The Evolving World Production Function

Robert Allen starts off his article on \”Technology and the great divergence: Global economic development since 1820\” by asking a classic question: Why have low-income countries been seemingly so slow to adopt the technologies for increased production that exist in high-income countries? The article appears in the January 2012 issue of Explorations in Economic History.  At least for now, Elsevier is allowing the article to be freely available here, but many academics will also have access through their libraries.

Some of the possible answers are that cultural factors, perhaps like Weber\’s \”Protestant work ethic,\” cause some countries rather than others to adopt new technology. Or perhaps institutional factors like a legacy of property rights and representative government make some countries likelier to develop technology. Allen argues a different view: \”This paper explores an alternative explanation of economic development based on the character of technological change itself. While the standard view assumes that technological progress benefits all countries, this paper contends that much technological
progress has been biased towards raising labor productivity by increasing capital intensity. The new technology is only worth inventing and using in high wage economies. At the same time, the new technology ultimately leads to even higher wages. The upshot is an ascending spiral of progress in rich countries, but a spiral that it is not profitable for poor countries to follow because their wages are low.\”

Simple examples of this phenomenon abound. It is cost effective to install price scanners in U.S. supermarkets, because it saves the time of cashiers, as well as purchasing and accounting workers behind the scenes. But for a low-income country with much lower wages, saving the time of workers isn\’t worth such an investment. Multiply this example all across the economy.

Using data on capital per worker and on GDP per worker across countries at different periods of time, Allen estimates a world production function. Here\’s is the evolution of the world production function for the period from 1820-1913, and from 1913 to 1920.

These production functions display some common patterns. On the far left, GDP per capita rises in a more-or-less linear way with capital per worker. On the right, at the technological frontier, GDP per capita doesn\’t rise with capital per worker. Over time, the technological frontier–where the gains from additional capital per worker don\’t add to per capita output–keeps rising. For example, the production function flattens out at about $2000 per worker in 1820, at about $4500 per worker in 1913, $17,000 per worker in 1965, and $35,000 per worker in 1990. Allen suggests that the technological leaders grow by stages, taking a generation or two to perfect the possibilities of one level of capital per worker, before then pushing further up the scale.

In this perspective, technology is quite transferable between countries with roughly similar capital to worker ratios: for example, this helps to explain the convergence in per capita GDP among high-income economies in recent decades. However, low-income countries find that the technology invented by high-income countries inappropriate for their circumstances; indeed, less capital-intensive technology from 50 or 100 years ago often seems more appropriate for them. This perspective also helps to explain why a ultra-high savings rate has often been so important as a precursor to rapid growth in places like Japan in mid-twentieth-century, and then to the East Asian \”tiger\” economies, and then to China. High savings creates a high capital to worker ratio, and thus makes it much more possible to leapfrog forward by adopting technologies closer to the frontier.

Looking ahead, an intriguing question is whether rapidly emerging economies around the world can become their own source of innovation: that is, can they take their high savings rates and draw upon world technological expertise to create a new kind of cutting-edge innovation aimed at their own home market. Can the emerging countries forge their own technological path? The Economist magazine has been predicting for the last couple of years that this process is now underway. For example, the April 15, 2010 issue had a lengthy \”Special Report\” called \”The new masters of management: Developing countries are competing on creativity as well as cost. That will change business everywhere.\” Here\’s a flavor of the argument:

\”Thirty years ago the bosses of America’s car industry were shocked to learn that Japan had overtaken America to become the world’s leading car producer. They were even more shocked when they visited Japan to find out what was going on. They found that the secret of Japan’s success did not lie in cheap labour or government subsidies (their preferred explanations) but in what was rapidly dubbed “lean manufacturing”. While Detroit slept, Japan had transformed itself from a low-wage economy into a hotbed of business innovation. Soon every factory around the world was lean—or a ruin. …

\”Now something comparable is taking place in the developing world…. Emerging countries are no longer content to be sources of cheap hands and low-cost brains. Instead they too are becoming hotbeds of innovation, producing breakthroughs in everything from telecoms to carmaking to health care. They are redesigning products to reduce costs not just by 10%, but by up to 90%. They are redesigning entire business processes to do things better and faster than their rivals in the West.

