Export-the departminant of economic growth in Asean developing countries 1986-2001, the case of VN

UNIVERSITY
OF
ECONOMICS INSTITUTE
OF
SOCIAL STUDIES
HO
CHI
MINH CITY
THE
HAGUE
VIETNAM
THE
NETHERLANDS
VIETNAM-
THE NETHERLANDS
PROJECT
ON DEVELOPMENT
ECONOMICS
EXPORTS -
THE
DETERMINANT
OF
ECONOMIC
GROWTH
IN ASEAN DEVELOPING COUNTRIES 1986-2001,
THE
CASE
OF
VIETNAM
A THESIS SUBMITTED IN PARTIAL FULFILLMENT OF THE
REQUIREMENTS

FOR
THE DECREE OF
MASTER
OF
ARTS IN DEVELOPMENT ECONOMICS
BY
HAVANDUNG
HO CHI MINH CITY, 2003
CERTIFICATION
I certify that the substance
of
this dissertation has not already been submitted for
any degree and is not being currently submitted for any other degrees.
I certify that to the best
of
my knowledge any help received in preparing this
dissertation, and all sources used, have been acknowledged in this dissertation.
Ha Van Dung
Date:

.
11
ACKNOWLEDGEMENTS
First
of
all, I would like
to
express my sincere and grateful appreciation to my academic
supervisor MA Nguyen Huu Loc for his guiding me during every step in my study,
especially during my time

of
writing thesis.
I would also like to express my grateful thanks to all professors, lecturers in Vietnam - the
Netherlands Project, especially Dr. Youdi Schipper, Dr. Gabrielle Berman, and
Dr.
Karel
Jansen for their precious lectures and assistance during the period
of
writing thesis
proposal. Furthermore, I would like to thank all the staffs
of
the project, especially the
librarian Ms. Dang Kim Chi, and the project secretary Ms. Dinh Anh Nguyet.
I would like
to
express my sincere thanks to all
of
my classmates in class
8,
who have
helped me a lots with their encouragements, collaboration, and ideas during my study as
well as during the time I
do
my thesis.
Above all, I am indebted to my grandmother, my parents and my daughters, who have
given me a lot
of
encouragement, sympathy, and support during my study.
11l
ABSTRACT

In recent years, Vietnam has gained impressive growth from the renovation in 1986. The
average growth
of
more than 7.5 percent has ranked Vietnam into the fastest growth group
in the world. This is a result
of
the process
of
transition from centrally planned economy to
market economy. The key element
of
this success is the openness
of
the economy and
trade has expanded its role in stimulating growth in Vietnam. In deed, exports have been
contributing to economic growth, and Vietnamese exports are quite similar to those
of
five
other ASEAN developing countries including Malaysia, Indonesia, the Philippines and
Thailand. Thus, it is useful to investigate the relationship between exports and economic
growth in these countries through the findings
of
determinants
of
economic growth.
By
using both descriptive and econometric method, the study examines the determinants
of
growth with an emphasis on the role
of

exports on economic growth in the ASEAN-5
developing countries during the period
of
1986-2001. The econometric method is based on
the neoclassical model, using panel data
of
five countries during sixteen years. The
empirical findings reveal that capital; labor force, export growth, spending on education,
and external debts are determinants
of
growth. In which, external debt and spending on
education have negative effect on growth while the rest has positive impact
on
economic
growth. In relation with the role
of
exports, the study has found that exports have positive
effect on economic growth in these countries, and this result is consistent with those in
previous studies.
It
also suggests that the opened-door policy in these countries has been
effective and it should be considered carefully in order to contribute more to economic
growth.
IV
TABLE OF CONTENTS
C ertifi cation
Acknowledgements
Abstract
Tables
of

contents
Lists
oftables
Lists
of
figures
Acronyms
CHAPTER
1:
INTRODUCTION
I.l.
Problem statement 1
!.2. Overall objectives 3
!.3.
Scope and limitation
of
the study 3
!.4. Methodology and data 4
!.5. Structure
of
the thesis 4
CHAPTER II: LITERATURE REVIEW
ILl Definitions 6
1!.2.
Literature review 7
11.2.1.
Growth theories 7
1!.2.1.1. Keys ian Growth 7
11.2.1.2. The neoclassical growth model
10

