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Doran and Butler (2011) ISNE Presentation

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This is a copy of the slide I presented at the Irish Society of New Economists Annual Conference in UCD on the 19th of August 2011. Please contact me if you are interested in obtaining a copy of the working paper.

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Doran and Butler (2011) ISNE Presentation

  1. 1. Irish Society of New Economists– 19th August 2011Competing Explanations of Economic Growth: Comparing New Economic Geography (NEG) and Neoclassical Growth Theory for EU Regions Justin Doran and Robert Butler Department of Economics, University College Cork, Ireland
  2. 2. 1. Introduction2. What are a. New Economic Geography Theory b. The Solow Growth3. Growth Models a. New Economic Geography b. The Solow Growth4. Empirical Methods5. Data & Results6. Policy Implications
  3. 3.  This paper examines the explanatory power of two competing growth hypotheses for a sample on European NUTS2 regions. ◦ New Economic Geography (NEG) Theory ◦ Neoclassical Growth Model. The research provides an empirical estimation of the NEG wage equation and the Solow growth model to provide a comparative test as to which theory can best provide an explanation of European regional growth performance. The comparative explanatory power of these competing hypotheses is assess through the utilisation of a J-test.
  4. 4.  New Economic Geography (NEG) is based on increasing returns to scale emerging from microeconomic foundations (Fujita et al. 1999; Fingleton, 2007). NEG models are grounded in the Dixit-Stiglitz model of monopolistic competition. The authors identify two sectors Perfectively competitive, Monopolistic competition with displays diminishing returns increasing returns to scale to scale and produces a and provides a large variety of single, homogenous good. differentiated goods.
  5. 5.  From Fujita et al. (1999) analyse a number of non-linear simultaneous equations which are central to NEG theory. The key equation derived is typically referred to as the wage equation. The wage equation relates the wages in a region to the market potential available to firms within that region. The market potential can essentially be thought of as a weighted measure of the income in other regions adjusted by transport costs.
  6. 6. • The Neoclassical growth model focuses on four key factors which are expressed in a constant returns to scale production function (Solow 1956).  Capital, labour, savings and knowledge. Output of a worker depends on the amount of capital that worker possesses and the technological capacity of this capital and not the size of the economy overall. The accumulation of capital stock per worker is dependent on the rate of depreciation of capital, the rate of population growth and the rate of technological progress in the economy.
  7. 7.  NEG theory relates the economic activity of a given region to that region‟s market access. It is based on a series of simultaneous equations which describe the relative prices, market potential, income and wage rate of a given region. In the NEG model two sectors are envisaged operating across „r‟ regions with transport costs existing between all regions. Transport costs are assumed to follow Samuelson‟s iceberg form, where a proportion of the value of the good “melts” away as the good is transported from one region to another.
  8. 8.  A Cobb-Douglas function is assumed where U  M  C 1 For our empirical analysis the key equation is the wage equation which relates the wages in sector M, in region i to Pi, the market access of region i. The wage equation can be expressed as: 1 wiM  Pi  The market access of a region depends on a number of critical factors and Pi can be specified as   T  1 P i   Yr GM  1 r ir r
  9. 9.  Nominal income in region i is given as: Y r r wrM  1   r wrC The M price index for region r Gr M   is given as: 1 G      1 1 M r   r wrM e ln Dir   r  Where are the transport costs between region i and region r and all other variables are defined as before. Finally transport costs are defined as: Tir  e ln Dir
  10. 10.  Solow‟s (1956) growth model specifies that output is a function of capital and labour, such that: Y  f K , L  The model assumes constant returns to scale. This results in: y  f k  It is possible to define the growth in the capital stock as: k  sf k     n  g k
  11. 11.  The capital stock at a given time period as a function of the capital stock in the previous period adjusted for new capital, depreciation, population growth and technological advancement can be expressed as: kt  kt 1  sf kt     n  g kt 1 These series of equations imply that the rate of economic growth in a region depends on the rate of capital accumulation within that region.
