The Competitiveness of Nations in a Global Knowledge-Based Economy
Morris Altman
Chapter 6: (extracts)
A Behavioral Model
of Endogenous Economic Growth
Worker
Satisfaction and Economic Performance
M.E. Sharpe, Armonk, 2001, 119-136.
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Content
The
Conventional Growth Model and Revisions
High
and Low Wages and the Path and Pattern of Economic Growth |
Conventional
economic theory tends to support the view that there is only one sustainable
wage path to economic development. In
the long run, one expects economies to converge to like levels of real per
capita gross domestic product (GDP) with like mean factor prices, of which the
wage rate is, of course, one. There can
be no such thing as a high-wage path to economic growth and development since
convergence occurs through the process of interregional and international trade
and factor mobility and is facilitated by the unfettered working of the
marketplace. A caveat to this argument
is related to the work of Paul Romer (1986, 1990,
1994), who, following the earlier work of Arrow (1962) and Young (1928),
introduces the notion of increasing returns and positive externalities into the
basic neoclassical model pioneered by Solow (1956, 1957;
see also Abramovitz 1952) by incorporating
knowledge, in the form of learning by doing or research and development, in the
production function. Gene Grossman and Elhanen Helpman (1994) add
endogenous innovations to the basic Romer framework
(see also Aghion and Howitt
1998). [1] Regions that begin first have a first-mover advantage
over those that are followers in the investment and development process. Economic growth then takes on a sustained and
cumulative form. In this case,
convergence need not take place through the free market forces of supply and
demand.
Off
the mainstream, Gunnar Myrdal’s
(1963) work on cumulative causation argues in favor of persistent divergence of
per capita GDP and factor
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prices as a
consequence of the unfettered working of the market economy. The law of supply and demand results in the
rich getting richer and the poor getting poorer. Once a region or country is ahead of the
economic pack, it becomes profitable for investment to be biased toward the
leaders. The advantaged areas have, in
effect, a first-mover advantage. Only
government intervention can break what becomes a vicious cycle. Nicholas Kaldor
(1957) also develops an endogenous theory of economic growth whereby the rate
of technical change is a function of the growth in capital stock. But like the neoclassical production function,
Kaldor’s enhanced production function is
characterized by diminishing returns. He
also constructs a model, based upon the work of Myrdal
and P. J. Verdoon, wherein exports, exports of
manufactured products in particular, cause differential levels of per capita
output and growth rates through the process of cumulative causation since it is
assumed that manufacturing is the most dynamic sector in an economy and is
characterized by increasing returns (Kaldor 1970). [2] However, like the basic neoclassical growth
model, the alternative growth models do not specify why one region should be
ahead of another to begin with, nor why and when regions should begin the
process of convergence or what variables actually initiate the process of
divergence. The causal process in all of
these models takes on a random form or, alternatively, becomes a function of
events exogenous to the model.
The
empirical evidence is heavily weighted in favor of the argument that
convergence has not taken place internationally over time (Altman 1999c; Baumol 1986; Baumol and Wolff
1988; De Long 1988; Dowrick and Gemmell
1991; Pritchett 1997). This is not to
say that no convergence whatsoever has taken place. Over the last one hundred-odd years the
presently developed economies have converged. Some less developed countries are in the process
of converging. Nevertheless, the majority
of the less developed countries are characterized by laggard economic
performances. In point of fact, over the
long haul, low-income and high-income economies have persisted side by side. The coexistence of these two types of
economies is an important stylized fact and should be explained by growth
theory.
A
model of endogenous growth is developed here that complements both orthodox and
nonorthodox growth theories. The main concern of this chapter is a causal
one. I attempt to provide an explanation
for sustainable “equilibrium” differences in real per capita GDP, as well as
for either transitory or “permanent” differences in growth rates that
ultimately cause differences in real per capita GDP. I therefore go beyond a discussion of the
immediate sources of growth, such as the traditional factor inputs, research
and development, and human capital, to an analysis of the motivational
structure that might help explain some of these important differences. [3] Using
the more
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realistic
behavioral assumptions embedded in efficiency wage and x-efficiency theory, I
argue that there are at least two sustainable paths to economic growth. At one extreme is the low-wage path, and at
the other is a high-wage path. The
latter is associated with a higher level of equilibrium per capita real GDP and
the former with a lower level. Convergence
in real per capita output need not take place through the workings of the free
market. Moreover, competitive pressures
(or market forces in general) need not result in the convergence of wage rates.