11.2.1.3. The endogenous growth theory
13
11.2.2.
The traditional theory
of
international trade and development
17
11.2.3.
Effects
of
Exports on Growth
19
v
II.3. Empirical Studies 28
II.3.1. Study
of
H. Sun and A. Parikh (1996) 28
II.3.2.
StudyofY.
A. Al-Yousif(1999) 29
II.3.3. Study
ofT.
Lloyd,
0.
Morrissey, and R. Osei (2001)
31
II.3.4. Study
of
G. K. Nigugala (1999) 32
II.3.5. Study

ofT.
Gylfason (1998) 33
11.3.6.
Study
of
E.
J.
Sheeney (1992) 34
II.3.7.
StudyofM.
A.
B. Sidique and
E.
A. Selvanathan (1998) 35
11.4.
Conclusions 37
CHAPTER III: AN OVERVIEW OF ECONOMIC PERFORMANCE
AND
EXPORTS IN ASEAN-5 DEVELOPING COUNTRIES
III.
I.
A background
of
five ASEAN developing countries 39
III.2. Export performance and sources
of
export growth
of
ASEAN-5 in recent years 40
III.2.1. Economic growth in ASEAN-5 40

III.2.2. Export Performance
of
ASEAN-5
in the studying period 42
III.2.3. Sources
of
Export Growth 44
III.3. Vietnamese exports in the studying period 47
III.3.1. Vietnam trade performance after applying 'renovation' policy 47
III.3.2. The commodity composition
of
exports 50
III.3.3. Main trading partners
ofVietnam
52
III.4. Conclusions
55
CHAPTER IV: DETERMINANTS OF ECONOMIC GROWTH IN
ASEAN-5 DEVELOPING COUNTRIES
IV.1. Methodology 56
Vl
IV.2. Descriptive Statistics 60
IV.3. Econometric Model 62
N
.3
.1. Model Specification 62
N.3.2.
Estimation results 66
IV.4. Conclusions
71

CHAPTER
V:
CONCLUSIONS AND POLICY
RECOMMENDATIONS
V .1. Conclusions 72
V.2. Policy recommendations
75
V.3. Suggestions for further study 77
Bibliography
Vll
· LIST OF TABLES
Table 2.1: Determinants
of
economic growth
Table 3.1: Growth rate
of
export in ASEAN-5, 1986-2001
Table 3.3: Vietnam: Commodity composition
of
exports, 1990-2001
Table
4.1
Description
of
variables
Table 4.2: Test for rank correlation between export growth and GDP growth
LIST OF FIGURES
Figure 2.1: Employment and foreign exchange effects
of
export expansion

Graph 3.1: GDP growth rate
of
ASEAN-5
Chart 3.1. Market's share ofVietnamese exports, 1995
Chart 3.3. Market's share ofVietnamese exports, 2001
Vlll
AFTA
ASEAN
ADF
CMEA
FDI
GDP
GSO
SUR
us
USD
VECM
VND
WDI
ACRONYMS
ASEAN Free Trade Area
Association
of
South East Asian Nations
Augmented Dickey Fuller
Council for Mutual Economic Assistance
Foreign Direct Investment
Gross Domestic Products
General Statistics
Office

