Persistent remaining productivity growth differentials between countries with common technologies and constant returns to scale under perfect international capital mobility at the very least raise doubts about the ability of poor underdeveloped countries hoping to achieve Japanese productivity levels and growth rates simply by opening their economies to international trade, capital mobility and technology transfer. In Discussion Paper No. 542, Research Fellow Willem Buiter and Kenneth Kletzer argue that `local' complementary inputs in the production process are essential to high productivity. They derive a two-country, three- period, overlapping generations model of consumption, whose production function includes non-traded `human capital', whose own production requires spent in education by young workers as a non-traded current input. The young choose between education and leisure; the middle-aged work, consume traded goods and save for retirement; while the old consume their accumulated savings. Human capital accumulation entails an externality in so far as each young generation starts with the level of human capital attained by the previous generation: without intervention, a decentralized competitive market therefore under- invests in education.

Buiter and Kletzer find that the existence of home-grown human capital forming an essential input in its own accumulation is a sufficient condition for international differentials in the level and growth of labour productivity to persist. A higher private rate of time preference will reduce relative human capital accumulation, while higher public debt will usually increase the relative growth of human capital and output: the young respond to a net redistribution of income to the old (who usually own the public debt) by increasing the time they spend in education. Policies of deficit financing and lump-sum intergenerational redistribution that boost conventionally measured savings may therefore reduce relative rates of human capital accumulation and labour productivity growth.

Buiter and Kletzer argue that the positive external effects associated with human capital accumulation suggest first-best policies of subsidizing education, taxing leisure, or assigning time and resources devoted to schooling through a `command' system that overrides individual choice. Subsidies to private borrowing for education (student loans), in contrast, fall short of full Pareto efficiency; while if public and private spending on education are equally efficient, any increase in the former will crowd out the latter more than one-to-one, unless the income effect of the transfer in kind is offset by tax increases.

Buiter and Kletzer note in conclusion that residence-based taxes will also affect world-wide productivity growth through the world interest rate, but they can only affect the productivity growth differential through their differential effects on the cost of borrowing for private educational expenditure. Source- based taxes on capital income also affect global saving, and they affect productivity growth differentially by altering relative wages.

Persistent Differences in National Productivity Growth Rates With a Common Technology and Free Capital Mobility
Willem H Buiter and Kenneth M Kletzer

Discussion Paper No. 542, July 1991 (IM)