In a word, what I show here is that both
a low-wage and a high-wage economy can be consistent with a competitive
economic regime in the long run. But a
high-wage economy potentially yields a higher level of material well-being for
all its members. I further maintain that
in the short run and under certain conditions in the longer run, the high-wage
economy may also be characterized by a higher rate of growth.
High
wages serve to pressure firms to become more efficient and innovative, whereas
low wages allow firms to engage in less efficient economic behavior, all the
while remaining competitive and profitable. For this reason, high wages are viewed as a
potential boon to the process of economic growth and development, whereas low
wages are viewed as a potential drag. This is contrary to the view typically held by
both neoclassical and nonconventional economists
wherein high wages are considered to be anathema to the growth process. In the model presented here, economic agents
can choose among different available growth paths. There is no one road to growth. The choice made, however, affects the long-run
equilibrium level of real per capita GDP and the rate of economic growth. It is evident that owners and managers of
business enterprises, the decision makers, when free to choose, are to an
increasing extent choosing the low-wage path to economic growth and profitability
(Bluestone and Harrison 1990; Perelman 1993). In my model, this choice would have
predictable negative consequences for the level of material well-being for the majority
of a region’s population. To the extent
that the purpose of growth is to allow for the maximization of the consumption
basket of the typical consumer, this “preferred” path to growth generates
inferior or suboptimal welfare outcomes. Only if the low-wage path is deemed the only
path to growth can it and all that it entails be considered in any way optimal
or welfare maximizing.
The Conventional Growth Model and Revisions
Conventional
neoclassical growth theory does not rule out the possibility of nonconvergence. In
particular, to the extent that technical change or innovations are not
transferable interregionally or internationally,
there is no reason for per capita GDP to converge. The same holds true if there are significant
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and persistent
barriers to trade. In fact, the classic
neoclassical growth model as developed by Solow is
not concerned with the question of international or interregional differences
in the level or rate of growth in real per capita GDP. Instead, it is largely concerned with
establishing the necessary conditions for the long-run sustainability and
stability of a given rate of growth. Solow’s model was developed in response to Harrod’s (1939) work on modern growth theory, which
suggests the likelihood of capitalist growth being characterized by
considerable long-run instability.
In
Solow’s analytical framework the long-run equilibrium
level of per capita output is determined by an exogenously given propensity to
save and rate of technical change. The
long-run equilibrium growth rate is given by an exogenously determined labor
force growth rate. Long-run stability is
achieved through variations in the capital to output ratio. In the basic model, real output is a function
of capital and labor inputs, where the production function is characterized by
constant returns to scale while the individual inputs are subject to
diminishing returns. Perfect competition
is also assumed, as is full employment in the long run, with Keynesian
macroeconomic policy in play in the background. In addition, savings are identically equal to
investment so that the growth in capital stock is identically equal to savings.
It is further assumed that production is
x-efficient. Therefore, all economic
agents are working as hard and as well as they can…
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If one introduces technical change into the argument,
this too has the effect of temporarily increasing the growth rate as the
production function is shifted upward, only to return to the equilibrium growth
rate... Nevertheless, as is true for an increase in the propensity to
save, the economy subject to technical change ends up with a higher level of
output per worker. It is important to
note that, for Solow, technical change is a shorthand
classification for any factor that shifts the production function. The term “technical change” embodies any and
all variables, such as learning by doing, human capital formation, innovations,
research and development, and improved efficiency, that contribute to enhancing
the productivity of factor inputs. Unless
all regions and nations are characterized by an identical propensity to save
and rates of technical change, which is what conventional wisdom suggests to be
true, convergence in per capita GDP is not expected.
With the introduction of technical change the Solow growth equation is transformed into… a permanent
feature of the growth equation insofar as technical change is a permanent and
persistent feature of the economy. More
generally, with technical change the growth in real GDP is a function of the
growth in factor inputs plus the rate of technical change, and the growth in
labor productivity becomes a function of the growth in the capital to labor
ratio (which is subject to diminishing returns) and the rate of technical
change.