Seemingly Unrelated Regression
United States
United States Dollar
Vector-Error-Correction Model
Vietnamese Dong
World Development Indicators
IX
CHAPTER
I:
INTRODUCTION
1.1. PROBLEM STATEMENT
Vietnam had made its unification more than ten years before it started the economic reform
to
take the economy out
of
the crisis in 1986 (Hoang, 1996). Vietnam's economic reform or 'doi
moi' (innovation) has been done
for
more than sixteen years and it gets many successes.
Gross Domestic Products (GDP) increases more than twice in the past ten years, economic
structure changes in the right direction
of
reducing the ratio
of
agriculture over GDP and
increasing the ratio
of
industry and service over
GDP
(Nguyen, 2002). From the beginning

of
innovation, Vietnam has gained a considerable growth with the average
of
GDP
of
7.55 per
cent per year (Vo,
2002). In which, the year 1995 is considered
as
the most successful for
growth performance with the growth rate
of
GDP reaching
9.5
per cent. Then, there is a bit
slowdown in GDP growth rate.
It
is only 5.8 and 4.8 per cent in 1998 and 1999, respectively.
However, it increases in
2000 and
2001
with the growth rate
of
6.7 and
6.8
per cent (General
Statistic Office (GSO), 2002). As a result
of
the economic growth, the living standard is
improved dramatically (Nguyen, 2002).

In accordance with GDP growth, the 2002 World Bank report shows that between 1986 and
2001, exports have increased by
an
average
of
around twenty three per cent leading
to
an
expansion in sectors that employ large number
of
people, combined with a stable
macroeconomic environment and reforms for favorable investment climate, it generated
exceptional growth in
GDP
(World Bank, 2002). Not only the total volume
of
exports
increases, the structure
of
exports has changed
as
well.
Vo
(2002) shows that while primary
exports have decreased the share in total exports from year
to
year, manufactured exports
have increased from only ten per cent in
1991
to

forty per cent in 1999 (Vo, 2002). The
Vietnamese economic performance
as
well
as
the export performance is
so
good in the
1
difficult circumstance
of
collapse
of
trade relations with Council for Mutual Economic
Assistance (CMEA) and the fall
of
aid from Soviet Bloc.
When economists consider the effect
of
export growth on economic growth, there are two
groups
of
thought. First, Krueger argues that economic growth could be gained when the
country experienced growth
of
export earnings (Krueger, 2000). Other writers such
as
Feder
(1983), Nidugala (1994),
Sun and Parikh (1996), Al-Yousif (1999), and Lloyd, Morrissey,

and
Osei (200
1)
also find that there is a positive effect
of
export growth on economic growth.
Additionally, Nidugala finds an interesting point that manufactured exports have significant
influence on
GDP growth for the case
of
India. This shows that economic structure also has a
role in the development process
of
India. In contrast, Raul Prebish and Hans Singer argued
that not only primary exports face sluggish growth
of
demand, but over time prices
of
these
commodities will fall in the world market,
so
they do not agree with an positive effect
of
exports on economic growth in long run (Gillis and al, 1996). Another author finding the
same conclusion is
Sheerey with the study
of
cross-section
of
53

countries in the world. After
examining the role
of
exports on economic growth, he concludes that exports have not got the
clear role in economic growth (Sheerey, 1992). Siddique and Selvanathan agree with this idea
when they
do
their research for Malaysia and find that their results
do
not give any evidence
to support the export-led economic growth hypothesis. They also indicate that for the case
of
Malaysia manufactured exports as the same
as
total exports have no role in economic growth
(Siddique and Selvanathan, 1998). In Vietnam, there is a debate on the role
of
exports on
economic growth. While many authors such
as
Nguyen (1997), Nguyen (2002), and Vo
(2002) have suggested a policy with more concentration on exports, Nguyen (2000) shows
that imports
of
machinery have increased from 21.8 percent in
1991
to
28
percent in 1999,
and this has contributed in pushing domestic production and thus, growth.