\”As our special report argues, the rich world is losing its leadership in the sort of breakthrough ideas that transform industries. This is partly because rich-world companies are doing more research and development in emerging markets. Fortune 500 companies now have 98 R&D facilities in China and 63 in India. IBM employs more people in developing countries than in America….

\”Even more striking is the emerging world’s growing ability to make established products for dramatically lower costs: no-frills $3,000 cars and $300 laptops may not seem as exciting as a new iPad but they promise to change far more people’s lives. This sort of advance—dubbed “frugal innovation” by some—is not just a matter of exploiting cheap labour (though cheap labour helps). It is a matter of redesigning products and processes to cut out unnecessary costs. In India Tata created the world’s cheapest car, the Nano, by combining dozens of cost-saving tricks.\”

This scenario suggests that in the future, technological change may not just disseminate gradually from the advanced countries to the rest of the world, as countries build up their capital/labor ratios. Instead, technological change and its effects may also be disseminating from the huge emerging markets back to consumers and firms in high-income countries.


Added note:

Louis Johnston writes from the College of St. Benedict at St. John\’s University to tell me that Robert Allen\’s article is also Chapter 4 of  Allen\’s recent book Global Economic History: A Very Short Introduction (

The Southern Silk Road: HSBC Global Research

Last June, Stephen King of HSBC Global Research published a lively report called \”The Southern Silk Road: Turbocharging \’South-South\’ economic growth.\”  Here, I\’ll mention a few points that especially jumped out at me, but the report is full of useful examples, background, and analysis.

1) Start with a quick reminder for readers who last course in world history is lost in the mists of time. What was the Silk Road?

\”The original Silk Road initially developed under the Han Dynasty in China, which ruled from 206BCE to 220CE. For the next 1000 years or so, the Road (or, more accurately, the various routes) linked China with India, Central Asia, Rome (for a while) and, eventually, the Arab Caliphate involving trade in everything from
spices and silk through to precious stones, ponies and slaves. The great Eurasian empires that developed during this period became mutually dependent. It all went wrong when the Mongols, under Genghis and Kublai Khan, managed to spread not just total brutality but also bubonic plague across the Eurasian land mass. Connections were severed and the various routes fell into disuse. Later, as the European nations
developed their ocean-going fleets, the case for expensive land-based trade across Asia economically collapsed. Unlike the original, the Southern Silk Road won’t only be confined to Asia and Europe. It stems
from connections over land, across the sea, through the air and within the electronic ether. And because the costs of transportation and communication have collapsed in recent decades, it is much more geographically diverse, offering the potential to create hitherto-unimaginable linkages between Asia, the Middle East, Africa
and Latin America. If it is able to advance, the Southern Silk Road will radically alter the dynamics of the global economy in the years ahead. The economic centre of gravity is about to undergo a major shift.\”

2) On a timeline of U.S. per capita economic growth, China, Mexico and Brazil have about the per capita GDP that the U.S. had in 1940. India has about the per capita GDP that the U.S. had in 1882.
Here\’s the figure. (On the vertical axis, GK$ refers to Geary-Khamis dollars, which is a purchasing power parity exchange rate.) However, in the last 10 years, India has caught up with 30 years of U.S. per capita growth, and China has caught up with 50 years of U.S. per capital growth. 

3)  Foreign direct investment has exploded in size, and the top recipients of inflows of foreign direct investment have changed substantially. 