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… The key to sustained growth in the Solow model is, therefore, technical change writ large. Increased savings can, in the long run, affect
only the level of per capita output. And
there is a limit to which a society can increase the average propensity to save.
Moreover, to the extent that the
assumption of diminishing returns to capital is reasonable, there is a limit to
the increase in output that can be evoked by increases to the capital stock. Since technical change is so much of a
catchall phrase in the neoclassical model and it is assumed to be exogenously
determined, this model has been criticized for leaving most of the growth
process unexplained. But as Solow argues, the assumption of exogenous technical change
makes his model more methodologically flexible: “To say that the rate of
technological progress is exogenous is not to say that it is either constant,
or utterly erratic, or always mysterious. One could expect the rate of technological
progress to increase or decrease from time to time. Such an event has no explanation within the
model, and may have no apparent explanation at all. Or else it might be reasonably understandable
in some reasonable but after-the-fact way, only not as a systematic part of the
model” (1994, 48). This, of course, leaves
us with no clear causal mechanism to explain the process of technical change
and economic growth.
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To
address this potential problem, the new growth theory, centered on the work of
Paul Romer (1986, 1990; also Aghion
and Howitt 1998; Grossman and Helpman
1994; Helpman 1992; Lucas 1988), has evolved wherein
growth is explained endogenously. In the
new growth models increasing returns to scale are assumed to characterize the
aggregate production function. In
particular, increasing returns are assumed to characterize investment in
knowledge as distinct from physical capital. Therefore, increasing investment in human
capital or research and development has the potential effect of increasing
labor productivity without bound (Solow 1994, 50). Thus the production
function becomes convex so that the rate of change in labor productivity
increases as investment in the knowledge sector(s) of the economy increases. As Grossman and Helpman
put it with respect to their version of the endogenous growth model: “The endogenous
learning here - like the exogenous technological progress of the neoclassical
model - prevents the marginal product of capital from falling to the point
where investment ceases to be profitable. Innovation sustains both capital accumulation
and growth” (1994, 35). With investments
in knowledge, sustained and persistent growth is possible above and beyond the
rate of growth in the labor force…, and technological change… becomes
endogenous to the model. Once the growth
process is triggered through investments in knowledge, it becomes
self-sustaining. Moreover, since
investment in knowledge is assumed to be characterized by positive
externalities to the economic agent or the firm, it is quite possible for an
economy to underinvest in knowledge and for the free
market to fail in generating the “optimal” level of investment and therefore
the “optimal” rate of economic growth and level of per capita output.
The
new growth theory, however, does not provide us with a framework within which
to understand why convergence does not take place or, indeed, why divergence
may take place over time or why leading economies might eventually become
laggards - Britain being a classic case in point. One is left with an understanding that
persistent differences in per capita GDP among economies and persistent
differences in rates in per capita economic growth are a product of a variety
of ad hoc factors, among which are
different types of economic policy or historical accident. For this reason, the new growth theory leaves
us no further ahead of the analytical game than Solow’s
theory of economic growth. Moreover,
empirical work on the new growth theory does not provide strong support for the
hypothesis that investment in knowledge is a fundamental cause for sustained
economic growth and differentials in growth and per capita output among
economies (Fagerberg 1994; Mankiw,
Romer, and Weil 1992; Pack 1994; Parente
and Prescott 2000; Solow 1994).
