Savings, Capital Deployment, and Growth
I was taught in graduate school that economic growth has two main drivers: the savings rate, which determined the steady-state capital-labor ratio; and the efficiency of labor, which increases over time due to technological change and better human capital.
Yesterday at a seminar, I heard IMF chief economist Ken Rogoff mention another parameter: the efficiency of capital allocation. He pointed out that China saves one-third of its income, a much higher ratio than the United States. Rogoff pointed out that if China and other countries deployed their capital more effectively, they could enjoy faster growth without having to save so much.
In his 2002 Richard Ely lecture, Edward Prescott presented a growth model that allowed for a capital allocation factor. He wrote,
Another policy associated with poor productivity performance is centralized allocation of savings to investments…
The candidate mechanism by which centralized financial systems adversely affect productivity is as follows. Inefficient producers are subsidized in order to preserve jobs. This has the perverse effect of lowering productivity and decreasing overall employment in the economy. Japan is another depressed country with a highly centralized financial system controlled by the state. Perhaps this accounts for the 17 percent decline in its productivity factor in the 1991-2000 period.
For Discussion. If Prescott and Rogoff are correct, then is the value of the capital stock overstated in countries that do not deploy capital efficiently?