Technological Progress

Technological Progress

What happens in the neoclassical model when technology does
change? A sudden revolutionary change can shift up the productivity
of capital. The AP curve in Figure 7.1 will thus shift to AP1 (see
Figure 7.2). Note that the downward sloping curve still remains –
diminishing returns to capital accumulation still operates – but now
the equilibrium capital per person will be arrived at point k**.
Standards of living have risen. A technological breakthrough in this
model causes a short-term boost in growth rates, only for the eventual
result to be zero growth again (albeit at a higher income level).
Growth/interest rates

Thus with a one-off technical change, income per head will rise
to a new level and then remain constant again.
The only way that per capita incomes can continue growing,
according to this theory, is for technical change to keep happening;
for the stalemate of diminishing returns – where average product
equals the rate of time preference – to keep being postponed. Thus
AP shifts out from AP to AP1 to AP2 to AP3, and so on, and equilibrium
capital per person keeps moving from k* to k** to k***,
and so on.
Neoclassical theory predicts, therefore, that the only explanation
for long-run growth is technological progress (Box 7.1).
The late history of the Soviet Union seems to corroborate the
neoclassical claim that technical change is essential. In the last
decades of its life as a command economy, the USSR was faced
with declining economic growth. The nation had the highest
investment rates and the highest labour participation rates in the
world. More and more marginal lands were also devoted to
production of agriculture or industry but growth rates still
declined and, fatally, rates of productivity were stagnant. No
matter what innovations were tried, output per person and output
per capital both failed to rise. The command economy had
increased the quantity of inputs in production up to the limits of
full employment but the country could not increase the quality or
productivity of those inputs. It was thus condemned to suffer
diminishing returns. Advanced technology was employed in Soviet
military applications where its use could be strictly controlled but
the command system prevented its free deployment elsewhere. As
a result, the standard of living of the average Soviet citizen stagnated.
There were queues for even the most basic of essentials
such as bread and meat. In the end it was the dissatisfaction of
ordinary people with their economic circumstances that brought
about the overthrow of central planning in the enormous
command empire that stretched from Berlin to Vladivostok.
Box 7.1 Technological progress and the Soviet Union
© 2004 Tony Cleaver
The problem with the neoclassical growth theory, of course, is that
it has no explanation for technical progress. Where does it come
from? In the earlier theories it is simply assumed to drop like
manna from heaven, yet this theory concludes that technology
is the only means to break the hold of diminishing returns.
Subsequent empirical studies showed that for countries such as
the US and other developed nations it was not so much physical
capital but increases in its quality, TOTAL FACTOR PRODUCTIVITY, that
accounted for a significant fraction of their modern economic growth.
How and why? More theorising was clearly called for.
Endogenous Growth Theory
Solow’s neoclassical model led eventually to a growth theory that
was built upon, or endogenised, the process of technical change. If
growth spawns advances in technology and, in turn, such advances
are not subject to the principle of diminishing returns, then the
spread of technology will engender increased growth and this will
cause further technical change, ad infinitum. What might explain
such a chain reaction? In the 1980s, Paul Romer introduced just
such an ENDOGENOUS GROWTH THEORY by emphasising the roles of
ideas and of human capital.
Unlike most other economic goods, a profitable idea is nonrivalrous.
My use of this idea does not deny yours. For example, in
the agricultural revolution that first led to economic growth in the
UK in the eighteenth century, ideas like sowing seeds in straight
lines and rotating crops in fields represented a great breakthrough
in technology. So too was the invention of calculus; steam power;
flow line production; healthy diets; DNA; the Internet. Profitable
ideas like these may have taken years to evolve but they can be
copied quickly and without denying access to the original innovator.
One person or a thousand people can thus pursue a new technology
with no diminution in the productivity of the idea. That is, ideas are
not subject to diminishing returns.
Profitable ideas do not come like manna from heaven nor even
from a broad cross section of the population. They are themselves the
product of much education, training and active experimentation – the
accumulation of human capital. Primary and secondary education,
universities, research laboratories, media of mass communication all
© 2004 Tony Cleaver
need to be set up. As Thomas Edison said: genius is 1 per cent