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High and Low Wages and the Path and Pattern
of Economic Growth
A
critical assumption of all standard models of economic growth is that wage
rates play no positive role in the growth process. At most, relatively high wage rates, by inducing
higher capital to labor ratios, yield a relatively higher level of per capita
output, although at the price of higher unit costs. But economic agents are assumed to be
x-efficient in behavior. For this
reason, economic agents cannot be made to work harder or better, and all firms
are assumed to be cost minimizers in the sense of
maximizing output per unit of input. Once
the assumption of x-efficient behavior is dropped, however, the predictions of
the conventional neoclassical growth model are dramatically affected. In a word, by only marginally modifying the
simplifying assumptions of the Solow model, a model
of economic growth is developed that can help explain persistent differences in
per capita GDP and rates of economic growth, as well the movement of regions
from leaders to laggards in the growth process. [4]
There
is now a significant literature suggesting that typically economic agents do
not work as hard or as well as they might. In other words, effort is a variable in the
process of production (chapter 9; Akerlof and Yellen 1986, 1990; Altman 1992; Blinder, ed. 1990; Frantz
1988, 1997; Leibenstein 1966). If effort is variable, then so is labor
productivity, and if effort is not maximized, neither is productivity. Effort and therefore productivity become discretionary
variables. Effort variability itself is
a product of incomplete contracts (both informal and formal) due to transaction
costs in drawing up, monitoring, and enforcing them. Moreover, the behavior of the firm hierarchy
is more in line with utility maximization as opposed to profit maximization so
that if the marginal utility costs of increasing the hierarchy’s own effort or
that of its workers exceed the marginal utility benefits, effort per unit of
time will not be maximized. Nevertheless,
the bottom line for the firm hierarchy remains the competitiveness of the firm,
at least in the short run.
An
important tenet of the behavioral model presented in this book is that in the
absence of an ideal work environment, x-efficient behavior will be the
exception to the rule. X-efficiency is
defined as that level of output that can be achieved in the ideal, relatively
cooperative work environment. It is possible
for x-inefficient firms to survive even with perfect product markets if wage
rates differ among firms and if the different wage rates and the work cultures,
for which they may be a proxy, affect labor productivity by affecting the
effort inputted into the process of production. The rate of labor compensation is therefore
positively related to effort per unit of time and thereby to the level of labor
productivity. Under these circumstances,
a low-wage
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regime goes hand in
hand with a low-productivity regime and a high-wage regime goes hand in hand
with a high-productivity regime, and the two wage regimes need not necessarily
yield any differences in unit costs or even in rates of return…
Under these conditions, one can postulate a given level
of average and marginal costs and rate of return to capital that correspond to
an array of rates of labor compensation. There need not be any unique wage rate or labor
compensation package that minimizes costs or maximizes the level of profits
(chapters 1 and 2; Altman 1998; Akerlof and Yellen 1990; Stiglitz I987). [5] In
this case, high-wage firms can compete with low-wage firms by becoming more
productive, and output is a function of effort per unit of labor input…, as
well as of labor, capital, and technical change…
In this scenario,
low-wage-low-productivity and high-wage-high-productivity firms and, more
generally, low-wage-low productivity and high-wage-high-productivity economies
can exist simultaneously and persist over time since there is no mechanism in
place within the structure of the free market (perfect product market
competition) to drive the wage rates and the levels of labor productivity
toward convergence: low-wage x-inefficient firms do not have a competitive
advantage over high-wage firms that can ultimately force convergence to take
place. Indeed, low wages serve to
shelter x-inefficient firms from competitive pressures. High wages are compensated for by higher
productivity. On the other hand, if
relatively high rates of labor compensation are not followed by sufficient
increases in labor productivity, the high-wage firms will, ceteris paribus, fall
by the wayside in the process of interfirm or international
competition. One can expect this to
occur once, given technology, firms become x-efficient and effort becomes
perfectly inelastic to increases in wages or improvements in overall working
conditions. It is theoretically possible
for wage rates to converge in the long run if perfect mobil-
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ity
exists in the labor market. I assume
that labor market mobility is far from perfect. In fact, labor does not move freely, nor does
it costlessly flow from one region or country to
another. Apart from this, many
economies, especially the high-wage economies, have institutional mechanisms in
place (the right of workers to organize and a social welfare safety net) that
can maintain wages at relatively high levels even in the face of significant
labor mobility. As long as relatively
high rates of labor compensation are accompanied by relatively high rates of
productivity, the product market cannot generate the forces necessary to bring
about the convergence in per capita GDP.
