Following the war, Grandpa Frank was very bullish on the potential of the French market. He saw a country that would not only experience short-term growth through its rebuilding effort, but also eventually catch up to the standard of living of the United States. As Exhibit 1 in the case clearly shows, this prediction never quite materialized. This question will help you understand what actually happened.
(a) Based on the initial setup parameters in your spreadsheet, what is the steady-state level of output-per-capita in the US? What is it in France? If they are the same, why? If they are different, what is causing them to be different?
(b) Based on the initial setup parameters in your spreadsheet, what is the eventual year-over year growth rate in output-per-capita in the US? What about France? What causes these to be the same or different? (Be sure to understand the difference between levels (previous question) and growth rates (this question).)
(c) So far, the graph (of output-per capita over time) that we've produced doesn't really look at all like exhibit 1 from the case (the real data). Since most of our initial parameters are correct, the main reasons our graph looks wrong is that we're assuming a 0% growth rate in productivity (a.k.a. TFP).
To fix this, set the TFP growth rate for both countries to 2%. With this, what happens to the steady-state level of output-per-capita in the US and in France? What about the growth rate in output-per-capita in the two countries?
Do these lines look closer to the real data from Exhibit 1? If it's still not quite right, what's wrong about it?
(d) Let's further improve our model by examining the role of the labor market. France's labor markets have evolved very differently than those in the United States in the decades following WWII. While the employment-to-population ratio was significantly higher in France in 1950, it declined steadily afterward and now sits much lower than the United States' level (see Exhibit 2 in the case).
To model this, adjust your spreadsheet so that the US employment-to-population ratio is constant, but in France:
? From 1950-55 the employment-population ratio in France is 125% of that in the US
? From 1956-75 the employment-population ratio in France is the same as in the US
? From 1976 onward the employment-population ratio in France is 75% of that in the US
Show the resulting graph of US and French output-per-capita. Does this graph look closer to the real data? Do these changes in employment-population ratio effect the long-run level or the long-run growth rate of output-per-capita or both?
ID#130304 CU81 PUBLISHED ON NOVEMBER 7, 2018 The Solow Model Unleashed: Understanding Economic Growth BY NICOLAS VINCENT * AND PIERRE YARED Background DURABUILD: SEEKING NEW INSIGHTS The peeling Durabuild Inc. sign, desperately in need of a touch up, caused Grant Stone to cringe slightly as he entered the company's St. Louis headquarters. He had mixed feelings about the meeting he had scheduled with the company's presidenthis father, Frank Stone Jr. Grant's agenda was a tough one: to try to get a better sense of what he viewed as his father's (and his grandfather's) less-than-perfect business acumen. In the weeks since Grant had left his analyst position in New York to join the family's firm as vice president for business development, he had become concerned about the company's future and had also grown curious about details of its early growth. Durabuild Inc. was a diversified, family-held business in the construction industry, with significant interests in France as well as in the United States. The president's spacious corner office looked out over the faded glory of an industrial brick skyline. Grant's father, finishing up what appeared to be a customer call, silently motioned for his son to settle into the most comfortable spot in the rooman overstuffed, butter-soft, leather armchair. A large-scale aerial photo of Durabuild's operations in France circa 1962 hung on the wall. As soon as his father hung up the phone, Grant cut right to the chase. \"I've been studying our books, Dad, trying to make sense of where Durabuild has been and where we are headed. From what I can see, the company's best growth period was in the middle of the last century, right after we opened operations in France. I want to work with you to understand that growth in a larger context so we can try and recapture it. Maybe, as we discussed last week, in China.\" DURABUILD: THE EARLY YEARS Frank Jr. loved to tell stories, and especially liked to sprinkle them with facts about US history, his passion. He poured himself a glass of chilled water from the carafe before he began. \"Grant, Author affiliation * Assistant Professor, Institute of Applied Economics, HEC Montral Roderick H. Cushman Associate Professor of Business, Columbia Business School Acknowledgements Jennifer Freeman '91 provided writing support for this case. Copyright information 2013-2018 by The Trustees of Columbia University in the City of New York. This version of the case replaces an earlier version that was published on May 9, 2013. This case is for teaching purposes only and does not represent an endorsement or judgment of the material included. This case cannot be used or reproduced without explicit permission from Columbia CaseWorks. To obtain permission, please visit www.gsb.columbia.edu/caseworks, or e-mail ColumbiaCaseWorks@gsb.columbia.edu This document is authorized for use only in Ari Shwayder's EMBA 637 E25 at University of Michigan - Ann Arbor from Jul 2019 to Jan 2020. I think you know how this story started. First, some history... At the end of World War II your grandfather saw a great opportunity in the G.I. Bill of Rights. Right after the war, the G.I. Bill provided free college tuition to the millions of soldiers who came home from the war. That bill gave veterans the opportunity to go to college, but it also gave them\"here he ticked the benefits off on his fingers \"housing subsidies, business loans, and other help in getting their lives back on track.