Several topics on economic growth theory are explored in this post, including research from the OECD on the likely sources of productivity growth, and McKinsey on the characteristics of high growth firms, industries and cities.
I. Essence of Economic Growth Theory
Fatas and Mihov’s 4-I’s framework describe the essence of economic growth. It specifies four important characteristics to help describe reasons for the rate and scale of economic development that nations experience:
- Innovation fostered by incentives such as intellectual property rights to create productivity growth;
- Initial conditions describe the potential for poor or lagging countries to ‘catch-up’ through means of technology and productivity adoption / diffusion;
- Investment (unsurprisingly) in forms such as physical capital, education and technology; and
- Institutions that enable political stability, investment and sound macroeconomic policies. This include independent central banks, checks and balances, rule of law, etc.
II. Future of Productivity Growth
Future global economic growth is expected to come from the rise in emerging
economies, higher productivity growth, and improved diffusion of technologies
and innovation. The latter two is critical to strong, sustainable and inclusive
economic growth. Unlike in past decades, population levels, education attainment
rates and labour force participation rates are less likely to be strong sources
of growth as these factors level out.
Four key factors are important to diffusion:
- Global connections in the form of trade, foreign investment, global value chains and international labour mobility;
- Conditions that enable firms to experiment with and adopt more productive technologies and business models;
- Improved allocation to enable labour, capital, skills and knowledge to flow to the most productive firms and sectors;
- Investment in education and innovation, including research and development;
Gains from diffusion are magnified by various issues. This includes prevalence of
productive but undersized firms, muting their potential economic and
productivity impacts due to scale; labour market rigidities attributed to high
rates of skill mismatches; and inability for firms to grow and exit rapidly
(causing small unproductive firms to linger and dawdle). Other factors such as
business R&D, managerial quality, barriers to entrepreneurship (incl. cost
and legislation), public infrastructure, and the quality of financial and risk
capital markets become important factors as well.
III. Empirical Characteristics of Growth
Empirical research over the last two decades from the McKinsey Global Institute found ‘superstar’ firms, sectors and cities that capture a greater share of income and economic profit to share similar characteristics:
- Higher levels of digitisation and innovation intensity;
- Greater share of skilled labour;
- Stronger connections to global markets and financial centers;
- Relatively lower fixed capital and labour input levels;
- Higher levels of intangible inputs and regulatory oversight;
The gap and variation between superstars and average performers has widened over the last two decades. However, churn and displacement rates remain high and reflects the effect of technological change and creative destruction. Top performers over the last decade have been concentrated in financial services, professional services, real estate, pharmaceuticals, medical products, and internet, software and media industries.
References
Fatas, A., and Mihov, I. (2009). The 4 I’s of Economic Growth, INSEAD. Available at <https://faculty.insead.edu/fatas/wall/wall.pdf>
McGowan, A., Andrews, D., Crisculo, C., and Nicoletti, G. (2015). The Future of
Productivity Growth, OECD. Available at <https://www.oecd.org/eco/OECD-2015-The-future-of-productivity-book.pdf>
Saia, A., Andrews, D., and Albrizio, S. (2015). Productivity Spillovers from the
Global Frontier and Public Policy: Industry-Level Evidence. OECD, The Future of
Productivity: Main Background Papers. Available at <http://www.oecd.org/eco/growth/Productivity-Spillovers-from-the-Global-Frontier-and-Public-Policy-Industry-Level-%20Evidence.pdf>
McKinsey Global Institute. (2018). Superstars: The Dynamics of Firms, Sectors,
and Cities Leading the Global Economy. <https://www.mckinsey.com/~/media/McKinsey/Featured%20Insights/Innovation/Superstars%20The%20dynamics%20of%20firms%20sectors%20and%20cities%20leading%20the%20global%20economy/MGI_Superstars_Discussion%20paper_Oct%202018-final.ashx>