligibility is more often than not essential to being granted a hukou. Significant gaps between migrants, eligible applicants and hukou winners have been revealed. In 2010, most migrants in Beijing failed to meet the education and job requirements, and they did not live where Beijing wished them to live. Even among the limited number of qualified applicants, the chances of obtaining a hukou still varied. Those with a postgraduate education had a much higher chance than those with an undergraduate education, a bias rarely mentioned in official documents. Preference was also given to those who worked in the civil service over workers in other key sectors. This was also a “hidden” rule. Although the Beijing government clearly sets out the eligibility requirements for hukou, it is less clear about what is needed to actually obtain one.

Clearly, the hukou system is, like with so many other things Chinese, a heavily controlled rural to urban migration process.

2. The Economist has an article on the corporate executive search market. This is apposite,

A recent Conference Board survey of executives and corporate secretaries found that 73% thought there was no need for a firm with a strong internal candidate for ceo to conduct an outside search. There appears to be no shortage of such talent within. Last year almost four-fifths of new s&p 500 bosses came from inside the firm... Yet most large companies will continue to use search firms—even if they do not fully buy the science, or harbour other doubts. That is because external validation has a value all of its own. Recruiters can be crucial in helping build consensus when, as is so often the case, boards are split. It is as diplomats that the best headhunters earn their keep.

This explanation for hiring head-hunters is, most often, just as much relevant for hiring consultants. Very often they deliver little by way actionable and real long-term value which is not known to the insiders. It is just an external assessment, with the veneer of objectivity, is convenient for executives both to buy the credibility and organisational buy-in required to undertake hard reforms or make high profile hires and also a means to cover their backs if things go wrong.

3. The Economist has another article about the Euston station redevelopment plan in the context of its origination point for the HS2 project,

Last month Camden council, within whose boundaries the station wholly lies, published a draft planning brief, which envisages up to 3,800 new homes, a quarter of a million square metres of commercial space and as many as 14,000 new jobs in a project that has the potential to become not only a massive transport hub but also what the plan calls “a new piece of the city”... The plan imagines green spaces, housing, offices and retail above the new station, as well as building over exposed, below-street-level tracks that extend north for nearly a mile. It foresees bringing back the ancient street pattern to reconnect Somers Town and Regent’s Park with pedestrian and cycle routes over the roofs of the stations. Camden council has experience in such matters. The redevelopment of King’s Cross, a nearby station, transformed a huge chunk of derelict land into a vibrant quarter of the city. Google is building its London headquarters there.

A potential addition to London's growing list of transit-based transformations - King's Cross, Liverpool Street, London Bridge, Canary Wharf, Battersea etc. Also a lesson for urban planners in India to learn from.

How about a mandatory requirement that any new metro project should be associated with an area transformation project or some linkage with housing and commercial stock development and job creation around at least some of its stations?

4. Nice NYT feature on perhaps the new Ground Zero for water wars, the Grand Ethiopian  Renaissance Dam being constructed on Nile River by Ethiopia. An estimated 95% of Egyptians live along or inside the delta and the river provides 95% of the country's drinking water, all of which are now threatened by the upstream $4.5 bn project.

In some respects this is also about the upper riparians exercising their rights over a river which was hitherto mostly exploited by Egypt.

5. Pronab Sen makes this point about unemployment rate in India,

The unemployment rate in the country for 2017–18 was estimated at 6.1%, which was the highest in the 45 years for which such data have been collected.

Is the unemployment situation so worse as to be a half-century low? Do we smell signatures of such an exceptionally high unemployment rate? So what gives?

There are two surveys here. One, the NSSO used to do employment-unemployment survey (EUS) once every 3-4 years which was last done in 2011-12 and since discontinued. Two, the PLFS, which was initiated by this government in 2017-18 and is done annually. 

Sen has competed the data from the two on a historical basis. This is wrong and they are not comparable. There are several differences, like for example, the PLFS gives higher weights to educational status. This in turn gives it a bias towards unemployment among the more educated, a rate which has always been higher. If we are to do a true comparison, we need to get the raw data for PLFS and subject it to the same statistical treatment/formula as was being done for EUS and then make comparisons. 

I can understand the regular journalist being loose with such interpretations, but for a professional statistician, and a credible one at that, to make such a claim. Am I missing something here?

6. Good article by Nidheesh in Livemint (HT: Ananth) about the challenges faced by small enterprises in Coimbatore due to economic slowdown and policies like GST, 

The issues with GST go beyond the tax rate, and is more about the system’s inadequacy in understanding the ground realities of a small enterprise, explained J. Maheswaran, owner of pump-set manufacturer GV Industries. The small and medium businesses in Coimbatore are almost completely running on credit, said Maheswaran. A local vendor usually supplies some spare parts on credit to a company, with the assurance of payment when the final product gets sold. In a slowdown, as products pile with sales drying, the vendor naturally suffers payment delays. But in the meanwhile, he has to pay his GST by the 20th of each month. “If I have made a turnover of about ₹5 lakh, I have to pay about ₹90,000 per month as GST. I get the payment from the customer after a minimum of 90 days, that too, sometimes, partially. This has been the procedure in the market for years. But now, after you have made the bill, you have to pay the GST within 20 days... even before the full amount comes to you," explained Maheswaran. “If you fail to pay the GST, you will get fined. If you continue to fail for three months, the GST will be blocked. Your bank account also will get blocked. So, now, we are borrowing money from wherever we can to pay the GST until we get the payment," he added.

It will always remain a challenge when such reforms are introduced into largely informal economic systems where not all costs and benefits are monetised. In a formal market, in such cases, there would be a market for factoring receivables or the cost of locked-up receivables would be captured in some higher receivable. 

Assuming that there are, say 4-5 transactions, in a typical production-to-consumer chain, I guess only the 2-3 (the original manufacturer and the wholesaler) would be formal, and the rest mostly informal. Some mapping study of a few typical such transactions would be useful. 

So, to this effect, I guess, given the large share of informality, GST is as close as it can get to being a genuine disruption (without being judgemental on this, since the reform itself is desirable) to the economic system. The best that can perhaps be done to such shocks is to cushion them as much as possible and have policy respond iteratively. The new equilibrium where costs are monetised and internalised and associated eco-system (like factoring receivables) will take time to emerge.

The RERA too will surface similar problems since construction sector is largely informal and the working capital locked up is much higher. 

