The determinants of economic growth a case study of six southeast asian countries

The results indicate that the most important source of economic growth of these countries is capital accumulation and labor.. Keywords: Economic growth, determinants, Capital, Labor, Pop

UNIVERSITY OF ECONOMICS ISS-INSTITUTE OF SOCIAL STUDIES

VIETNAM-NETHERLANDS PROGRAMME FOR MASTER’S DEGREE

IN DEVELOPMENT ECONOMICS

THE DETERMINANTS OF ECONOMIC GROWTH: A CASE STUDY OF SIX SOUTHEAST ASIAN COUNTRIES

MDE-K16

HO CHI MINH CITY, DECEMBER 2012

ACKNOWLEDGMENT

I’ve experienced the great time in this course with acquire academic knowledge, open-mind to approach new things, and be straightforward to express ideas I’ve guided by open-mind lecturers who always encourage us to express our opinions and discuss it This is really quality and extensive course We’re encouraged to be ourselves and be self-confident to discuss ideas, it’s really meaningful thing Sincerely, I would like to take this opportunity to express my honest thanks to the Vietnam-Netherlands Master Program for Economics of Development for the interesting and extensive curriculum, as well as sincere thanks to all of people who engage in this course such as management board of this program, lecturers, tutors

To fulfill this course, I’ve received the help and support from many people such as director and vice director of this program, lecturers, tutors, my supervisor, classmates, friends, course administrators, librarians of MDE & Fulbright, and other people who give me the instructions, comments, advices, supports, sympathies, and encouragement during the course process Without these things, I could not fulfill the Thesis and finish the course

First of all, I would like to express my gratitude to my supervisor – Dr Nguyen Minh Duc, who always remind me to finish the Thesis timely and make me determine to finish the Thesis with high effort, very patient and sympathy with me for delaying the time of submitting Thesis, spent his valuable time to help me, give comments and correct the Thesis mistake by mistake From bottom of my heart, I sincerely thank him for all

I would like to express my special thank to Dr Nguyen Trong Hoai - Director of the Program, Vice Principal of UEH He fosters us to study and finish the course actively and efficiently, take care of us step by step And special thanks to Dr Pham Khanh Nam steps with us to overcome obstacles in thesis process honestly, give us the valuable advices and encouragement to finish the thesis

Thanks to TRD board defense give me valuable comments and advices to continue this topic Thanks to Dr Phan Minh Ngoc supplies me materials at my TRD time Thanks to Dr Le Dinh Truc gives me valuable comments and advice on panel technique in Eview And thanks to tutor Phung Thanh Binh for helping us honestly

in the course

Thanks to all classmates in MDE-K16, all of you support me unconditionally with discussions, talks, shared materials, team working playing, and other Thanks to friends Thu Huyen and Thanh Tien, your sharing materials are very useful for me Hope all of you fulfill this course and get success in your life

Lastly, I would like to thank to my dear family, warm friends that supports and sympathies with me for spending most time on studying this course

Thanks all for all, hope you will be happy and successful in life

I pledge to take full responsibilities for mistakes, errors, omissions and shortcomings of the study

ABTRACT

This study based on the neoclassical growth theory, an extended version of this model As common trend, Cobb-Douglas production function is used to evaluate the robustness of determinants of economic growth in a dataset of six Southeast Asian countries from 1993 to 2009 The fixed effect model (FEM) is used to estimate this model The results indicate that the most important source of economic growth of these countries is capital accumulation and labor

Keywords: Economic growth, determinants, Capital, Labor, Population growth,

Government expenditure, Southeast Asian countries, Neoclassical Model, Douglas production function, FEM

Cobb-TABLE OF CONTENT

CHAPTER 1: INTRODUCTION 1

1.1 Problem statement 1.2 Research structure CHAPTER 2: RESEARCH OBJECTIVES & RESEARCH QUESTIONS 5

2.1 Research objectives 2.2 Research questions 2.3 Research scope 2.4 Research contribution CHAPTER 3: LITERATURE REVIEW 7

3.1 General Overview 7

3.1.1 Concept and Definitions 7

3.1.2 Traditional methods of examine determinants of economic growth 13 3.1.3 Measurement indicator group of development and growth 14

3.1.4 Overview of economic development theory 15

3.1.4.1 Classify theories by time 15

Classical theory Neoclassical model Endogenous Theory 3.1.4.2 Classify theory by four main classes 21

Linear stages of growth theory Structural change theory International dependence theory Neoclassical counter revolution theory 3.2 Theoretical Framework 26

