Technological Progress, Employment and Living Standards in the Long-Run

Overview of the Lecture

• Part 1 (CORE Unit 16)

Technological progress, employment and living standards in the long-run

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• Part 2 (CORE Unit 21)

Innovation as a driving force of technological change

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Principles of long run growth (Unit 16 of CORE)

• The increasing use of machinery and other capital goods has been the foundation for rising living standards
• The ‘creative destruction’ of older ways of producing goods and organizing production has led to continuous job loss as well as job creation, but not higher unemployment
• A country’s economic institutions and policies can be evaluated by their capacity to:
• keep involuntary unemployment low and
• sustain increases in real wages.
• South Africa’s institutions and policies have not performed well on this basis with the country’s high level of structural unemployment, and inequality and dualism.

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3

Technology and Jobs

• Technological progress has not created rising unemployment rates.
• Instead it has raised the lowest wage that firms can pay while still covering their costs.
• Technological progress expands the resources the firm has to invest in increasing production, and it also incentivizes continued investment.
• In most economies for which data is available, at least 10% of jobs are destroyed every year, and about the same number of new ones are created.

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Winners and losers

• Creation (of new technologies and investments) ….
• New economic sectors emerge
• Underpinned by new technologies
• And new investments
• Which create new jobs
• ….goes together with destruction (of old technologies and investments)
• Destruction affects particular occupations that may often be concentrated in particular regions or towns or on particular groups with large losses in wages and jobs
• SA’s Energy Transition may promote lower-cost, cleaner energy to the wider benefit of the SA economy, but it will impact negatively on coal producing regions e.g. Mpumalanga and ”just transition” support will need to be given to assist people in those regions to develop new job creating activity

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Production function showing output per worker and capital equipment per worker

• The concave slope of the production function means that with increasing quantities of capital goods, output per worker (living standards) rise, but at a slowing rate i.e. there is a diminishing marginal product of capital
• The magnified section at point A shows how the marginal product of capital is calculated
• Slope of production function is given by Δ(Y/worker) / Δ(K/worker) = ΔY/ΔK or marginal product of capital (MPK) (the slope of the tangent)
• The marginal product of capital is falling as we move along the production function.

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Interpreting the production function

• The important role of technological change in long-run growth
• A production function that exhibits diminishing returns to capital is concave.
• Concavity captures the fact that output per worker increases with capital per worker (more machines), but less than proportionally.
• Concavity means that an economy will not be able to sustain growth in output per worker simply by adding more of the same type of capital.
• At a certain point, the marginal productivity of capital becomes so low that it is not worth investing any further

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• Sustained economic growth requires technological change that increases the marginal productivity of capital.
• This shifts or rotates the production function upwards and makes it profitable to invest domestically, leading to increased capital intensity. (e.g. Digital or 4IR tech revolution)

Average product of capital = Y/K

• you can see a dotted blue line from the origin through the production functions for the old and new technologies
• the slope of this line tells us the amount of output per unit of capital goods at the point where it intersects the production function
• Points B and C on the two production functions have the same output per unit of capital goods (Y/K).
• Comparing B to C:
• At B Y/K is 15/20 = 0,75
• At C Y/K is 22,5/30 = 0,75�

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If there were no technological change (B to A)

Capital would be added and Y/worker would grow slowly due to diminishing marginal product of capital

If technology does not change and capital equipment per worker increases form USD20 000 to USD 30 000, output per worker would be less than USD22 500

Due to technological change (B to C)

Y/worker (and living standards) rises more rapidly to USD 22 500 due to combination of new technology and increased capital intensity (K/worker)

Technology has not resulted in job losses

• Productivity growth has reduced labour input per unit of output: some feared this would cause permanent job loss.
• But this has not been the case, as the historical paths traced out by actual economies are not curved like a single production function, rather the production function shifts upwards due to technological progress
• Successful economies experience a combination of capital accumu­lation and technological progress i.e. they move along paths similar to the blue dotted line between B and C�

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Long-run growth in certain economies

• From the figure it is clear that the historical paths traced out by these economies are not curved like a single production function
• This is because they experienced a combination of capital accumu­lation and technological progress.

