Arnold Kling  

Savings, Capital Deployment, and Growth

Trading with Weasels... Job-Creation Arithmetic, II...

I was taught in graduate school that economic growth has two main drivers: the savings rate, which determined the steady-state capital-labor ratio; and the efficiency of labor, which increases over time due to technological change and better human capital.

Yesterday at a seminar, I heard IMF chief economist Ken Rogoff mention another parameter: the efficiency of capital allocation. He pointed out that China saves one-third of its income, a much higher ratio than the United States. Rogoff pointed out that if China and other countries deployed their capital more effectively, they could enjoy faster growth without having to save so much.

In his 2002 Richard Ely lecture, Edward Prescott presented a growth model that allowed for a capital allocation factor. He wrote,

Another policy associated with poor productivity performance is centralized allocation of savings to investments...
The candidate mechanism by which centralized financial systems adversely affect productivity is as follows. Inefficient producers are subsidized in order to preserve jobs. This has the perverse effect of lowering productivity and decreasing overall employment in the economy. Japan is another depressed country with a highly centralized financial system controlled by the state. Perhaps this accounts for the 17 percent decline in its productivity factor in the 1991-2000 period.

For Discussion. If Prescott and Rogoff are correct, then is the value of the capital stock overstated in countries that do not deploy capital efficiently?

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COMMENTS (4 to date)
Kip Dyer writes:

If I may comment. I believe that the capital structure in Japan and China in particular are built to minimize risk, rather than maximize growth. Central control and an effective continuity of that control through at least the last several centuries have lead to a culture within the beuracracies that cannot countenance the general nature of risk taking that marks the western style capital management, at least in relative comparison to the oriental philosophy. In one sense, you can see some of this in China, in that Hong Kong has been less imposed upon than one would have thought after the handover. The beuracracy in China recognizes that Hong Kong is a good generating center that is in a real sense vital to the future of their economy as a whole. It wouldn't surprise me if this thinking also helps to moderate the Taiwan situation.In Japan, this appears to be reflected in the fact that real institutional form just has not been done, no matter 10 years of recession.

Kip Dyer writes:

Oops, that should be "real institutional REform" towards the end of the above post.

Eric writes:

The question at hand is answered "Duh, yes!". Common sense tells you so.

Not that a centralized financial system is the only way to get your country an overstated capital stock. Another is to have a dot com bubble!

But I guess the Japanese would be happy if their bubble resulted in as mild a recession as we have had. As bad as the end of the Internet bubble has been, we are far, far from the disaster that is Japan.

Say what you want about Americans, when we finally admit that we have a problem, it does get solved. We are not people to allow problems to fester once there is widespread agreement that there IS a problem. Sometimes we have a hard time agreeing that there is a problem, however.

Scott writes:

It seems to me that allowing companies to fail, rather than be propped up, is an essential element in efficiently allocating capital. By propping up the failing airlines, we are misallocating capital in the US right now.

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