\" \"When Grandpa Frank came back from France, he took out a business loan and established Durabuild in 1947 with offices in the United States and France. The construction industry was a good choice. After 15 years of the Depression and five years of war, housing in America was in bad shape, or at least in need of renewal. Mortgage loan guarantees provided by the G.I. Bill were helping the war veterans buy homes, which started a big housing boom. Those were some of our best years.\" \"But why expand into France? I never quite understood that choice.\" Frank Jr. gazed out the window. \"As you know, during the war, your grandfather fought on the front lines in Normandy. He saw firsthand the destruction of factories, the ashes of villages, the wreckage of schools and bridges. As the US housing market shot up after the war, he saw that once the recovery got underway in Europe, France would have an even greater need to rebuild than we did here in America. And he was right. For nearly two decades, France's economy soared.\" \"I remember once when I was about 10 years old, your grandfather told me about the miracle of postwar Europe. 'Out of the ashes of destruction have risen the wings of opportunity,' he said. We, Durabuild, were helping to make that happen.\" \"But Dad, did Grandpa Frank think the growth was going to continue forever?\" \"Well, there's the catch. The housing market in France that had boomed so impressively in the 1950s and 1960s leveled off in the 1970s, and my father didn't understand what was happening. He fully expected the French market to get back on track any minute. He kept thinking opportunity was just around the corner, because there was still so much room left for France to grow.\" He shook his head. \"Expecting the building industry to come roaring back, Grandpa invested Durabuild's capital year after year in factories and warehouses from Calais to Cannes. While the US part of the business held steady, Durabuild's French affiliates suffered. The demand for new construction in France was drying up, but Grandpa Frank refused to see it. I was a young apprentice at your grandfather's side at that time, and I admit I was taken in by his view of the world. Or maybe blind to the same things.\" Grant felt himself growing impatient. \"What's frustrating to me is that you guys waited around for more than 30 years, just hoping that Europe would return to the high growth rates of the postwar times. Thirty years in the twentieth century and beyond! Didn't you even try to understand what was going on? It seems like the best tool in your whole analytical toolkit was hope!\" The Solow Model Unleashed: Understanding Economic Growth | Page 2 NICOLAS VINCENT* PIERRE This document is authorized for use only in Ari Shwayder's EMBA 637 E25 at UniversityBY of Michigan - Ann Arbor fromAND Jul 2019 to JanYARED 2020. \"Hindsight is always 20/20, Grant. Why don't you bring your MBA toolkit in here and show me how we should have done it.\" LESSONS FROM THE PAST A few days later, when Grant had calmed down, he opened his laptop in the company conference room and dug into the kinds of source material he had not looked at since his days at Columbia Business School, nearly a decade before. The growth of the construction and building materials industry was closely tied to the overall economy, so he spent many hours looking at macroeconomic trends in France and the United States since the end of World War II. He also tried to recall the precise modeling tool that would help him to understand how Grandpa Frank had so inaccurately forecast the longer-term potential of Durabuild's operations in France. Drawing on his experience as an analyst, he prepared a report for his father. Grant's report highlighted a number of important macroeconomic trends in the United States and France. \"In the decades following World War II,\" he wrote, \"France grew at a much faster rate than the United States. GDP per capita growth in France from 1950 to 1980 averaged 3.8%, compared to 2.2% in the United States. Between 1980 and 2000, however, GDP per capita growth in France averaged 1.6%, compared to 2.3% in the United States. In other words, economic activity expanded at a much more rapid pace in France during the early years after the war, but the growth rate of the economy eventually tapered off.