 

7. Nice data journalism on European club football.

8. The checks and balances on executive activism in the US are fast disappearing, as the US Attorney General starts acting as the private lawyer to the President.

9. A New Yorker essay which raises questions with the quest for perpetual prosperity and income growth,

Dietrich Vollrath, an economist at the University of Houston and the author of “Fully Grown: Why a Stagnant Economy Is a Sign of Success”... argues that slower growth is appropriate for a society as rich and industrially developed as ours. Unlike other growth skeptics, he doesn’t base his case on environmental concerns or rising inequality or the shortcomings of G.D.P. as a measurement... Vollrath offers a detailed decomposition of the sources of economic growth... The movement of women into the workplace provided a onetime boost to the labor supply; in its aftermath, other trends dragged down the growth curve. As countries like the United States have become richer and richer, Vollrath points out, their inhabitants have chosen to spend less time at work and to have smaller families—the result of higher wages and the advent of contraceptive pills. G.D.P. growth slows when the growth of the labor force declines. But this isn’t any sort of failure, in Vollrath’s view: it reflects “the advance of women’s rights and economic success.”

Vollrath estimates that about two-thirds of the recent slowdown in G.D.P. growth can be accounted for by the decline in the growth of labor inputs. He also cites a switch in spending patterns from tangible goods—such as clothes, cars, and furniture—to services, such as child care, health care, and spa treatments. In 1950, spending on services accounted for forty per cent of G.D.P.; today, the proportion is more than seventy per cent. And service industries, which tend to be labor-intensive, exhibit lower rates of productivity growth than goods-producing industries, which are often factory-based. (The person who cuts your hair isn’t getting more efficient; the plant that makes his or her scissors probably is.) Since rising productivity is a key component of G.D.P. growth, that growth will be further constrained by the expansion of the service sector. But, again, this isn’t necessarily a failure.

“In the end, that reallocation of economic activity away from goods and into services comes down to our success,” Vollrath writes. “We’ve gotten so productive at making goods that this has freed up our money to spend on services.” Taken together, slower growth in the labor force and the shift to services can explain almost all the recent slowdown, according to Vollrath. He’s unimpressed by many other explanations that have been offered, such as sluggish rates of capital investment, rising trade pressures, soaring inequality, shrinking technological possibilities, or an increase in monopoly power. In his account, it all flows from the choices we’ve made: “Slow growth, it turns out, is the optimal response to massive economic success.”

10. On sexual assault cases, some very shocking findings from the US,

Only 23 per cent of rape or sexual assault victims report the crime to the police, according to a US Department of Justice study. Within that group, only a fraction of these cases lead to a trial, and about 35 per cent of rape trials end in conviction, the DoJ found. Sexual assault cases are often difficult to prove and become a battle of credibility

11. FT review of an Adam Cohen book that highlights how since 1970 the US Supreme Court has continuously helped maintain the status-quo by privileging the interests of the rich and well-off over those of the poor and less well-off.

12. Finally, what is the real-world purpose of this paper, and that too with five Principal Investigators?

Simple and incremental knowledge gains, and their diffusion

I had blogged here about our propensity to underplay or even gloss over simple and incremental solutions to problems, and instead search for innovative and big-bang solutions.

In the context of explaining the advances made in rock-climbing over the decades, especially the Alex Honnold's free solo (no aids, no protection at all) climb of El Capitan in Yosemite, John Cochrane writes,

In studying economic growth, we (and especially those of us in Silicon Valley) focus way too much on gadgets and too little on simple human knowledge. Southwest Airlines’ ability to get an airliner back in the air in half the time it took in the 1970s (and still does at many larger airlines) is as much about an increase in productivity as it is about installing the latest gadget. Growth is about the knowledge of how to do things, knowledge that is only sometimes embodied in machines. Free Solo is a great example of the expansion of ability, driven purely by advances in knowledge, untethered from machines.

This is important in the growth of such knowledge,

The key insight of modern growth theory is that, in the process described above, the larger the group studying any problem, the faster the knowledge advances. If 1,000 people are figuring out how to climb, and all of their good ideas disseminate through the group, each member of the group gets to use new ideas more quickly than if there are 100 people doing it.

So relevant at multiple levels!

Story of growth - ideas and institutions?

Andrew Haldane has a nice speech where he draws attention to the work of economic historians Steve Broadberry and John Wallis, who offer an alternative explanation for long-term economic growth. 

The conventional wisdom is that since per capita incomes were largely stagnant till it started rising from the middle of 18th century, historically the "global economy stood still in growth terms" and that industrial revolution (and associated "ideas") was the game changer for economic growth. By this argument, the subsequent versions of general purpose technologies led industrial revolution - electricity, IC engines, and sanitation (late 19th century); digitisation, computers, and internet (later part of 20th century); and AI, Big Data, automation, robotics, nano-technologies (ongoing) - have been the growth drivers. In other words, "ideas" were the drivers of growth.

But closer scrutiny questions this line of reasoning. Broadberry and Wallis use moving ten year average annual GDP per capita growth data to show that there were as many, or more and higher, growth spurts in the 1300-1750 period as in the subsequent period. But, unlike during that period, there were as many similar contractionary episodes. As Haldane writes,

Between 1300 and 1700, GDP expanded slightly more than half the time. Over these expanding periods, growth averaged 5.3% per year. The reason average growth was far-lower over this earlier period – indeed, little more than zero – was because expanding periods were almost exactly offset by contracting periods. They accounted for slightly less than half the period, during which growth averaged minus 5.4% per year.

So what has changed in the period since the Industrial Revolution? Growth during expansion periods is relatively little changed. Since 1750, it has averaged 3.2% per year. That is in fact a bit less than growth during expansion periods prior to the Industrial Revolution. This strongly implies it is not the greater incidence of ideas-fuelled booms after 1750 that accounts for the growth inflexion. The explanation lies instead in the dramatic fall in both the probability and cost of GDP contractions. Recessions have occurred only 30% of the time since 1700 and only 17% of the time since 1900. During these periods, growth has averaged minus 2.2% per year since 1700 and minus 3.4% per year since 1900. Since 1750, recessions have become far less frequent and less painful. It is the avoidance of deep recessions that differentiates the Golden Era from its Malthusian predecessor. 