So, it
is
necessary
to
push this kind
of
imports (Nguyen, 2000).
2
So, this paper aims at investigating the role
of
exports on economic growth, and through
which to find out what are determinants
of
economic growth in Vietnam from the year
of
innovation 1986 to 2001, also reference with other ASEAN developing countries.
1.2. OVERALL OBJECTIVES
The
study concentrates on economic dimensions
of
economic growth and exports, as well as
other determinants
of
growth in Vietnam.
It
is envisaged that this will correlate the export
growth rate, investment, human capital, which are necessary conditions for sustainable
economic growth.
The overall objectives
of

this study will therefore be to identify and qualify, through
economic investigation
of
growth, the relationship between export growth and
economic growth, and last suggest trade policies stimulating further economic growth.
The study has two specific objectives, with an emphasis on the later one:
1.
What are determinants
of
GDP growth in ASEAN-5 developing countries
including Thailand, Malaysia, Indonesia, the
Philippines, and Vietnam.
2.
Is
there a positive effect
of
the growth rate
of
exports on the growth rate
of
GDP
in ASEAN developing countries during the period
of
1986-2001?
1.3. SCOPE AND LIMITATION OF THE STUDY
The year 1986 is considered as the initial year
of
totally innovative in Vietnam since the
innovation in the mid-1986. From 1986, data available is not sufficient enough to
econometric model and thus lead to unreliable results. So, to increase the sample size the

study chooses additional four ASEAN economies including Thailand, Malaysia, Indonesia,
and the Philippines. These countries are chosen because
of
two reasons. The first reason is
that all these countries are located in Southeast Asia and are members
of
AFTA. The second
reason is that the economic background
of
these countries is quite similar each other. These
countries are pursuing regional and international integration with greater openness
of
the
3
economies
as
well as trade liberalization. They all first develop by industrialization
of
import-
substitution strategy and then shifted into export-oriented strategy (Bende-Nabende, 1999).
For
limitation, since some data are missed and not available, the thesis just focuses on some
main determinants
of
growth. The study also just focuses on visible exports while it ignore
invisible exports due to the reason
of
data constraint. Another limitation is some data are not
available, so it will reduce the observations
of

regression model.
1.4. METHODOLOGY AND DATA
Both qualitative and quantitative methods are used
to
analyze, however econometric method
is used as the main methodology.
The econometric method will be used to analyze the impacts
of
exports on economic growth
in
ASEAN developing countries and Vietnam.
It
will investigate how export growth can
affect on economic growth in these countries.
Most
of
data come from CD-Rom named World Development Indicator
of
the World Bank
group. Another source
of
data is from Statistical Year Books (GSO, various years)
as
well
as
in the book named World Development Indicator 2001 and 2002. The World Investment
Report 1999
of
United Nations Conference on Trade and Development, United Nations, and
The World Tables 1995

ofthe
World Bank are also used to extract data.
These sources are official so, data used are reliable and acceptable for the study.
1.5. STRUCTURE OF THE THESIS
Basing on the objective and methodology, the thesis is classified into five chapters.
Following introduction, chapter two introduces the literature review.
It
focuses on the growth
theories, trade theories, and effects
of
exports on economic growth. Then, it also includes
some empirical studies, which examine the relationship between export growth and economic
growth.
4
Chapter three introduces an overview
of
economic performance and exports in ASEAN-5
developing countries from 1986. Especially, the case
of
Vietnam will be examined more
carefully in order
to
have a general picture
of
Vietnamese economy since applying the
'innovation' policy in mid-1986.
Chapter four is the main one with the qualitative and quantitative methods in examining the
relation between economic growth and export growth.
It
consists

of
methodology, descriptive
statistics and the derived model. Then, the estimation results are presented. After that
hypotheses testing are done within the model in order
to
give reliable findings from the
regression results and answer the research question.
Finally, chapter five will close the thesis with some conclusions and policy implications,
basing on the findings in the previous chapter.
It
also offers some suggestions for further
studies.
5
CHAPTER II: LITERATURE REVIEW
In
order to understand the relation between economic growth and its determinants including
exports, it
is
necessary to examine the theoretical framework. This chapter first introduces the
definitions
of
key concepts and then the literature review will be presented.
In
the literature
review, there are three sub-parts: the first sub-part is composed
of
growth theories including
the Keysian growth, the neoclassical model, and the endogenous growth theory. From these,
some determinants
of