 Using the standard UNCTAD data on foreign direct investment, the U.S. economy had the highest inflows in 1980, 1990, 2000, and 2009. But from 1980 to 2000, the level of those FDI inflows to the U.S. economy rose by a multiple of 18–before sagging back in the economic turmoil of 2009. But perhaps more interesting is that if one looks at the top 10 recipients of FDI inflows, one China and Hong Kong don\’t appear in 1980 or 1990. By 2000, China is 9th in FDI inflows and Hong Kong is 7th. By 2009, China is 2nd in FDI inflows and Hong Kong is 4th–and together, they would exceed total FDI inflows to the U.S. economy. Also by 2009, the Russian Federation, Saudi Arabia, and India are all in the top 10 for FDI inflows. Here\’s the table:

4) Predictions for continued long-run growth in China, India, Brazil, and elsewhere have a buried assumption that their growth will become far less dependent on the buying power of high-income countries, and instead far more dependent on growth generated internally or by trading with each other.

King writes: \”Excluding the possibility of trading with Mars or Venus, there are two primary options: either more of each emerging nation’s growth comes from internal sources or more comes from the emerging nations connecting economically with each other. The developed world simply won’t be big enough to accommodate the emerging world’s ambitions and expectations.\”

Asian Century or Middle Income Trap?

Will Asia come to dominate the global economy during the 21st century? The Asian Development Bank published a thoughtful report on the subject in August called \”Asia 2050: Realizing the Asian Century.\” The Executive Summary is available here; the full report is available by searching the web. Despite the triumphalist-sounding title, the report actually has a cautionary focus. 

\”The rapid rise of Asia over the past 4-5 decades has been one of the most successful stories of economic development in recent times. Today, as Asia leads the world out of recession, the global economy’s center of gravity is once again shifting toward the region. The transformation underway has the potential to generate per capita income levels in Asia similar to those found in Europe today. By the middle of this century, Asia could account for half of global output, trade, and investment, while also enjoying widespread affluence.

While the realization of this promising outcome—referred to as the “Asian Century”—is plausible, Asia’s rise is by no means pre-ordained. Given Asia’s diversity and complexity, this rapid rise offers both important opportunities and significant challenges. In its march towards prosperity and a region free of poverty, Asia will need to sustain high growth rates, address widening inequities, and mitigate environmental degradation in the race for resources. In addition, Asian economies must avoid the middle income trap in order to realize the Asian Century.\”

As a starting point, the report offered a useful simplification for thinking about the huge region of Asia. Seven countries in Asia have roughly three-quarters of the region\’s population, and about 90% of the region\’s GDP. So in thinking about prospects for the the Asian region, one can reasonably focus on China India, Indonesia, Japan, the Republic of Korea, Thailand and Malaysia.

In the \”Asian century\” scenario, the region of Asia will regain the position in the world economy that it last held in the 1700s–that is, the region will produce more than half of all global output.

 Much of the report is a lots of discussion of possible issues that could derail this pattern: governance, urbanization, an aging population in some countries, education, regional cooperation, energy, environment, others. Here, I will pick out just a couple of broad theme.

A primary concern for Asia is the \”Middle Income Trap.\” For an illustration, consider per capita growth of Korea compared with that of South Africa and Brazil. Korea has kept per capita income generally rising, even after terrible shocks like the 1997-98 financial crisis in east Asia. In contrast, Brazil, much of Latin America, and South Africa have been stuck at more-or-less the same place for several decades.

The report explains: \”But many middle-income countries do not follow this pattern. Instead, they have bursts of growth followed by periods of stagnation or even decline, or are stuck at low growth rates. They are caught in the Middle Income Trap—unable to compete with low-income, low-wage economies in manufactured exports and with advanced economies in high-skill innovations. Put another way, such countries cannot make a timely transition from resource-driven growth, with low-cost labor and capital, to productivity-driven growth.\”

If the rising economies of Asia go follow the pattern of Latin America over most of the last 3-4 decades, then the world economy in 2050 will not look dramatically different than it does today. Instead of the Asian region producing over half the world\’s GDP by 2050, in this scenario it would produce just 31% of global GDP by 2050– not far above current level. In this scenario, by 2050 the U.S. economy would be larger than the economies of China and India combined.