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Job creation and job destruction

• Technological progress:
• allows more outputs to be produced with a given amount of labour
• contributes to the expansion of production.
• How does technology destroy jobs?
• Jobs linked to old, obsolete technologies are lost
• How does technology create jobs?
• By incentivizing new investment using the new technology
• What is the net effect?
• When more jobs are created than destroyed in a given year, employment increases.
• When more jobs are destroyed than created, employment decreases.

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Understanding how unemployment is measured

• The number of unemployed people is a stock variable, measured at a particular point in time.
• The number of people getting and losing jobs is a flow variable.
• The total job reallocation process is the sum of job creation and destruction.
• Compared to that, the net growth of employment is typically small
• If the job creation > job destruction the the net flow of people into employment is positive, then the stock of employed people will increase

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Job destruction, job creation, and net employment growth

• Note that in the UK from 1980 to 1998, more jobs were destroyed than created: net employment growth was negative.
• In most countries, about one-fifth of jobs are created or destroyed each year
• e.g. as the new IT based retail technologies came into place in the 1990’s and early 2000’s retail chains grew and spread widely (creating highly productive jobs) and destroyed less productive jobs in old-style retailers that did not adopt the new technologies

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Job flows, worker flows and the Beveridge curve

• Job creation is strongly procyclical: this means that it rises in booms, and falls during recessions.
• Conversely, job destruction is countercyclical: it rises during recessions
• English economist and politician Lord William Beveridge (1879–1963) was the founding father of the UK social security system
• Beveridge suggested a simple relationship between job vacancy rates (the number of jobs available for workers) and the level of unemployment (the number of workers looking for jobs)
• Beveridge noticed that
• when unemployment was high, the vacancy rate was low; and
• when unemployment was low, the vacancy rate was high
• During recessions, there will be high unemployment and firms advertise fewer positions.
• During booms, unemployment will decline and the number of vacant jobs posted by firms increases.

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Beveridge curve

• There is a negative or downward-sloping relationship between the vacancy rate and the unemployment rate
• As unemployment rises vacancies fall
• As unemployment falls vacancies rise

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Matching people and jobs can be difficult

• Even tough vacancies fall when unemployment rises – why are there any vacant jobs when there are unemployed people looking for a job at the same time?
• Because there are factors that prevent unemployed people from being matched with newly available jobs:
• This is sometimes a matter of skills required by firms and the skills of jobseekers. For example, the telephone engineer whose job was recently eliminated may not have the computer skills required to fill the vacancies in the company’s billing department.
• The redundant workers and the vacancies may be located in different parts of the country. Travelling to another area to find a job would mean severing ties with neighbours, schools, and relatives.
• Jobseekers or those seeking to hire may not have relevant information: the firm and the jobseeker may not know about each other
• Observing a combination of high unemployment and a large number of vacancies is an indicator of inefficiency in the matching process in the labour market.

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Comparing the US and German Beveridge curves

• The German Beveridge Curve is lower than the US Beveridge Curve indicating that the German labour market appears to have done a better job of matching workers with jobs.
• For every level of unemployment there is a lower vacancy rate in Germany.

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• Why did job matching work better in Germany?
• Germany implemented the so-called Hartz reforms between 2003 and 2005, which
• (1) provided more adequate guidance to unemployed workers in finding work and
• (2) reduced the level of unemployment benefits sooner, so as to provide the unemployed with a stronger motive to search
• In the US, the Great Recession of 2008 led to a situation from 2008 to 2009 where for a every given level of vacancies, there was a higher rate of unemployment.

Long-run models

• In long-run models, the size of the capital stock, and the number of firms operating in the economy—can fully adjust to a change in economic conditions.
• In short-run and medium-run models, capital stock and number of firm are presumed to be fixed.
• In the long run, the growth and employment rate will depend on two big incentive problems:
• Work incentives:
• Wage and salary workers must work hard and well.
• Investment incentives:
• The owners of firms must invest in job creation when they could invest abroad, or simply use their profits to buy consumption goods and not invest at all.
• Firms considering investment decisions will take account not only of the rate of profit after taxes, but also the risk of adverse changes such as hostile legislation or confiscation of their property (or expropriation risk)
• Just as workers cannot be forced to work hard, but have to be motivated to do so, firms cannot be forced to invest or create new jobs or to maintain existing ones.
• Countries must create policy to solving both problems simultaneously to achieve a low level of unemployment and wage increases.
• But, there may be tensions between these objectives e.g. policies that lead to very high wages may induce employees to work hard, but leave owners of firms with little incentive to invest.

