ECON 330 UOM Public Capital Bateman Et Al 2009 Reading Questions

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Short Response: Bateman et al (2009)
Q1
100 Points
Using the text boxes below, answer the following questions (1.5-3 paragraphs).
Make sure that your answer is brief, clear, and *to the point. Avoid discussing
aspects of the readings that are not directly related to the questions.
What is the role of Public Capital (e.g. infrastructure) in Bateman et al’s
explanation for the lack of industrialization in the US South prior to World War II?
Specifically, what role does increasing returns to scale in public capital play in
the authors’ explanation? (see, esp., p. 317)
Did New Deal and World War II Public Capital Investments Facilitate a “Big Push” in the
American South?
Author(s): Fred Bateman, Jaime Ros and Jason E. Taylor
Source: Journal of Institutional and Theoretical Economics (JITE) / Zeitschrift für die
gesamte Staatswissenschaft, Vol. 165, No. 2 (June 2009), pp. 307-341
Published by: Mohr Siebeck GmbH & Co. KG
Stable URL: http://www.jstor.org/stable/40752762
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307
Did New Deal and World War II Public Capital
Investments Facilitate a “Big Push”
in the American South?
by
Fred Bateman, Jaime Ros, and Jason E. Taylor*
The “big push” theory claims that publicly coordinated investment can break the
cycle of poverty by helping developing economies overcome deficiencies in private incentives that prevent firms from adopting modern production techniques
and achieving scale economies. Despite a flurry of research, however, scholars
have offered scarce few real- world episodes that seem to fit the theoretical model.
We argue that the postwar performance of the American South, which followed
large public capital investments during the Great Depression and World War II,
is such an application. Both econometric analysis and a contemporary survey of
firms strongly support the notion that big-push dynamics were at work. (JEL:
N92, O 10,0 11)
“In some degree, the South has been traditional
because it was poor. At the same time, it has also
remained poor in part because it was traditional.”
(William H. Nicholls, the 1959 Presidential Address of the Southern Economics Association)1
1 Introduction
Nicholls’ statement above is indicative of many aspects of the American South
between the Civil War and the mid-20th century. The South had an underdeveloped
transportation infrastructure because it was poor and the South was poor because
it had a bad system of transportation. The South had substandard schools because
it had so little money to devote to education and the region was poor because it
* We are grateful to Elmar Wolfstetter and anonymous referees for helpful suggestions for improving the paper. We also thank Ted Beatty and David Beckworth, as well
as seminar participants at Indiana University, Tulane University, Northwestern University, Central Michigan University, and the Southern Economic Association meetings
for useful comments.
1 See Nicholls [1960, p. 187].
Journal of Institutional and Theoretical Economics
JITE 165 (2009), 307-341 ©2009 Mohr Siebeck – ISSN 0932-4569
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308 Fred Bateman, Jaime Ros, and Jason E. Taylor JITE 165
lacked good schools. The South was slow to develop modern power plants because
of a lack of economic incentive to develop such capacity and the South provided
few economic incentives for modernized industrial firms to locate there because
it lacked power. The South lacked buying power because it relied on agriculture
and small-scale production and the South was non-industrialized because it lacked
buying power. In the terminology of the economic development literature, the preWorld War II South confronted several aspects of the “vicious circle” or “poverty
trap” that befalls many developing economies.
According to the big-push theory of economic development, publicly coordinated
investment can break the underdevelopment trap by helping economies overcome
deficiencies in private incentives that prevent firms from adopting modern production
techniques and achieving scale economies. These scale economies, in turn, create
demand spillovers, increase market size, and theoretically generate a self-sustaining
growth path that allows the economy to move to a Pareto preferred Nash equilibrium where it is a mutual best response for economic actors to choose large-scale
industrialization over agriculture and small-scale production. The big-push litera-
ture, originated by Rosenstein-Rodan [1943], [1961], was initially motivated by
the postwar reconstruction of Eastern Europe. The theory subsequently appeared
to have had limited empirical application and was largely abandoned in the early
1960s. This literature has been resurrected in several recent contributions including
Murphy, Shleifer, and Vishny [1989], Matsuyama [1992], Hansen [1995],
Rodriguez-Clare [1996], Skott and Ros [1997], Gans [1998], Yamada
[1999], Ros [2000], and Trindade [2005].2 Yet, scholars have found few realworld examples of such an infusion of investment helping to “push” an economy to
high-level industrialization equilibrium.
