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Research & Development for Sustainable Long-Term Growth in Economies

23 Feb 2009 | Category: uncategorized | Author: admin

INTRODUCTION

Economists like to use the Gross Domestic Product (GDP) as an indicator for how well a country is doing. In order to make predictions regarding the future of countries and the industries that support the country it is essential to be able to evaluate just what makes the GDP vary so dramatically over time and across countries.

Over the past 130 years the output of countries has dramatically improved in a good portion of the world. Some countries have improved much better than others. Many studies have been done to determine what the factors are that influence the growth of the GDP. We will briefly touch on the major factors that have the most influence and then explain in a little more detail the important factors that have helped stable, mature industrial economies sustain long-term growth. After that we will discuss why the majority of these factors will not sustain continued growth in established economies and finally we will offer a solution for providing real sustained growth over the long term.

THE BUSINESS CYCLE

All businesses and economies, just like a stock market, have trends. There are also fluctuations to these trends over short term. These fluctuations above and below the output trend are known as business cycles. It is believed that over short-term analysis business cycles do affect output, however when one looks at the long-term, these cycles, or deviations from the trend (average), tend not to be as influential in the level of output as we would think. The long-term output tends to be the average of the peaks and troughs of the cycles of business.

FACTORS THAT GO INTO THE GDP (OUTPUT)

The GDP per capita is a function of the (hourly productivity) x (the average hours worked per person) x (the employment rate) x (the participation rate).

These three functions in the equation are all considered to be a part of LABOUR and thus can be simplified as such:

(the average hours worked per person)

(the employment rate)

(the participation rate)

Hourly Productivity is dependent on many different factors: the physical infrastructure in which the worker works (buildings and machinery); education, skills, technology level and efficiency of the worker and more.

We could further subdivide this "hourly productivity" into two more categories:

Physical Capital Stock (buildings and machinery), and
"Other" (education, skills, technology level and efficiency, etc.).

In economics terms, this "other" is known as Total Factor Productivity (TFP).

Now if we look at the equation, we can see that GDP (output) is affected by Physical Capital, Labour, and TFP.

GDP = Capital x Labour x TFP.

DECREASING MARGINAL PRODUCT CAPITAL (DPK)

Decreasing marginal product capital (DPK) tells us that as each new machine is added to the system; it boosts productivity less than the previous machine until at one point the last machine added offers no boost in productivity. This line is the point of equilibrium for productivity beyond which we no longer have positive results. As long as the net investment is positive a company will continue to invest, but as soon as it crosses over the line of positive output growth, they will no longer invest.

PHYSICAL CAPITAL EQUILIBRIUM STATE

We can accumulate physical capital and thereby allow the worker to work more efficiently. Capital includes machinery and buildings in which to work. Usually there is a depreciation factor in these physical products therefore over time, their value works toward equilibrium, such that the input of capital equals exactly the same value as the depreciation. It is at this steady state point that capital ceases to provide increased growth output. All companies and industries eventually move toward this steady state position. If all companies achieve this steady state, as shown in Figure 4.12 on page 71 of our text, they will converge to the same position, and competitive advantage due to physical capital will no longer exist.

In order to continue growth beyond this point, industries must therefore focus either on labour or TFP. Since it is impossible to achieve a 0% unemployment rate, eventually companies will all move toward equilibrium as well in the use of labour.

LABOUR EQUILIBRIUM STATE

As work becomes busier, more people are employed. And increase in workers (labour) will increase the productivity of an industry. There comes a time, however, where, as the industry becomes more advanced, the labour factor can get saturated beyond the point of effectiveness and actually exceeds the optimum productivity. Further research has shown that as productivity increases, GDP increases and the standard of living also increases. The general incentive to make more money by working harder begins to be replaced by a desire to sacrifice more money for more private time. Because people are social creatures and not machines they value time away from work with friends and family. Because they make higher salaries, they trade off more money for more time knowing that they can now live the same lifestyle if they work less.

In so doing, the actual productivity of the labour force reaches an equilibrium point where it stops being beneficial to the industry, and levels off. Table 3.8 of our textbook (p48) confirms this assumption.