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Labour market and firm entry and exit

• The long-run labour market model will allow firms to enter and exit, and owners to expand or shrink the capital stock.
• constant returns to scale are assumed to any percentage increases in employment is matched by the same percentage increase in capital.
• long-run equilibrium means following are constant:
• real wages
• employment level,
• number of firms
• Number of firms change as follows:
• Firms exit due to a low markup

meaning that the expected rate of profit after taxes is not attractive relative to the alternative uses to which the owners could put their assets.

• Firms enter due to a high markup:

If the markup is sufficiently high, the resulting high profit rate will attract new firms to enter the economy.

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Markups and firm exit and entry

• The downward-sloping line gives the markup that maximizes the firm’s profits.
• the horizontal line shows the markup that is just sufficient to retain the existing number of firms, which we call μ*.
• At A the number of firms is stable at 210 firms
• At C with 250 firms, the markup is below μ* and firms will leave the economy.
• At B with 190 firms, the economy is at B and the markup exceeds μ*, so new firms will enter.
• The markup has a tendency to self-correct.
• If it is too low then firms will exit and it will rise, and if it is too high then firms will enter and it will decline.

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Improvement in conditions for doing business

• If there is an improvement in the conditions for operating a business, such as, a tax cut or reduced risk of expropriation, then a lower markup is required for firms to operate.
• At A initial mark-up (210 firms)
• At C business conditions improve and firms require a lower markup (250 firms)

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Price-setting mark-ups and employment

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• In the left-hand panel:
• the equilibrium markup is on the horizontal axis the wage on the vertical axis
• Real wage w is the share of output per worker λ that is not claimed by the employer through the markup μ*.
• As w = λ (1 - μ*), with a zero markup (μ*= 0), the real wage is equal to output per worker λ
• The right-hand panel
• Price-setting (PS) curve is lower for high mark-ups μ* and lower real wage w
• As PS falls the demand for labour falls lower and employment falls (at intersecion with WS curve)

What leads to increased employment and wage levels?

• First scenario:
• Even for a given level of technology 𝜆 unchanged, the price-setting (PS) curve shifts up if firms reduce their markup leading to real wage and employment increases
• Firms reduce their markup if:
• higher competition:
• lower risk of expropriation of owners in the home economy
• higher quality environment for doing business: for example, better human capital or infrastructure
• lower expected long-run tax rate
• lower opportunity cost of capital: for example, a lower interest rate on bonds
• lower expected profits on foreign investments
• lower expected long-term cost of imported materials
• Second scenario:
• PS also shifts up leading to real wage and employment increases if 𝜆 rises i.e. technology improves leading to the higher the output per worker

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New technology, employment and wages in the long-run

• Second scenario:
• New technology and the increase in the amount produced in an hour of work results in:
• rising employment
• rising wages
• At A is the old technology
• At B there is a new technology 𝜆 rises and the real wage is higher and unemployment is lower

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Rate of Upward shift of PS curve

• It often takes years before an improved technology is widely introduced in an economy.
• This diffusion gap causes differences between the productivity of labour in the most advanced firms and the firms that lag technologically, slowing the upward shift in the output per worker curve and the PS curve.
• What are some of the effects of the diffusion gap:
• Some firms may have lower wages
• Some firms may go out of business: e.g. if collective bargaining requires that equivalent workers are paid the same throughout the economy, the least productive firms (which are also those paying low wages) will experience wage increases, making some of these firms unprofitable
• There may be appeals for protection: Employees and owners of the lagging firms may gain protection through subsidies, tariff protection, and bailouts

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In the long–run the economy may move from A to B, but after some time has passed…

• In the long-run, due to the new technology, the economy will move from point A (at 6% unemployment) to point B (at 4% unemployment) at higher real wage.
• A to D the new technology initially displaces a substantial number of workers from their jobs.
• D to E New firms will be attracted to enter the market and investment will rise. Profits are high and real wages remain at the initial level.
• E to B with lower unemployment, firms have to set higher wages to secure adequate worker effort, so wages go up.