\" (See Exhibit 1.) Grant's report continued, \"Part of the reason why France grew so quickly at first was that it started at a much lower level relative to the United States. As a consequence of the destruction of the war, in 1950 France's GDP per capita was 54% that of the United States', and its capitalto-labor ratio was less than 10% of the United States'. France and the United States had similar investment rates during this period, and because France started from such a low capital base, its capital stock grew very rapidly, achieving the same capital-to-labor ratio as the United States by 2000. Nonetheless, France never caught up. In 2000 its GDP per capita was 75% that of the United States'.\" (See Exhibit 2.) Grant's report then went on to try to analyze some of the problems with the French economy and to describe some of the differences between the French and the American labor market, which may have been behind the slowdown. \"In the decades following World War II, unemployment in France was so low, around 3%, that US economists wondered how the United States could replicate the labor miracle of France and the rest of Europe. By the end of the century, however, France's unemployment rate had risen to over 11%, more than twice that of the United States'. Moreover, total labor hours per capita in France were 72% that of the United States'.\" (See Exhibits 2 and 3.) \"The French live very differently than Americans,\" the report went on. \"At the end of the century, in France, the work week could not legally be longer than 35 hours, with a mandatory five-week vacation. The average French worker put in 40 weeks per year, while the average US worker put in 46.2 weeks.\" The report then explained some of the possible reasons behind these differences: \"The French unemployment insurance program, which replaces 60% of prior pay for up to two years, may discourage individuals from seeking work, while high marginal tax rates make working additional hours less interesting. Furthermore, firms have little Page 3 | The Solow Model Unleashed: Understanding Economic Growth BYThis NICOLAS VINCENT* AND YARED document is authorized for PIERRE use only in Ari Shwayder's EMBA 637 E25 at University of Michigan - Ann Arbor from Jul 2019 to Jan 2020. incentive to hire new workers, given the high minimum wage regulation as well as the legal restrictions which make it difficult to fire workers.\"1 LESSONS FOR THE FUTURE Grant was now walking along the Mississippi River, lost in his thoughts, envisioning Durabuild's future plans. Did China present the best long-term potential, or would its current high-growth phase peter out as it had in France? China's rate of investment was extraordinarily high; it had never been replicated by either the United States or France and was driving very rapid economic growth. Nonetheless, doing business in China was difficult, given the difference between its regulatory environment and the United States' or France's. How easy would it be to apply new technologies in China? How does China's one-child policy affect its economic growth? When Grant had gotten about a mile down the river, the tool he was searching for finally dawned on him: the Solow model. The Solow Model Unleashed: Understanding Economic Growth | Page 4 NICOLAS VINCENT* PIERRE This document is authorized for use only in Ari Shwayder's EMBA 637 E25 at UniversityBY of Michigan - Ann Arbor fromAND Jul 2019 to JanYARED 2020. Exhibits Exhibit 1 Real GDP per Capita in France and the United States Source: Original 1950-2000 GDP per capita data for France and US is from Penn World Tables 7.1. Exhibit 1 compares the logarithm of the GDP per capita data. Exhibit 2 Comparison of Factors in GDP per Capita (France/United States) Year Y/POP A (K/N)^0.3 N/POP 1950 0.54 0.99 0.44 1.25 1980 0.86 1.05 0.88 0.93 2000 0.75 1.02 1.01 0.72 Source: Population (POP) and GDP per capita (Y/POP) are from Penn World Tables 7.1. Total hours worked (N) is from the Conference Board. Capital (K) in 2000 is assumed to be 3 time total GDP at 2001, and capital at other dates is calculated using investment and a depreciation rate of 4.4%. (A) refers to total factor productivity. Page 5 | The Solow Model Unleashed: Understanding Economic Growth BYThis NICOLAS VINCENT* AND YARED document is authorized for PIERRE use only in Ari Shwayder's EMBA 637 E25 at University of Michigan - Ann Arbor from Jul 2019 to Jan 2020. Exhibit 3 Labor Force Participation in France and the United States Source: 1950-2000 population data France and US is from Penn World Tables 7.1. Total hours worked is from the Conference Board. The Solow Model Unleashed: Understanding Economic Growth | Page 6 NICOLAS VINCENT* PIERRE This document is authorized for use only in Ari Shwayder's EMBA 637 E25 at UniversityBY of Michigan - Ann Arbor fromAND Jul 2019 to JanYARED 2020. Endnote Robert Solow, \"Unemployment in the United States and in Europe: A Contrast and the Reasons,\" Working Paper no. 231 (January 2000); Olivier J. Blanchard, \"Explaining European Unemployment,\" NBER Reporter: Research Summary (Summer 2004); Richard Rogerson, \"Understanding Differences in Hours Worked,\" Review of Economic Dynamics 9, no. 3 (July 2006). 1 Page 7 | The Solow Model Unleashed: Understanding Economic Growth BYThis NICOLAS VINCENT* AND YARED document is authorized for PIERRE use only in Ari Shwayder's EMBA 637 E25 at University of Michigan - Ann Arbor from Jul 2019 to Jan 2020
