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1
Q

How does our new definition of efficiency differ from our previous all encompassing definition?

A

Efficiency, here, is an umbrella concept used to capture anything that accounts for differences in productivity other than differences in technology.

2
Q

Since we can’t measure efficiency directly, what’s the best way to study it?

A

By looking at it’s absence.

3
Q

What is productivity determined by?

A

Productivity is determined by two things: technology, which represents the knowledge about how factors of production can be combined to produce output, and efficiency, which measures how effectively given technology and factors of production are actually used.

4
Q

Which mathematical expression encompasses all of productivity?

A

A = T X E

where T is available technology and E is efficiency.

5
Q

How does the story about the difference in the seeds used by Farmer A and Farmer B capture the difference between technology and efficiency?

A

The difference stemming from Farmer A’s workers throwing away part of the harvest illustrates the idea of efficiency. The technology of Farmer A is twice as good as that of Farmer B, but his production process is only half as efficient. As a result, the two farmers have the same level of productivity.

6
Q

Suppose that India is G years behind the United States technologically. That is, the level of technology in India in 2009 was the same as the level of technology in the United States in the year 2009 – G. Which expression encompasses this difference?

A

T2009, India = T2009−G, US

7
Q

Let g be the growth rate of technology in the United States.
How would this be expressed mathematically? How would we substitute this equation to get the technological level of India?

A
T2009,US = T2009−G,US × (1 + g)^G.
Becomes 
T2009,US = T2009,India × (1 + g)^G
Which in turn becomes
T2009,India / T20019,US = (1+g)^-G
8
Q

What is the function T2009,India / T20019,US = (1+g)^-G illustrating?

A

The ratio of technology in India to technology in the United States as a function of the gap in technology measured in years, G, and the growth rate of technology in the United States, g.

9
Q

What’s an adequate way of summarizing the equation T2009,India / T20019,US = (1+g)^-G ?

A

A,India / A,US = (T,India / T,US) X (E,India / E,US)

10
Q

What can we deduce from the equation A,India / A,US = (T,India / T,US) X (E,India / E,US) ?

A

The message from this exercise is that, unless lags in technology are extremely large, most of the difference in productivity between India and the United States must be the result of a difference in efficiency.

11
Q

What is meant here by the break-even point?

A

The technology lag at which technology and efficiency would be equally important in determining the productivity gap between India and the United States.

12
Q

Why does the former Soviet Union provide one of the best examples of low output as a result of inefficiency?

A

The Soviet economy was relatively good at accumulating factors of production. Despite its technology, the USSR was a disaster in terms of producing output. Because this dismal performance could not have been the result of deficiencies in technology or factor accumulation, it must have been the result of low efficiency.

13
Q

Under central planning, government bureaucrats determined how labor, capital, and raw materials were allocated, what goods were produced, which firms supplied inputs to which other firms, and so on. In theory, such a centrally planned economy could produce output just as efficiently as, or even more efficiently than, a market economy.
What’s the first reason the Soviet Union fail miserably?

A

In practice, central planners did a poor job of fulfilling the roles that prices play in coordinating activity in a market economy, such as channeling productive inputs to the firms that value them most, giving firms an incentive to produce goods that are in high demand, and equalizing the quantities of each good that are supplied and demanded. As a result, shortages were rampant.

14
Q

Under central planning, government bureaucrats determined how labor, capital, and raw materials were allocated, what goods were produced, which firms supplied inputs to which other firms, and so on. In theory, such a centrally planned economy could produce output just as efficiently as, or even more efficiently than, a market economy.
What’s the second reason the Soviet Union fail miserably?

A

The lack of incentives for managers and workers. Because firms had no owners seeking to maximize profits, managers of firms had no incentive to minimize their production costs, much less to implement new technologies that would raise productivity. Because so many goods were in short supply, firms similarly had no incentive to maintain the quality of their output—consumers would snap up whatever the firms produced. Plant managers had little leeway to fire unproductive workers or to reward those who did a good job, so absenteeism and on-the-job drunkenness were rampant.