3.2.1 Production function Cobb-Douglas 26

3.2.2 Harrod-Domar Growth Model 28

3.2.3 Neoclassical model-Solow model 29

3.2.4 Capital Fundamentalism 30

3.3 Empirical Review 30

3.3.1 Development and growth of Vietnam and Southeast Asia 30

3.3.2 Review the empirical studies 33

CHAPTER 4: RESEARCH METHODOLOGY 39

4.1 Analyzed Framework 39

4.1.1 Model 1- Traditional neoclassical model 39

4.1.2 Model 2- Extend neoclassical model 40

4.1.3 FEM is selection for estimation 40

4.2 Variables 44

4.2.1 Dependent variable: GDP per capita 44

4.2.2 Independent variables 44

4.3 Data Description - Data collection – Data analysis 50

CHAPTER 5: DATA ANALYSIS AND DISCUSSION 52

5.1 Descriptive Statistics Analysis 52

5.1.1 Descriptive Statistics

5.1.2 Correlation Matrix 54

5.2 Econometric Analysis 54

5.2.1 Whether FEM or REM is more suitable 54

5.2.2 Model 1 – Traditional model 58

5.2.3 Model 2 - The Extened Neoclassical Model 59

5.3 The limitations of data, and modeling techniques 61

CHAPTER 6: CONCLUSION AND POLICY RECOMMENDATION 63

6.1 Main findings 63

6.2 Managerial Implications and Policies 64

6.3 Limitations and future research 65

REFERENCE 67

APPENDICES 71

APPENDICES

A: Data of GDP, Capital, Population growth, Labor, Government expenditure 70

B: Descriptive statistics of each country 77

C: Correlation Matrixes of each country 79

D: Residual Graph 81

E: Regression Results 82

F: Main Empirical studies Summary 92

E: Regression results 81

LIST OF TABLES

Table 3.1: Sources of Growth in East Asia, by Country and Period 37

Table 4.1 Estimated Capital-Output ratio some Asian Countries 1980 45

Table 4.2 Range forecast of COR for 6 countries 46

Table 4.3 Summary of variable 49

Table 5.1 Sample observations - Descriptive statistics - sample: 1993 2009 54

Table 5.2 Correlation on the sample observations 54

Table 5.3 Model 1 - A comparison of results with FEM 55

Table 5.4 HAUSMAN TEST for MODEL 1 55

Table 5.5 Model 2 - A comparison of results with FEM 57

Table 5.6 HAUSMAN TEST for MODEL 1 57

Table 5.7 Estimated results for FEM with tradition model (Model 1) 58

Table 5.8 Estimated results for FEM with extended model (Model 2) 60

LIST OF FIGURES

Figure 3.1: Population of 1993 of countries 9

Figure 3.2: Population of 2009 of countries 9

Figure 3.3: GDP per capita of 1993 of countries 10

Figure 3.4: GDP per capita of 2009 of countries 10

Figure 4.1: Conceptual Framework of the study 39

Figure 5.1: GDP per capita of 6 countries for the period of 1993-2009 52

Figure 5.2: Capital per capita GDP per capita for the period of 1993-2009 53

Figure 6.1: An overview of determinants of economic growth of countries 64

ABBREVIATIONS

COR : Capital output ratio

DCs : Developed (high-income) countries FEM : The fixed effects method

GCF : Gross Capital Formation

GFCF : Gross fixed assets formation

GDP : Gross Domestic Product

ICOR : Incremental capital output ratio LDCs : Less developing countries

LICs : Low-income countries

LSDV : The least-squares dummy variable OLS : Ordinary Least Square

PCI : Province Competitiveness Index REM : Random Effect Model

CHAPTER 1: INTRODUCTION

1.1 Problem statement

The human kind history experienced a very long period of changing and developing

process During a rapid development process since the century of 19th, with an

increasing growth in income and standard living, people’s welfare is improved

considerably In second haft of the 20th century, most countries have doubled their

real income per capita when hand over from this generation to the next one In

particular, the rise of East Asian economies so called “Miracle” opens up important

turning-point and attracts attentions of policies makers and researchers

However, there are a lot of emerged questions such as:

(a) Why are some countries rich, and other poor? How some countries develop

very quickly and stably with their citizens enjoying rapid increases in their

average incomes, meanwhile others development are very slow or not at all?

(b) What are the determinants of economic growth and the characteristics that

distinguish fast-growing from slower-growing countries?

And as can be seen, after thousands years of very slow economic growth, the world

economy suddenly experienced an enormous change explosion, but why it did not

occur earlier; and why it occurred where it did, this country instead of that country

Normally, developed and developing countries focus on how to foster economy in

balance between fast growth and sustainable development As a matter of fact, it’s

very challenging question and not easy to find out the unique solution As there’s no

a general answer for growth problems of developing countries, economists suggest

some approaches to impulse the growth process Firstly, that is applying open

commodities markets but isolating from international capital market in order to

stabilize and increase economic independence Secondly, developing countries can

choose industrialization way by their own policies such as indirect subsidization

Thirdly, they can combine these policies above depending on specific conditions of

Commented [m1]: So ambitious to solve in this study; should

delete

Commented [m2]: Rewrite into one paragraph

each nation However, the issue here that is developing countries need to consider which best solutions they should choose to benefit economic most

Since 1975, when being reunified, Vietnam had applied a central planning economic system following Soviet model program named “Doi moi” (1) 1986 to open out the world and built a market-based economy It began to step in a new page of history onwards As the result, Vietnam has achieved a high rate of economic growth to get out the list of least developed nations During the economic reform and growth, capital accumulation and labor played main roles in a finding by Ngoc (2008) found out That contribution from other factors such as human capital and technological progress are likely to be still limited This statement is the same for other countries

in Southeast Asia In order to achieve sustainable growth in coming years, some researches (Ngoc, 2008) suggest that Vietnam should enforce their growth based on

a working productivity improvement

Obviously, sustainable development and growth are very important for developing countries, in particular Southeast Asia The annual higher economic growth is usually a good sign; however it’s not always mean this development is sustainable or

at good statement, vice versa it can be a bubble or overheating development However, the economic growth seems to be an important indicator for evaluating a health of an economy Because of importance of economic growth of a nation, my study would like to experiment on the contribution of determinants such as capital, labor, etc… to economic growth of Vietnam and other Southeast Asian countries including Indonesia, Malaysia, the Philippine, Singapore, and Thailand through the period 1993-2009 And I hope this paper can disclose a part of development picture

of Vietnam as well as Southeast Asia nations Consequently, the suggestion for _

(1) Doi moi is the name of policy change from a central planning economic system to market economy in

Vietnam in 1986

implication policies can be made base on this research result In particular, through

it, Vietnam can get the lessons for suggestions on the trend that Vietnam should pursue for its long term stable development in coming years

1.2 Research structure:

The content of this study is divided into 6 chapters:

Chapter I – Introduction

Chapter II – Research objectives and research questions

Chapter III – Literature review

Chapter IV – Research Methodology

Chapter V – Data analysis and discussion

Chapter VI – Conclusion and policy recommendation

The chapter I is introduction

Chapter II determines the Research Objectives and Research Questions which this study will carry out in next parts

The very important content is Chapter III - Literature Review, reviews some theoretical frameworks of economic development and growth Throughout this chapter will clarify the determinants for economic growth, especially capital and labor Moreover, this chapter review some related empirical studies which analysis the relationship between factor accumulation, productivity growth and economic growth

Indispensably that is Part IV - the Research Methodology which, present the method and procedure applied in this study to answer the Research Question

The fifth part is Data Analysis and Discussion It’s very important part, in which analysis result will be presented through descriptive statistic analysis and econometric analysis as well

Continuously, chapter VI concerns conclusion, from these information to point out suggestions that will help the economic growth of Southeast Asian generally and Vietnam specifically achieve high and stability

CHAPTER 2: RESEARCH OBJECTIVES AND RESEARCH

QUESTIONS

2.1 Research Objectives

The world experienced the fastest growth in the last half of the 20th century with the

“golden age” was 1950–73 when world economic growth per capita reached a phenomenal 3 percent yearly Specially, economic growth in developing countries was much more rapid after World War II than ever before This story of growth is important as it helps determine whether societies can meet basic needs of food, clothing, housing, health, literacy, and widen human’s choice to enable people to control their environment, enjoy greater leisure, acquire learning, and use more resources for aesthetics and humanistic endeavors Therefore, as identified, the general objective of this study has been conducted to figure out the contribution of some main macro factors such as financial capital, labor, etc… to economic growth

of some Southeast Asian countries including Vietnam, Indonesia, Malaysia, the Philippine, Singapore and Thailand through the period 1993-2009 It’s expected

to disclose the trend and the real situation of Vietnam’s economic growth as well as some other Southeast Asian countries Since then Vietnam can get lessons from other countries’ development origin in this region; and suggest the trend that Vietnam should pursue for the fast and sustainable development in the future

[2] In specific case, how growth factors such as capital, labor, population growth rate, and government expenditure to industries contributed to economic growth

of Vietnam relative to some other countries in Southeast Asia?

[3] To recommend general policies for sustainable development in term of economy and society of six Southeast Asian countries

2.3 Research Scope:

This study is not ambitious for figuring out the detailed richness origin of Southeast Asian countries It just would like to present a general views for the trend of economic growth of Southeast Asian territories, and examines determinants of economic growth of few of these Though out it, this study will propose implications for achieving fast and sustainable economic growth for Vietnam as well as other developing countries in this region

2.4 Research Contribution:

There are many working papers research determinants of economic growth of countries through out the world, but just few papers research on Vietnam case as well as Southeast Asia Most countries in this area are developing countries such as Vietnam, Indonesia, Malaysia, and they always want to develop their own economy

in order to catch up developed ones in this area as well as the world Thus, it’s necessary to determine the robust factors that contribute to economic growth of developing countries Through it will support to decision makers to be aware of the determinants of economic growth, then they can build appropriate plan to foster country economy efficiently

As mentioned above, because of non ambitious for pointing out the detailed origin

of richness, this study just hope to contribute partly in order to examine and determine the main determinants of economic growth of some nations in Southeast Asia including Vietnam

CHAPTER 3: LITERATURE REVIEW

3.1 GENERAL THEORY

3.1.1 Definitions

a) Economic growth – Economic development – Sustainable development

Economic growth is the growth rate in gross product or income per capita

(Nafziger, 2006), an increase in a country’s output per capita. Similarly, economic growth happens if output increases faster than population It should be understood as changing process that creates higher real output per capita Furthermore, this process makes changes in quantity and quality of production and expenditure structure

In order to measure economic growth, economists usually use data on GDP, which measures the total income of everyone in the economy It often refers to real GDP growth of a region, or industry sector’s real income increases At the country level, economic growth is often measured by the growth rate of a country’s annual GDP

One of other important economic term is economic development It references to

economic growth accompanied by changes in output distribution as well as economic structure. It is economic growth leading to an improvement in the

economic welfare of the poorest segment of the population or changes in educational level, output distribution, and economic structural change It includes comprehensive changes in politics, culture, society, and institution

Another popular economic term is sustainable development that was coined in the

1987 at UN Commission on Environment and Development, it refers to the progress meets the needs of the present without compromising the ability of next generations

to meet their own needs Till the conference in Rio de Janerio 1992, economists define sustainable development is development to meet present need but don’t make

a bad effect to next generations In addition, sustainability means not only the survival of the human species but also maintaining the productivity of natural,

produced, and human resources from generation to generation (E Wayne Nafziger, 2006)

b) Government Expenditure

Barro (1996) specified the government expenditure can be applied in the model by the ratio of government expenditure (exclusive of spending on education and defense) to GDP, and this particular measure of government spending is intended to approximate the outlays that do not enhance productivity The common conclusion for this independent variable is a greater volume of nonproductive government spending, reduce the growth rate for given starting value of GDP In this sense, a big government is bad for growth

c) Output

GDP is a general indicator reflecting the final results (output) of production and business activities of the economy in a given period The measure of aggregate output in the nation is GDP