The
notion that relatively high wages can positively affect labor productivity and
thereby cause long-run international differentials in real per capita GDP is
not a new one. Such a scenario was
suggested by H.J. Habbakkuk (1962) in his classic
comparative study of nineteenth-century American and British economic
development. He argues that America’s
advantage lay in the relatively high rates of labor compensation that
characterized its industrial sector. Habbakkuk maintains that in order to remain competitive and
profitable, American firms were forced to make more efficient use of their
factor inputs (to be more x-efficient), and American entrepreneurs were induced
into becoming more creative and innovative in developing new technology, as
well as being more apt to adopt known technology. Thus in Habbakkuk’s
interpretation of American-British comparative economic development, America’s
relatively high-priced labor was the primary cause of two key events. First, it affected the x-efficiency of
production. Second, it affected both the
extent and the rate of technological progress. All of this would have the effect of shifting
the production function upward… yielding a higher level of per capita output in
British as compared to American firms.
The
critical adjustment to the conventional neoclassical growth model suggested in
this chapter is that given the possibility of x-inefficiency, relative
differences in wage rates in like industries affect the differences in x-inefficiency
among industries and economies and the extent and pace of technological
progress. This, in turn, affects
equilibrium differences in real GDP per capita among economies, as well as, at
a minimum, the short-run growth rate in per capita real GDP. Output becomes a function not only of capital
and labor, but also of relative rates of labor compensation and other labor
costs, which, in turn, affects the shift or technical change parameter through
its effect on x-inefficiency and technological progress…
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Output is now only an
indirect function of effort since effort per unit of time is assumed to be the
product of relative rates of labor compensation among economies... To
simplify the discussion, I assume that the output of two (or more) economies is
identical.
In this model, an increase in the relative price of
labor has the immediate and short-term effect of increasing the cost of
production and reducing the rate and amount of profit. If the firm is to survive, however, ceteris paribus, an
increase in the relative rate of labor compensation must be accompanied by a
sufficient increase in labor productivity. This wage effect on productivity can be broken
down into three components. The
x-efficiency effect, the technological progress effect, and the savings effect
will be discussed in turn.
1.
The x-efficiency effect. High-wage
firms are pressured into becoming more x-efficient. The decisionmakers
of the firm cannot be expected to increase x-efficiency on their own if the
benefits of the increase accrue largely to the employees and if the process
incurs increased disutility to members of the firm hierarchy in terms of
increased effort, loss of status, and even loss of jobs to some (chapter 9). Increasing the level of x-efficiency serves to
shift the production function outward. On
the other hand, the relatively low-wage firms remain relatively x-inefficient
as a result of low wages.
2.
The technological progress effect. High-wage
firms are forced to adopt already available technologies that are new to these
firms. These firms may also find it
worthwhile to develop new technologies (to innovate). The new technologies might also require the
investment in on-the-job training and formal education for employees and the
firm. Technological progress shifts the
production function upward. Low-wage
firms need not adopt new technology or innovate if they can effectively compete
on the basis of low wages. Moreover, the
low-wage regime may result in labor being too x-inefficient for the new
technology to be cost-effective…
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131
…
3. The savings effect Under pressure to adopt new technology or new
forms of organization by higher rates of labor compensation, high-wage firms
may be forced to increase the propensity to save so as to increase the rate of
investment. This may result in an
increase in the economy’s propensity to save. Much depends on the extent to which increasing
wages serve to pull down the economywide or average
propensity to save (with workers being characterized by a relatively low
propensity to save). To the extent that
the saving rate increases, the production function shifts upward.
These
three wage effects serve to increase the level of real per capita GDP in the
high-wage economy. In the short run, at
least, the rate of per capita growth is also augmented as the high-wage economy
adjusts to the new higher level of per capita output. It is quite possible that in the long run the
growth rate in output will converge toward the growth rate of the labor force. However, growth may be positively affected
over the longer run to the extent that relatively higher and increasing rates
of labor compensation affect the rate of improvement in x-efficiency and the
rate of technological progress writ large. But clearly the wage effects can be expected,
at a minimum, to increase real per capita output and the short-run per capita
growth rate. Moreover, the consequences
of higher rates of labor compensation should be stable insofar as they are
consistent with Solow’s stability conditions for
economic growth. In addition, the
low-wage economies have no competitive advantage over the high-wage economies. In this sense, both the high- and low-wage
path to economic growth and development are sustainable in the long run.