growth are drawn. Then in the second sub-part, theories relating
international trade and economic growth are presented, and last, effects
of
exports on growth
will be examined. The third part introduces some previous empirical studies, which examine
the determinants
of
economic growth, including export growth. Finally, conclusion for
theories and empirical study will be drawn.
11.1. DEFINITIONS
According
to
Pearce (1996) export is
'a
good or service which is produced in one country and
sold
to
and consumed in another. A visible export
is
a good which is physically tangible and
an invisible export is the provision
of
a service which is consumed by someone from another
country' (Pearce, 1996: p145).
Then it is the definition
of
export growth by Krueger (2000) 'Export growth is defined
as
the
long term trend in a country's foreign exchange earnings from goods and non-factor services'

(Krueger,
2000: p27).
Last,
Pearce (1996) states that economic growth is 'typically taken
to
the mean an increase in
real level
of
net domestic products although the measure will then be sensitive to the way in
which domestic product
is
measured. Thus an economy with a large sector containing
battered goods and un-recovered consumption
of
its own product (e.g. farmers' consumption
of
their own product) may raise its actual level
of
domestic product without the recorded
level showing an increase' (Pearce, 1996: p120).
6
11.2. LITERATURE REVIEW
11.2.1. Growth theories
In the last haft
of
century, there are three waves
of
growth theory: firstly, the work
of
Harrod

and
Domar (or Keynesian Growth), then neoclassical model
of
Solow, and last, endogenous
growth theory
by
Romer and Lucas (Ruttan, 2001
).
11.2.1.1. Keysian Growth
The
model
of
Roy Harrod (1939) and Evsey Domar (1946) is built basing upon Keynesian
economics.
The
simple model
of
economic growth is expressed as following (Todaro, 1994): we denote k
as the capital-output ratio, and s is the proportion
of
saving (S) over national income (Y)
S
=sY
Investment (I) is defined as the change in capital stock (K)
Capital stock is a part
of
output so
K/Y = k or Y = k or = Y
Since total national savings equal total investment (S
=I)

so
I =
= Y = S = s Y or
YIY
= s/k
The
simple equation
of
Harrod-Domar model states that the growth rate
of
GNP Y/Y) is
determined
by
national savings ratio, s, and the capital-output ratio,
k.
This implies that an
economy have to save and invest as much as possible in order to get high growth rate. The
more they can save and invest, the faster they can growth (Todaro, 1994).
7
The
Two-Gap Model
The
two-gap model is quite similar to the Harrod-Domar model but it puts a further
assumption that investment program needs an import component in the form
of
machinery
or
intermediate goods. So, the economic growth can
be
limited

by
two constraints: the total
amount
of
available capital for investment and the amount
of
foreign exchange for imports
(Kasliwal, 1995).
dY=K.I
From the national income identity
Y=C+I+(X-M)
S=Y-C
M-
X=
F where F is capital inflows
Insert (3) into (2) and combine with (4), it results
(M - X) = (I - S)
Insert ( 5) into (
1)
=>
dY = K.(S
+F)
and dividing both sides
by
Y then
dY/Y =
K.(SN
+FlY)
or
gy = K.(s +

FN)
(1)
(2)
(3)
(4)
(5)
(6)
The
equation (6) shows that domestic and foreign savings determine the growth rate.
However, the foreign exchange constraint may
be
the one problem. To examine this, total
imports are split up in imports
of
capital goods
(Mk,
proportional to the level
of
investment)
and other imports (Mi, proportional to the level
of
output)
M=Mk+Mi
Mi=mj.Y
MK
=mK.I
Insert (9) to
(1) then
(7)
(8)