When we conduct a research for across countries, we should use output per capita instead of total output There’re two reasons for looking at the numbers for output per capita rather than for total output The first, the evolution of the living standard

is giving by the evolution of output per capita, not a country’s total output Secondly, when comparing countries with different populations, output numbers must be adjusted to take into account these differences in population size of countries Therefore, this is exactly what output per capita does (Blanchard, 2009) Here’s the population of 6 Southeast Asian countries in 1993 and 2009 Through it, Indonesia has the biggest population, has 186.7 mil people in 1993 and reach up 229.9 mil people in 2009, in creased by 23% Next, in descending order of population size, the Philippines increased by 37%, Vietnam 25%, Thailand 15%, Malaysia 40%, and Singapore 45%

\

While the level of GDP per capital at constant price 2005 of each countries seem vices versa the population size Singapore is the top of highest, it leaves a big gap to the next one is Malaysia The lowest GDP per capita in these times is Vietnam Surprisingly, the order or these countries doesn’t change from 1993 to 2009

3.2

3.1

d) Population and population growth rate

Population of a country is simple the number of citizens of this country in a considered time And population growth rate is increasing or declining percent of population of a country in a year compare with root year, with expected sign is negative It’s because that a higher rate of population growth have a negative effective on GDP per capita Moreover, a higher population rate means that increased resources must be devoted to childrearing rather than to production of

3.3

3.4

goods (Barro, 1996) Similarly, another research of Mankiw et al (1992) found that higher population growth lowers measured total factor productivity

Increased urbanization and congestion, rapid labor force growth, growing unemployment, and high dependency burdens are some major costs of high fertility rates and rapid population growth Contemporary LDC population growth has been faster than that of the DCs during their early transitional period because of a sharper drop in mortality rates in LDCs Today’s developing countries were able to take advantage of advances in food production, new pesticides, improvements in transport and communication, improved nutrition, better personal hygiene, medical innovations, and immunization in a short time – many of which were not available to DCs during their early demographic transition

Fertility decreases with economic development, urbanization, industrialization, mobility, literacy, female labor force participation, reduced income inequality, and greater family-planning efforts But, these efforts are not likely to be successful unless socioeconomic development and improved income distribution make birth control seem advantageous

e) Labor

In this study, Labor force or so-called economically active population, it refers to people have age from 15 and above of a country annually, and includes employed and unemployed people:

+ Employment force refers to people who have job or business but are absent in temporary because of illness, accident or other reasons

+ Unemployment force mentions to people who don’t have a job or work or never have a job but are available for work and looking for job

f) Capital stock

At any moment, the capital stock is a key determinant of an economy’s output, in particular developing countries It can change over time and these changes can effect

on economic growth obviously Two factors influence capital stock are investment and depreciation The investment refers to the expenditure on new plant, building and equipment, and it causes rise of physical capital Meanwhile, the depreciation refers to the wear of old capital and it causes the fall of the physical capital (Mankiw, 2009) According to Nafziger (2006), capital stock is total of previous gross capital investments minus physical capital consumption (depreciation), natural capital depletion, and environmental capital damage T.T Dat (2004) explained that physical capital includes inventories and fixed capital With the inventories comprise raw materials, tools, finished goods and semi-finished And fixed capital includes plant, buildings and other constructions; land improvement, plantation and orchard, transport vehicles; machinery and equipment, breeding stock, animals, dairy cattle

In general, physical capital is investment accumulation after taking account of depreciation Further more, it needs to distinguish Gross Capital Formation (GCF) from capital stock According to GSO 2009:

GCF = gross fixed assets formation (GFCF) + change in inventory

Many researches indicate that capital deepening explains more than half of the growth rate of output per worker in a majority of countries such as Charles R Hulten et al (2007) researched over 100 countries through out the world

g) Human Capital

The set of skills of the workers in the economy what economists call is human capital Obviously, an economy with many highly skilled is like to be much more productive than an economy in which most workers cannot read or write The increase in human capital has been as large as the increase in physical capital in recent decades

Human capital is investment expenditures in the education, training, research, and health of people that increase their income or productive capacity” (Nafziger, 2006)

It refers to anything that can push on higher productivity, including education and training, physical fitness and healthiness (Jacobsen, 1998) Regarding to education

and training, a higher educational attainment indicates higher quality of workers Thus, one respect of human capital is generally measured through average years of schooling of the working population, the rate between the numbers of professional secondary school/college/university students and total labor force Respect of people health can be measured by life expectancy, etc

h) Technological Progress

The efficiency of labor is meant to reflect society’s knowledge about production methods: as the available technology improvements, the efficiency of labor rises (Mankiw, 2009) According to the Solow model, only technological progress can explain persistently rising living standards

Blanchard (2009) defined technological progress has many dimensions such as it may mean larger quantities of output for given quantities of capital and labor, better products, new products, or a larger of variety of products Most technological progress in modern economies is the result of the outcome of research & development (R&D) activities The level of R&D spending depends not only on the fertility of the research process but also on the appropriability of research results If

a firm cannot appropriate the profit from development of new products, they will not engage in R&D and technological progress will be slow

3.1.2 Traditional methods of examine determinants of economic growth

There have been various research measuring the determinants of economic growth regarding to physical capital, labor, human capital, TFP, fertility rate, government consumption, the-rule-of-law-index, term of trade, ratio of investment to output, R&D, … (Barro, 1996) Besides, there are many models are applied to estimate determinants such as Neoclassical in particular Solow’s model, Endogenous models

of Romer 1986 and Lucas 1988, Harrod-Domar Model, … with estimation of times series, cross section or panel data In addition, production function Cobb-Douglas usually is used to modify and apply in such researches

