Is there a direction in economic development?

1. Is there a direction in economic development? Pier Paolo Saviotti, INRA GAEL, Grenoble, and CNRS GREDEG I2C, Sophia Antipolis, France.

2. Econ Dev, Stylised facts • STF1) Economic development is characterised by qualitative change. • STF2) The efficiency of existing processes increases in the course of economic development. • STF3) The diversity/variety of the economic system rises during the process of economic development.

3. Efficiency vs diversity • Efficiency grows when a constant output is produced with (a) decreasing quantities of all inputs or (b) decreasing costs of all inputs • Efficiency at constant quality • Qualitative change: emergence of new entities, qualitatively different (distinguishable) from the pre-existing ones. • N° distinguishable entities  Diversity

4. Development as system transformation • Structural change: change in the structure of the economic system (components + linkages/interactions). • Defined at the level of aggregation of industrial sectors. But: structural change can occur at lower levels of aggregation. • Structural change can occur for activities and actors as well as for outputs, thus also for knowledge, and institutions.

5. Importance of qualitative/structural change. • They affect the composition of the economic system. They are determinantsof system performance. • Economic development is a process of transformation, involving both quantitative/efficiency change at constant composition and qualitative change.

6. Development vs Growth • Need to measure = need to transform qualitative differences into quantitative measurements (conventions, approximations) • Changes in efficiency can be easily measured, qualitative changes are much more difficult to measure

7. Diversity/variety • Definition(PPS): number of actors, activities and objects required to describe the economic system at a given time • Variable to represent analytically changes in composition = N° distinguishable economic species in system • But: also (I) extent of diffusion of new entities in the economic system (balance), and (ii) intrinsic difference between economic species (Disparity) (Stirling)

8. Modern phenomena • Most people could only purchase the bare essentials to survive until the end of the XIXth century, and many people still do today • Diversity existed only for the rich • But in the XXth century diversity became available for many people in developed societies

9. Diversity for most

10. Efficiency and Diversity • Two complementary forces/trajectories : • growing efficiency • growing diversity • Hypothesis 1: The growth in diversity is a necessary requirement for long-term economic development. • Hypothesis 2: Diversity growth, leading to new sectors, and efficiency growth in pre-existing sectors, are complementary and not independent aspects of economic development.

11. Compensation • At constant output  growing efficiency + saturating demand  possibility to produce all demanded output with declining fraction of resources (labour force)  Marxian trap • Emergence of new sectors compensates for the falling capacity of existing sectors to create employment • Growing diversity avoids Marxian trap. • Supply side: surplus old sectors search activities new goods & services + creation of demand for new goods & services needs income

12. Family expenditure Workers UK

13. Necessities and higher goods/ services • The efficiency in the production of necessities had to increase to leave room for the purchase of higher goods/services • During the XIXth century the share of family expenditures allocated to necessities increased and it started to fall only at the beginning of the XXth century • Necessary condition for social stability and for economic growth

14. Economic development by the creation of new sectors • A model in which the number of new sectors varies endogenously during economic development • Sector created by an important innovation establishing an adjustment gap (size of the potential market)‏

15. Intra sector dynamics • First entrepreneur enters the market (expectation of a temporary monopoly) imitators enter  rising intensity of competition  inducement for further entry falls until exit starts dominating entry. Innovation has become part of the ‘circular flow’ (Schumpeter, 1912-1934) • Sector  oligopoly or monopoly

16. Demand dynamics • Demand dynamics: Adjustment gap (distance from saturation) is gradually closed leading to a saturated market, but the product/service is improved by means of search activities • The joint dynamics of competition and of demand gives rise to an industry life cycle (ILC)‏

17. Creation of new sectors • The decline of mature sectors induces entrepreneurs to look for new opportunities of temporary monopoly, to be found by exploiting new important innovations leading to new niches and sectors.

18. Competition • Competition both intra- and inter-sector: • Intra- sector:  density of product/output population. • Entrepreneur induced by expectation of temporary monopoly to enter. If innovation successful  imitation  increasing intensity of competition  decreasing inducement to enter  exit

19. Inter-sector competition • Inter- sector: different sectors can provide comparable services. • Important component of contestable markets • Total intensity of competition perceived within each sector = intra + inter • Limits the extent of oligopoly/monopoly that could be achieved within individual isolated sectors

20. Search activities • Activities by means of which one scans the external environment looking for alternatives to existing routines (Nelson, Winter, 1982) • Generalized analogue of Research and Development • All economic activities can be divided into routines and search activities

21. Model equation

22. Number of firms • Life cycle: in each sector Ni first increases rapidly, reaches a maximum, and then falls (oligopoly, monopoly)‏ • But, life cycle driven purely by dynamics of competition and demand (See ILC models). • Shape of life cycle affected by several variables (AGi, Di etc).