As industries become more advanced, the efficiency of the Labour unit tapers off.

Of course, the richer nations are able to invest more in capital and labour which allows them to have a higher level of (equilibrium) output in comparison to the developing nations who cannot invest as much and operate at a lower level of (equilibrium) output. We must also keep in mind though, that it is possible to over-invest in capital at the expense of spending and consumption which would negatively impact the economy.

UNRELIABLE CONTINUED IMPROVEMENT OF HUMAN CAPITAL

Human capital, "the skills and knowledge that accumulate in people, the labour force and society over time", is another valuable asset for improving output. Even if companies have reached an equilibrium stage for investment in physical capital and labour, simply by increasing the knowledge of the worker, one can shift the output curve upward, resulting in an increase in output, and a constant capital investment rate.

The problem with this asset is that there are a great deal of variables which can affect the education of individuals in a negative way. It is difficult to control these and therefore it becomes difficult to rely upon human capital for sustained growth over a long period of time.

UNRELIABLE INSTITUTIONAL SUPPORT

Another important factor, as seen by many economists is the role that many institutions play in the development of the industry. However, due to the difficulty in controlling things that affect the benefits of institutions, such as stability, corruption, regulation etc. as well as the continuing change of the guard in various institutions, leading to changes in policy it would not be a wise decision to consider these institutions as a major force for continued growth in established economies.

TECHNOLOGY DEVELOPMENT

Theoretically, if economies reach the equilibrium steady-state of growth, then diminishing marginal products of capital (MPK) predict that there should be zero growth in the GDP. However, looking at real life results show this is NOT HAPPENING; although advanced countries and economies are not advancing as quickly as developing countries, their GDP is increasing which means growth is occurring.

As time passes, people are continually producing new products, developing new ideas and concepts and researching into new technology. Technology is constantly changing, and morphing to meet the ever-demanding needs of the future. We can see throughout history that technology is always progressing. Since technology positively affects the development of the economy, if industries have reached their steady state, that equilibrium must also be advancing in harmony with the advancement of technology.

Research and Development (R&D) will provide a vertical shift of the output curve, leading to greater output (from the same input due to an increased efficiency), as well as a horizontal move along the curve because new technology leads to advancement in production practices allowing for better machines to be made, and thus the continual increase of physical (and human) capital. Figure 5.11 on page 102 of the textbook sums this up very nicely.

Because growth is diminishing over time, the amount of output is not as great as we move along the curve, but as long as we move along the curve, and shift the curve up, there will be an ever-increasing output of GDP.

The diminishing MPK rule for established, richer industrialized nations pushes them to focus less on capital and labour as the major factors of production, and instead leads them to expend more time, effort and money on research and development. If we look at figures 5.12 and 5.13 on page 103 of our textbook, we can see that countries shift to spending more of their investments on research and development in order to continue sustained growth.

CONCLUSION

There are many factors of productivity that affect the output of nations. In the developing stage, capital growth and labour growth dramatically improve the GDP. As time passes, and the nations become richer, they run into a wall, or a state of equilibrium in which these factors no longer provide what is needed for continual growth.

Peter's Law explains the capital and labour equilibriums very well:

"In any hierarchy, each individual rises to his own level of incompetence, and then remains there."

When this happens, nations need to rely on other factors that will assist in continued growth in order to prevent a no-growth situation which leads to stagnation, and eventually a negative growth or decline in output.

Total Factory Productivity (TFP) encompasses "any factor that affects output other than capital accumulation or labour input" (pg 86 of text). There are a huge number of factors that affect the growth of the national GDP however the only reliable one for continued growth of richer, established nations is research and development. This is because as nations progress, and time progresses, technology is also continually advancing. It has, to date not seemed to hit a wall, or reach any stage of equilibrium. Employing the advanced knowledge from research and development, companies can improve their capital, thus receive better returns once again. In addition to that, they are also able to reap the benefits of improved technology.

Cameron Switzer

Intrmarket Solutions

Fukui, Japan

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