Moreover, when we conduct a research for across countries, we should use output per capita instead of total output There’re two reasons for looking at the numbers for output per capita rather than for total output The first, the evolution of the living standard is giving by the evolution of output per capita, not a country’s total output Secondly, when comparing countries with different populations, output numbers must be adjusted to take into account these differences in population size of countries Therefore, this is exactly what output per capita does (Blanchard, 2009:204) In other words, countries clearly differ in population size, thus a natural starting point is to normalize country output by scaling by population or number of workers (King and Revine, 1994) This point is very important for this study bases

on

In order to measure fairly most respects of economic growth, a research should measure respects of economics, society, and environment Furthermore, in each these respects, all main factors should not omit Regarding economic respect, some common variable are measured such as GDP or GDP per capita, physical capital or physical capital per capita Social aspect comprises of labor, fertility rate, unemployment rate, human development index, gender development Index … There are also some variables of environmental issues such as CO2 emissions per capita, or environmental sustainability index (ESI)…

3.1.3 Measurement indicator group of development and growth

Economists researched to build up indicators which measure growth and development There are many way to category indicators Commonest way is be

divided into three groups: economic group, social group, and environmental group

Firstly, regarding economic indicator group, economists and researcher usually use some indicators to measure growth and development such as growth-evaluation indicators (GDP, GNP, and economic growth rate), competition capacity-evaluation

of import-export goods and GDP, density of total value of import-export services and GDP, density of direct investment and GDP, etc)

Secondly, that is social indicators with labor and employment measurement (labor, unemployment rate, employment rate, etc), indicators for poverty and inequality (poverty gap index, squared poverty gap index, poverty mapping, poverty and richness ranking, ect), or indicators for human development (HDI-Human development Index, GDI-Gender development Index)

The third is environmental indicator group with environmental quality evaluation index following millennium development goals (MDGs) or environmental sustainability index (ESI)

Generally, these three indicator groups quantize result of growth and development of

a nation or territory on all three respects: economic, society, and environment Economists and policy makers use these indicators to analyze and evaluate the development status of country, since then propose appropriate development policies

As a matter of fact, it’s available a lot of indicators and many ways to classify indicator by group, mentioned above are just very common indicators, does not include all

3.1.4 Overview of economic development theory

3.1.4.1 Classify theories by time

The developing process of development theories by time is a process to look for the answer for the origin of richness of countries Adam Smith is a person who go along with the development history of economic theories, we can divide it into three periods are classical, neoclassical, and endogenous theory (growth theory) The first period that is classical theory with analysis based on the works of late of 18th and

19th century, British economists such as Adam Smith, David Ricardo, and Thomas Malthus who believed in natural law, government non-interference (laissez faire), and diminishing returns from population growth The next is neoclassical theory of growth with Robert Solow is typical Solow’s theory of growth stressed the importance of savings, capital formation for economic development, and for empirical measures of the sources of growth The last, new growth theory is a theory

which assumes that technology is endogenous or explained within the model This

theory contends that innovation or technical change is the engine of growth, and that

this model is closer to the realities of international flows of people and capital than the neoclassical model (E Wayne Nafziger, 2006)

a) Classical theory

Most economists in the end of 17th century such as Adam Smith and the beginning

of 19th century such as Ricardo, Lohn Stuard Mill, Thomas Malthus, Joseph Schumpeter, and Karl Marx … focus on economic growth and the role of economic growth to social welfare A major goal of poor countries is economic development

or economic growth

According to classical theories, economic growth of a country depends on labor As emphasized by Adam Smith, a scholar of classical school, each country can promote its growth rate by labor specialization These theories lead a lot of shortcomings in explaining the difference problems between countries For instant, there is an existence of big gap between GDP per capita of the US and Vietnam, the US index

is normally about 20 times higher than Vietnamese index It can be asserted that the participation of labor in the US is 20 times higher than Vietnam As a matter of fact,

it is only 4 times in the period 2003 to 1997 Hence, later on, economists realized that labor couldn’t be the only factor in accounting for growth It leads to appearance

of neoclassical school with Solow’s growth model is typical

b) Neoclassical model

Later on classical theories, economists realized that labor couldn’t be the only factor

in accounting for growth It leads to appearance of neoclassical school with Solow growth model is typical In 1960s, growth theory consisted mainly of the neoclassical model, as developed by Ramsey, Solow, Swan, Cass and Koopmans One feature of this model, which has been exploited seriously as an empirical hypothesis only in recent years, is the convergence property The lower of starting level or reach per capita GDP the higher is the predicted growth rate

If all countries were the same except for its initial capital magnitude, convergence will apply in an absolute sense: poor countries have tendency to grow faster per capita then rich countries Vice versa, if countries differ in various respects together (tendency to have children, to save, willingness to work, access to technology, or government policies), the convergence force applies only a conditional meaning The growth rate tends to be high if the starting of GDP per capita is low related to its long-run or steady state position

Solow (1957) built a framework for explaining the source of growth in developed countries as well as developing countries The assumptions are constant returns to scale, perfect competition, marginal cost pricing and diminishing returns to capital With this theory, the result shows that an economy’s output growth depends on the quantities of available inputs such as capital, labor as well as technological progress

At first, Solow assumed that there are only two main factors of production function are labor and capital:

Yt = F ( K, L, t)

Where Y: amount of output, K: Capital input, L: Labor input, t: time period This equation is continuous and homogeneous to degree 1 (constant returns to scale) Differentiate this equation with respect to time t, we have:

dY/dt = δF/δK dK/dt + δF/δL dL/dt + δF/δt dt/dt

Where δ represents the partial derivative

Next, divide by Y in both side, and insert K and L for numerator and denominator in right side, we have:

(dY/dt )/Y = (δF/δK) K/Y (dK/dt)/K + (δF/δL) L/Y (dL/dt)/L + (δF/δt)/Y Where (dY/dt )/Y: growth rate of output, can be written as ΔY/Y