And the explanation, "institutions". So "ideas" and "institutions" were responsible for the remarkable growth since industrial revolution. Haldane writes,

I will argue that it was the emergence of institutions that explains the rise in the other capitals that were essential pre-conditions for growth (human, social, infrastructural, intellectual etc.) It was the emergence of these same institutions which also cushioned the damaging effects of recessions... a rather broader set of “capitals” – not just physical capital (plant and machines) but human (skills and expertise), intellectual (ideas and technologies), infrastructural (transport and legal systems), social (co-operation and trust) and institutional (national and civic, private and public) capital.

Political upheavals and technological disruptions are the common triggers for emergence and evolution of institutions. They trigger the formation of social infrastructure or "enabling" and "insuring" institutions. As to the latter, relevant today for developing countries, there was a wide-ranging shift in the role of State in society from 17th century,

State spending as a proportion of national income rose from around 1% in the 16th century to around 12% in the 18th, 14% in the 19th and 33% in the 20th.39 It financed social infrastructure of various kinds supporting those facing greatest hardship. This ranged from social housing to healthcare to income support. Its effect was to cap the downside, recessionary risk to individuals, economies and societies.

So the takeaway,

Well, the story that better fits the facts appears to be one in which the conveyor belt of ideas and innovation has been continuous over the centuries, causing lengthy if lumpy ideas-fuelled expansions. But whereas prior to the Industrial Revolution this conveyor belt was regularly halted by recessions, more recently these interruptions have been far fewer and less costly. Put differently, the real revolution in living standards after 1750 came about not exclusively, or perhaps even mainly, from the surge in ideas and technologies. Rather, it resulted from societies having found some means of avoiding the subsequent recessionary bullets. Prior to the Industrial Revolution, these killed expansions dead. After it, societies appear to have found some effective means of dodging them... 

Joseph Schumpeter spoke powerfully about the forces of “creative destruction”. The lesson of history seems to be that we need both to “cultivate the creative” and to “disarm the destructive” if innovation is to translate into rising levels of social, human and infrastructural capital and, then, higher living standards. It is only by establishing strong institutional roots that technological fruit can subsequently be harvested... But if history is any guide, the story of growth will hinge on the interplay between the two “i”s – the disruptive forces of innovation on the one hand, the stabilising role of institutions on the other.

Limits to rapid growth - Higher Education Edition

A recent ASSOCHAM study found out that just 7% of the pass-outs from business schools in India, excluding the top 20 schools, are employable and are able to get a job immediately after completing their course, 

India has at least 5,500 B-schools in operation now, but including unapproved institutes could take that number much higher... Low education quality coupled with the economic slowdown, from 2014 to 2016, campus recruitments have gone down by a whopping 45 per cent. There are more seats than the takers in the B-schools... In the last five years, the number of B-school seats has tripled. In 2015-16, these schools offered a total of 5,20,000 seats in MBA courses, compared to 3,60,000 in 2011-12. Lack of quality control and infrastructure, low-paying jobs through campus placement and poor faculty are the major reasons for India’s unfolding B-school disaster...

While on an average each student spent nearly Rs 3 to Rs 5 lakh on a two-year MBA programme, their current monthly salary is a measly Rs 8,000 to Rs 10,000... Of the 15 lakh engineering graduates India produces every year, 20-30% of them do not find jobs and many other get jobs well below their technical qualification. There is clearly a rush towards engineering, that which is engineered largely by parents and the society... There is a large mismatch in the aspirations of graduating engineers and their job readiness. 97% engineers aspire for a job in IT and core engineering. However, only 18.43% employable in IT; 7.49% in core engineering, adds the paper.

This is a teachable moment. The tripling of business school seats, like with similar explosion in engineering colleges in the 2006-11 period, came with a prohibitive cost in terms of quality. The provision of good quality professional education requires competent faculty, adequate infrastructure, and good students. And finally, there should be enough jobs going around to absorb those passing out. These are not achieved easily at the speed and scale expected, given our antecedent human and physical capital quality deficiencies. And in any case, colleges take time to develop good quality and establish credibility. They cannot be manufactured on a production line in a routine manner.

This is equally true of the spurt in IITs, IIMs, AIIMS, and other institutions of national excellence. After failing to build on the success of these brands by gradually increasing their numbers over the years, there has been a swing to the other extreme in recent years in terms of sanctioning of a slew of such institutions. It is only to be expected that the supply-side in terms of quality of faculty and students fail to keep up with the growth in such institutions.

This is true not just of higher education, but any sector. There are limits to how quickly any sector can grow in a country with a very narrow base in industry, human resource, agriculture, financial capital, state capacity, and so on. India needs economy-wide human and physical capital accumulation for a long period of time to build up the platform necessary for sustainable growth. Without this foundation, high growth can only happen in short episodes of over-heating followed by cleaning up balance sheets, as is happening now. 

Why an exclusive focus on economic growth is misplaced?

The biggest criticism of the current government in New Delhi has been that its excessive focus on redistribution programs has skewed governance priorities. It is argued that these programs have taken away from other more important growth creating and growth sustaining interventions like structural reforms (the second generation of reforms) and investments in infrastructure. Further, the large fiscal burden imposed by these subsidies has distorted incentives and engendered macroeconomic problems which have been a drag on the country's economic growth.

If we follow the mainstream critiques of the government, one cannot but not get the impression that it has taken the form of an aversion to all forms of growth redistribution. Accordingly, in this narrative a "subsidy" to a poor person is virtually a four letter word. An important argument of people like Jagdish Bhagwati is that India should initially focus just on raising growth, through structural reforms and liberalization, and then use the increased revenues to both expand its welfare state and re-distribute. If this ideology were to assume power, we would experience a drift to the other extreme with excessive focus on growth creation and a marginalization of growth redistribution policies. I believe that this would be as detrimental to long-term growth as the current skewed focus on growth redistribution.    

It is perplexing as to why this should be so difficult to understand. It has been widely accepted, and has also been borne out by India's experience over the last 15 years, that economic growth does not automatically create the conditions, capacity, and resources for sustained poverty reduction as well as further growth. This is because economic growth happens when markets expand - more people demanding goods and services attracts investments, raises production, creates jobs, increases purchasing power, creates demand for more and newer goods and services, and so on. 

The critical factor is "more people demanding goods". In other words, the base of the "demand pyramid" has to become as broad as possible, eventually encompassing all the citizens of the country. But more people can enter the market only if they are equipped with the human capital resources to access the opportunities that arise once economic growth picks up. In case of all successful growth stories, including East Asia, governments have laid this platform by making large and effective investments in human capital formation. They have generally been in the form of investments in education, health care, nutrition, and skill development.  

