Long-Run Growth Effect of the Physical Capital-Human Capital Complementarity: An Approach by Time Series Techniques



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Along the same line with our argument above literature shows that in an environment 

where there are frequent innovations (post 1970 period), once the technology turns to an 

innovation (marketable form) capital and human capital factors are no longer substitutes of 

production, on the contrary becomes complimentary which on the overall effects productivity 

rates reflecting to faster economic growth rates. In this respect, physical capital and human 

capital complimentarity simply reflects that skilled and more skilled educated labor is more 

complimentary with new technology or physical capital than low human capital endowed labor. 

This also explains the wider inequality among skilled and unskilled labor wages. 

Second approach looks at physical and human capital complementarity in terms of market 

structure. The argument states that complementarity arise through the nature of equilibrium 

interaction (Matsuyama, 1999). Although an economy may never find itself in an unstable 

equilibrium suggest multiplicity of stable equilibrium position. This could well reflect presence 

of complimentarity which alters the structure of equilibrium observed. 

Along the market structure arguments, in time new technologies are substitutes to older 

ones. But, at the same time new technologies complements to older technologies. The importance 

of complementarity can be best shown by balance between inventive and productive activity 

(Young, 1993). 

As an outcome of the second argument of complementarity, unlike Romer (1987, 1990) 

argument gains from specialization for all inputs could only be true with complimentary skill and 

human capital levels. In this respect, Young's argument towards complimentarity is dominated by 

steady state compliments our K/H criteria in explaining existing economic growth rates. 

Third approach to complementarity could be viewed as the micro foundations at a firm 

level. As the skilled labor use information technology, the pace of complimentary innovation 

improves (Bresnahan et al., 1999).  Thus, the author conclude that skilled-biased  technological 

change is a function of information technology. Along the same line, Grilliches (1969) and 

Berndt et al. (1994) argue that skilled-biased technological change is a function of the way goods 

and services are produced. From this argument the human capital development phase at the firm 

level increases in the firms information technology stock that is associated with productivity 

increases where high levels of human capital is available. However, firms which implement only 

one component without the others are often less productive than firms which implement none at 

all. 

To sum up, classical, neoclassical and endogenous economic growth theories



independent of inputs taken into consideration, have neglected physical capital-human capital 

complementarity. To be modest, this complementarity component could have become more 




 

 



dominant factor of economic growth and productivity changes in an era continues innovation. As 

stated earlier, given the innovation lengthy time component can create a component for higher 

substitutability among factors of production. But, in times of heavy industrial technologies (e.g.  

smoke-truck), which changes every other five years ( unlike 20 years in pre 1970 period) and 

high technological innovations change every other two years. As a result, substitutability of 

inputs becomes less important than complementarity of inputs. This is why we have literatures 

around like TQM, JIT, Benchmarking etc. All this explanations reflects economic theory as, in 

the classical isoquant approach continuity and slope of the isoquant showing the level of 

substitutability makes isoquants more convex to the origin, longer the use of that technology. 

 

Graph 1. Changing Structure of Isoquants in Time of Adaptation 

 

 

 



 

 

 



 

 

 



 

 

Thus, in a dynamic sense isoquant properties change in time reflecting stronger elements 



of complementarity in the first phase and decreasing in time. So, in times of frequent 

technological changes, innovations force physical and human capital complementarity converge 

to achieve faster economic growth rates. 

As in the case of Uzawa (1965) and Lucas (1988), there are economists incorporating k 

relationship, with z (gross average product of physical capital) trying to show the scarcity of 

human capital.  

On the contrary, our attempt hypothesis that, increasing improvements in technology and 

a number of innovations is aggravating the difficulty of human capital substitutability with the 

existing technology.  This dynamics is expected to be a more dominant retardant of economic 

growth at the growing stages of globalization. The key element that led to globalization of 

market seems to be low cost of  information, know-how and technology transfer among  regions 





Increased 

Substitutabilty 

Eckaus Phase 

Innovation 



 

 



and countries.  But this in no means guarantee the absorption, diffusion and learning by doing of 

this product to every production element involved in the creation of GDP.  Thus, given the 

increasing  share of schooling, R&D and other innovative efforts in GDP in developing 

countries, the gap between technological improvements and  human capital creation is widening 

in terms of absorption and diffusion of technological advances which  are commercialized with 

short time lags due to increased competition. The hypothesis put forward, if proven to be true, 

seems to have the potential to explain low growth rates of developed countries. As long as 

technological improvements and competition rules stays the same, any country converging in 

terms of income with the developed world will face similar problems, thus will be forced to 

lower their growth rates.  

 

Traditional human capital theory incorporates, educational (formal and informal), 



managerial, health and migration components. In our hypothesis widening of technology and 

human capital incorporates R&D and innovation, absorption, diffusion and learning by doing 

within the human capital component.   

 

2. Recent Developments in Economic Growth Theory



  

 

Frank Ramsey’s  1928 dated   publication  “A Mathematical Theory of Saving” could be 



named as the first contribution to the modern theory of economic growth. The developed theory 

aims to optimize the decision making process between different time spans. In 1950’s R.F. 

Harrod and E.D. Domar had an attempt to turnaround the static Keynesian growth model to a 

dynamic model.  

 But 

unfortunately 



1929 Great Depression reduced the popularity of above cited economic 

models and economists. 1950’s also witnessed another important contributions to growth theory 

by R. M. Solow. The contribution of  Solow to economic growth theory can be summarized as 

diminishing marginal returns on inputs and constant returns to scale which is very typical for 



neoclassical

 production functions. Advancements in the Solow’s theory integrated with constant 

saving ratios had been utilized in developing the simplified general equilibrium model. 

Neoclassical

  features of the model  depicts that relatively lower GDP holding countries will be 

facing faster growth rates. Solow reaches to this striking result, by looking at the capital factor 

which faces diminishing marginal returns. In other words, countries with low physical capital per 

worker will have higher capital return ratios, thus will have higher growth rates where this 

occurrence will reflect to the incomes of developed countries. This type of convergence is known 

as absolute convergence in economic literature. The narrow degree of convergence  stems from; 

stable nature of physical capital per labor, savings rate, population growth rate and from the 






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