International Business Economics - Essay Example

 International Business Economics Introduction Economic growth has always been a source of constant interest among economists as it is the core element of evolution of a country. Economists have come up with different sources that contribute to the growth of a nation and commonly synthesized elements in the literature include capital, labour and productivity growth. This paper focuses exclusively on the idea of total factor productivity and undertakes a critical evaluation of it as a determinant of economic growth. The origin of total factor productivity (TFP) could be traced to the work of Tinbergen (1942) who had defined TFP as a ratio between: This concept was later popularized in the work of Solow (1957 cited in Prescott, 1998) who had established that the economic growth models which suggest that growth occurs exclusively from accumulation of resources is unlikely to be permanent and enhancement of productivity is fundamental to generate economic growth. Therefore, there is no singularity in the opinion of researchers regarding the determinants of growth yet there is no denying the fact that TFP is important for economic growth. There is now a growing consensus among researchers that much of the differences between income per capita between the developing and the developed countries can be accredited to TFP differences. The concept of TFP is quite broad and it includes a number of factors like education, health and skills of the entire human technology, utilization of technology possessed by a country and the absorptive capacity of the economy (Miles and Scott, 2005). Therefore, this essay studies the link between TFP and human capital, TFP and technological progress and finally determines the impact it has on the overall economic growth of the nation. This paper first introduces the concept of TFP, the way in which it can be measured and its main determinants. Then the relation of TFP with human capital and technology is explained in details. Finally, the impact that TFP has on the economic growth is discussed. The burgeoning literature on the South East Asian countries and its growth determinants has also been studied to understand the role of TFP. Discussion Concept of TFP There are two primary factors for which the concept is aligned to a neoclassical one namely productivity is measured for every factor of production and it has been integrated in the production function. The basic definition of TFP remains same in the works of most of the researchers who observe it as a ratio between net output and the factor inputs. An insightful explanation of the term has been provided in the works of Comin (2006) who had stated that TFP accounts for that part of the output which are not produced by inputs employed in the production process. It is rather the output which is produced from utilizing the means of production in an efficient manner. According to the idea developed by Solow (1957) TFP have a wide implication on the economic growth of a country by altering the income per capita. Measurement of TFP The past studies suggest that there are four major ways in which TFP can be measured (Sloman, Norris and Garrett, 2013). The first one is the least square production models of econometrics, the second one is the growth accounting techniques, third one is the data development analysis and the fourth type is the stochastic frontier models. The first two groups of models can be considered as time series approaches measuring data of individual nations across various years. These approaches consider that production units are efficient in terms of technology. The other two sets of method use cross section method to find differences in productivity between regions (Sloman, Norris and Garrett, 2013). The first one relates to concept that was developed by Solow known as the Geometrix index. His approach has also been defined as the residual approach which employs a growth equation in order to determine the TFP. The contribution of the physical capital is taken into account in this approach and actual growth that cannot be explained by the physical factors is attributed to productivity improvement. However, this method suffers from a number of drawbacks like missing information regarding the wages and profits. In order to overcome the limitations of Solow’s approach other measures of TFP use regression equations (Van Beveren, 2012). In the approach of regression equations a fundamental problem is that the value of residual keeps on falling as the researcher increases the number of dependent variable. For instance, the research of Liu and Rivkin (1993 cited in Lin, 2003) had shown that in classical equations which use simple labour and capital endowments are unable to account quality differences of factor inputs like labour and capital. Hence their viability of measuring growth is questionable. If the growth equation accommodates the qualitative difference between labour and capital then the value of the residual falls and the measure of TFP changes. Determinants of TFP Over the course of time the research on TFP has strengthened and till date a number of independent factors have emerged. One of the common variables is the capital accumulation or intensity of capital use by the economy (Kim and Lau, 1994). The amount of capital that is invested in capital equipments like plants and machinery has a direct implication on the output. Another major determinant of TFP is the amount of investment that is made in development of human capital. The role of human capital in the overall growth of productivity is well accepted as improvement of human capital through investments made in education and health sector of the economy is likely to improve the capacity of the people to carry out innovation (Kim and Lau, 1994). Improvement in the workforce like development of superior skills automatically creates better products and services. Therefore, development of human resource through adaptation of training programs and ensuring better education of the population improves the overall productivity. The research conducted by Meyer (2001 cited in Teixeira and Fortuna, 2010) had shown that importing of superior quality of goods relating to production positively affects