It is of course possible that in a continental economy like India, high growth rates can be sustained for some time by a much narrower pyramid, in relation to its potential size. Further, an initial spurt of pent-up demand, locked-up entrepreneurial energies, and readily available capital will help generate high growth rates and achieve some poverty reduction for some time. Furthermore, this initial phase of growth can be used to build up the capacity to provide a massive thrust on human capital formation. 

But neither does the access to opportunities for human capital formation nor the capacity of the state to provide the required thrust for improvements in human capital formation automatically follow from economic growth. It is here that Jagdish Bhagwati and Arvind Panagariya's argument about sequencing priorities fail. This assumes even greater significance in case of India since we carry a legacy of extremely poor performance on the human capital formation side. A weak state, misplaced policy priorities, and historical legacies, have come in the way of development of our human capital base. Despite the latest exultation on poverty reduction, an overwhelming majority of our citizens are even today not equipped with the basic skills and resources to access the opportunities in a competitive market place. 

In fact, it is possible that the dynamics of initial growth spurt created conditions that worked against the desired trends that economists like Bhagwati have taken for granted. There is growing evidence to argue that except for the small knowledge-based services sector, India's spectacular economic growth spurt of the past 15 years has been exclusionary and also been underpinned by a crony capitalism that may have even weakened the state's already feeble capacity to create the conditions for sustained economic growth. In any case, its sustainability is already in question.  

So the obvious answer is to acknowledge the importance of addressing the challenge of human capital improvements, without seeing it as a trade-off with economic growth. Economic growth is built on the size and quality of human capital. This does not of course mean that we should go the other way, as Amartya Sen and Co appear to suggest, and should spend time improving human capital before we focus on economic growth creating policies. But it should undoubtedly be a matter of great concern that this issue does not get anything remotely close to the attention that growth creation policies get in mainstream discussions in India. 

There is another argument for being cautious against an exclusively growth creating focus. In a large country like India structural transformations are most certain to be long-drawn, destabilizing, and politically difficult. A generous social safety, which seeks to provide a basic dignified human existence, is desirable not only on moral considerations, but even more importantly on economic and political grounds. Economically, it would be the necessary first step to equip these people with the requisite human capital to compete in the market place. It would provide the political space to push through the difficult structural reforms. 

We need to seriously debate this social safety net. Who should be its beneficiaries? What should be its components? What should be the design of each component, so that incentives are aligned towards minimizing distortions and achieving the objective? What should be the exit protocol from this safety net? What should be the most effective channel for its delivery? How much resources are we able to spend on it? What should be the role of the private sector in this endeavor? 

One gets the impression that critics of the government suffer from representativeness bias. They appear to conflate the idea of a growth model that simultaneously focuses on human capital formation, establishment of a social safety net, and growth creating policies with those being pursued by the present government. This narrative sub-ordinates everything to economic growth and policies that are perceived as directly contributing to economic growth. Its occasional concern with distributional issues and sustainability of growth is confined to simplistic advocacy like replacing the PDS with cash transfers and increasing private participation in the delivery of health and education services.

The clearest proof of this comes from their diagnosis of the current weakness with the Indian economy. They blame the weakness on inadequate liberalization of foreign investment norms, lack of labor market reforms, still-born financial market liberalization, insufficient domestic tax reforms, deficient investments in physical infrastructure, and pervasive corruption. Investments in human capital formation and building state capacity to improve it are rarely discussed with anything like the passion associated with the former. Policies to establish a comprehensive social safety net has received even less attention.

In other words, a development model that focuses exclusively on economic growth creating policies, without much concern for enabling the availability of conditions for a broad-based and therefore sustainable economic growth, has come to dominate the mainstream media. If Amartya Sen's provocative push in the other direction, irrespective of its extremism, contributes towards re-balancing the agenda, he would have done more, albeit unwittingly, to the long-term future of Indian economy than any other intellectual.

Update 1 (27.07.2013)

This is a classic example of what I mean by mainstream discussion. One gets the impression that liberalization of FDI norms, infrastructure investments, and policies to make India more externally competitive are enough to overcome the "looming crisis". 

The slowing escalator - has Africa missed the bus?

Dani Rodrik and Tyler Cowen have written about the bleak prospects of rapid economic growth in developing countries.

The argument goes something like this. Historically, due to its ease of replicability (of new processes and foreign technologies), sustained economic growth has been mostly based on structural transformations, in particular rapid industrialization. But this model faces challenges from three trends. Technological advances, by automating routine work, has made manufacturing much more skill-intensive and therefore less capable of absorbing large quantities of labor. Globalization has internationalized the production supply chain and increased competition among developing countries. Finally, the weak economic prospects of developed economies will make them less receptive to being passive export markets for the industrializing economies. Prof Rodrik concludes,

Manufacturing industries will remain poor countries' "escalator industries", but the escalator will neither move as rapidly, nor go as high. Growth will need to rely to a much greater extent on sustained improvements in human capital, institutions, and governance. And that means that growth will remain slow and difficult at best. 

Tyler Cowen points to efforts by Nike, motivated by rising labor costs in the factories of its traditional East Asian suppliers, to engineer labor out of its production chain using technology and innovation.

Truth to tell, even before all these studies, this fear was occasionally discussed in many forums. The rising labor costs in East Asia, especially China, and the Great Recession have brought this threat to our door-step faster than expected. So has Africa missed the bus? I believe that we need much more compelling evidence before I can agree with Prof Rodrik's pessimism. Few questions need answering.

What is the limit to the automation of factory floor work in the foreseeable future? How soon will the cost of technological innovation fall below Africa's real labor costs? Is it possible for textile manufacturers of Ghana to co-exist with their Chinese counterparts in a global market place? How rapidly will the Chinese move up the escalator, thereby vacating space for more of their own people and those from other developing countries? Which countries will occupy that space?

Most importantly, even if the aforementioned trends take hold, it will take time. Further, in the meantime, even if China's progress up the escalator slows, the space vacated will be large enough to accommodate many others. Will atleast some parts of Africa be ready to step up? If that happens, and we know that dominoes can have unpredictably surprising effects, prospects will be brighter. So there may be much more to the story before we can write its epitaph.