23. Adjustment gap

24. Demand

25. Search activities

26. Competition

27. Employment • li = ki/Qia = ki/Qi/Ni = (ki*Ni)/Qi • li = Li/Qi

28. Aggregate employment

29. Demand function Di0 = initial demand for the output of the new sector I Ddisp,i = the disposable income for new good or service I Yi and Δyi = level of services supplied by the new product/service and degree of product differentiation, pi = the price of the new product/service Ddisp,i can be calculated by subtracting from total income the expenditures on all previous goods or services. Evolution of demand constrained by the creation of disposable income

30. Demand, disposable income Demand, new function (left); Demand, old function (right)

31. Effects of (low-high) product quality Effect of product quality on sectoral demand, low (pink) and high (blue) case Product quality in the low (pink) and high (blue) case Effect of product quality on output, low (pink) and high (blue) case Effect of product quality on wages, low (pink) and high (blue) case

32. Effects of (low-high) product quality (2) Quantity of Human capital Human capital/output ratio Quality of human capital

33. Effects of (low-high) product quality (3) Disposable income (high product quality) Disposable income (low product quality) Aggregate income (low product quality, pink, high product quality blue) Aggregate employment (low product quality, pink, high product quality blue)

34. Model summary • The model shows that if diversity/variety grows economic development can continue in the long run • Many experiments can be carried out with the model by assessing the effect of varying its parameters on system behaviour and performance • Experiments: micro-macro dynamics, competition and growth, industry life cycles, Emergence of bubbles, etc.

35. Direction of development Reversal? • Growing efficiency and growing diversity/variety • If the efficiency of basic functions (e.g. Food, housing etc.) were to fall the resources of the system could be concentrated on these functions thus reducing diversity • Possible examples: (I) fall of earth temperature of 50 degrees; (ii) increased environmental fluctuations • We live in a fairly benign environment

36. Implications for development • Countries at different levels of economic development. Catching up. • How? If world diversity/variety grows then national diversity/variety should grow in parallel keep (national/world) diversity/variety ratio approximately constant • But, short run exceptions : specialization strategies compensating narrow range with increased competitiveness within range, but only viable in short run

37. Trends and systems • General trends (e.g. towards growing diversity) not followed in exactly the same way by all countries, but interpreted. • Two types of persistent asymmetries: • In output structure • In institutional and organisational configurations • National Innovation Systems

38. Heterogeneity vs homogenization • Innovations created at particular places and times  asymmetric distribution of in world economic system raise heterogeneity • Diffusive forces (trade, technology transfer etc) tend to homogenize technologies, capabilities etc. • Dynamic steady state where complete homogeneity unthinkable

39. Catch-up strategies

40. Variety based interpretation of past policies • Two extreme choices: a) only natural resource based sectors; b) add manufacturing (ISI)‏ • a) leads to relative decline in national variety, b) can lead to increasing or constant share of world variety

41. Empirical studies • Test: calculate output variety/diversity in the course of time for different countries and compare with GDP Growth, labour productivity growth, etc. • But comparable and disaggregated output statistics generally not available • Netherlands study (Frenken et al, 2007): output variety of regions determinant of labour productivity growth & of output growth

42. Variety and the entropy function • Entropy can measure variety because the greater the number of distinguishable entities there are in the system, the greater the amount of information required to describe it. • Decomposable nature of entropy: variety at several digit levels can enter a regression analysis without necessarily causing collinearity.

43. Related vs unrelated variety. • Related variety (RV): measured at a lower level of aggregation where any two sectors are likely to show greater similarity (intra-group variety)‏ • Unrelated variety(UV): measured at a higher level of aggregation where two sectors are very different (inter-group variety) • Given the properties of the informational entropy function RV and UV can be combined in the same econometric equation

44. Variety growth and trade • Netherlands, only related variety is a determinant of employment growth in the regions of the Netherlands in the period considered • Meaning: in order to grow you have to diversify your economy but remaining in the vicinity of your previous production structure

45. Variety growth & trade (2)‏ • OECD countries (1963-2003): related export variety( 3 digits) short run determinant of economic growth, unrelated variety(1 digit) and semi related variety(2 digits) not short run determinant of economic growth • unrelated variety(1 digit) long run determinant of economic growth

46. Real GDP growth rate vs Export variety, UN data data 1961-1999

47. Real GDP per capita growth rate vs Export variety, UN data data 1961-1999

48. Related vs unrelated variety, Short vs Long run

49. Related vs unrelated variety, Short vs Long run (2)

50. Variety, Proximity