by L Peilin · 2017 — does not lead to a significant decrease in capital efficiency since the diminishing marginal return to capital effect is offset by the rapid catching-up of technology.
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The Working Paper series is a continuation of the formerly named Discussion Paper series; the numbering of the papers continued wit hout interruption or change. ADBI ™s working papers reflect initial ideas on a topic and are posted online for discussion. ADBI encourages readers to post their comments on the main page for each working paper (given in the citation below). Some working pap ers may develop into other forms of publication. ADB recognizes fiChinafl as the People™s Republic of China; fiHong Kongfl as Hong Kong, China; and fiKoreafl as the Republic of Korea. Suggested citation: Liu, P., S. Jia, and X. Zhang . 2017. Catch -up Cycle: A General Equilibrium Framework . ADBI Working Paper 660. Tokyo: Asian Development Bank Institute. Available : https://www.adb.org/publications/catch -cycle -general -equilibrium -framework Please contact the author s for information about this paper. Email : zhangxun@ bnu.edu.cn This article is supported by 2013 Development Research Center of the State Council™s major subject, fiGrowth Phase Transition: Reasons, Challenges, and Strategiesfl, the National Natural Science Foundation of China projects (71073033, 71273012, 71173058 and 71350002) , China Postdoctora l Science Foundation funded project (2015M580055 ), and Youth Scholars Program of Beijing Normal University . The authors are fully responsible for all errors and inaccuracies in the paper. Liu Peilin is the vice director general and a research fellow at the Development Research Center of the State Council of China . Jia Shen is also from the Development Research Center of the State Council of China . Xun Zhang is an assistant professor at Beijing Normal University . The views expressed in this paper are the views of the author and do not necessarily reflect the views or policies of ADBI, ADB, its Board of Directors, or the governments they represent. ADBI does not guarantee the accuracy of the data included in this paper and accepts no responsibility for any consequences of their use. Terminology used may not necessarily be consistent with ADB official terms. Working papers are subject to formal revision and cor rection before they are finalized and considered published. Asian Development Bank Institute Kasumigaseki Building, 8th Floor 3-2-5 Kasumigaseki , Chiyoda -ku Tokyo 100 -6008, Japan Tel: +81 -3-3593-5500 Fax: +81 -3-3593-5571 URL: www.adbi.org E-mail: info@adbi.org © 2017 Asian Development Bank Institute
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ADBI Working Pap er 660 Liu, Jia, and Zhang Abstract Certain stylized facts are common among s uccessful economic latecomers: an inverse U -shaped gross domestic product and capital per capita growth rate, high growth rates during the catch -up period , and rapid structural changes. This paper, for the first time, proposes a general equilibrium framework to document the catch -up cycle that a successful latecomer is likely to experience. We argue that technology adoption and imitation , and the diminishing marginal return s to capital are the two driving forces of the catch -up cycle. The technological gap and speed/efficiency of technological catching -up are two fundamental factors for successful catching -up. This paper concludes with a case study for the People™s Republic of China and sheds light on the different policy choices in various stages of the catch -up cycle. JEL Classification: E13, E60, O11
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ADBI Working Pap er 660 Liu, Jia, and Zhang Contents 1. INTRODUCTION .. .. .. 1 2. MECHANISM AND MODEL .. .. .. 4 2.1 Descriptive Evidence .. .. 5 2.2 Empirical Evidence .. .. 7 2.3 Model .. .. .. 8 3. DETERMINANTS OF SUCC ESSFUL CATCHING -UP .. .. 13 3.1 Factors of Successful Catching -up .. . 13 3.2 Empirics of .. .. . 14 4. CONCLUDING REMARKS: A CASE STUDY OF THE PEOPLE™S REPU BLIC OF CHINA .. .. 16 REFERENCES .. .. .. 18
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ADBI Working Paper 660 Liu, Jia, and Zhang 1. INTRODUCTION The economic growth of latecomer economies comes in various forms. Some latecomer economies, such as Japan; the Republic of Korea; Singapore; Hong Kong, China; and Taipei,China have succeed in catching up with developed economies, while some other latecomers have not, such as the People™s Republic of China (PRC), India, and Thailand. Can they finally catch up with developed economies and become successful latecomers? How can we describe the process of catching -up? Do policy choices dealing with different stages of econo mic catching -up differ? In this paper, we analyze the common characteristics that those successful latecomer economies share. Extracting these characteristics is important and even fundamental for us to understand the mechanism of the successful catch ing -up, as well as to provide policy implications for those latecomer economies which have just begun to catch -up. Generally, there are three stylized facts accompanying the catch -up processes of those successful latecomer economies. First, gross domestic produ ct (GDP) and capital per capita growth depicts an inverse U-curve over time. Economies start with low growth in their low -income conditions, followed by a takeoff, a high -speed catch -up for 20 Œ30 years, a growth rate decrease, and ending with medium or low but stable growth (see Figure 1). Second, there is a 20 – to 30 -year phase during which GDP and physical capital per capita increase rapidly. Figure 1 shows that the growth rate of latecomer economies