Dynamics, Economic Growth, and International Trade

8. Efficiency and Productivity in Rich and Poor Countries

CHAPTER 8 Efficiency and Productivity in Rich and Poor Countries Rolf Fare and Shawna Grosskopf 1. Introduction The motivation for our work is based in part on several recent articles in The Economist concerning growth and income.1 Part of the discussion concerns new and old growth theory, including the debate over convergence . More specifically we are interested in looking at Mancur Olson's hypothesis that the persistence of low income in some poor countries may have to do with inefficiency rather than with their endowments of productive inputs and human capital.2 In his own words, The argument offered here also fits the relationships between levels of per capita income and rates of growth better than does either the old growth theory or the new. As has often been pointed out, the absence of any general tendency for the poor countries with their opportunities for catch-up growth to grow faster than the rich countries argues against the old growth theory... The argument offered here suggests that poor countries on average have poorer economic policies and institutions than rich countries, and, therefore, in spite of their opportunity for rapid catch-up growth, they need not grow faster on average than the rich countries. But any poorer countries that adopt relatively good economic policies and institutions enjoy rapid catch-up growth: since they are far short of their potential, their per capita incomes can increase not only because of their technological and other advances that simultaneously bring growth to the richest countries, but also by narrowing the huge gap between their actual and potential income... (Olson, 1996, p. 20) 1. See, for example "Economic Growth: The Poor and the Rich", The Economist, May 25, 1996, pp. 23-25. 2. In fact, this general idea was first brought to our attention by Bob Parks from Washington University. He told us that his colleague, Douglass North argued that poor countries were poor because they have higher transactions costs than rich countries. 243 244 Dynamics, Economic Growth, and International Trade The chapter begins with a discussion of the static activity analysis model which we use to compute a measure of relative efficiency levels for the APEC countries in each of the years 1975-1990. Our results suggest a positive correlation between efficiency and per capita income in any given year. Next we turn to a comparative static model. In our activity analysis framework, this yields another measure of performance which has turned out to playa central role in the renewed interest in growth theory, namely productivity change. Following Fare, Grosskopf, Lindgren, and Roos (1994), our activity analysis framework allows us to decompose productivity change into a "catching-up" and technical change component . This allows us to look at the relationship between imitation and innovation and per capita income: we compute productivity change for the APEC countries over the 1975-1990 period and relate this to per capita income. Finally we turn to specification of a dynamic activity analysis model, in order to provide a dynamic measure of efficiency. This is based on the idea of a network model, in the spirit of Shephard and Fare (1980). The idea is to allow for intermediate outputs (in our case investment) that link adjacent periods. One of the goals of this exercise is to provide an estimate of the loss in potential output due to dynamic misallocation of resources. This is accomplished by including investment as endogenous in the model. We use our data from the APEC countries to compute dynamic efficiency and relate it to per capita income. The three models used here capture different aspects of the Olson hypothesis. The static model is used to see whether there is a positive relationship between levels of relative efficiency and per capita income. The comparative static model allows us to consider whether productivity change, and its components, technical change and efficiency change (catching up or imitation) are correlated with per capita income, i.e., do successfully developing countries succeed through catching up [as suggested by Van and Wan (1997)] or technical advance? Our dynamic model is used to find out whether there is a dynamic relationship between efficiency and per capita income, in particular, does endogenous investment play an important role in the relationship between efficiency and income? Efficiency and Productivity in Rich and Poor Countries 245 2. The Static Model In this section, we present the static activity analysis or DEA3 model, together...