(dK/dt )/K: growth rate of capital, can be written as ΔK/K

(dL/dt )/L: growth rate of labor, can be written as ΔL/L

(δF/δK) K/Y: the share of capital

(δF/δL) L/Y: the share of labor

Or we can re-write this equation as below:

ΔY/Y = α ΔK/K + β ΔL/L + ΔA/A

ΔA/A is so-called residual in Solow model, or labeled technological progress, in

addition it can be described as the growth in total factor productivity The last

equation explains sources of the growth rate of output are growth rate of capital,

growth rate of labor and growth rate of TFP

The strengths of neoclassical model are it discovered new explained variable TFP in

production function, it contributes partly to explain why GDP per capita (a

measurement of standard of living) is so different between countries It found more

precise explanation the reason why there is different GDP per capita between

countries, emphasized the important role of capital accumulation, labor and TFP as a

key factors in economic growth In addition, this model expands the concept of

capital accumulation including physical capital as well as human capital However,

neoclassical model also has limitations In this model, TFP is seen as an exogenous

variable, and its change won’t affect the growth rate of output When use this model,

we cannot avoid the assumptions such as constant returns to scale, marginal cost

pricing and perfect competition, diminishing returns to capital

The convergence property derives in the neoclassical model from the diminishing

returns to capital Countries that have less capital per worker in long-run tend to

have higher return rates and higher growth rates The convergence is conditional

because the steady-state level of capital and output per capita depend on the

neoclassical model with the propensity to save, the population growth rate, and the

production function-characteristics of vary across countries Recent extensions of

the model suggest additional sources of cross-countries variation: government

policies with respect to level of consumption spending, protection of property right,

and distortions of domestic and international markets (Barror 1996)

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Note that the key point of economic growth based on the analysis of neoclassical concentrates on capital accumulation with the assumption of diminishing returns However, this opinion does not always correspond with the fact In some countries, high capital rate exists in parallel with high rate of output per capita over long time, and there is not even any sign of economic slowdown Therefore, the Solow models introduce one exogenous variable named technological progress

c) Endogenous Theory

Because of limitations of neoclassical theories, economists try to improve the neoclassical model recent years and the endogenous growth theories emerge Endogenous growth theories that include the discovery of new ideas and methods of production are important for providing possible explanations for long–term growth This theory still uses the assumption of constant returns to scale normally, but doesn’t use assumption of diminishing returns to capital Furthermore, TFP is broadened the meaning that lead to technological innovation such as new ideas, new knowledge, specific institutions, human resources development, etc However, this theory still have limitations certainly

Endogenous growth theory asserts that factors such as knowledge, human capital and technological progress that are excluded or assumed to be exogenous by other models should be internalized Endogenous growth models differ from Solow model

in that they emphasize increasing efficiency of physical and human capital According to this, a small investment on physical or human capital or an increase of resources allocated to these factors has significant effects on output The characteristic that makes new theories different than old ones is how they view investment Old theories consider capital accumulation as the engine of growth On the other hand, new theories state that basic determinant of investment (on physical and human capital) is the wave of innovation in the economy Moreover, these innovations are not exogenous; they are motivated by profit seeking

Rebelo and AK model

This model mentioned not only physical capital but also human capital as a factor of growth source This model still uses the assumption of constant returns to scale but

no diminishing returns to capital

Yt = A Kt

Yt is output of an economy

Kt is capital of an economy (physical capital and human capital)

A is an improvement in the level of technology as Solow model (A>0)

In this equation, the role of TFP is endogenous clearly, and it’s more progressive compare with orthodox neoclassical theory Both AK and neoclassical model emphasize the most important role of capital in growth

Learning-by-doing models

Kenneth Arrow and Sheshinsky constructed models in which ideas were unintended

by products of production or investment This mechanism is described as by-doing In this model, each person’s discoveries immediately spilled over to the entire economy, each investment activity of individuals or firms can affect economic growth In 1986 Paul Rome showed the competitive frame work to determine an equilibrium rate of technological advanced This model also under assumption of constant returns to scale: Yt = Kt α [At Lt] 1- α

learning-K: Capital input including physical and human capital

A: Increase in knowledge, stemmed from the learning-by-doing process

The term of increase in knowledge here can be measured by a function A(t) as follows: At = B Kt θ (B>0, θ>0): the increase in investment may lead to an increase

in level of knowledge, and otherwise, in turn an increase in knowledge makes an increase in output aggregate Yt in a country as well

Each firm in the a country can learn new knowledge during its investment in production process, and the investment of firms effect on the production process of

whole economy, the investment (means increase in capital stock) leads to an increase in level of knowledge as well This model introduces another respect of TFP, human knowledge, and built its endogenous in growth model

R&D models

Uzawa, Lucas and Romer are typical representatives for this school of thought R&D models concentrate on human capital role into the productivity of production and growth In this model, human capital is more important than physical capital R&D sector produces new ideas or improved ideas for producing for final goods Through R&D activities, an improvement of human capital is created, and this also has a tendency to increase output in economy

In this model, TFP is an endogenous factor, and it’s expended to improvement of technology level and new knowledge by R&D activities However, it’s still under assumption of constant returns to scale and it’s difficult to measure human capital

3.1.4.2 Classify theory by four main classes

In other way, besides Neoclassical theories as mention above, economists classify development theories by more four main schools: linear-stages-of-growth model, structural change theory, international dependence theory, and neoclassical counter revolution theory By this way we can have other look at development theories history (Hoai et al, 2010) (2)

a) Linear stages of growth theory

These theories emphasize the economic development process which has to experience some given stages, and it emphasizes the process of capitalaccumulation It regards capital accumulation as a compulsory condition for a country’s development Typical models of this class are Rostow (1016-2003), and

(2) This classification follows the Vietnamese Text book of Dr Nguyen Trong Hoai el at (2010) named

“Development Economic”, Minister of Training & Education, UEH Published by Labor Publication House

Harrod-Domar (1900-1978).

