Question

a. Describe the three pillars of productivity growth. b.Why is a market economy susceptible to coordination failures that can lead to unemployment and inflation? What do you think can be done to rectify these failures? c. Unemployment is socially wasteful. Why? Does the existence of unemployment insurance eliminate the economic costs of unemployment? c. Several countries in the world have failed to "converge" with industrialized countries. What does this mean about their economic growth rates? Explain why poorer countries have failed to "catch up", in terms of the pillars of economic growth. Are there any special problems facing these countries?

Answer 1

Ans : (a) Three pillars of labor productivity growth are:

• Capital (K)
• Technology and capital formation
• Labor force Quality

Capital

Capital productivity is the measure of how well physical capital is used in providing goods and services.Capital deepening which implies that increase in the proportion of capital stock to the number of labor hours worked. Capital deepening generally leads to an increase in the growth rate of total output.It is thought to be an important factor in the economic development of emerging markets. For a given technology and a given labor force productivity will be higher when capital stock is larger.

Capital Formation and technology

Capital formation means increasing the real capital stock in the country when more capital goods are produced like machines, tools etc which further increase the future production of other goods.Technology is theonly source of permanent increase in the productivity, Solow Model explains that only technical progress can lead to the permanent increase in per capita level of capital. Total Factor Productivity also increases due to the increase in the levels of technology. If the level of technology increases then a country can produce more output with the same levels of inputs.

Labor Force Quality

Education, health and training determine the quality of the workforce, better educated and healthyworkers have the potential to develop more output. Human capital formation - increase in the level of skills acquired bythe human capital can think of more ideas which can lead to efficiency in the output. By investing in the human capital the productivity is boosted.

(b) It isvery difficult to coordinate the actions of hundreds of millions of producers, consumers etc. Paradoxically, Adam Smith's idea of Invisible Hand tells us that the market forces will guarantee an efficient allocation of resources.Coordination failure expalins the recessions through the failure of firms and other price setters to continue. In an economy with the multiple equilibria it arises when a group of firms desire to achieve an equilibrium but they lack in the coordination of each other's action.

The way in which a worker reacts tothe choices of other workers' choices determine the reaction function. This curve tells that if the productivity of each individual increases with the effort of his co- workers, then it will slope upward thereby implying that if all the other workers increse their effort then the remaining worker will find it optimal to work harder.  

Labor market can create multiple equilibria such as employment protection andunemployment funded program, Employment protection helps to reduce worker displacement and job destruction by imposing the costs on employers who fire workers.On of the equilibia that it can generateit low job turnover and high unemployment ; it can lead to the situation where employers are reluctant to fire workers. Alos if the employers believethat if the economic conditions worsen then the workers will not quit their job and they have to incur high firing costs in the future. Due to high firing costs workers will not hire workers in the first place and it will lead to the unemployment at a high level and also high inflation if govt tries to avoid such a high unemployment then according to the Taylor's Rule there is a trade off between inflaion and unemployment. Thus the level of inflation will also be high.

Ways to rectify the failure

If the government can coordinate the actions of the individuals instaed of opting high unemployment benefits if the government adopts a levelof taxes and adjusts the level of benefits according to taxes it collect then low unemployment and low tax equilibrium can be the only equilibrium and ,multiple equilibia will not arise and coordination failure will not occur.

(c) Unemployment is socially wasteful beacuse if an economy is not able to create jobs for those who are able and willing to work then a valuable resource is lost. Potential goods and services which can be produced and consumedby the people are lost forever.The lost output is a cost to the economy and we can measure this cost by measuring the actual and potential GDP. This cost is quite considerable and it is to be shared by the people living in the economy and it results in the low quality of living standards of the people.

Existence of unemployment insurance doesnot fully eliminate the economic costs of unemployment. Even those who receive social welfare and other unemployment benefits suffer when the joblessness strikes. The full economic costs are not eliminated even though it helps to increase the support to the unemployed but in the long run it can lead to the inflation and the unemplyment benefits are not revised in accordance with the infaltion which leads to the reduction in the purchasing powe of the individuals.

(d) This imply that the economic growth rates of these countries is less than that of the industralised economies, The economic growth rates can be low because of the factors like high unemoplyment, infaltion rate and because of the govt policies or because the countries may not be open up, because of all these factors these countries may not be ableto catch up the growth rates of the industralised countries.

One theory about the lack of the poor country to catch up the growth is that they do not open up their markets internationally.Local interest groups may have little incentive to open up the domestic market to the foreign firms withmore advanced technologies.Another raeson can be dueto bad political institutions which may not have devisedenough policiesto boost the FDI or to attract the foreign investment. It can dueto dictatorship, or some another reason

Also social considerations can also be the problem because if the education and health levels or the technology levels are not vey high then no one will invest inthe countries.