We argue here that the postwar transformation of the American South, which
followed large public capital investments during the Great Depression and World
War II, is one such application. Although 1930s New Deal programs are typically
presented in the context of their attempt to bring relief and recovery to the U.S.
economy through demand-stimulating public expenditures, the long-term economic
effects of these and subsequent wartime expenditures were profound for the South.
Specifically, and consistent with big-push theoretical literature, the infusion of
public capital – roads, schools, waterworks, power plants, dams, airfields, and
hospitals, among other infrastructural improvements – fundamentally reshaped the
Southern economy, expanded markets, generated significant external economies,
increased rates of return to large-scale manufacturing, and encouraged a subsequent
investment stream. These improvements helped create the conditions that allowed
the region to break free from its low-income, low-productivity trap and embark on
its rapid postwar industrialization.3
2 For a recent survey of poverty trap models, including the big-push literature, see
AZARIADIS AND STACHURSKI [2005].
3 While other scholars such as Field [2003], [2006] note the importance improvements in depression-era public capital had upon subsequent productivity advances in
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(2009) Did New Deal and World War II 309
In this paper, we develop an extension of the big-push m
stylized facts of the early- to mid-twentieth century Sout
investments facilitate big-push dynamics. We also presen
a state’s growth in public capital between 1933 and 1945
impact on growth in manufacturing immediately after the w
surveys of industrial firms that moved to the South in the t
War II reveal locational decisions that strongly support th
infusion of the Great Depression and war created big-pus
2 An Overview of the Big-Push Theoretical Liter
The big-push theory claims that with respect to product
economies can have two locally stable Nash equilibria – o
which mass production and increasing returns to scale t
and another, “no-industrialization,” in which production
scale agriculture and cottage industries. In its classic v
[1943]), the presence of plant-level economies of scale, c
duction methods, is the source of pecuniary external econ
nologies characterized by increasing returns involves sign
from each industrializing sector to all others. These spil
may be unprofitable for any sector to unilaterally industr
trialization of several sectors would be profitable for ea
economy under these conditions finds itself in its “no-ind
librium, it could be trapped there indefinitely. Breaking f
trap requires a big push in the form of simultaneous large
will increase output capacity in multiple sectors, create ex
the market, and create a self-sustaining growth path of in
Murphy, Shleifer, and Vishny [1989] formalized this
tisectoral, closed economy model of horizontal pecuniary
assumes that each final goods sector has a competitive frin
with constant returns to scale (cottage industries) and a
increasing returns to scale (mass production) technology
sector operates and industrializes only if it is profitable to
monopolist’s profits are distributed to its workers and/o
creases spending and, in turn, the potential market size an
monopolists in all other sectors. Under certain conditions,
itable for any one sector’s monopolist to unilaterally ind
the U.S., this paper differs in its emphasis upon big-push d
nomic development.
4 Fleming [1955] distinguished between “horizontal” and
ternal economies, depending on whether interdependence tak
related markets of final goods industries (horizontal spillov
interacting as suppliers and customers (vertical effects).
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310 Fred Bateman, Jaime Ros, and Jason E. Taylor JITE 165
such positive pecuniary externalities implies that the greater the number of sectors
that industrialize, the greater the profits to the potentially industrializing monop-
olists of all sectors. There are then two Nash equilibria: one in which all sectors
industrialize and one in which none do.
The authors also present a model with vertical pecuniary externalities showing
how investments in infrastructure projects, subject to increasing returns, which
allow industrializing firms to more cheaply transport goods and expand markets,
can coordinate a big push. In this case, private sector investment in, for example,
a railroad will only be profitable if many firms industrialize and it will only be
profitable for many firms to industrialize if the railroad is built. Again, two Nash
equilibria exist, one in which the railroad is built and industrialization occurs,
and another where neither of these happens. Government subsidization of railroad
construction, therefore, may be a means to “push” the economy out of the lowincome trap and into the preferred Nash equilibrium. Murphy, Shleifer, and
Vishny [1989] note that railroads are, in fact, just one of several infrastructure
projects that might require public subsidies to help a developing economy break out
of the no-industrialization trap. They list power plants, roads, airports, and training
and education facilities as others.