Rostow model

Walt Witman Rostow (1916-2003) is an American historian, economist He published the book named “Stages of Economic Growth” in 1960 and it’s seen as a person started trend of linear stages of growth theories Rostow supposed all countries must experience 5 stages of growth: traditional society, preconditions for take-off stage, the take-off stage, the drive to technological maturity stage, and the age of high mass consumption He shows the typical characteristics of each stage and its importance in development process Many economists comment this theory

is so simple for development process This theory omits important issues such as how to promote the transit from this stage to next stage It only focuses on respect of growth, disregards capital element, political institution, role of government, international relative, etc Moreover, the conclusions for each growth stage doesn’t verify in the reality yet

Harrod-Domar model

Casually, a British economist Sir Roy Forbes Harrod (1900-1978) in 1939 and a Russian economist Evsey David Domar (1914-1997) in 1946 developed and built an important economic development model that focuses on growth in relative between saving and investment So this model is so-called Harrod-Domar model

This model supposes that all economies must save a rate of income to compensation for depreciation of capital that invested such as equipment, building, materials, etc

In addition, a country wants to foster the growth must have new investment or net investment The production function with assumption is constant returns to scale is:

Y = f (K, L) Y/L = f (K/L,1) it’s so-called production functions per worker

This model assumes that k = K/Y doesn’t change

 Y = 1/k * K  ΔY = 1/k * ΔK  k = ΔK/ ΔY (1) This ratio is so-called ICOR-Incremental Capital Output Ratio

ICOR is required quantity of capital that creates a growth unit in income

set g = ΔY/ Y = 1/k * ΔK/Y and set s = S/Y

with S is total saving of economy, assumption is total S is transfer to investment

Harrod-b) Structural change theory

This class considers the structural movement in economy is important, and it can create the growth for economy Thus, the movement of structure between urban and rural areas, between industrial fields together, the movement of structure of consumption, etc are main topics that economists analyze in this class This class makes experimental researches and indicates that there’re some given template

models for most countries during their development process These template models can be impacted by polices of governments in developing countries

Lewis model

One of famous theory of Structural change theory class is of W Arthur Lewis (1915-1991) announced 1950, then it was expanded by John Fei and Gustav Ranis Two-sectors model of Lewis becomes a general theory of labor force growth process This model supposes in a low developing economies always have two basic sectors traditional sector and modern sector

Firstly, the traditional sector where is focused on most population and in redundant labor, thus marginal of labor is zero It means that even thought labor force of this sector increase, agricultural output still doesn’t increase Therefore, Lewis called this increasing labor is redundant labor, and it doesn’t change agricultural output irrespective of its withdrawal of this sector

Secondly, modern sector with specificity is high productivity In this sector, if labor increase, output increase al well Consequently, this model suggests the movement from traditional sector to modern sector

This model is simple and has a significant gap with reality However, it supplies a new view for structural movement policies in developing countries

Chenery model

Hollis B Chenery (1918-1994) surveyed the actual movement of structural productions of many countries He gave important conclusions for template structural movement for countries’ economies One of these is when income per capita increases, there’s a movement from agricultural production to industrial production The transit between two sectors is a point that ratio of agriculture in GDP as same as ratio of industry in GDP, and an increase in total of import and export during transit period But there’s a fairly increase in industrial products in total export, and fairly decrease in industrial products in total import In addition,

there’s movement trend of labor from agricultural sector to industrial and services sector, although this movement has a lag from structural change Thus, agricultural sector plays an important role in creating jobs for before and later of development process Productivity of agricultural areas increase slowly in first stage, and it will equal productivity of industrial areas when finish the transit period However, total productivity of whole economy increases In transit period, the biggest general tendency of countries is urbanization phenomenon because of industrial development and migration But industrialization and urbanization create many problems such as inequity income distribution, income focuses on urban area This thing requires countries should follow the balanced benefit policies in their industrialization process

This model has average property from experimental research of many countries, hence it simplifies and bypass different elements of each countries that sometimes make different development models between countries such as national resources scale, political institution, etc

c) International dependence theory

This kind of class focuses on to analyze external factors that cause of development such as international aid, international investment These external factors are required premises for developing a country, in particular poor countries

Neocolonial dependence theory

In history, the imbalance in relative between rich countries and poor countries is inspiration for building neocolonial dependence theory The co-existence of rich and poor countries in the same international system which is dominated by rich side leads to inequity relationship between them unavoidably It maybe caused difficulties for poor countries that try to overcome recent problems to achieve development and independence

Briefly, viewpoint of this theory about less development and third world countries becomes worse due to outside impact, power and rich countries

The False-Paradigm model

This model supposes that the cause of underdevelopment in 3rd world countries is due to inappropriate and false consultants from foreign or domestic experts These experts come from developed countries, multinational corporations, international aid organizations, or they are educated from developed countries They are equipped by good and latest knowledge that is suitable for statement of developed countries as well But when they apply this knowledge without modifying for suitable in underdevelopment one, thus it doesn’t help these countries escape poorness

Dualistic-Development thesis

Dualism is a common concept of development economic field This is an image of rich countries and poor countries In developing countries, dualism can be understood as image of well-off areas inserted between poor areas The meaning of dualism includes a set of groups have different conditions, including some groups belong to upper class, and other belong to secondary class; the co-existence is persistent, and it’s not a temporary statement of transit period; the gap between richness and poverty doesn’t reduce, vice verse its tendency is increase; rich countries do less things or nothing to help and support poor countries

d) Neoclassical counter revolution theory

This class supposes that the cause of low development of developing countries is from internal causes itself For instance, the government’s over intervention makes distort the market, it leads to sources cannot be allocated effectively This theory supports free market with a small size government