The high-wage regime might be more unstable than a low-wage
regime, however, insofar as corporate leaders might have a preference for the
latter and have the capacity to undermine the former by political means or by relo-
132
cating
to low-wage regions. This is
particularly true if an economy approaches the neoclassical ideal of perfect
competition, with the perfect mobility of capital and the absence of tariffs. Footloose industries would be more prone to
this particular problem. High-wage
industries tied to a region or country for geographical, economic
(transportation costs, economies of scale), or political reasons would be more
stable.
A
high-wage regime would also be difficult to sustain if the necessary infrastructure
to maintain a high level of productivity were not established. This includes the educational, research and
development, health, legal, and transportation and communication infrastructure,
which Moses Abramovitz (1986) refers to as a nation’s
“social capabilities.” Social
capabilities represent necessary conditions for sustained growth and
development (see also Olson 1996). High
wages may induce governments to engineer the social capabilities necessary. A low-wage regime may have the opposite effect
on government. On the other hand,
adequate social capabilities are not sufficient to induce high rates of economic growth and high levels of real per
capita output. On a microeconomic level,
high wages are necessary to induce firms to become more x-efficient and to
adopt more productive technology. [7]
The
key point this chapter seeks to make is that one can develop a reasonable
endogenous theory of economic growth by introducing wage rates as a causal
determinant of the extent and rate of x-inefficiency and technical change into
the Solow growth model. Thus the origins of important and stable differences
in per capita GDP and growth rates become more comprehensible. Moreover, it is now possible to more clearly
explain how an economy can revert from leader to laggard in the growth and
development process. Whether or not
convergence takes place depends on the state of the labor market and the extent
to which an economy can sustain relatively high rates of labor compensation. This is not to say that other factors, both
endogenous and exogenous, are not important to explaining this process. However, by focusing on the relative rate of
labor compensation, one is isolating an easily identifiable and measurable as
well as significant economic variable as a possible supply-side determinant of
the growth process. This variable has
typically been ignored in the literature as an important determinant of
x-efficiency and technical change. As
with all hypotheses, the one presented in this chapter must bear the test of
empirical scrutiny.
Conclusion: The
Low Wage Economy and Market Failure
To
the extent that both high- and low-wage economic regimes are sustainable over
time, the low-wage regime can be regarded as a product of a market failure. The objective of economic growth is not growth
itself; rather it is
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to maximize a
social welfare function. One might argue
that an important argument in such a welfare function is the basket of
commodities consumed by members of an economy over a specified time horizon. A low-wage-low-productivity economy cannot
serve as the basis for maximizing the consumption basket of the typical
consumer of such an economy. Apart from
this, such an economy produces a level of output that is below its potential
where this potential is given by what is produced in the high-wage-high-productivity
economy. But the behavior of economic
agents in both economies can be consistent with utility-maximizing behavior. And this is the rub. The low-wage economy might be preferred by the
utility-maximizing members of the firm hierarchy and corporate leaders in
general, as well as political leaders - that is, those individuals who ultimately
determine the wage regime firms follow given the institutional, social,
political, and economic constraints they face. What is of some importance from the
perspective of social welfare is whether the utility function or preferences of
the decision makers take into account the preferences of the larger population.
In other words, do externalities exist
when choosing the wage regime that an economy is to follow?
If a high-wage economic regime is adopted, this can be
expected to increase the utility of workers in terms of the higher income
generated. These benefits are typically
not part of the preference function of corporate leaders. In this case, by maximizing their own utility,
the corporate leadership will tend to “underinvest”
in the development of a high-wage economy. But why might a low-wage regime be favored by
corporate decisionmakers when both regimes yield
competitive and profitable economic structures? It all depends on their utility function. If utility is negatively related to more work
and effort on the part of the firm hierarchy and these are required to develop
a high-wage economy, the marginal costs of developing a more productive economy
tend to outweigh the marginal benefits. Such
benefits might be zero, given our assumptions. If creating a high-wage-high-productivity
economy also involves investments that can only be covered over time, this will
further encourage a preference for a low-wage economy. This is especially true if members of the firm
hierarchy are present-oriented, if they have a high rate of time preference. Since choosing a low-wage regime ignores the
benefits accruing to consumers in general, such a choice generates a market
failure.