(9)
8
dY=K.MIJmK
Assuming furthermore that X =
e.
Y
From (7) and ( 4)
=>
MK
=F
+X-
Mi
orMK
=F+
e.Y
-mi.Y
Dividing both sides
of
(12) by Y, it gives the result
of
growth rate:
mK
(10)
(11)
(12)
(13)
The equation (13) sets the growth rate as determined by net export earnings, net receipts
of
factor services and other current transfer, and foreign savings. The equations (6) and (13)
suggest a positive impact

of
capital and export on growth in the two-gap model. The equation
(5) shows the role
of
foreign capital. Foreign capital will help one country to fulfill the gap
between investment and saving
of
the country.
The two-gap model is a useful starting point for the analysis.
It
is a single and powerful tool
to draw attention to some crucial variables determining the relationship among capital,
export, and economic growth.
It
can be used as a quick device to calculate growth while other
elements are held constant.
It
also shows the important role
of
foreign capital in fostering
growth. However, it bases on assumptions
of
constant parameters, which is unrealistic in the
real life.
In conclusion, the Harrod-Domar model gives an idea for source
of
economic growth, which
is the saving rate
of
the economy. However, the model does not always work since the model

has used inappropriate or irrelevant assumptions about the necessary structural, institutional,
and attitudinal conditions. The model considers all economies with well-integrated
commodity and money market, highly developed transport facilities, well-trained and
educated labor force, efficient government bureaucracy, etc (Todaro, 1994). Actually, these
9
assumptions are unrealistic even with developed economies. The differences in working
conditions, education, national resources have made different growth between among
economies.
It also neglect to the role
of
price index
in
the model
So, this theory is considered as one
of
the most fundamental "tricks"
of
economic growth
but
it
is not widely applied for real economies.
11.2.1.2. The Neoclassical Growth Model
Solow (1956) and Swan (1956) have developed the neoclassical growth model.
It
is an
aggregate, constant-returns-to-scale production function that combines labor and capital
(Agenor and Montiel, 1996). Technology improves are assumed as an exogenous rate while
savings are assumed to
be
a fixed fraction

of
output.
The
production function is Cobb-Douglas; output
per
capita y is given by:
y=Ak
1
-a.O<a<1
(1)
Where k denotes as the capital/labor ratio and A as the level
of
technology
The capital accumulation is given
by
k=sy-5k
s > 0,
<1
(2)
Where
s denotes the propensity to save the rate
of
depreciation
of
physical capital.
The
neoclassical growth model leads to the 'source-of-growth' approach, which uses an
aggregate production function to decompose growth into 'contributors' from different
sources. These sources can be named
as

the growth rate
of
factor inputs weighted
by
their
shares plus a residual. This residual is often called 'technical progress'
or
the growth rate
of
total factor productivity (TFP) (Agenor and Montiel, 1996: p513-14).
(3)
Where
Ui
is the elasticity
of
output with respect to input i, and
gA
is the growth rate
of
total
factor productivity and as a residual.
10
Technological Progress
The assumption
of
constant technology
is
unrealistic
so
in 1950s and 1960s, the neoclassical

economists amended the basic model and let technology improve over time. The
technological improvement is exogenous. To introduce exogenous technological progress
into the model, most economists use neutral inventions, which
do
not save relatively less
capital input or relatively less labor input (Barro, 1995).
When A and L are integrated, AL means effective labor and is called labor augmenting or
Harrod-neutral. The model is then expressed in the new form
Y = F(K, AL)
Or
1)
AL-
AL'
Where F I AL =
y*:
output per unit
of
effective labor
Kl
AL = k*: amount
of
capital per unit
of
effective labor
y*
= f(k*) (Romer, 1996: p8)
(4)
Or in short time, the increase
of
output is determined by the increase