The model of Murphy, Shleifer, and Vishny [1989] assumes a closed econ-
omy. Rodriguez-Clare [1996] and Skott and Ros [1997] develop models
of an open economy with nontradable inputs in which a big-push scenario can
arise. The source of external economies is different in these two contributions. In
Rodriguez-Clare [1996], productivity gains arise from increasing differentiation
of intermediate goods as the market for these inputs increases. In Skott and Ros
[1997], external economies arise from the presence of increasing returns to scale
in the production of infrastructure. In this respect, the model in Skott and Ros is
closer to the infrastructure model of Murphy et al.5 The policy implications offered
by Skott and Ros include stimulating the production of public capital (or “social
overhead capital”) such as power, transportation, communications, or training facil-
ities as a means of breaking the underdevelopment trap. Thus, big-push dynamics
are not restricted to cases where firms, themselves, coordinate entry. It is this aspect of big-push theory – a brisk government expansion of public capital stimulating
widespread adoption of large-scale manufacturing techniques – that can lend insight
into the postwar development of the American South.
The big-push literature consists almost exclusively of theoretical studies – only
recently have scholars explored potential real- world examples of big-push dynamics
taking an economy from a poverty trap to an industrialization equilibrium. Among
these are Voigtlander and Voto [2006] on the industrial revolution in England,
Rodrik [1995] and Trindade [2005] on South Korea and Taiwan, and Sauer,
Gawande, and Li [2003] on East Asia and Eastern Europe. Other recent empirical
5 An early model with increasing returns to scale in the production of non-traded
inputs is presented in Faini [1984]. The focus of Faini, the conditions for cumulative
divergence of regional growth rates, is quite different, however, from the analysis of
multiple equilibria and the big push.
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(2009) Did New Deal and World War II 311
literature using samples of countries to identify poverty t
as a result of a big push includes Berthélemy [2006]
paper offers another such example.6
3 A Big-Push Model with Public Capital
A classic criticism of the initial big-push model of R
that in a small open economy facing exogenously given
investment is profitable or not depends on those terms
demand spillovers from other tradable goods indust
criticism does not apply, however, when the source o
existence of nontradable inputs produced under increasi
see Ros [2000, eh. 13]). As the American South was an
models to understand its poverty trap and subsequent
those with nontradable inputs and vertical pecuniary
we discuss in more detail the big-push dynamics rely
model, presented formally in the Appendix, extends t
push model of Murphy, Shleifer, and Vishny [19
economy and, besides making more general assumptio
beyond the open economy model in Skott and Ro
conditions for multiple equilibria and comparing wa
traditional economy and modern economy equilibria.
In the big-push literature, investments in public capit
turn for private investments in modern technologies an
[1953, p. 152], for example, notes that in the absence
systems, power plants, waterworks, schools, and hos
jection of private capital may turn out disappointin
overhead capital” exists, increases in incentives for ind
the vicious circle of poverty. In the public capital litera
[1989a], [1989b], [2000], Deno [1988], Munnell [199
and Easterly and Rebelo [1993], among others, empi
ments in public capital significantly increase the rate of
stimulate private investment.
In our model, which is designed to conform to the s
American South circa the Great Depression and Wor
good can be produced with two different technologies:
6 Additionally, Ades and Glaeser [1999] examine dat
in the 20th century, as well as the 19th century Unit
nomic growth is positively correlated with the extent of t
documented processes of divergence in per capita incom
and country samples (Maddison [1995], Pritchett [19
[1997], Ros [2000]). While these contributions are perhap
the empirical findings are consistent with the barriers t
markets and the existence of poverty traps highlighted in
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312 Fred Bateman, Jaime Ros, and Jason E. Taylor JITE 165
technology, using capital and labor and a modern technology which is capitaland infrastructure-intensive – a sensible assumption given the need for modern
power, communications, and roads to coordinate and transport manufacturing production both within and outside of the South. The key difference between the
two technologies is that while the modern technology generates a Hirschmanian
“backward linkage” with the sectors producing public capital, there are no linkages in the case of the traditional technology. Market structures are such that in
the final goods sector firms operate under atomistic competition while in the sec
tor producing public capital producers operate under conditions of monopolistic
competition.