15
Q

What were the most important findings regarding the textile industry in 1910?

A

That differences in technology, in the sense of some countries using more advanced production methods than others, were almost completely irrelevant for explaining differences in wages. The reason was that the technology used in textile production in the countries studied was basically the same—indeed, most of the machines used in production were identical, having been manufactured in England and shipped throughout the world. Nor did differences in raw materials explain any of the differences in wages among countries.

16
Q

Describe how the key factor seems to be the efficiency of the workers.

A

In countries in which workers tended more machinery, wages were higher. Workers in high-wage countries tended up to six times as much machinery as workers in low-wage countries. Equally surprising, the fact that workers in the richest countries tended more machines did not mean that machinery in these countries was any less productive, as one might have expected if poor countries were substituting labor for capital. Rather, the opposite was true: Each loom in the more-developed countries, though tended by fewer workers, produced more output.

17
Q

Why were workers in rich countries able to tend so much more machinery? (Textiles 1910)

A

Differences in factors such as workers’ health and education do not seem to be the reason. Rather, differences in factory organization and in labor practices are evidently the main explanation. Workers in the poorer countries were capable of tending more machines, but something in the way the economy was organized prevented them from doing so.

18
Q

Which interesting differences in relative productivity among industries have studies found?

A

The differences in productivity at the industry level were much larger than those in aggregate productivity.

19
Q

In answering the question: “what was the source of these large differences in productivity among industries?” why does it seem unlikely that they were the result of differences in technology? (3)

A

Because the three countries considered are clearly at the frontier of world technology, and ideas flow easily among them. Also, that some of these productivity differences hold true even within a single company! Finally, in some cases, productivity was low in a country even though the country clearly had better technology than its rivals.

20
Q

Give an example illustrating how differences in the organization of production among the countries is a better explanation for the productivity differences among industries?

A

Japanese automobile makers worked closely with their parts suppliers to streamline procedures and improve productivity. In Germany and the United States, by contrast, the relationship between automakers and their suppliers is more antagonistic. Suppliers fear that if they improve their productivity, the firms to which they sell their parts will simply negotiate lower purchase prices, and this reduces the incentive to become more efficient. Regarding the Japanese food-processing industry, the authors of the study blame low productivity on “a Byzantine network of regulation and custom that surround agriculture and distribution.”

21
Q

Differences in productivity within a single industry are even visible within a single country. One such extensively studied industry is health care in the United States, which accounted for 18 percent of GDP in 2011. Elaborate.

A

There are enormous differences among regions in the United States in the quantity of medical care that individuals receive, with little or no corresponding difference in the health outcomes that result from this spending.

22
Q

What did Atul Gawande attribute the differences in productivity between states in terms of health-care to?

A

Varying norms among the doctors in the two regions regarding how much the incentive of extra revenue from doing additional procedures should be allowed to influence the practice of medicine.

23
Q

Why would the increase in the price of coal during the 1970s decrease efficiency?

A

Increased demand for coal made coal-mining companies highly profitable. The rise in profits in turn improved the bargaining position of the mine workers’ union because it raised the cost that the union could impose on firms by going on strike. The union took advantage of its improved bargaining position to change work rules so as to raise the level of employment—and thus lowered productivity.

24
Q

What is featherbedding?

A

The sort of behavior in which employers are forced to hire more workers than are required for production.

25
Q

What are the 5 main types of inefficiencies?

A
  • Unproductive Activities
  • Idle Resources
  • Misallocation of Factors among Sectors
  • Misallocation of Factors among Firms
  • Technology Blocking
26
Q

From society’s point of view, why do unproductive activities waste resources?

A

For society as a whole, the fewer resources that are used for production, the less will be produced, and the less will be available for consumption.

27
Q

From the perspective of the individual, how could engaging in unproductive activities be beneficial?

A

People can earn more for themselves by engaging in unproductive activities than they could by producing
output because such an unproductive activity must necessarily involve some redistribution—that is, taking output away from others.