reached almost 10% and remained high during the high -speed growth phase. For instance, during 1950 Œ1974, Japan experienced six declines and seven booms, but each recession lasted no more than 12 months. Figure 2 shows that the growth rates of physical capital per capita during the phase were also approximately 10%. The growth rates in developed economies, such as the United States (US), the United Kingdom, Germany, and France were only between 2% and 6% during the same period. Third, rapid industrial upgrading and dramatic structural changes occur during the high -speed growth phase. The successful latecomers experienced rapid industrial upgrading in the high -speed growth phase, during which the capital stock accumulated rapidly, as did technology progress . At the same time, the structure of exports, consumptio n, and allocation of urban and rural populations also experienced rapid changes. It is well known that the growth of developed economies remains at a low level. For instance, over the past 180 years, the 30 -year moving average GDP annual growth rate of th e US has been roughly 4%, and the 40 – and 50 -year moving average growth rates have been roughly 3% Œ4%. The long -term GDP per capita growth rate has been roughly 2%. Latecomer economies, by definition, have lower income originally. Therefore, in order to ca tch up, the growth rate of successful latecomers must be higher than that of advanced economies for at least several decades. As we will discuss, this is due to the large technological tap between latecomers and developed economies. After a certain period of high -speed growth, the technology difference between latecomer and developed economies decreases and the latecomers™ economic growth rates begin to decrease and finally converge with advanced economies. Thus, there exists a common inverse U -shape growth pattern among the successful latecomers . This pattern is similar to a normal business cycle. We, for the first time, document it as a catch -up cycle. 1
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ADBI Working Paper 660 Liu, Jia, and Zhang dominate and bri ng down the income growth rate. Thus, the income and capital per capita growth rate both depict an inverted -U shape, or catch -up cycle. The recognition of the catch -up cycle can deepen the understanding of short -term economic fluctuations and long -term eco nomic growth. We also conduct a case study for the PRC, which is now the world™s biggest latecomer economy, is currently in the high -speed growth phase, and has begun to switch to a medium -speed growth pattern. Based on the finding of the catch -up cycle, w e are able to tell whether the PRC™s slow -down is due to short -term economic fluctuation or a long -term cycle. Among current studies, the main literature offering explanations for the latecomers™ catch -up mechanism is empirical research framework provided by Barro (1991) and Barro (2012), which is inspired by the neoclassical growth theory (Solow 1956). They argue that the catch -up mechanism is the diminishing marginal return to capital. The implicit assumption of the framework is that latecomers obtain th e same technology as developed economies at the beginning of the catch -up process. Therefore, the above framework ignores the technological catch -up (Lucas 2009) and, therefore, fails to explain why the successful latecomer economies can take off with econ omic growth rates that are much higher than developed economies. In this paper, we document the catch -up cycle as the combination of diminishing marginal returns of capital and technological catching -up. As we will demonstrate, the combination of technolo gy imitation and diminishing marginal returns to capital can successfully explain the complete process of the catch -up cycle. This paper is also related to studies on economic cycles. Cycles recognized by current studies primarily cover the Kondratieff cyc le, which is a 50 – to 60 -year long -term technology advancement cycle; the Kuznets cycle, which is a 20 – to 25 -year medium – to long -term building upgrade cycle; the Juglar cycle, which is an equipment upgrade cycle lasting approximately 10 years; and the Ki tchin cycle, which is a commercial cycle caused primarily by inventory fluctuation lasting approximately 4 years. However, the catch -up cycle differs significantly from other cycles in several aspects, including their natures, properties of structure chang es, policy implications, and durations. The rest of the paper proceeds as follows. Section 2 sets up a general equilibrium model to illustrate the mechanism of the catch -up cycle. Section 3 discusses the determinants of successful catching -up based on the model . Section 4 concludes by conducting a case study for the PRC. 2. MECHANISM AND MODEL The core mechanism of the catch -up cycle is the different sources of technology improvements among developed economies and latecomers. The technological progress of developed economies is primarily based on trial and error, or innovation. The costly and risky innovation results in moderate long -term growth. However, the latecomers can achieve technological progress through technology adoption and imitation, which cost s much less than research and development (R&D) , as there is a large technological gap between latecomers and developed economies . Therefore, in the early stage of catch -up, the technological growth rate of latecomers is much higher than that of developed economies. Only when the technology gap between latecomers and advanced economies narrows, the technology growth rate begins to slow down. The income growth rate is thus brought down. 4