3. 1 The Choice of Technology
The choice of technology depends on profitability. Profitability, in turn, depends on
how many firms adopt a given technology and thus, under certain conditions, th
choice depends on which technology happens to be in use.
Let r^ be the profit rate for the final goods producer when the modern technology
is in use. This profit rate increases with the capital stock given the wage. The reason
is that an increase in the physical capital stock raises the demand for public capital
and reduces marginal costs in the sectors producing infrastructure goods. The fal
in the relative price of public capital (for a given value of the wage) raises profits in
the final goods sector. This is not the case when the traditional technology is in use
There, given the wage, the profit rate (r^) is independent of the capital stock since
the traditional technology does not use inputs produced under increasing returns.
The choice of technology does not depend, however, on a comparison between
the profit rates prevailing in a traditional economy (r^) and a modern economy (r^).
When the traditional technology, say, is in use, the choice depends on the comparison
of the profit rate r^ with the profit rate that an individual firm would obtain using
the modern technology in isolation. The profitability of the modern technology in
isolation is not rjj, but rather the profitability of the modern technology evaluated a
the prices and wages prevailing in a traditional economy (r^). Similarly, when th
modern technology is in use, the choice of technology depends on the comparison
of the profit rate r^ with the profit rate that an individual producer would obtain
using the traditional technology in isolation (rf ), the profit rate of the traditional
technology evaluated at the prices and wages of the modern economy.
3.2 Existence of Equilibrium and the Poverty Trap
The traditional economy is an equilibrium if r^ is higher than r^, i.e., if the profit rate
prevailing in a traditional economy is higher than the profit rate that an individua
firm would obtain using the modern technology in isolation, so that there is no
incentive for an individual firm to invest in the modern technology. Under our
assumptions, a traditional economy equilibrium always exists. The reason is that
the traditional technology does not use public capital produced under increasing
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(2009) Did New Deal and World War II 313
returns. If it did, there would generally exist a level of th
which the costs of public capital goods would be low en
than rj.
In turn, a modern economy equilibrium exists if r^, the profit rate when the
modern technology is in use, is higher than rf , the profitability of investing with the
traditional technology in a modern economy. It is only then that in a modern economy no individual firm will find it profitable to invest in isolation in the traditional
technology. The existence of a modern economy equilibrium requires a sufficiently
large physical capital stock so that, when the whole of it uses the modern technology, the price of public capital is low enough to make the modern technology
self-sustaining. Since a traditional economy equilibrium always exists, it follows
that a sufficiently large physical capital stock is also a condition for the existence
of multiple equilibria. Then which technology is more profitable depends on the
technology in use.
Multiple equilibria are associated with the existence of pecuniary externalities.
The presence of increasing returns to scale in the production of public capital implies
that production decisions in this sector, and investments in the modern technology,
have important external effects. An increase in the output of a component of public
capital affects adversely the current demand for other components of public capital,
but reduces the price index of public capital and raises both the combined input of
public capital and the profitability of the modern technology. Apart from these static
effects, there is a dynamic externality: higher profitability of the modern technology
leads to increased accumulation by modern firms and thus to an increase in the future
demand for all the components of public capital. On the investment side, atomistic
producers consider all prices given and fail to take into account the external effects
of a higher capital stock on increased future demand for public capital and a lower
future price of the combined public capital input.
As a result of these dynamic pecuniary externalities, an insufficiently large capital stock, i.e., an initial mass of modern firms below a critical level that makes
the adoption of the modern technology viable keeps the economy in a traditional
equilibrium when all firms follow behavior that is individually rational. Alternatively, rather than a critical mass of modern firms in the tradable goods sector, we
may think of a threshold level of investments in public capital below which the
adoption of modern technologies is not viable. Because the mass of investments in
the modern technology is small, the demand for public capital is low and the components of public capital are produced at a high cost, thus keeping the profitability
of the modern technology low. Thus, in this trap, despite the low wages prevailing
in the traditional economy, firms lack incentives to adopt the modern technology
in the absence of a sector producing public capital. At the same time, there is no
incentive for the production of public capital given the high costs of production in
the absence of demand from modern firms. This is why a big push – aimed either at
increasing the rate of accumulation of modern firms above the individually rational
level or at raising the supply of infrastructure (or both) – becomes necessary to
ensure industrialization.