The preference for a low-wage regime on the part of members
of the firm hierarchy cannot always be realized, however. They are not always free to choose. The state of the labor market acts as a
powerful constraint on the behavior of corporate leaders. Labor market conditions, which are influenced
by supply and demand considerations as well as by institutional factors, can
prevent the low-wage route to growth and development. But once the labor mar-
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ket
becomes “flexible,” the low-wage regime becomes the chosen path of corporate
leaders unless their utility functions undergo a significant transformation. As Bluestone and Harrison remark, an
environment has emerged “in which it was simply easier for many firms to
attempt to contain their own labor costs than to seek enhanced profits through
investments in expensive new plant and equipment. For the most part, firms abandoned
revenue-enhancing strategies to boost profits and turned sharply towards
tactics that emphasized cost reduction instead” (1990, 369). This comment on the American economy is applicable
to an increasing number of developed high-wage economies.
To
the extent that the choice of a low-wage route to growth represents a market
failure, it is important to develop institutions that prevent such a failure. At a minimum, labor market institutions need
to be developed that minimize the probability of the low-wage path when the
high-wage path is a competitive and profitable option. Moreover, an institutional environment (social
capabilities) must be developed that contributes toward making the high-wage
path competitive and profitable. This is
particularly important since, according to the behavioral model of economic
growth presented here, the low-wage path is viable and sustainable over time in
spite of its being suboptimal from a social welfare perspective. Market forces, left to their own devices,
cannot easily push an economy from a low- to a high-wage path. As a result, there are significant long-run
regional and international differences in per capita output.
1. Many of these
arguments, often referred to as the new growth theory, are predated by Abramovitz (1952), albeit in a less formal presentation. Moreover, Schumpeter’s (1974) classic study on
technological change, first published in 1934, has also informed much of the
new growth theory literature, as well as the recent work on evolutionary growth
(see Nelson 1995, 1998).
2. See Hodgson (1989) for
a critical assessment of Kaldor’s theory of
cumulative causation. Kaldor’s (1970) rendition of “Verdoon’s
Law” is that there exists a strong positive relationship between the rate of
growth of productivity and efficiency and the rate of growth in the scale of
economic activities. Thus there is a
strong positive correlation between the rate of growth of exports and the rate
of growth of productivity and efficiency.
3. Nelson (1998) points
out that both the basic Solow growth framework and
the new growth theories fail to take us beyond a discussion of the immediate
sources of economic growth. He argues
that variables that underlie the immediate sources of growth hold the secret to
a better understanding of the persistence of growth and per capita income
differentials across nations. Nelson
identifies the organizations that adopt technologies, the institutional
framework in which they operate, and the process of technological change as key
underlying variables that affect the process of economic growth.
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4.Unlike the Solow model, the
model developed in this chapter does not assume x-efficiency in production or
perfect labor market mobility. Also, as
with the conventional growth models the demand side is not dealt with here,
which is not to say that it is unimportant. Rather, I focus on the supply-side variables
that may affect the growth process. See
You (1994) for an alternative wage-led growth model that incorporates the
demand side.
5.
In the traditional efficiency wage literature there
exists a unique wage that maximizes effort per unit of time and thereby
minimizes the cost of labor per unit of time. This unique wage is chosen by the profit-
maximizing firm (Akerlof and Yellen
1986).
6.
The argument presented here clearly fits in with the
notion of induced technological change, wherein changes in relative factor
prices affect the direction of technological change (Hayami
and Ruttan 1971; Hicks 1932; Ruttan
1997).
7. Reviewing the history of technological change,
Nelson and Wright (1992) find that the globalization of the world economy has
resulted in common technologies across nations, easing the international transfer
of technology when the appropriate social capabilities are available in the
target nations. Fagerberg
(1994) finds that the most important determinant of technological change, given
the existence of a sufficiently strong social capability, are the “intentional
activities of private firms.” The model
presented in this chapter suggests that in a world of accessible technologies
and adequate social capabilities differentials in wage regimes can have a significant
impact on the “intentional activities of private firms.”
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