An assessment of "The Economic Complexity Atlas"

I've been thinking of writing about this for sometime. Now that I've passed a preliminary muster of Cesar Hidalgo and Ricardo Hausmann's concept of diversified productive knowledge within an economy, and its role in economic growth, I am left with mixed feelings.

Obviously (or so atleast I think) the Atlas has a two-fold agenda. It has brilliantly explored the manifestations of growth, as reflected in the profile of each country's export products and mapped them. It has also quantified the productive knowledge of an economy in terms of the Economic Complexity Index (ECI), and has shown that this is a reliable predictor of economic growth. Its next objective would be to explore what can be done to help countries acquire a diversified base of productive knowledge. I am not sure whether we are covering much new ground here.

1. The Atlas tells us where countries stand on the complexity map and that complexity appears to be a better predictor of economic growth prospects. So what? Standard endogenous growth theories have for long dwelt on the importance of accumulation of knowledge - both product variety/diversification and specialization - as the critical driver of economic growth.

Yes, the Atlas qualifies the character and dynamics of this knowledge. And Hausmann and Hidalgo believe that this "new" information (about drivers of growth), with its close relationship with growth, would help countries, presumably unaware of this, focus on its acquisition.

But I'm not sure whether there is compelling enough evidence - qualified interpretation of existing theories or new evidence - in anything presented by them to convince political leaders and policy makers anywhere to re-visit their prevailing notions about economic growth. However, it does undoubtedly add significant value to the continuous refinement of the endogenous growth models. But that is a matter of interest for academicians and to this small group sitting in Sweden.

2. Even assuming that we have learnt something new, what does it tell about how to get there? What can knowledge about the current level of a country's productive knowledge base and the desired level of complexity tell about the actual path of getting there? In broad terms, this quest is similar to industrial policy regimes followed by many countries that have sought to promote the acquisition of knowledge and technology in specific sectors.

In fact, the decades experimentation on industrial policy, and its mixed results, should itself caution us about the difficulty of any effort at promoting growth with the productive knowledge destination map. Obviously, even when we know our current location and future destination, we still need to know the path and the vehicles to get there. And if the path is itself a dynamic target and we also have to travel in multiple vehicles at the same time, then the quest for destination becomes even more difficult.

3. It finds that diversity of productive knowledge is a more important predictor of growth than even investments in human capital. Maybe. But even controlling for various "observable" factors, we simply cannot quite infer causal relationship between acquisition of diversified productive knowledge and economic growth. The interaction dynamics of the contextual (I am wary of using "institutional"!) factors are too complex to do that with any degree of reliability. It could just be that countries with high ECI scores also had the right environments to acquire that knowledge.

4. Then there is the practical difficulty of its assumptions. Clearly, we cannot expect the numerous small least developed countries like Gabon, Sudan, and Malawi, who are languishing at the bottom of the ECI rankings to do anything much, even in the medium to long-run, to acquire a diversified base of productive knowledge. In an ideal world, the inhabitants of these places should merely migrate to other more habitable locations. In the real world though, their most realistic chance of expedited development lies not in acquiring diversified productive knowledge, but in being able to achieve success with a few sectors.

5. The Atlas points to the relatively low growth potential of the richer natural resource endowed economies, attributing it to their low productive knowledge base. But it can also be argued that given the low economic base from which they started, the natural resources provided them to best and fastest path to economic growth. And atleast some of them grew faster than their other similarly placed colleagues. It is true that many of them have not leveraged that growth to diversify their economies (and expand their productive knowledge), which in turn raises questions about the sustainability of their growth.

While we may claim that once we control for the role of oil, the Middle Eastern economies, with their low productive knowledge base, would have been as backward as any other developing country, it cannot be denied that the people of these countries today enjoy lives which are far better than those in non-resource developing countries, including those with much higher productive knowledge base. If they, like Norway, had used resource windfall to build up a modern economy, we would today have been talking about that as a growth model. There is no reason to lend any more credibility to the productive knowledge base model than one which advocates leveraging natural resources to develop an economic base and then move up the technology frontier.

6. Finally, the Atlas is created using export data. This may be a less reliable proxy for the productive knowledge base of the larger economies, whose domestic economy may contain a diversity of productive knowledge that may not be appropriately reflected in the exports.

Lest we need any more reminders, all "holy grail" explanations of economic growth and development are futile exercises. It all ultimately boils down to exercises in circular logic. Critics will rightly point out that countries lagging behind on diversified productive knowledge base do so because of lack of effective institutions, culture, inadequate investments in human capital, geography, historical factors, weak governance systems, and a series of other factors. Supporters will say that the process of acquisition of productive knowledge will help overcome these other deficiencies. And so on...

On "Why Nations Fail"

So Jeff Sachs, via MR, argues that geography is as much a factor in development as political institutions,

In places where production is expensive because of an inhospitable climate, unfavorable topography, low population densities, or a lack of proximity to global markets, many technologies from abroad will not arrive quickly through foreign investments or outsourcing. Compare Bolivia and Vietnam in the 1990s, both places I experienced firsthand as an economic adviser. Bolivians enjoyed greater political and civil rights than the Vietnamese did, as measured by Freedom House, yet Bolivia’s economy grew slowly whereas Vietnam’s attracted foreign investment like a magnet. It is easy to see why: Bolivia is a landlocked mountainous country with much of its territory lying higher than 10,000 feet above sea level, whereas Vietnam has a vast coastline with deep-water ports conveniently located near Asia’s booming industrial economies. Vietnam, not Bolivia, was the desirable place to assemble television sets and consumer appliances for Japanese and South Korean companies.

I agree. Furthermore, I strongly believe that "inclusive" political institutions - which protect individual rights, secure property rights, foster entrepreneurship and thereby promote inclusive economic institutions - do not guarantee higher incomes and improved human welfare forever. The increasingly unsustainable trend of widening inequality, decreased income mobility, and concentration of wealth and political power in the US - an exemplar of inclusive political institutions - would appear to weaken their hypothesis.

This is no Marxian argument. As I have blogged here, here and here, there is an inexorable dynamic to modern capitalism (as is practiced and promoted world-wide), even with all its inclusive political institutions, that makes elite capture of the economic and political institutions inevitable. Even when those at the lower part of the wealth ladder experience income growth (and this is itself debatable), the disproportionately higher rate of income growth at the top of the ladder makes concentration of wealth and political power a near certainty.