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314 Fred Bateman, Jaime Ros, and Jason E. Taylor JITE 165
3.3 The Two Equilibria Compared and the Big Push
Let us assume that multiple equilibria exist and compare the wage and profit rates
in the two equilibria. When a modern economy equilibrium exists, the profit rate in
this equilibrium is higher than in the traditional economy equilibrium. The existence
of a modern economy equilibrium does not guarantee, however, that the wage in
this equilibrium is higher than in the traditional economy equilibrium. This require
the aggregate capital stock to be larger than a critical level. In this case, a modern
economy equilibrium will exist and feature both a profit rate and a wage rate higher
than in the traditional economy equilibrium.
If this condition is fulfilled, a shift from the traditional to the modern technology
will move the economy to a Pareto superior equilibrium. In such a big push, the
economy undergoes a sudden expansion of public capital and modern firms together
with an increase of industrial profits and wages (and thus of per capita incomes).
Moreover, after this initial sudden expansion, the economy will be growing at a faster
rate than the previously traditional economy to the extent that the profit rate is higher.
4 Factors in the South ‘s Lack of Industrialization prior to 1945
It is clear that prior to World War II, the American South was an underdeveloped
economy, largely isolated from the rest of the nation. Wright [1986], in fact, calls
the pre- 1 940s South a “quasi-nation,” citing a startling lack of commodity flows
between the region and the rest of the U.S. as well as the persistence of a distinctive
Southern socioeconomic culture. “There is,” according to WRIGHT [1986, p. 4],
“a ‘Southern economy’ [with] a history of its own.”
This history did include periodic attempts toward economic modernization. For
example, the so-called “New South” movement, which proposed that the region
leave behind its historical ties to plantation agriculture and industrialize, began in
the late 1870s when several Southern businessmen attempted to coordinate sig-
nificant capital investments in the region. By the 1880s, however, MERTZ [1978,
p. 22 1 ] notes the movement was little more than a “promotional campaign,” gener-
ating relatively few tangible results.7 While states north of the Mason-Dixon Line
witnessed widespread adoption of mass production and large-scale techniques in both agriculture and industry – production methods in the Southern economy
changed relatively little over the course of the following six decades. In the con-
text of a multiple-equilibria big-push model of economic development, this failur
may be viewed as an example of infrastructure investments remaining below the
threshold level necessary to make the widespread adoption of modern industrial
technologies viable.
In fact, past research has shown that infrastructural inadequacies impeded Southern industrialization as early as the middle of the nineteenth century. Atack [1977],
7 A notable exception to this was the growth in the Southern textile industry in the
late 19th and early 20th centuries.
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(2009) Did New Deal and World War II 315
[ 1 987] and B ateman and Weiss [1981] note that comp
cially the Northeast, the Southern economy faced limit
external diseconomies. Specifically, these authors not
turing firms could potentially realize many of the in
with the technology of the time, they were at a stark d
ern producers in terms of external influences such as
cost. Furthermore, Bateman and Weiss show that the re
“failure to industrialize” resulted not purely from com
deliberate actions by some politically powerful planters
lose from the emergence of a sizable manufacturing
influences were unsuccessful in the long term, they m
ing path dependencies on the creation of infrastructure
development. That said, while public infrastructure in
evolved to serve the demands of a modern industrial se
remained more suited to the traditional agricultural eco
into the twentieth century.
Figure 1 illustrates the socioeconomic differences betw
the Mason-Dixon Line at the onset of the Great Depre
mortality and illiteracy – two standard proxies of econo
cantly higher in the South than elsewhere, but striki
urbanized region in the nation, more rural than even th
regions. Likewise, in terms of income and manufacturin
hind the rest of the nation in 1929. In that year no Sout
largest manufacturing states (U.S. Bureau of the Ce
shows that value added per capita in manufacturing in th
by a factor of four than that of the Middle Atlantic, N
Central regions. Per capita income in the South, likew
that of the rest of the country.8 At the onset of the Gr
predominantly agricultural, rural, and, relative to the r
In a well-known 1938 letter to the Conference on the Economic Conditions in the
South, President Franklin Roosevelt singled out the South as “the Nation’s No. 1
economic problem.” Citing a lack of demand spillovers, Roosevelt expressed the
classic low-income, low-productivity poverty-trap problem for the region saying
that, “On the present scale of wages … and buying power, the South cannot …
succeed in establishing new industries” (quoted in Mertz [1978, p. 230]). This
sentiment was repeated by the Roosevelt Administration in The Report on the
Economic Conditions of the South, which declared, “The purchasing power of the
southern people does not provide an adequate market for its own industries nor an
attractive market for those of the rest of the country” (Carlton and Coclanis
[1996, p. 77]).