  12. 12.  Estimating the Wage Equation is done by converting the original wage equation into a double log form resulting in: 1 ln w  M ln Pit   it  it Including technological advancement potential and labour efficiency across regions our equation yields the following: M 1 ln wit  ln Pit   0  1S it  2t   it 
  13. 13.  Estimating the Solow Model we once again take the natural logarithm of the original production per worker equation resulting in ln yit   ln kit  vit Solow equation is augmented to incorporate labour efficiency and technological progress. The proportion of the workforce employed in high technology sectors is again used as a measure of labour efficiency, while a time trend allows for technological advancement. This results in the following: ln yit   ln kit   0  1Sit   2t  vit
  14. 14. 1  H 0 : ln wit  M ln Pit   0  1Sit   2t   1 yit   it  Where π1 are the predicted values from the estimation of the Solow equation. M H1 : ln yit  ln kit   0  1Sit   2t   2 wit  it Where π2 are the predicted values from the estimation of the NEG equation.
  15. 15.  If π1 is found to be statistically insignificant , then it is possible to reject H1. This would imply that the NEG model provides a better explanation of economic output than the Solow model. It is also necessary to test π 2. If π 2 is found to be statistically insignificant, then it is possible to reject H0. This would imply that the Solow model provides a better explanation of economic output than the NEG model. If neither hypothesis can be rejected, both can be deemed valid explanations of output across regions. In order to control for possible spatial dependence in the estimation of the models, all equations are estimated as specified above and include a spatial lag of the dependent variable.
  16. 16.  The data utilised by this paper is the Cambridge Econometrics Dataset from 1980 to 2009. Data on regional Gross Value Added (GVA), population, employment and capital flows are used. Due to the presence of significant gaps in data for some of the new accession states it was decided to exclude some economies from the analysis so as to provide the maximum possible time frame for analysis. This resulted in the dataset being reduced to cover what had traditionally been referred to as the EU-15 countries, with the exception of Luxembourg and East Germany. Hereafter, the composite regions and countries are referred to as the EU-14.
  17. 17. Table 1: Fixed Effects Estimation of Equations (12) and (14)Variable NEG SolowConstant -10.0794*** -13.8540 (0.5647) (0.2922)Market Potential (lnP) 0.1124*** (0.0060)Capital per Worker (lnk) 0.3809*** (0.0096)Labour Efficiency (S) 0.4354*** 0.2047* (0.1208) (0.1105)Technological Advancement (t) 0.0067*** 0.0099*** (0.0005) (0.0002)Spatial Lag (Wy) 0.0140* 0.0102 (0.0077) (0.0070)Obs 5910 5910F 4460.10 5635.82Prob > F 0.0000 0.0000R2 0.3599 0.4297Note 1: *** indicates significant at 99%, ** indicates significant at 95% and * indicates significant at 90%.
  18. 18. Table 2: Fixed Effects Estimation of J Test equation (15) and (16)Variable NEG SolowConstant 7.2803 2.5803 (0.6688) (0.9465)Market Potential (lnP) 0.0969*** (0.0053)Capital per Worker (lnk) 0.3683*** (0.0094)Labour Efficiency (S) -0.0461 -0.2237** (0.1079) (0.1100)Technological Advancement (t) -0.0066*** -0.0027*** (0.0005) (0.0007)Spatial Lag (Wy) 0.0001 -0.0021 (0.0068) (0.0068)ln Solow 0.9668*** (0.0247)ln NEG 0.8625*** (0.0474)Obs 5910 5910F 4835.83 4835.83Prob > F 0.0000 0.0000R2 0.4592 0.4592Note 1: *** indicates significant at 99%, ** indicates significant at 95% and * indicates significant at 90%.
  19. 19.  This paper has provided an analysis of two competing growth models; new economic geography (NEG) theory and the neoclassical growth model. Both models are estimated using data for fourteen EU countries for the time period 1980 to 2009. The paper indicates that both NEG theory and neoclassical theory can be used to explain regional economic output with competing predictions for EU regional convergence/divergence.
  20. 20.  Under NEG theory, the potential to promote regional equality is constrained by transport costs and the advantages associated with agglomeration. The development of better infrastructure and integrated markets will reduce these, if not removed them entirely. The accumulation of capital may be viewed as a more promising potential mechanism through which regional convergence can be achieved. This could be developed through the use of policy incentives directed towards the incentivisation of the investment of capital in poorer European regions. It is noteworthy that labour efficiency is found to have a positive effect on economic output. This suggests yet another mechanism through which convergence can be pursued. The investment in human capital throughout EU regions should provide another route through which convergence can be achieved.

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