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The move form A to B may not happen or may take a long time and can result in winners and losers

• The time between the introduction of new technology and the new long-run equilibrium is usually measured in years or even decades, not weeks or months.
• Younger workers might have more to gain from the eventual higher wages and employment, but older workers might never experience the outcome at B.
• Wage may fall if the economy were to stay at point D for a long period, firms could lower the real wage so that it lies on the wage-setting curve at the new level of unemployment.
• There may be an adjustment gap (delaying move from A to B) if institutions and policies hamper the entry of new firms and the creation of jobs in new sectors.
• Some countries have well-designed product-market regulation and competition policy that make it easier to start a new business.
• In others, incumbent businesses have succeeded in making it difficult for new firms to enter, which slows or even prevents the economy moving to point B.

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Creative destruction and unemployment protection

• Unemployment protection may help to speed up the adjustment process from A to B
• Creative destruction: Improvements in living standards often occur by a process of technological progress in which jobs, skills, entire sectors, and communities become obsolete and are abandoned.
• Consumption smoothing: Households faced with shocks to their income seek to even out the ups and downs of their standard of living
• The two themes above are related. People suffering from job destruction will suffer less if they can smooth their consumption.
• The attitude of unions to the process of job destruction and creation is an example.
• Unions fight for the worker rather than the job - In countries with adequate consumption-smoothing opportunities, trade unions tend not to insist on a worker’s right to keep a particular job. Instead they demand adequate new job opportunities, and support in searching and training for new work.
• Unions fight for the worker to keep his or her job - In other countries, unions and government policy seek to protect the status quo matching of workers to jobs, for example by making it more difficult to terminate a labour contract, even when the worker has performed inadequately. This employment protection legislation may be harmful to labour market performance by enlarging the diffusion and adjustment gaps, and slowing the rate of technical progress, while at the same time pushing the wage-setting curve up.

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Technological change, labour markets and trade unions

• A union organized across many firms and sectors will not exploit all the bargaining power it possesses. It knows that large wage gains will lead to:
• In the medium run: Restrictive aggregate demand policies, as the government and central bank seek to keep inflation close to target
• In the long run: The exit of firms and a smaller stock of capital goods, which will slow the rate of productivity growth.
• Unions that act this way are called inclusive trade unions, also known as ‘social unionism’
• Non-inclusive unions may bargain for high wages in their own corner of the economy without regard for the effects on other firms or workers, both employed and unemployed.
• Employers’ associations that take account of the interests of all businesses, including those that might enter an industry and compete with its incumbent firms, are called inclusive business or employers’ associations.
• Inclusive trade unions also support generous income floors and high quality publicly provided healthcare, occupational retraining, and educational services (sometimes called the ‘social wage’) —all of which reduce the risk to which most individuals are exposed.
• This has the effect of making the creative destruction of technological change less destructive for people’s lives and allows them to be generally more open to change and to risk-taking. These attributes are essential for a technologically dynamic society.

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Technological change and income inequality

• What happens to the distribution of income in an economy when a new technology is introduced that raises the productivity of labour?
• Short run: At point D Inequality increases for two reasons:
• first, because of the rise in the number of unem­ployed workers with low or no income, and
• second because in the short run only employers reap the benefit of the new technology. The employers’ share of output goes up. 
• Long-run: At point D There is a new level of productivity at the old real wage, firms are making sufficient profits to either attract new firms to enter or to incentivize existing firms to expand their output.
• So the economy expands and more people are employed. This also pushes wages up along the wage-setting curve.
• This process will continue until the wage is sufficiently high that firms stop expanding or entering the economy, that is until the economy reaches point B.

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Long-run effect of the change in technology was to slightly reduce inequality

• Both workers and employers benefit from the new technology.
• The wage share is back at its initial level and inequality is lower at B because the unemployment rate is lower.
• Although the wage share at B is no higher than at A, real wages are higher.
• The long-run effect of the change in technology was to slightly reduce inequality because:
• the share of output going to employees was restored to its pre-existing level in the long run due to an increase in real wages
• the higher real wage allowed employers to maintain motivation for workers to work hard at a lower level of unemployment�

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Using Lorenz curve to measure inequality

• At A: The economy starts in long-run equilibrium before the new technology, with a share A of the population being unemployed 
• At D: New technology displaces some workers from their jobs so that unemployment now increases to D, assume that wages remain the same for the remaining workers, so since output per worker has risen, wages as a share of output declines.
• At B: New firms will be attracted to the economy and investment will rise, so existing firms will expand.
• The share of output going to employees is restored to its pre-existing level in the long run due to an increase in real wages.
• Unemployment eventually falls to the level shown by point B, the new long-run equilibrium.
• Overall, the degree of income inequality is reduced as the Lorenz curve at B is slightly closer to the perfect equality line
• With the new technology the overall size of income has increased and income inequality is slightly reduced.

