Technological Progress, Output Elasticity, FDI, and Growth Cycles

Abstract

Economic growth is, in reality, not a smooth process, and it is not clear why economic growth is rather unstable across OECD countries and the global economy. Economic growth is certainly influenced by many factors, including innovation dynamics and technology, respectively. Technological progress can have domestic sources and is, then, largely related to the innovation system, but in open economies, the subsidiaries of foreign MNCs can also play a role in the host country. Moreover, there could be international technology spillovers, part of which is related to international trade and FDI dynamics. Foreign direct investment has rarely been included in the analysis of economic growth, despite the fact that economic globalization has clearly reinforced the role of multinational companies in world investment. From a macroeconomic perspective, the presence of MNCs’ subsidiaries should not only bring effects on capital accumulation and technology transfer, rather it is important to consider that a distinction has to be made between GDP and GNP. This distinction, which concerns the specification of the savings function as well as other functions, has been much neglected in the literature; it is relevant both in medium-term macro-models and in long-run growth models. In the standard neoclassical growth model with exogenous technological progress, a rise of the progress rate leads to a fall of the level of the growth path and a higher permanent growth rate of output. This suggests that a technology shock should bring about a quasi-growth cycle and such a phenomenon—with a temporary fall of output—is, however, not observed in newly industrialized countries. The empirical patterns of growth and innovation dynamics do not show such a paradoxical temporary fall of income and income per capita, respectively. The paradoxical result of the standard growth model is avoided in a model in which the output elasticity of capital depends on the progress rate; certain parameter restrictions apply which are highlighted in the analysis; furthermore, we get additional insights into the issue of the golden rule and maximization of per capita consumption, respectively. Moreover, it is interesting to consider the role of foreign direct investment for the growth model of an open economy and technological progress, respectively. In this semi-endogenous setup, the focus is mainly on asymmetrical foreign investment, namely inward FDI inflows. Foreign direct investment inflows have a direct impact on the steady state solution, namely both on the level of the growth path and the permanent growth rate—the latter to the extent that we consider a technological progress function in which both the foreign progress rate and the share of the capital stock owned by foreign investors are considered. The relative impact of domestic progress and internationally induced progress is discussed. Finally, the issue of a consistent investment function which takes into account both the short-term and the long-run consistency is considered, and the impact of changes in the progress rate are pointed out—along with broader policy conclusions of the analysis presented. At the bottom line, it is shown that a positive impact of the progress rate on the output elasticity of the capital stock can bring a smooth transition to both a higher level of the growth path and a higher permanent growth rate. The perspectives on the role of FDI inflows in a two-country model with symmetrical flows have to be explored in further analysis. Key policy conclusions concern the question of to what extent government should try to achieve a golden state while adequately taking into account the role of foreign direct investment inflows. Within a broader group of countries, it would also be useful to consider options for cooperation in growth policies—certainly to the extent that there are symmetrical or asymmetric international technology spillover effects.