inspiration and 99 per cent perspiration. True, there is an irreducibly
random element involved but there is nonetheless a lot that can be
done by investing in research and development if you want to
generate improved technological progress.
Romer’s growth theory makes the same starting assumptions as
the neoclassical model – competitive markets, flexible prices, mobile
resources – but not with respect to the returns to capital. As
explained, the productivity of ideas applied to industry – technology
– will not lead to diminishing returns but instead to
constant returns to capital invested. Thus, in Figure 7.3, average
productivity does not fall as capital per person increases. And so
long as returns are higher than the rate of time preference, then
business will continue to invest and growth will continue to raise
incomes, engender more ideas, more technology, more growth and
on and . . .
Social Capital
Endogenous growth theory gives a role to governments as well as
to markets. Although much investment in research and development
can be undertaken by private business concerns, it can only be
Growth/interest rates
AP Average
productivity
5% Rate of
time
preference
Capital per
person
Growth
Figure 7.3 Endogenous growth theory.
© 2004 Tony Cleaver
Pure public goods like national defence confer social benefits
that are non-excludable. They cannot be packaged, restricted in
supply and sold only to paying customers for a profit. (If I am
protected by my country’s armed services then so too is my
neighbour.) MERIT GOODS, such as education and health services,
are excludable (and thus can be provided to some by private
enterprise) but the social benefit in opening access to all is
judged to be so great as to warrant their public provision.
Formal education is an excludable merit good (schools can
decide which students to exclude or not) though it nonetheless
confers many external benefits on society. You and I benefit if we
both live in a community where everyone else is educated.
Primary and secondary education provided only by a market
system is likely to be highly inefficient and inequitable. Just a
minority would be able to afford private schooling and who
knows what talent would thus go undiscovered, uneducated?
How many potentially brilliant scientists, engineers, artists and
musicians escape the net in poor countries whose genius, if
cultivated, might otherwise transform these nations?
State provision of schooling is thus necessary, though expensive.
To produce one Einstein you have to educate millions at
primary level before a process of selection, much later, can identify
the research abilities that can be employed at postgraduate
level.
Note that market allocation of educational services becomes
less inefficient, the more able it is to spot talent. The most prestigious
universities can pay for themselves in the private sector
since in their late teens and early twenties students can better
calculate whether or not they have a reasonable chance of
gaining the skills and career contacts from these institutions
that will enable them to earn high financial rewards. That is, at
this age, the private consumer can make a good guess that the
rate of return on his/her educational investment will, or will not,
be measurably above the rate of time preference.
Box 7.2 Private and social returns to education
© 2004 Tony Cleaver
based on the social capital that the public sector already provides
and it could not occur without it. Free markets fail to supply what
we know as PUBLIC GOODS AND SERVICES since there is no profit to be
had from so doing. Millions of people receive state primary and
secondary education because an educated populace confers external
benefit to society. For the same reason, the state builds transport
and communication networks of open access that facilitate the
mobility of resources. No independent business will educate all children
and provide roads for the entire nation since a private
enterprise cannot recoup this investment. But without basic education
and transport and communication services, how can the private
sector ever recruit the resources necessary to invest in technological
development? The state must provide the foundation upon which
the market can build (see Box 7.2).
Without the support of the state, therefore, technical progress
will be limited and insufficient to generate growth. But having
opened this Pandora’s box, Romer’s growth model cannot give
precise instructions as to what exactly must be done next. All sorts
of variables can impact on technological progress – for example,
should government allocate funds to basic research or should this
be left to the financial markets? Should infant technological industries
be subsidised, and if so, for how long? Public officials might
find an excuse for all manner of government interventions. Where
do you draw the line?
Growth theories can go only so far. Reviewing the empirical
evidence helps to fill in the gaps in our knowledge and this has led
to an active debate over which precise policy recommendations are
important to stimulate growth.