of
amount
of
capital per
unit
of
effective labor. The Harrod-neutral has emphasized the role
of
capital as the only one
determinant in fostering growth in short-run.
In the model,
Solow has explained the cross-country differences in the growth rate by mainly
on transition dynamics and he shows the technical progress as the source
of
sustained growth.
However, the diminishing returns have prevented the model from providing an explanation
for the wide variation across countries in either per capita income or growth rate.
In
addition,
since population growth and technological change are assumed exogenous, the model does
not give explanation for the mechanisms generating steady-state growth, and therefore there
is
no evaluation
of
the mechanisms through which government policies can influence the
growth process (Agenor and Montiel, 1996). Moreover, the model assumes unrealistic
11
efficient market and
doesn't
give any explanation for the sources

of
technical progress, which
can be considered as indirect contribution to growth.
The Augmented Solow Model
Mankiw, Romer, and Weil (MRW) (1992) extend the Solow model
by
adding human capital
accumulation. They introduce the stock
of
human capital (H) into the production function
(5)
As
before, the production function has constant returns to scale and diminishing returns to all
capital. We divide both sides
by
effective labor (AL)
(6)
where: h*
= H/(AL) and h = H/L
The
equation shows that output per worker (y) depends on skills
per
worker (h) and capital
per
worker (k) as well as technology (A).
Assuming that a constant fraction
of
income is invested in physical capital (s) and a constant
fraction
of

income is invested in human capital (
sH),
the growth rate
of
human capital is n and
both types
of
capital depreciate at the same rate
(l5).
The accumulation equations for physical
and human capital are then:
k • =
sy
• I k • - ( n + g + 5 )
(7)
(8)
Setting k = 0 and h = 0
we
obtain the steady state values
ofk*
and h*:
(9)
(10)
Substituting (9) and
(1
0) into (6), we have the steady state value
of
output per worker:
(11)
12

The
equation (11) shows that besides A, s, and (n + g + o); the rate
of
human capital
(sH)
also
affects on the steady state value
of
output
per
worker.
To estimate the rate
of
growth,
we
substitute into Y/L =
AkuhP,
then taking logs
of
both sides,
and we get an estimating equation with human capital
a a
a+P
log(y) = log(A(O)) + og(s) + og(sH)- log(n + g + o) (12)
1-a-p
1-a-P
1-a-p
This model also faces the problem that the original Solow model does. That is no explanation
for the sources
of

technological progress.
It
does not seem to provide a satisfactory solution
to the shortcomings
of
technology gaps. The lack
of
supporting empirical relevance is also a
shortcoming
of
the growth theory.
However, in the model, three determinants
of
growth are clearly defined. They are human
capital, physical capital and technological progress. Among these, capital plays a crucial role
to growth as show in equation 12.
In
conclusion, the neoclassical growth model has well developed from the basic model. The
following models have gradually removed the shortcomings
of
previous ones. From
just
one
determinant
of
growth - physical capital, the followings have developed and allow human
capital to grow and technological progress to improve over time. This has made the model
become more realistic and it can be able to apply for real economies.
11.2.1.3. The Endogenous Growth Theory
A new boom

of
research on economic growth is beginning
by
the work
of
Romer (1986) and
Lucas (1988) and this is called endogenous growth theory.
The endogenous growth theory has proposed a variety
of
channels through which steady-state
growth is reached endogenously. First, it is necessary to examine the role
of
externalities and
increasing returns to scale, then the human capital accumulation.
13
Externalities and increasing returns
There are two broad approaches following the way that relaxes the assumption
of
diminishing
returns
to
capital (Agenor and Montiel, 1996). First, some economists consider all production
inputs
as
some forms
of
reproducible capital including physical capital and human capital
(Lucas, 1988) or 'state
of
knowledge' (Romer, 1986). Robelo (1991) has developed the AK

model along this line.
From the equation
Setting
8 = 0
=>y=Ak
Where k is measure
of
the physical and human capital.
The growth function exhibits the constant returns
to
scale, but not diminishing returns to
capital. The steady-state growth per capita is then
g=sA-8
The implication
of
the equation is that an increase in the saving rate will raise the growth rate
per capita.
In
addition, the AK model implies that poor nations with the same characteristic
of
technological degree
as
other nations always growth at the same rate
as
rich countries,
regardless
ofthe
initial level
of
income (Agenor and Montiel, 1996).