As a low-wage region within the United States, standard convergence theory
suggests that the South should have been quite attractive to either Northern or
8 Historical Statistics of the United States (1975), Part 1, Series F 287-296.
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316 Fred Bateman, Jaime Ros, and Jason E. Taylor JITE 165
Figure 1
(a) Infant Mortality, 1929: Deaths of Infants under 1 per 1000 births
Source: U.S. BUREAU OF THE Census [ 1 935b]. For Infant Mortality, South Dakota and Texas
are 1932 and 1933 data respectively since 1929 data are not available.
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(2009) Did New Deal and World War II 317
Table 1
Value Added per Capita in Manufacturing by Region, 1 929
New England 396.78
Mid Atlantic 387.50
East North Central 394.25
West North Central 140.63
South Atlantic 160.60
East South Central 93.50
West South Central 78.06
Mountain
Pacific
Source:
local
U.S.
99.97
234.66
Bureau
OF
industrialists.
THE
In
CE
fact,
C
relatively low labor costs wer
in attracting manufacturing.
not attract industry prior to W
wage rates may attract busines
infrastructural costs are low,
incentives prior to the public c
In particular, the South lacke
its underdeveloped markets to
systems
prior
to
World
War
II
kets to international ones – mo
Charleston, Savannah, Brunswic
markets
freight
such
as
rates
Chicago,
were
39
New
and
75
Y
pe
respectively than in the indus
differentials reflected an
rate
Southern
afford
rates
were
Aside
tors
rail
to
high
from
clearly
production
one-third
lines.
“export”
a
Again,
goods
because
hindering
and
These
the
a
a
the
lac
poor
s
Southern
poor
system
land a
the South Atlantic, East South
only one-fifth of the nation’s
miles of telephone wire in 1930
9
of
of
relatively
the
to
nation’s
numbers
South (Carlton and Coclanis [1996. dd. 76f.l).
are
10 See Table 3 notes for sources.
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from
th
318 Fred Bateman, Jaime Ros, and Jason E. Taylor JITE 165
The Report further documented the South’s relative backwardness in 1938. For
example, 26 percent of households in Southern cities or towns were without indoor
flush toilets, twice the nationwide figure of 13.1 percent. From an education standpoint, in 1936 Southern states spent an average of $25.1 1 per pupil – less than half
the average amount spent in the rest of the nation. With respect to Southern higher
education, the combined endowments of Harvard and Yale were larger than the tota
combined endowments of all colleges and universities in the South.11
5 The Growth in Southern Manufacturing
Although the pre- World War II South was, by the modern definition of the term, a de-
veloping nation, the transformation the postwar South underwent is extraordinary.
Barro and Sala-i-Martin [1992] and Michener and McLean [1999] show
that the Southern growth is the key factor behind the acceleration of convergence
from 1940 onwards that has been observed in U.S. data on state per capita incomes.12
After six postbellum decades with little if any convergence in per capita income
between Southern and non-Southern regions, Wright [1986, p. 239] concludes that
“the southern ‘takeoff is most appropriately dated from World War II.” Figure 2
shows that the development of a large-scale manufacturing sector was a major event
within the South’s economic coming of age. In real dollars, value added per capita
in manufacturing doubled in the Middle Atlantic states and tripled in the East and
West South Central regions between 1939 and 1954. To compare movements in
Southern manufacturing to that in the rest of the United States, in 1 929 the South
accounted for only 14 percent of the nation’s manufacturing output. However, by
1967 and 1977 the South’s share had grown to 22.8 and 27.4 percent respectively.
Figure 3 displays the grow