the quality of human capital in a country. Finally, technical progress of the economy is also an important determinant of the overall productivity. Technological advancement has long been identified as a major source that contributes to the economic growth. Many researchers have shown that not all the countries are endowed with similar technology but technology can be adopted effectively by other countries to improve their growth (Teixeira and Fortuna, 2010). The most common avenues of technological transfer are foreign direct investments (FDI) and trade between nations. For instance, the research of Keller and Yeaple (2003) had shown that the impact of FDI flows on the economy is profound and FDI have maximum spill over effects on the technology sector. Trading of equipments and machinery related to research and development has been found to have a strong impact on productivity growth. The view of Pickles (1990 cited in Frankel and Romer, 1999) tries to integrate the approaches of technological progress and human resource development as sources of TFP. He had argued that it is both technological progress which and human capital and it should be combined together to understand TFP. Total factor productivity and Technological Progress There is a great debate regarding the understanding of what constitutes technological progress. According to the research of Chen (1997), most of the research works of the neo-classical school of thought considers any type of technical progress as a part of TFP. Technological progress has always been considered to be predetermined in the neo-classical models while the endogenous growth theorists consider it to be related to investment, education and learning by doing activities. In this context the works of Aigner, et al. (1977 cited in Bauer, 1990) are quite insightful as it considers a breakdown of TFP into two broad segments namely technological progress and technical efficiency. This implies that any improvement in the TFP that emanates from advancement and diffusion of technology can be considered as technological progress whereas any changes that take place in moving the production closer to the production possibility frontier can be regarded as improvement in technical efficiency. The distinction between technological progress and technical efficiency has been particularly helpful in understanding the course of action of the developing countries. This is because if too much emphasis is given on technological progress then subtle efforts to improve technical efficiency is neglected and full potential of the country is not realized. Further works of researchers like Kumbhakar and Lovell (2000) had shown that technological progress in measuring TFP can be broken into four main segments. The first two were already identified in the works of Aigner, et al. (1977 cited in Bosworth and Collins, 2003) and the additional components were scale effects and efficiency in allocation. Therefore, issues in correct form of measurement of technological progress are also concerns for measuring TFP. A completely different view was presented in the research of Carlaw and Kosempel (2004) regarding the role of technological progress in TFP. Their research had studied the growth dynamics of Canada before reaching the conclusion that TFP should be divided into two broad components called investment specific technology and residual neutral technology. Their research had shown that technological progress may not be an appropriate component to measure the TFP. Technological progress is better captured by investment specific technology. Based on these works it is almost impossible to have a singular opinion regarding technological progress and its role in TFP. Specific components of technology are rather important drivers to measure TFP. Total Factor Productivity and Human Capital One group of researchers had considered human capital as input in the production function while others have included it as a factor of productivity growth (Foster and Rosenzweig (19950. The relation between TFP and human capital has been studied by a number of researchers. For instance the research conducted by Foster and Rosenzweig (1995) had shown that nurturing the human capital of a country allows them to develop a comparative advantage to implement new technologies. Human capital has a positive influence on the total factor productivity. Human capital impacts TFP both directly and indirectly. Researchers are of the view that human capital helps in spreading technological diffusion mainly by interacting with the level of FDI in the country. In fact, the explanation of human capital as a source of productivity difference has been incorporated in the neo-classical models when technology gaps were not able to explain the difference between the levels of growth. Mankiw (1992 cited in Miller and Upadhyay, 2000) thought that it was imperative to look beyond physical technological progress and human capital became an alternative avenue to express the growth in TFP. One of the biggest limitations of the exogenous growth models was that it did not account for the sources of technological improvement and considered it to be given beforehand. This was however not the case and avenues such as human capital improvement has emerged. Human capital leads an increase in the TFP by causing technology spillovers. Human capital has also been identified as a source causing innovation. These views are however not uncontested as most of the researchers found divergent empirical evidences regarding the impact of human capital and TFP. Fleisher and Chen (1997 cited in Miller and Upadhyay, 2000) have found a positive relationship between human capital and TFP growth but others find a negative relationship. A number of reasons have surfaced for the variation in results. Problems like difficulty in the measurement of human capital and its endogenous nature have dominated the debate of measuring it effectively. Economic growth and TFP The phenomenon of economic growth had diverse explanation in the due course of time. Four strands of literature can be identified that tries to explain the course of economic growth. First strand of literature conducts analysis of economic growth by using regression equations while the second