28
Q

Why are many illegal activities considered unproductive?

A

In addition to wasting resources directly (in the case of burglary, using labor to break into houses rather than to produce output), such activities also require further nonproductive spending on the part of those who would rather not see their property taken away (e.g. hiring guards or installing alarm systems). In many countries, the costs of defenses against illegal appropriation are high.

29
Q

What are examples of unproductive activities which are rampant in poor countries?

A

kidnapping for ransom, banditry, and even civil war, where the object of conflict is the right to exploit natural resources.

30
Q

What is rent seeking?

A

Unproductive activities that involve the use of laws or government institutions to bring private benefits.

31
Q

What is an economic rent?

A

An economic rent is a payment to a factor of production that is in excess of what is required to elicit the supply of that factor.

32
Q

When does rent-seeking typically arise?

A

Rent seeking usually arises in cases where government policy creates an artificial or contrived rent, such as through licenses or protected monopolies.

33
Q

When does one of the most common instances of rent seeking occur?

A

When developing countries use quotas to limit the imports of some goods. Because the domestic price of these goods is much higher than the world price, firms that obtain import licenses can make large profits. In pursuit of these licenses, the managers of import firms expend a good deal of effort

34
Q

What is one of the reasons that capital cities of many developing countries are so big?

A

Firms locate there to maximize their chances of capturing rents generated by the government. In addition to the direct costs expended on rent seeking, a second form of waste occurs when the best and brightest workers choose to enter government service to reap the rewards of bribery, rather than to work in the productive sector.

35
Q

What does the extent to which people devote their efforts to producing output rather than trying to get a bigger slice of the pie depend on?

A

On the relative rewards of these two activities. If rent seeking pays well, then talented people will pursue it. If talent is better compensated in productive activities, then that is where it will be applied. The relative rewards to these two activities depend in turn on the institutional structure of the economy.

36
Q

How can worker’s be inefficient? (idle resources)

A

The inefficiency includes both actual unemployment, where a worker has no job, and underemployment, where a worker has a job but spends only a fraction of his or her work time producing output.

37
Q

How can the use of capital be inefficient?

A

Capital can similarly be unemployed (a factory that sits unused) or underemployed (a factory running at less than full capacity).

38
Q

What does the unemployment of workers and capital often results from?

A

Macroeconomic instability

39
Q

What does underemployment frequently result from?

A

Institutional arrangements that encourage the hiring of more workers than are needed. State-run enterprises are notorious for their overstaffing. In a similar instance of overstaffing, many developing countries guarantee jobs for educated workers by hiring them into bloated and unproductive bureaucracies.

40
Q

As in the case of unproductive activities, underemployment of workers entails a transfer of resources from one person to another rather than the production of more output. How is this?

A

The employee who is paid for not working is receiving a subsidy from someone else in the economy—his employer, his fellow employees, the government, or the consumer of the goods that his firm is producing. Although he may be better off using his labor unproductively than he would be if he were using it productively, society as a whole is worse off.

41
Q

What is misallocation?

A

A form of inefficiency which occurs when resources are used in producing the wrong things.

42
Q

How do worker move between sectors of the economy?

A

They shift from one industry to the other until the MPL of one industry equals the MPL of the other.

43
Q

In a well-functioning market economy, which forces help in reaching the optimal allocation of labor between sectors occurs automatically? (Invisible hand)

A

Labor will be paid its marginal product as a wage. If the marginal product (and thus the wage) for the same unit of labor is different in different sectors of the economy, then workers will have a strong incentive to move from the sector with low marginal product to the sector with high marginal product. This movement of labor will lower the wage in the sector that has high marginal product and will raise it in the sector with low marginal product. The movement of labor will continue until the two marginal products are equalized, and thus the quantity of output is maximized.

44
Q

Why might the optimum amount of labor in each sector not be reached?

A

Factors might not be allocated according to their marginal products.

45
Q

What are 2 possible reasons why factors might not be allocated according to their marginal products.