At the other extreme, in India, again despite relatively robust and inclusive political institutions, poverty and underdevelopment has remained persistently high for more than half a century. Inclusive institutions which protect individual and property rights have not translated to the expected economic growth. Clearly, there is something more to the story of "making development happen" or "sustaining growth" that goes beyond "inclusive" political institutions.

In both cases, other ingredients or conditions, which are essential to the effective functioning of these inclusive institutions have declined (as with the US) or not taken strong enough roots (in case of India). In other words, "inclusive" institutions cannot sustain by themselves nor are they adequate to generate high growth rates. Alternatively (and may be simultaneously), Governments have not been able to effectively mitigate market failures. 

However, I am inclined to largely agree with their converse argument that "extractive" political institutions - which place power in the hands of a few and beget extractive economic institutions, which feature unfair regulations and high barriers to entry into markets - inhibit sustainable economic progress.

In any case, there is something amiss about the disproportionate focus on "inclusive institutions", to the near exclusion of all else, in "Why Nations Fail". The search for that magic pill which can explain economic development and national economic growth has a long history of failures. Despite their hugely impressive scholarship, Acemoglu and Robinson are only the latest set of explorers in this quest.

Job creation in China - the role of cities and services sector

Felix Salmon has a superb post which highlights the critical role played by urban areas in sustaining economic growth and job creation in China. He points to two less-discussed facts about the Chinese economy.

1. Services sector employs more people than the manufacturing sector. The graphic shows that manufacturing sector, in terms of total jobs in the sector, actually declined for some part of the nineties but recovered slowly in the last decade.



Examining China's jobs growth over the past twenty years, Felix Salmon writes,

But it is surprising to see that if you take out the services sector, total Chinese employment has been going nowhere, and basically falling... Meanwhile, the services industry — tertiary industry — has been on fire: it now employs 263 million people, more than are employed in secondary industry (218.4 million), and has doubled since 1992... Of course it’s hard to find work in the services industry if you’re a rural peasant: tertiary industry is a fundamentally urban thing.

2. The growth in jobs has been coming mainly from the urban areas though rural China provides more employment than its cities. Apparently 13.7 million urban jobs were created in China in 2010 alone.



Felix Salmon makes the important point that unlike the US, where the construction boom was confined to the real estate sector, the Chinese construction boom "is building cities and roads and crucial infrastructure, which allows the service economy to keep on growing at a torrid place".

Both these graphics highlight the important role played by the services sector and cities in boosting China's labour market. Felix Salmon points to the closely inter-twined nature of cities and services sector job creation,

How do you create service-industry jobs? By investing in cities and inter-city infrastructure like smart grids and high-speed rail. Services flourish where people are close together and can interact easily with the maximum number of people. If we want to create jobs in America, we should look to services, rather than the manufacturing sector. And while it’s hard to create those jobs directly, you can definitely try to do it indirectly, by building the platforms on which those jobs are built. They’re called cities.

Will policy makers in India, obsessed with a rural-centric public policy paradigm, take notice and emulate China?

Do small firms underpin economic vibrancy and create major share of jobs?

One of the recurrent themes in the debate about the problems facing the US economy has been the relative weakness of small enterprises who are traditionally believed to have provided the labor market firepower in the aftermath of recessions and also underpin economic vibrancy of any economy. However, this conventional wisdom has been questioned by Jared Bernstein and Tyler Cowen in different contexts.

Tyler Cowen points to an interesting possible structural cause for the economic weakness in Italy and some of the peripheral economies - the over-sized role of smaller firms in their economies. Referring to Italy's vibrant clusters of family-owned niche businesses, he writes,

"With the advent of modern communications and information technologies, arguably the return to 'small family firms' has fallen. The return to 'largish projects consummated over large distances' has gone up. For Europe, the big winners here are the Nordic countries, which have worked very effectively with information technology and which do not rely so much on family ties to get efficient, non-corrupt management. The losers are Italy and Greece and Portugal too... Portugal is cursed by being stuck with all these small firms, inefficiently small for legal and regulatory reasons. These countries seem to be locked out from some of the major sources of contemporary economic growth."

He also points to Serguey Braguinsky, Lee Branstetter, and Andre Regateiro, who studied the transformation of Portugal's firms and found,

"For decades, the entire Portuguese firm size distribution has been shifting to the left... Portugal's shrinking firms are linked to the country's anemic growth and low productivity. We show that the shift in the Portuguese firm size distribution is not reflected in other advanced industrial economies for which we have been able to obtain comparable data."

Matt Yglesias has an excellent graphic that clearly refutes the small-firms-cause-economic vibrancy thesis.



I cannot but not agree with his broad assessment of firm growth in any economy. He writes,

"The way a healthy economy works is that you start with a bunch of firms and then it turns out that some of those firms are better-managed than others. The well-managed firms expand while the poorly-managed firms go out of businesses. At the end of the day, then, you wind up with the majority of workers working for relatively well-managed firms. Because the firms are well-managed, the workers are more productive and earn the well-known-in-the-literature large firm wage premium. Alternatively, you can have an economy like Italy’s with lots of barriers to competition so that poorly managed firms stay in business with low productivity."

Jared Bernstein writes about the role of small businesses in the US economy,

"It’s not small businesses that matter, but new businesses, which by definition create new jobs. Real job creation, though, doesn’t kick in until those small businesses survive and grow into larger operations."

Bernstein's assessment and the findings from the study of Portuguese economy has important lessons for India, where small businesses and policies favoring them are seen as holy cows. Braguinsky et al write about the distortionary role played by Portugal's uniquely strong protections for regular workers,

"Drawing upon an emerging literature that that attributes much of the productivity gap between advanced nations and developing nations to the misallocation of resources across firms in developing countries, we develop a theoretical model that shows how Portugal's labor market institutions could prevent more productive firms from reaching their optimal size, thereby constraining GDP per capita."

Their assessment of the Portuguese economy would also apply to India which too has similar tight labor market restrictions aimed at protecting smaller enterprises,

"Portugal's policy commitment to employment protections for regular workers in the formal sector is extreme, even by Western European standards. We present a model in which high levels of employment protection e ectively operate as a tax on wages, and can produce a shift in the rm size distribution, relative to the distortion-free benchmark, that reflects, in some ways, what we have seen in Portugal. An immediate implication of our model is that the same policy regime that shrinks firms also lowers aggregate productivity. Even a uniform tax tends to hit the most productive enterprises disproportionately hard, causing a degradation of the allocation of resources across enterprises. More resources are tied up in smaller, less protective enterprises and fewer resources are allocated to the most productive firms, relative to what we would see in a distortion-free economy."