The second approach
of
examine endogenous growth has introduced externalities in the
growth process.
In
the model, externalities exist in the form
of
technological knowledge for
all firms and they are used for developing new methods
of
production. However, there are
some exceptions such as Lucas (1988) has considered externalities
as
the form
of
public
learning, and Barro (1990) has introduced externalities as public investment.
Human capital and knowledge
The accumulation
of
human capital is one particular source
of
externalities that has been
emphasized in recent growth theory.
In
his model, Lucas (1988) has developed upon the idea
14
that individual workers are more productive, regardless
of
their skill level,

if
other workers
have more human capital. Lucas has developed the model as following
Y = Ak
0
[uh]J-a
0 < U < 1
Where
k denotes physical capital
per
worker, and h human capital per worker
or
'knowledge'
capital.
u is the fraction
oftime
that individuals devote to producing goods.
Then, the growth rate
of
physical capital is:
I=
sy
And
the growth rate
ofhuman
capital is:
hi h =
a(1-u)
a>
0

The model has shown that in the long run, the growth rate
of
both capital and output
per
worker is a(l-u), whereas the rate
ofhuman
capital growth and the ratio
of
physical to human
capital converge to a constant.
In
addition, the model implies that under purely competitive
equilibrium, external effects lead to an under-investment in human capital because private
agents do not consider the external benefits
of
human capital accumulation. The equilibrium
growth rate is smaller than the optimal growth rate because
of
the externalities. Since the
growth rate is determined
by
the rate
of
investment in human capital, the externality implies
that with more investment in human capital, the growth would be higher.
So, government
policies are necessary to increase the equilibrium growth rate up to the optimal growth rate
and subsidy
on
human capital formation would make a substantial increase in the economic

growth rate (Agenor and Montiel, 1996).
Romer (1986) has proposed another approach to accessing the role
of
external effect in his
framework.
He
considers the source
of
externality is the stock
of
knowledge rather than the
stock
of
human capital. Knowledge is produced
by
individuals, but since newly produced
knowledge can
be
partially and temporarily kept secret, the production
of
goods and services
depends on not only private knowledge but also the aggregate stock
of
knowledge. Next,
15
Romer (1990) has explained endogenously the decision to invest in technological change
with a model based on a distinction between a research sector and the rest
of
the economy. In
this work, he states that firms cannot benefit all from knowledge production, implying that

the social rate
of
return exceeds the private rate
of
return to certain forms
of
capital
accumulation. This leads to a conclusion that tax and subsidy can promote the rate
of
economic growth (Romer, 1990).
The
shortcoming
of
the model is that the endogenous growth theory has faced a classic policy
problem associating with the production
of
knowledge under the conditions
of
increasing
returns and imperfect competition.
In
Romer model, new ideas, which depend on the number
of
researchers engaging the
discovery process, can create technological change, and in tum, technological change
requires government provision
of
intellectual property rights (Riedle, 2003). The endogenous
model has solved the problem
of

source
of
technological change. While in Solow model,
technological change is not explained, the Romer model explains it as a result
of
investment
in human capital or new ideas from researching.
In
addition, other advances
of
these theories
is that in the models, the authors have considered the roles
of
the government, the effects
of
per
capita income and wage rate
of
population.
The endogenous growth model has developed into higher level compared to previous ones.
With the close attention to empirical studies and to the relation between theory and data, the
endogenous growth model has been more widely applied for real economies.
In
conclusion, the growth theories from Keysian growth to neoclassical growth and
endogenous growth have explained the sources
of
growth. From one determinant
of
growth -
physical capital, the followings have found other two main determinants

of
growth such as
human capital, technological progress. Besides, some others are institutional conditions,
16