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ADBI Working Paper 660 Liu, Jia, and Zhang We first provide some evidence of the technological catch ing -up of lat ecomers. Then we propose a general equilibrium framework to characterize the catch -up cycle. 2.1 Descriptive Evidence As we have mentioned, the necessary condition for latecomers™ rapid catching -up is the low cost of technology imitation. Take the PRC as an e xample. The most popular explanations for the PRC™s economic growth are low labor costs, demographic dividends, low land costs, and low environment costs, among others. However, although developed economies, such as the US, enjoyed similar elements in thei r early stages of development, they never experienced a high -speed growth phase. The reason is clear: latecomers are able to adopt and imitate technology at a lower cost. This is the key condition that enabled the PRC to maintain a growth rate of nearly 10 % for 30 years. Further, during the high -speed phase, the rapid accumulation of capital does not lead to a significant decrease in capital efficiency since the diminishing marginal return to capital effect is offset by the rapid catching -up of technology. Second, after the high -speed phase, the transition from high to medium/low economic growth is due to the narrowing technology gap between latecomers and advanced economies. Consequently, latecomer advantages decrease, and the speed of technological progres s is not sufficient to offset the diminishing marginal returns of capital. Therefore, the rate of economic growth begins to decrease. It is noteworthy that during the growth transition a series of changes occur: a slowdown of technology advancement, econom ic growth and investment growth, a change from technology imitation to R&D, and a decrease in capital returns. As the technology gap narrows, these changes continue until the latecomers complete the catch -up process and converge with developed economies. Figure 3 shows the total factor productivity (TFP) growth rate and the relative ratio of TFP to the US of the five successful catching -up economies. We find that the following: Catching -up economies experienced high TFP growth rates for years before economi c slowdown. At the high -speed growth phase, when latecomers™ capital per capita rapidly accumulated, capital output efficiency, as measured by the incremental capital -output ratio, 1 remained at a relatively high level (see Table 1). 2 The TFP growth slowdow n of latecomers occurs when TFP is close to that of advanced economies. For instance, Japan; the Republic of Korea; and Taipei,China entered this period when their TFP reached 70%, 70%, and 100% of the US TFP, respectively. The above stylized facts are consistent with the definition of the catch -up cycle as we propose. 1 The annual ratios of investment and production increase are economic indicators of investment efficiency. Generally speaking, the higher an economy™s incremental capital -output ratio is, the lower its investment efficiency and production efficiency are. 2 Bai et al. (2006) found that despite high inve stment, the PRC™s capital return rate did not decrease significantly during the high -speed growth period. 5
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ADBI Working Paper 660 Liu, Jia, and Zhang Table 1: Capital Output Efficiency at the High -speed Growth Phase Economy Period Growth Rate of Capital Per Capita ICOR Japan 1951 Œ1970 9.3% 2.07 Republic of Korea 1966 Œ1995 11.6% 2.64 Singapore 1965 Œ1984 12.0% 2.53 Hong Kong , China 1963 Œ1996 7.5% 2.46 Taipei,China 1965 Œ1998 9.7% 1.86 United States 1951 Œ2011 2.5% 3.55 ICOR = incremental capital output ratio. Note s: Calculations are based on the Penn World Table. We eliminate the samples with negative ICOR. 2.2 Empirical Evidence Next, we provide some empirical evidence. The core assumption of the catch -up cycle is that the TFP growth rate is negatively correlated with the TFP gap with developed economies. Therefore, the larger the TFP gap with developed economies, the higher the TFP growth rate. We us e country -level data from Penn World Table and regress the average TFP growth rate on TFP gap with developed economies, see Eq. (2.1): =+ + (2.1) where is the TFP gap, defined by the ratio of latecomers™ TFP over the TFP of the US. Here we use the average TFP gap in the early period .3 is the average growth rate of TFP in the later period .4 denotes the error term. We expect <0. To simplify the model setup, we also test the following restricted regression function: =(1 )+ (2.2) can be seen as the speed (or efficiency) of the technology adoption and imitation. We expect to be positive. Figure 4 plots the primary relationship between the TFP gap and the TFP growth rate. As expected, the larger the TFP gap with developed economies in the early period, the higher the TFP growth rate in the later period. Table 2 presents the empirical results of equations (2.1) and (2.2). We conduct a robustness check by altering the time interval . Columns (1) , (3), an d (5) are the results of (2.1), and columns ( 2), (4), and (6) are the results of (2.2). In all regressions, we find that the TFP growth rate is negatively correlated with the TFP gap with developed economies. Specifically, according to columns ( 2), (4), an d (6), the global average speed of catching -up ( ) is roughly 0.01 . The empirical findings provide justification and support for the catch -up cycle model, as we present below. 3 We report the empirical results of three time intervals: 1960 Œ1964, 1965 Œ1969, and 1960 Œ1969. Altering the time intervals does not change our resul ts significantly. 4 For the time interval 1960 Œ1964, we average the TFP growth rate of 1965 Œ2011. The rest is done in the same manner. 7
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