In simple terms, the major share of job creation happens when small industries which started recently consolidate and start their expansionary phase. Public policy should accordingly facilitate this expansion. Unfortunately, both public policy and pervailing socio-economic institutions and conditions, both hinder such expansion.

Catch-up growth and global convergence

Citigroup economists Willem H. Buiter and Ebrahim Rahbari, who earlier identified 11 global growth generating (3G) economies for the first half of this century, have another paper investigating the likely future sources of global economic growth between 2010 and 2050.

They use 40 year economic forecasts by Citi economists, historical GDP data for the most recent 10-year period, and available economic research on the drivers of long-term growth, to examine national-level global growth generators. They assume United States as the technology frontier country and draw the distinction between growth at the technology frontier (productivity growth at the frontier) and catch-up or convergence growth (mainly through adoption and importation of best-practice technology and know-how from the frontier countries). Naturally, they foresee most of the global growth to come from the latter source.

Their earlier 3G index aggregates some key growth drivers - gross fixed domestic capital formation; gross domestic saving; a measure of human capital (which aggregates demographic, health and educational achievement indices); a measure of institutional quality; a measure of trade openness; and the initial level of per capita income. Their final analysis and prescription about how a country grows fast

"1. Start poor
2. Start young
3. Open up to trade in goods and services and to foreign direct investment
4. Achieve reasonable political stability (the absence of significant external and internal conflict)
5. Create some semblance of a functioning market economy
6. Boost the domestic saving and investment rates
7. Invest in human capital (educate and train both boys and girls, focusing on pre-school, primary and secondary education and on vocational training)
8. Invest in infrastructure
9. Don’t be unlucky. Avoid war-like neighbours and natural disasters
10. Don’t blow it. Avoid internal conflict and populist assaults on the incentives to work, save and invest; avoid macroeconomic mismanagement, premature capital account
liberalisation and financial regulatory disasters.

Catch-up and convergence will do the rest."

If we examine the Indian economy with respect to these ten attributes/tenets, the picture is indeed encouraging, especially if point 9 is taken care of. Points 1, 2, 4, and 5 are inherent and historical advantages. Points 3 and 6 are true reform achievements. Even point 7 is being addressed. This leaves us with the real concerns - points 8 and 10.

All our immediate (inflation) and long term (growth prospects and convergence growth pace) macroeconomic challenges are closely linked with infrastructure. This is all the more so since infrastructure forms the basic platform that underpins the growth of the modern economy. We need to plan, design, raise resources and execute massively in all infrastructure sectors. And even if we mobilize the resources and show the requisite commitment to conceptualize and create infrastructure, the greater challenge is to ensure that we do not blow it up.

Here I am not worried about macroeconomic mismanagement nor financial market problems nor even corruption or internal conflicts. All these dangers always lurk around the corner and will even explode once a while, but when seen in historic perspective and when analyzing growth prospects over half-century, they are all surmountable, especially for a continental economy like India. A real worry will be with picking up the pieces from the "populist assaults on the incentives to work, save and invest". I will come back and post on this in the days ahead.

"Big push" theory of development

In a seminal 1943 paper, "Problems of Industrialization of Eastern and South-Eastern Europe", the Austrian economist Paul Narcyz Rosenstein-Rodan built on a 1928 paper by Allyn Young, "Increasing Returns and Economic Progress", and conceptualized the 'Big Push' model of economic development.

He advocated planned large-scale investment programmes in industrialization for countries with a large surplus workforce in agriculture, in order to take advantage of network effects - economies of scale and scope - to escape the low level equilibrium "trap". As Rajiv Sethi wrote in a recent blog post, "the argument is based on the fact that the development of any particular industry may only be privately profitable if an entire set of interlocking industries were emerging simultaneously".

In a 2008 NBER working paper, Fred Bateman, Jaime Ros, and Jason E. Taylor found that the economic rebound of American South was the result of a 'Big Push' from large public capital investments during the Great Depression and World War II. They described the 'Big Push' development strategy thus,

"According to the 'big push' theory of economic development, publicly coordinated investment can break the underdevelopment trap by helping economies overcome deficiencies in private incentives that prevent firms from adopting modern production techniques and achieving scale economies. These scale economies, in turn, create demand spillovers, increase market size, and theoretically generate a self-sustaining growth path that allows the economy to move to a Pareto preferred Nash equilibrium where it is a mutual best response for economic actors to choose large-scale industrialization over agriculture and small-scale production."

About the success of the "Great rebound" in America's South, they wrote,

"Specifically, and consistent with big push theoretical literature, the infusion of public capital — roads, schools, waterworks, power plants, dams, airfields, and hospitals, among other infrastructural improvements — fundamentally reshaped the Southern economy, expanded markets, generated significant external economies, increased rates of return to large scale manufacturing, and encouraged a subsequent investment stream. These improvements helped create the conditions that allowed the region to break free from its low-income, low-productivity trap and embark on its rapid postwar industrialization."

David Beckworth though points to the other factors that sustained the South's postwar economic recovery - improved human capital formation, industrial policy, increased political competition, and the climate or Sunbelt effect.

In 1989, Andrei Shleifer, Kevin Murphy, and Robert Vishny examined the Rosenstein-Rodan idea of simultaneous industrialization of several sectors of the economy "in the context of an imperfectly competitive economy with aggregate demand spillovers and interpret the big push into industrialization as a move from a bad to a good equilibrium".

Under the 'Big Push', industrialization in one sector "raises the demand for other manufactures directly and so makes large-scale production in other sectors more attractive". The complementarities between the simultaneously industrializing sectors, which is the underlying rationale in favour of a large-scale planned industrialization, gets amplified through market size effects. Their findings have a strong echo in China's development story over the last quarter century,

"A program that encourages industrialization in many sectors simultaneously can substantially boost income and welfare even when investment in any one sector appears unprofitable. This is especially true for a country whose access to foreign markets is limited by high transportation costs or trade restrictions. The net payoff from a program of simultaneous industrialization can also be high when all markets are open, but a shared infrastructure - such as a railroad or a stock of managers - is necessary to operate profitably in any given sector. In the latter case, simultaneous development of many export sectors may be necessary to sustain any one of them...

countries such as South Korea that have implemented a coordinated investment program can achieve industrialization of each sector at a lower explicit cost in terms of temporary tariffs and subsidies than a country that industrializes piecemeal. The reason is that potentially large implicit subsidies flow across sectors under a program of simultaneous industrialization. Any cost-benefit analysis of subsidies or of temporary protection should reflect both the lower direct costs and the higher net benefit of a program that is coordinated across sectors."