A

Factors may not be able to move between sectors in response to the signal provided by differences in the payments they receive, or the payments received by factors may not reflect their marginal products.

46
Q

How are barriers to mobility inefficient?

A

If there are barriers to mobility between sectors, then a gap in wages may persist. The higher these barriers, the larger the gap between marginal products that can be sustained, and thus the larger the degree of inefficiency.

47
Q

What is one type of barrier to mobility?

A

Geographic isolation. Because moving from one part of a country to another involves costs, both economic and psychological, interregional wage gaps may persist for a long time. However, as costs of communication and transportation fall, the availability of information about wage gaps will increase, as will the ease with which workers can move to the parts of a country where they are most valued, thus increasing efficiency.

48
Q

What’s a second type of barrier to mobility?

A

When a minimum wage is imposed in the high-wage sector. In this case, the process by which people move from the low-wage to the high-wage sector will be short-circuited. Firms in the high-wage sector will not be able to expand their payroll by hiring workers from the low-wage sector because this shift would involve lowering the marginal product of labor below the minimum wage.

49
Q

If workers are not paid their marginal products, what does that say about movement between sectors?

A

If workers are not paid their marginal products, then a difference between sectors in the marginal product of labor will not automatically translate into a difference in wages, so workers will not have an incentive to move between sectors.

50
Q

What is a common example of overallocation of labour?

A

The overallocation of labor to family farms in developing countries. Family members who work together on a farm do not receive a formal “wage.” Rather, the output of the farm is generally divided equally among the family members. In economic terms, the workers are receiving a payment of their average product rather than their marginal product. Because production on a farm, where the quantity of land is fixed, is characterized by declining marginal product of labor, the payment that is received by a worker will be higher than the marginal product of labor. By contrast, a worker who leaves the farm to work in the industrial sector will receive a wage equal to his or her marginal product there. The resulting allocation of labor will mean that the marginal product in farming is lower than the marginal product in industry.

51
Q

What is another reason that wages may not be equal to marginal products?

A

If there is segmentation or discrimination in the labor market, such that potentially productive people are unable to work in certain sectors. People who would be productive in high-skilled occupations are working in some job for which they do not have a comparative advantage because of ethnic or gender discrimination.

52
Q

What can be a major source of growth for a country which is misallocating its factors of production?

A

The reallocation of factors between sectors—from sectors with a low marginal product to sectors with a high marginal product—can be a major source of growth. Indeed, if we see examples of growth through the reallocation of factors, this is good evidence of an initial misallocation and thus an initial inefficiency.

53
Q

What was a major component in the rapid growth of the Asian Tigers (South Korea and Taiwan)?

A

Sectoral reallocation out of agriculture and into manufacturing.

54
Q

How may the ease of geographic mobility be one explanation for the particularly high efficiency of the U.S. economy vs, say, Europe?

A

Americans are notoriously willing to relocate in search of economic advantage—and this willingness is aided by having a large country with a single language. By contrast, geographic mobility within Europe has traditionally been low, in part because Europeans have much deeper cultural roots in the places where they were born than do most Americans.

55
Q

What is the lack of geographic mobility is abetted by in many countries?

A

Policies that pay people to stay in economically depressed areas, rather than encouraging them to move to areas where there is more opportunity.

56
Q

What is the most dramatic example of labor reallocation in the world today?

A

China, where workers are moving both from agriculture to industry and from the impoverished interior of the country to more prosperous coastal regions.

57
Q

In a well-functioning economy, resources will move from less productive to more productive firms, thereby raising the overall level of productivity in the economy. How does this happen?

A

This shift happens naturally when firms compete with each other. A high-productivity firm can make a profit at prices that lead less productive firms to lose money. Less productive firms are thus driven out of business, and the capital and labor they used are absorbed by more productive firms.