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Calculating Gini

• G = Gini coefficient, g = u + n-(1-u) w/λ
• u = unemployed
• n = employed
• 1 – n – u = employers
• w/λ – fraction of total output that workers wages can purchase (as wn/λn is total wages/total output)
• At A: 6 unemployed, 84 employed, 10 employers wage share is 60% of output
• g = u + n-(1-u) w/λ; g = 0.06 + 0,84 – (1 – 0,06)*0,6 = 0.336
• At D: 10 unemployed, 80 employed, 10 employers wage share is 60%*(1/(0.84/0.8) = 57.1% of output (as if total output is constant with quantity of labour reduced from 84 to 80 then productivity is increased by 84/80 = 1,05)
• g = 0.1 + 0,8 – (1 – 0,1)*0,571 = 0.386 (higher degree of inequality)
• At B: 4 unemployed, 86 employed, 10 employers wage share is 60% of output
• g = 0.04 + 0,86 – (1 – 0,04)*0,6 = 0.324 (lower degree of inequality)

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Shift of labour to services

• The amount of labour devoted to agriculture has declined.
• The recent big shift in work has been from the production of goods (manufacturing and agriculture) to the production of services.
• The era of expanding manufacturing employment ended sometime in the third quarter of the twentieth century (see Figure)
• The production of services rather than goods has replaced manufacturing.

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Modelling the shift of labour to services

• The total amount of labour employed in the economy is assumed to be 1 (it could be 1 million hours, for example).
• If all of this labour is devoted to the production of goods, 1 unit of goods is produced.
• If all of this labour is devoted to the production of services, 1 unit of services is produced.
• The solid red line is the feasible frontier, showing the amounts of goods and services that are possible given the existing technologies and the amount of labour employed.
• At A (and along black line from origin) it is assumed that the same number of units of goods and services are consumed.
• In the second period, feasible frontier shifts to dashed red line, as productivity rises in manufacturing while staying constant in services.

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What happens when goods productivity rises?

• If at B, people continue to consume equal amounts of goods and services, consumption will have increased from1/2 to 2/3 units of each.
• At B, labour has shifted from the production of goods to the production of services
• At B, 1/3 of labour produces goods,
• At B, 2/3 of labour produces services.
• The model shows that due to an increase in productivity in the production of goods, there is a shift of labour away from the production of goods to the production of services
• How is this calculated?

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Shift of labour to services

• λs is productivity of labour in services λg is productivity of labour in goods
• λs = Qs/Ls (quantity of services divided by labour employed in services production)
• λg = Qg/Lg (quantity of goods divided by labour employed in goods production )
• Therefore, by definition if output of goods equals output of services:
• λsLs = Qs = Qg = λgLg
• λsLs = λgLg
•  As Ls + Lg = 1 (total labour force)
• λsLs = λgLg = λg(1 - Ls)

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• Rearrange:
• λsLs = λg(1 - Ls)
• λsLs = λg - λg.Ls
• λg.Ls + λs.Ls = λg
• Ls(λg + λs) = λg
• Ls = λg / (λg + λs)
• If the productivity in both sectors is 1 i.e λg = λs =1
• Then Ls = λg / (λg + λs) is Ls = 1/1+1 = ½
• If the productivity in the goods sector doubles:
• λg = 2 and λs =1
• Then Ls = 2 / 2+1 = 2/3
• Thus, 2/3 of labour is producing services after the increase of productivity of labour in the production of goods

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Will the shift to services mean the end of the technological revolution? (Unit 21 of Core)