strand of literature focuses on the role of public policy. The third group highlights the importance of the investments made by an economy and its acceptance of trade liberalization. The final strand of literature recognizes the importance of TFP. However, majority of the work done in this field have tried to distinguish between accumulation of factors and productivity growth. In other words, the role of TFP in economic growth has come under a lot of scrutiny. There are mainly two category of debate which has emerged regarding the role of TFP. The first group is the fundamentalists who claim that inputs were mainly responsible for the growth of the economies of South East Asian countries and the other group is called the assimilationists. It is the second group which has supported the idea that economic growth is largely driven by improvements in the TFP. The basic idea of the assimilationists is that the growth of the South East Asian countries was largely driven by adaptation of superior technology from the foreign countries particularly (Carlaw and Kosempel, 2004). Before understanding the reasons for which TFP can be considered as a contributing factor of economic growth it is imperative to understand the avenues which stimulate growth. The earliest explanations for this came from Solow who had considered all the growth that could not be attributed to labour and capital to increases in productivity. Solow had asserted that the growth of a given technology growth of a country reaches its maximum value determined by its sum of labour and productivity growth. So, if there is no technical progress in the economy the growth cannot be ongoing as diminishing returns set in and growth finally stagnates. Solow’s analysis did not provide a clear idea regarding the elements of TFP. In this regard, the research of Bosworth and Collins (2003) can be regarded as insightful as it provides a comprehensive idea regarding the components of TFP and the way it affects growth. Factors like openness of trade of a nation, institutional practices of nations, geographical factors and government policies are all variables that affect TFP which in turn causes higher economic growth. The researchers have also included intangible factors in explaining TFP. Combination of these factors has been termed as catch-up effect. They commented that human capital is a key variable that improves the TFP of a region and the investments made in the R&D of the country are also important determinants of TFP. It is the development of human capital which is the primary factor causing growth of the South East Asian countries. The proponents of endogenous growth models and neoclassical growth models have different stances on the role of productivity growth. There is a strong debate among researchers regarding the role of productivity as a source of economic growth because the works of Young (1995) had shown that the role of total factor productivity was almost negligible in the successful growth of the South Asian countries. The study conducted by Young (1995) had considered Singapore in his sample and had shown that total factor productivity of the country had improved only by 0.2% from the time from 1960-99. Their research had primarily focused on the role of capital as the source of growth. Also the role of input-driven growth was clearly visible in the responses of the researchers. The work of Krugman (1994 cited in Bosworth and Collins, 2003) had stated that the growth of a country strongly depends on its ownership of resources and the growth in the total factor productivity. By including the role of TFP in his thesis, Krugman had placed importance on the neoclassical growth models. Krugman had also commented that the growth of South East Asian countries was not going to be sustainable as it did not include TFP. The empirical research conducted by Baier, et al. (2002 cited in Joutz and Abdih, 2005.) also supports the findings of Young as they had found that TFP did not explain the growth of most of the countries considered by him in his sample. The staunch opposition against the explanation provided by Young can be observed in the works of Solow who had propagated that any growth which is propelled by inputs are not sustainable as inputs are subjected to law of diminishing returns. The notion regarding the role of TFP remains unclear as there is no agreement regarding the topic. The works of Solow had later been empirically tested by other researchers like Hall and Jones (1999) who had found validity of the Solow model regarding the fact that TFP causes differences in the income of rich and the poor countries. Most of the researchers belonging to the neo-classical school of thought had argued that the differences in the level of physical technology between countries and the efficacy of the use of these technologies are key channels which determine productivity growth of the nation (Hall and Jones, 1999). The research conducted by Felipe (1999) can be treated as a disenchantment of the existing debate regarding the contribution of TFP in economic growth. This paper had conducted a thorough review regarding the chosen matter and has rather reached dramatic conclusions. The core theme of the paper was to analyze the growth of the South East Asian countries based on the fundamentals of the Solow growth model and its proponents. The results reached by him had shown that there are five fundamental problems regarding the acceptance of Solow’s model of productivity. Firstly, they had shown that the concept of technical progress described in most of the papers is exogenous and fragmented. Felipe (1999) argues technological progress should be included in factors of prodcution. Secondly, the research had pointed out that the idea of breakdown of several components of growth is not a very sound concept as most of the factors are complementary to one another. Under conditions of imperfect competition in the labour market it also becomes difficult to measure elasticity so decomposition of factors of growth is redundant. The third factor according to his study was the intervention of the government actions in the South East Asian countries and the impact that they had on the overall growth. The neoclassical production function is unable to