3.2 THEORETICAL FRAMEWORK

3.2.1 PRODUCTION FUNCTION COBB-DOUGLAS

Staring point of any theory of growth must be an aggregate production function, a specification of the relation between aggregate output and the inputs in the production The simplest production function has form as follows:

Y= F(K,L)

This is the aggregate production function: the relation between aggregate output and two inputs

K = the sum of all the machines, plants, and office building in the economy

F = aggregate output tell how much output is produced for given quantities of capital and labor

However, there are some restrictions reasonably impose on this function as follows:

 this is decreasing return to labor as well

Constant return to scale:

Constant return to scale implies that we can re-write equation above as follows: Y/L = F (K/L; L/L) = F (K/L; 1)

It says that output per capita depends on capital per capita

Furthermore, at the center of the determinants of output in the long run are two relations between output and capital Firstly, the amount of capital determines the amount of output being produced Secondly, otherwise, the amount of output determines the amount of saving and investment, and so the amount of capital being accumulated Together, these two relations determine the evolution of output and capita over time

One of extension form of Cobb-Douglas production function was built as follows:

Y = 0 2

K 3

L 4

R X

Where: Y is yield, K is capital, L is labor, R is natural resource used, X is

technology, 2 = capital's share of output, 3 = labor's share of output, 4 = used natural resource's share of output

According to modern ideas, X is the rest that effect on output Y and generally referred to total factor productivity (TFP), X includes human capital, technological efficiency, etc…

Normally, taking log of both side of the equation and get the result as follows: log(Yt) = log(0) + 2 log(Kt) + 3 log(Lt) + 4 log(Rt) + log (Xt)

log(Y t ) =  1 +  2 log(K t ) +  3 log(L t ) +  4 log(R t ) + log (X t )

This equation is logarithm linear regression model

3.2.2 HARROD-DOMAR GROWTH MODEL

During the 1940s, two economists Roy Harrod and Evsey Dorman (Robert G.King

& Ross L., 1994) developed independently an economic growth model based on a fixed-coefficient, constant return to scale function The model assumes that capital and labor are always used in a fixed proportion to produce out equal amount of output The model’s equation is:

Y = K / k

Where: k is capital output ratio (COR)

COR (capital output ratio) is ratio of amount of capital and total yield that this capital creased it It is difference from ICOR (incremental capital output ratio) ICOR (incremental capital output ratio) is “the amount of additional capital required

to increase output by one unit The inverse of the ratio of increase in output to investment, which, together with the added, and excise taxes The burden of these taxes can be passed on to consumers depending on the elasticity of demand and supply” (E.Wayne Nafziger, 2006) If Y is income, K capital stock, then the ICOR =

K / Y

Harrod-Domar model is simple model with small data requirements and this equation is easy to use This model can provide accurate short-term forecast of growth and be used extensively in developing countries Nevertheless, this model only remains in equilibrium status (full employment of both labor force and physical capital), thus it lead to inaccurate long-term economic forecast, and cannot explain the technological change as well as productivity gains for long-term growth

3.2.3 NEOCLASSICAL MODEL: SOLOW MODEL

As mentioned, staring point of any theory of growth must be an aggregate production function, a specification of the relation at least between aggregate output and the inputs in the production That is the Solow model does as well Then it can

be extended to other input factors such as technology progress, human capital, etc The Solow growth model is built to show how growth in the capital stock, in the labor force, and advances in technology interact in an economy, and how they affect

a country’s total output of goods and services (Mankiw, 2009)

Along history of formation and development of economic theories, before Solow model, most economic growth analysis based on Harrod-Domar growth model, it discusses growth in relationship between saving and investment, and in order to foster the growth it must have new investment or so called net investment Afterwards, Solow growth model developed by economist Robert Solow in 1956 (Solow, 1956), used Cobb-Douglas production, and so far it can be seen as a standard neoclassical growth models in long-term growth theory system According

to Robert Solow, economic growth and economic development are process in its own dynamic property, it focuses on explain which things cause output, expenditure, capital and population change by time Hence, Solow model is so called the dynamic general equilibrium model This model can be built on the frame of discrete time or continuous time And in this model, it not only capital but also labor and technological change have relationship with output

Robert Solow built a framework for explaining the sources of growth in developed territories as well as developing one He assumed capital and labor can replace each other in production process, output is the constant return to scale, perfect competition, marginal productivity of input factors is positive and diminishing in growth model and growth accounting Furthermore, in this theory, result of economy’s output growth depends on the quantity of inputs such as capital, labor, and technological progress Beside the weakness of Solow model, the important and undeniable strength of this model are discovered a new explained variable in production function as well as found more precise analysis the reason why exist the different GDP per capita between different nations

3.2.4 CAPITAL FUNDAMENTALISM: The Standard Perpetual Inventory Method with Steady-State Estimates of Initial Capital

According to Robert G King et al (1994), in order to compute the capital stock series, firstly we have to assume that each country is continuously at a steady-state with a constant capital-output ratio The advantage of this method is that we do not have a assume anything about the initial capital stock; its weakness is that it assumes

a constant capital-output ratio The second, we use the standard perpetual inventory method of estimating capital stocks with different guesses at the initial capital stock This method requires an initial capital stock value; its strength is that it does not require assumptions about the ratios we want to study Here’re details of these: a) Steady-State Estimates

This method is based on the assumption that the capital-output ratio (COR) is constant Therefore, the steady-state COR of country j is computed by:

i : steady-state investment rate,

It is gross investment in year t, Yt is GDP in year t