The closing words of the report are: \”Asia’s future is fundamentally in its own hands.\” That statement is a bit evasive: referring to \”its own hands\” seems to imply a more unitary identity for Asia than is actually true. A great many hands will be involved in shaping the region\’s future. However, the statement also contains a deeper truth is worth considering. U.S. and Europe will surely influence the outcomes in Asia in modest ways, but Asia is a huge region, with huge population and huge resources. While exporting to the U.S. and western economist has jump-started growth in the region, it surely the capability at this point of generating continued growth from within.  Of course, whether that capability will be realized remains to be seen.

Given that the U.S. isn\’t going to determine what happens in Asia, how should it regard the possibilities?  If Asia falls into the Middle Income Trap, the U.S. can focus less on that area, both economically and politically. I personally would hope for continued economic growth in the region, because it would improve the standard of living so dramatically for several billion people. In this Asian Century scenario, the U.S. should be striving to find a way to connect its human, managerial, technological, financial, and other resources with all that vibrant economic growth, so that we can benefit from it. If the world economy is going to be pulled ahead by an Asian locomotive, the U.S. had better start figuring out how to reserve some good seats on the train. 

For a previous post on this topic, see Will Emerging Economies Dominate the World Economy? from July 22, 2011. For posts in the last few months on China catching up to and perhaps surpassing the U.S. economy, see Will China Catch Up to the U.S. Economy? from June 27, 2011, and Is China\’s Economic Dominance in the Long Run a Sure Thing? from September 9, 2011.

Not What You Know or Who You Know, But Where You Work

Since the 2009 World Development Report on \”Reshaping Economic Geography\” was published, I\’ve had the opening paragraphs up on the bulletin board outside my office door, as food for thought for those passing by. 

\”Place is the most important correlate of a person’s welfare. In the next few decades, a person born in the United States will earn a hundred times more than a Zambian, and live three decades longer. Behind these national averages are numbers even more unsettling. Unless things change radically, a child born in a village far from Zambia’s capital, Lusaka, will live less than half as long as a child born in New York City—and during that short life, will earn just $0.01 for every $2 the New Yorker earns. The New Yorker will enjoy a
lifetime income of about $4.5 million, the rural Zambian less than $10,000. A Bolivian man with nine years of
schooling earns an average of about $460 per month, in dollars that reflect purchasing power at U.S. prices. But the same person would earn about three times as much in the United States. A Nigerian with nine years of education would earn eight times as much in the United States than in Nigeria. This “place premium” is large throughout the developing world. The best predictor of income in the world today is not what or whom you know, but where you work.\”

I think I work hard. Lots of Americans think they work hard. But when you compare the economic situation of modern America with the rest of the world, or with long-ago history, then (in a phrase commonly attributed to the old football coach Barry Switzer) we\’re all born standing on third base, congratulating ourselves for hitting a triple. 

Medical tourism

John Rosenthal has written an interesting piece for the Milken Institute Review on the phenomenon of \”medical tourism, that is, Americans going abroad to have medical procedures performed. The article has lots of interesting details and anecdotes, but here is some of the big picture.

How many people go abroad for medical procedures? \”In 2009, Deloitte revised its estimates down to 648,000 travelers annually, but forecast 35 percent increases in each of the threesucceeding years. It predicts that more than1.6 million Americans will travel abroad for health care in 2012.\”

What is the assurance of quality? \”Accreditation from the Joint Commission International (JCI) is recognized worldwide as the gold standard for hospitals. JCI screens facilities for the condition of their physical plants, their management of medications, the quality of their surgical care, their commitment to continuous improvement, and their responsiveness to feedback from patients. In the United States, the organization accredits more than 17,000 facilities, from hospitals to laboratories to long-term-care centers. JCI began accrediting hospitals outside the country in 1999. Today, the organization vouches for the quality of care at some 400 institutions in 45 countries from Austria to Yemen.\”

What are some of the potential cost savings?

Incidentally, the Milken Institute Review, with Peter Passell  as editor-in-chief, is a consistently excellent source for lively and well-written essays on economic policy. The contents are available free on-line, although you do need to fill out a registration form.