If equipment investment is weak, growth will not be rapid, especially in developing countries
Poor and rich countries alike benefit from high rates of accumulation of technology-embodying equipment.
Growth and equipment investment are highly correlated among developing economies: relatively poor economies appear to benefit as much as do richer economies from an investment effort concentrated on machinery and equipment. De Long and Summers find that rapid growth is found where equipment investment is high, and slow growth where equipment investment is low.[1]
Indeed, if there is any region where the post-World War II growth-equipment nexus appears to be weak, it is the well-integrated and very rich region of western Europe---not the developing world.
The price of investment goods relative to the deflator for GDP as a whole is much greater in poor than in rich economies. The wide divergence in relative price structures from poor to rich economies means that it is very hazardous to attribute the same meaning in terms of additions to the physical capital stock to savings in poor as in rich economies. Poor economies require a much greater "investment effort," in terms of forgone consumption, to produce the same actual investment in machinery and equipment purchased and installed, or buildings constructed, or infrastructure created (see the figure).
How much of the growth-equipment nexus is associated with total factor productivity (TFP) growth, and how much with capital deepening, holding TFP constant? The lack of accurate estimates of investment rates in the 1950s, and thus of capital-output ratios as of 1960, provides a substantial obstacle to cal-culating good estimates of TFP growth for the cross-section samples.
De Long and Summers calculate a lower bound to the proportion of the growth-equipment nexus that is attributable to a correlation between equipment investment and TFP growth. Countries that had high investment shares after 1960 had, in all likelihood, high investment shares before 1960 and high capital-output ratios in 1960 as well.
A strong correlation is found between equipment investment and TFP growth (see the table). By and large the countries that have experienced rapid output growth have done so because of rapid TFP growth, no matter how TFP is estimated.
The cross-section regressions suggest net social rates of return from equipment investment in the range of 25% a year or more. This estimate assumes that the large coefficient on equipment investment arises because equipment investment is a trigger of learning-by-doing and thus of substantial TFP growth. If that causality flows from growth to equipment investment as well as from investment to growth, the social rate of return will be somewhat lower. If most of the productivity gains from learning how to use and organize production with new machine technologies occur soon after their introduction (rather than steadily over the life span of the equipment), the social rate of return will be somewhat higher.
Governments such as those in East Asia were able to jump-start industrialization by encouraging high equipment investment and transforming economic structures into efficient, market-driven systems. Likewise, it was thought that public sector incentives in support of industrialization and equipment investment could provide substantial benefits. But the lesson was that they must be incentives that support industrialization, and not incentives that tend to enrich currently producing industrialists. Indeed, as Lawrence Westphal asserts, governments that attempt to promote growth by means of industrial policies usually fail---for reasons made familiar by theorists of the rent-seeking society. Failed (or only marginally effective) industrial policy in such countries as Argentina, Ghana, and India as well as Japan and the Republic of Korea adds force to his argument.
Thus the positive recommendations (in favor of public sector incentives for equipment investment) have to be tempered by a recognition of possible political complications and dangers. The data suggest that first among those policies that cripple growth in developing economies are those that cripple equipment investment.
At a very minimum results suggest that economies with low rates of real equipment investment need immediate and comprehensive economic reform. Clearly, macroeconomic stability should be a precursor to high investment rates. Central banks should strive to maintain a stable money stock because such a condition is necessary (but not sufficient) for macroeconomic stability. National governments ought to strive to maintain a high rate of equipment accumulation for the same reason: it appears necessary, although perhaps not sufficient, for economic growth. Judging policy mixes by their effect on the rate of equipment accumulation is a good shorthand way of assessing their effect on long-run economic growth ---if equipment investment is weak, growth will not be rapid.
Estimates of total factor productivity growth regressed on equipment investment (5K Table)