In another influential 1991 paper, Paul Krugman brought in the role of expectations and argued that "the willingness of firms to invest depends on their expectation that other firms will invest, so that the task of development policy is to create convergent expectations around high investment". This argument is different from the standard competitive view of the world. He highlighted the important role played by self-fulfilling expectations (about growth path and prospects), in addition to history and traditions (past events set the preconditions that drive the economy to one or another steady state), in shaping the development path and determining the final outcomes.

He argues that in view of the presence of multiple equilibria (of outcomes), the choice among them will be determined based on the contributions from both history and expectations. Further, the "relative importance of history and expectations depends on the underlying structure of the economy - in particular, on the costs of adjustment".

Using a simple one-factor, two-sector (or two goods) model with increasing returns in one sector and constant returns in the other, two long run equilibria (each of which involves complete specialization in one of the two goods), and an initial state of incomplete specialization, he explored the possibility and direction of movements in resources across the two sectors. Rajiv Sethi nicely summarizes Krugman's findings

"If shifts in resources across sectors cannot be costlessly reversed, then such movements will depend not only on current inter-sectoral wage differences, but also on anticipated future differentials, which in turn depend on expectations about the future movements of resources across sectors. Krugman shows that there is a range of initial conditions, which he calls the overlap, from which either one of the two long run states can be approached if and only if it is expected to be realized.

If initial conditions lie outside this range, then history is decisive, otherwise expectations matter a great deal in affecting the eventual pattern of specialization.
The overlap may be viewed as a zone of uncertainty within which coordinated optimism can have major economic effects. Outside this zone, for better or worse, we are shackled by our history. Within it, expectations become crucially important."

The question, then, with the development prospects of any country is whether or not it is now in or around this zone of uncertainty (overlap) where expectations can be a critical determinant of its future development performance.

In a his blog post, Rajiv Sethi draws attention to the possibility that encouraging developments over the last few years in many parts of Africa may have laid the ground for these countries joining the group of high-growth emerging economies provided they are supported with a "big push" on investments in education and infrastructure. In order to finance this, Ngozi Okonjo-Iweala of the World Bank proposes the diversion by donor nations of a portion of anticipated future foreign aid in order to back a current bond issue, effectively securitizing these flows.

The "big push" model may also have a critical role to play in understanding India's economic growth prospects. This is especially so if the decade-long high GDP growth rates are to be sustained and the fruits of development are to reach the millions of poor living in the country's villages. Like in the American South in the inter-war years, rural India requires a co-ordinated push towards investments in roads, schools, water and sewerage, power plants, dams, telecommunications, hospitals, and other infrastructure. These investments and the externalities generated by them would create the conditions that unleashes the full potential for a long period of manufacturing and services-led economic growth.

Further, the economic reforms over the past decade-and-half and resultant spurt in economic growth may have pushed the Indian economy into Krugman's "overlap" zone, from where convergent expectations about large-scale investments can contribute towards achieving development in the country's rural backwaters.

New "facts" on economic growth theories

Charles I. Jones and Paul M Romer have a new working paper which revises Nicholas Kaldor's six "stylized" facts that summarized the patterns discovered in national income accounts of economic growth in the 20th century and the growth models that explained these patterns. In contrast to Kaldor's physical capital centric facts, Jones and Romer identify four interesting endogenous variables - ideas, institutions, population, and human capital - and focus on models that uncovered subtle interactions between these variables to answer questions on growth and trade.

Kaldor had identified six stylized facts about economic growth - labor productivity has grown at a sustained rate; capital per worker has also grown at a sustained rate; the real interest rate or return on capital has been stable; the ratio of capital to output has also been stable; capital and labor have captured stable shares of national income; among the fast growing countries of the world, there is an appreciable variation in the rate of growth 'of the order of 2–5%'. All these facts are embodied in the neo-classical growth model and part of any other subsequent explantions of economic growth.

Jones and Romer have their list of new stylized facts about economic growth today.

1. Increases in the extent of the market. Increased flows of goods, ideas, finance, and people — via globalization as well as urbanization — have increased the extent of the market for all workers and consumers.



2. Accelerating growth. For thousands of years, growth in both population and per capita GDP has accelerated, rising from virtually zero to the relatively rapid rates observed in the last century.



3. Variation in modern growth rates. The variation in the rate of growth of per capita GDP increases with the distance from the technology frontier. The variation of growth rates is much smaller for the richest countries than for the poorest. Both rapid catch-up growth and tremendous lost opportunities can be seen in the growth experiences among the poor.



4. Large income and TFP differences. Differences in measured inputs explain less than half of the enormous cross country differences in per capita GDP. A large TFP residual accounts for a large share, at least as large as the measured factor inputs, of the differences in levels of per capita GDP across countries. Poor countries are poor not only because they have less physical and human capital per worker than rich countries, but also because they use their inputs much less efficiently.



5. Increases in human capital per worker. Human capital per worker is rising dramatically throughout the world. The sustained increases in educational attainment may largely explain this.



6. Long-run stability of relative wages. The rising quantity of human capital relative to unskilled labor has not been matched by a sustained decline in its relative price. Despite the large increases in educational attainment by some people in the United States, the wage premiums associated with college and with high school show no tendency to decline. The standard interpretation of this fact is that skill-biased technical change has shifted out the relative demand for highly-educated workers, more than offsetting the downward pressure on the wage premium that is associated with the increase in their relative supply.




They write, "In the near term, we believe that this model should capture the endogenous accumulation of and interaction between three of our four state variables - ideas, population, and human capital. For now, we think that progress is likely to be most rapid if we follow the example of the neoclassical model and treat institutions the way the neoclassical model treated technology, as an important force that enters the formalism but which evolves according to a dynamic that is not explicitly modeled. Out on the horizon, we can expect that current research on the dynamics of institutions and politics will ultimately lead to a simple formal representation of endogenous institutional dynamics as well."