capture the overall policies taken by the government in a country. Fourthly, he finds that TFP is an inadequate measure because it does not account for the way in which the South East Asian countries have technology from foreign countries. Finally, the most important drawback of TFP approach is that the inherent weaknesses of production function to provide a comprehensive view of the overall growth. Based on these arguments Felipe had concluded that total factor productivity growth is not a major determinant of the growth miracle experienced by the South East Asian countries. There is no common consensus regarding the effects of TFP on overall economic growth. However, based on an extensive study of the existing literature few factors have been distilled and these are now being widely accepted as a source of economic growth. These variables are very common and have widely emerged in the works of a number of researchers (Nachega and Fontaine, 2006). The role of government and fiscal policies: If the expenditure of the government is very high and the rate of savings is poor then the rate of taxation on the households and commercial activities are high to fund the expenditure and the overall efficiency of economic activity is affected adversely. Similarly, if fiscal deficit to GDP ratio is very high then macroeconomic stability is affected and the overall TFP is hampered. So government policies and fiscal policies are important determinants of TFP (Jones, 1995). Price Stability: In an economy the monetary policy and the consequent price level is crucial to determine efficient market outcome. This is because very high expansionary monetary policy may fuel inflation in the economy and undermine the productivity of the investments. Poor investment and in turn poor productivity can also hamper economic growth. Therefore maintaining stability in monetary policy is important for determining both productivity and growth of the economy (Nachega and Fontaine, 2006). Trade liberalization and openness: The extent of trade liberalization and openness of economy has been recurrent in the discussions of the researchers as a key to enhance productivity growth of the economy. An open economy is one where investment in technology happens through trading and this increases the well being of the country as a whole. Though the view has been contested, there is no denying the fact that trade liberalization did help the Asian countries to adopt better production techniques (Reinert, 2011). Financial Sector: A good state of the financial sector is also crucial to ensure that the rate of savings is high and overall economic efficiency is stable. Proper financial sector stability is required to allocate the resources to the most important projects so that maximum productive gains are obtained. Development of the financial sector helps in overall growth of productivity and this in turn causes higher economic growth. Echoing this sentiment the research of Beck, Levine and Loayza (2000) had shown that development of financial sector development helps a country to achieve higher economic growth and this happens mainly by stimulating the TFP of the inputs. Physical Capital: Accumulation of capital has long been a component of economic growth. Many researchers have argued that formation of physical capital can be equated with the investment that is made in the economy. Investment in plant and machinery is also regarded as a part of the quality capital formation causing higher economic growth (Nachega and Fontaine, 2006). Human capital formation: Education of the workforce has been treated as an important variable to improve the quality of human capital and economic growth. Working on specific skills of the workforce also allows them to absorb the new technologies to improve production. Terms of Trade: This is another factor which can cause growth of TFP and economic growth. The association of the business cycle and TFP makes terms of trade an important variable particularly for the developing countries. A combination of all of these factors has been considered to be influencing TFP and overall economic growth of a nation. The fragmented treatment of TFP is not a good way to understand its impact on economic growth. Rather a combined picture provides a better understanding about economic growth. Conclusion From the present research it appears that there is no single determinant of economic growth. The aspect of TFP is a highly complicated one both in terms of its components and measurement. This is because the empirical literature regarding the hypothesis is mixed and the theoretical framework has been questioned vehemently. There are evidences of TFP being a major contributor to economic growth but questions regarding what constitutes TFP is blurred. It would be best to decompose TFP according to components. For instance, technological progress which is considered to be a major factor in economic progress should not be considered as an overall constituent of TFP. It is rather effective to break it down into its components before analyzing the results. The debate regarding the TFP and its impact on the economic growth of the South East Asian countries had renewed the interest of researchers. A close analysis of the concept of TFP reveals that there are certain issues regarding its specification and measurement which makes reaching a dramatic conclusion difficult. The debate between input driven capital growth and productivity driven growth represents half picture of economic growth. Therefore they should be treated as supplements and not complimentary. Exclusive neo classical view that technological factors are exogenous may not be an appropriate measure to understand TFP. The endogenous growth models have come to supplement the neo classical views to explain the source of economic growth. The inclusion of human capital, trade and technology transfer in the economy explains how a country moves towards a higher growth levels. Apart from these factors, effects like the policies taken by the government namely monetary and fiscal policies are also important determinants of TFP and growth. So, economic growth is indeed influenced by a lot of variables and TFP is one of them. 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