58
Q

Which things can get in the way of this reallocation of resources between firms? (2)

A

If low- and high-productivity firms collude to maintain high prices rather than competing with each other, then low-productivity firms will be able to stay in business and thus not free up the factors they are using (although they will earn smaller profits than high-productivity firms). Similarly, many low-productivity firms manage to get government help staying in business, in the form of subsidies, favored contracts, trade protection (if the more productive firms are located abroad), or other means.

59
Q

When does misallocation among firms becomes rampant? (2)

A

In nonmarket economies (of which few are left in the world) and in firms that do not have to make a profit because they are owned by the government. In government-owned firms, workers’ wages are not closely related to the amount of output they produce. Workers or other resources may be allocated among industries on the basis of managers’ political power, for example, rather than on the basis of where they will be the most productive.

60
Q

How does monopoly power provide another reason that labor may be misallocated among firms?

A

A firm with a monopoly will restrict production to keep prices high, so it will not hire more workers even if the marginal product of labor is higher than the wage. As a result, the marginal product of labor will be higher in monopolized industries than in industries in which markets are competitive. Unlike government-owned firms, which tend to employ too much labor, monopolistic firms tend to employ too little labor from the point of view of economic efficiency.

61
Q

A recent study gives a more detailed picture of what factor misallocation among firms can look like. Elaborate.

A

If labor and capital are allocated efficiently among firms, their marginal products should be equal across all firms. Differences in marginal products between firms, therefore, indicate a misallocation of resources

62
Q

What is another indicator of the efficiency of allocation of factors among firms?

A

The correlation between firm size and productivity level. Given a fixed degree of variation in productivity among firms, the economy as a whole will be more efficient to the extent that the larger firms are the more productive ones.

63
Q

What is technology blocking?

A

Technology blocking occurs when a technology could feasibly be used but someone deliberately prevents its use. The technology in question can be either foreign or domestic in origin.

64
Q

Why do we think of technology blocking as a form of inefficiency rather than as a type of technological backwardness?

A

Because there is no physical or technical obstacle to the use of an intentionally blocked technology

65
Q

One of the key determinants of how efficiently an economy functions is the performance of its financial system, which is composed of banks and other institutions (such as insurance companies and pension funds), markets for stocks and bonds, as well as the government agencies that monitor and regulate them. Why is this?

A

The financial system performs a number of functions that serve to raise the efficiency of production.

66
Q

The financial system performs a number of functions that serve to raise the efficiency of production. Which 4 functions are the most important toward this end?

A

The financial system

  1. Directs capital toward its most productive use by evaluating the potential returns from different investment projects.
  2. Pools the savings of many individuals to allow for large investments.
  3. Monitors the outcomes of investment projects to make sure that investors are properly compensated.
  4. Spreads the risk of any one project among a large number of individuals.
67
Q

How else does the financial system raise efficiency?

A

By easing transactions, they allow for more specialization in production. In addition, by channeling investment funds from people who have money to people who have good investment projects (either good business projects or good opportunities for human capital investment) the financial system profoundly affects the degree of income inequality and intergenerational economic mobility.

68
Q

Which measures do economists use to assess the degree of financial development in a country? (2)

A
  • The size of the banking system is often measured by the value of bank deposits relative to gross domestic product (GDP).
  • The degree of development of the stock market is measured at the “turnover ratio,” that is, the value of shares traded in a given year divided by the total value of listed shares.
69
Q

What is the correlation between financial systems and GDP per capita?

A

There is a strong correlation between the degree of financial system development and the level of GDP per capita. Further, holding constant a country’s level of income, those with better financial systems grow more quickly.

70
Q

We can use the development accounting framework discussed in Chapter 7 to examine how financial development is related to the different proximate determinants of GDP. What does the data show?

A

That the link is much tighter between financial development and productivity than it is between financial development and factor accumulation. This is consistent with the view that financial development raises economic efficiency.

71
Q

The strong correlation between income and financial development leaves open the question of whether differences in financial systems among countries are a cause of observed income differences, or whether differences in finance simply reflect other factors that determine income. This question has not yet been definitively answered, but a number of types of evidence point, at least tentatively, to causality running from finance to income.
What’s the first piece of evidence supporting this view?