• If service productivity grows more slowly than manufacturing productivity, the shift from goods to services reduces overall productivity growth in the economy.
• Will this limit the ability of technological progress to increase labour productivity?
• Robert Gordon, author of The Rise and Fall of American Growth believes that the rapid growth era from the first half of the twentieth century is long gone, and slower growth lies ahead of us.
• Erik Brynjolfsson and Andrew McAfee advance the view that digital technology is opening up a ‘The second machine age’ and that productivity will continue to increase

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Driving forces of innovation and technological change

• The prospect of innovation rents induces others to try to copy new inventions.
• If they are successful, the temporary rents of the innovator are eventually entirely competed away.
• Latecomers are also eventually pushed to adopt the innovation, because the falling prices that result when the new methods become widely adopted typically mean that sticking with the old technology is a recipe for bankruptcy.
• A firm that does not innovate will make negative economic profits, meaning that its revenues fail to cover the opportunity cost of capital.
• This carrot-and-stick combination of the promise of rents from successful innovation and the threat of bankruptcy if firms fail to keep up with innovators has proved a powerful force in reducing the amount of labour required to produce goods and services, thereby raising living standards.

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Innovation rents

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• Individuals or companies who introduce socially beneficial innovations are rewarded with profits above the opportunity cost of capital, referred to as innovation rents.
• Innovation rents are eventually competed away by imitators who spread the new knowledge by using it.
• Innovation involves developing new knowledge, and putting it to use.
• Knowledge is unusual in two ways:
• It is a public good (what one consumes does not subtract from what is available to others)
• Its production and use are characterized by increasing returns to scale.
• Public policy therefore seeks to spread socially beneficial innovations, while at the same time providing adequate rewards for those producing innovations.
• See example in Core Unit 21 regarding innovation in AIDS drugs and SA’s struggle in the early 2000’s to make them widely available. Similar to demand to make Covid-19 vaccines widely available across the globe and today’s rejection of vaccine apartheid.

Innovation systems: The secret of Silicon Valley’s success

• During the 1960s, Silicon Valley was a minor player in technology compared to the Route 128 concentration near Boston, Massachusetts, which benefited from proximity to Harvard and MIT.
• But Route 128 differed from Silicon Valley by including the use of non-compete contracts that prohibited anyone leaving one firm from taking up employment with a competing firm, as a way of protecting information that a firm produced:
• The state of Massachusetts enforced non-compete contracts: This limited inter-firm mobility and the information-sharing that resulted from it.
• The state of California outlawed non-compete contracts, saying that: ‘Every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is … void.’
• The resulting circulation of engineers among firms in Silicon Valley promoted the rapid diffusion of new knowledge among firms

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Promoting systems of innovation

• 1. Intellectual property rights
• Where a novel idea is both codifiable (it can be written down) and nonexcludable (imitation cannot be prevented), governments have created laws protecting intellectual property rights.
• The most commonly used are patents, trademarks, and copyright.
• They give the holder of the right exclusive use of the thing covered by the right for some designated period of time.
• In economic terms, the holder of the intellectual property right is made a temporary monopolist.
• This results in two opposite effects:
• Creating a monopoly: This has a beneficial effect for the holder of the intellectual property rights, and creates economic profits (innovation rents) which stimulate research and development.
• Impeding innovation and diffusion of new ideas: These rights limit diffusion and the ability of others to copy the innovation.

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2. Government funding and policies

• Adequate government policies concerning innovation can help in two main ways:
• Increasing the pace of innovation: This occurs through such interventions as the support of basic research and communications infrastructure, setting standards, as well as the design of patents, copyright, and trademarks.
• Influencing the direction of innovation: This tilts the process towards the production of novel ideas and applications with environmental, learning, medical, or other socially valued applications.
• Mariana Mazzucato argues that digital innovations such as the Internet, GPS and touch screens show that the government has an essential role in funding research and start-up technology companies.
• Another area is incentives for development of drugs for neglected diseases like malaria that are common in parts of the world in which there is little pharmaceutical innovation as the market is limited by the low incomes of those afflicted with the diseases.

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Conclusions

• For successful innovation what is required is the combination of private incentives and supportive public policy and infrastructure
• Innovation and technological change are long-term drivers of growth and rising living standards
• A well-functioning economy will also feature high levels of investment that ensure that jobs are created at least as fast as they are destroyed.
• In high-performing economies, institutions and policies work so that the incentives of the main actors are to increase the size of the pie, rather than wasting resources fighting over the size of the slices.

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