A

The first type of evidence is based on timing. It appears that in many countries with good financial systems and rapid growth, the presence of the good financial system preceded growth.
Similarly, episodes in which countries liberalized their financial markets are followed, on average, with an increase in the growth rate of output.

72
Q

The strong correlation between income and financial development leaves open the question of whether differences in financial systems among countries are a cause of observed income differences, or whether differences in finance simply reflect other factors that determine income. This question has not yet been definitively answered, but a number of types of evidence point, at least tentatively, to causality running from finance to income.
What’s the second piece of evidence supporting this view?

A

The second type of evidence comes from the history of banking deregulation in the United States. For much of the 20th century, state laws restricted the number of branches any one bank could open. As a result, the banking system was characterized by a large number of inefficient local monopolies. States that liberalized their markets experienced faster economic growth than similar states that did not. Interestingly, the total quantity of bank lending did not rise in states that liberalized; rather, growth seems to have accelerated because what lending took place was being more efficiently allocated to borrowers with good investment projects.

73
Q

The strong correlation between income and financial development leaves open the question of whether differences in financial systems among countries are a cause of observed income differences, or whether differences in finance simply reflect other factors that determine income. This question has not yet been definitively answered, but a number of types of evidence point, at least tentatively, to causality running from finance to income.
What’s the third piece of evidence supporting this view?

A

The third piece of evidence suggesting that causality runs from finance to growth is that in countries with well-developed financial systems, it is a particular set of industries—those that are dependent on the financial system—that do well. If it were the case that high income simply led to the development of a good financial system, then we would not expect to see this phenomenon.

74
Q

The strong correlation between income and financial development leaves open the question of whether differences in financial systems among countries are a cause of observed income differences, or whether differences in finance simply reflect other factors that determine income. This question has not yet been definitively answered, but a number of types of evidence point, at least tentatively, to causality running from finance to income.
What’s the fourth piece of evidence supporting this view?

A

A final piece of evidence for the importance of finance in determining income comes from comparing the legal environment in which investment takes place. The commercial law that governs investment (creditors’ rights, contract enforcement, and accounting standards) in most countries can be classified as deriving from one of four origin countries: England, France, Germany, or Scandinavia. Of the four, investors are most strongly protected under the English system, and least protected under the French. These differences in legal origin predict differences in the degree of financial development as well as economic growth among countries. Because it is hard to think of how the origin of a country’s legal system should affect growth other than through financial development, this is strong evidence for causality running from finance to growth.

75
Q

What does existing evidence say about how countries can improve the functioning of their financial systems?

A

Government-owned banks perform more poorly than those that are privately held, that countries that permit foreign banks to compete in their domestic banking systems have more efficient finance than those that do not, and that strong legal systems that protect the interests of small investors relative to corporate “insiders” lead to more efficient allocation of capital.

76
Q

What is the reason for most cases of technology blocking?

A

Creative destruction.

A new technology, although beneficial for society as a whole usually makes someone worse off.

77
Q

Although opposition to new technologies often comes from worker, how is the phenomenon far more widespread?

A

Firms, even those in the high-tech sector, are prone to engage in technology blocking if it serves their best interest.

78
Q

Why doesn’t technology blocking always work?

A

Its success depends on the relative power of those who are hurt by a new technology and those who benefit from it.

79
Q

Although many of the forms of inefficiency examined in this chapter seem to be particularly serious problems in developing countries, how may rich countries be even more prone to technology blocking than poor ones?

A

Blocking a new technology often requires the assistance of a well-functioning government, which is more frequently found in rich countries than in developing countries.

80
Q

What is our most important conclusion from this chapter?

A

That differences in efficiency among countries are much larger than differences in technology. Thus, variation in efficiency explains most of the variation in productivity among countries.

81
Q

Which preliminary lesson can we learn from our study of efficiency?

A

That the level of efficiency in an economy depends crucially on its institutional structure.

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