On “Dynamic Efficiency”

The term “dynamic efficiency” (DE) is used incorrectly in Singapore JCs. (Or, at any rate, differently from how mainstream economists use it.)

What “DE” Means in Singapore JCs 

Like much else in JC economics, the term “DE” is never precisely defined. For example, in the 2012 RI Year 5 notes, we are told (i) when DE occurs; (ii) what DE focuses on; and (iii) how DE can be boosted. But we are never actually told what DE is.

Dynamic Efficiency: This occurs in a market over a period of time. It focuses on changes in the amount and quality of goods and services available in the markets over a period of time. For example: Is new technology being developed and adopted at the best rate? Are firms reducing costs over time? Dynamic efficiency can be boosted by Research and Development (R&D) spending that leads to improvements in products and the production process; investment in the human capital of the workforce leading to gains in the product quality which is vital in high value high-knowledge sectors; greater competitive pressures in markets and the transfer of knowledge and ideas across countries.

Reading between the lines, one suspects that “DE” is supposed to simply mean “innovation”. This is confirmed by what is written in the suggested solutions to various schools’ JC2 Prelim Exams. Examples:

the entrant (sic) of big foreign pharmaceutical firms could bring about more innovation and thus dynamic efficiency (ACJC H2 Prelim 2015, Case Study 1, part d-ii).

Market dominance tends to lead to dynamic Inefficiency (sic). A market dominant firm may become complacent and do (sic) not have the incentive to engage in R&D. Thus dynamic inefficient (sic) occurs and there will be a lack of product variety and consumers choices and probably an increase in cost of production (CJC H2 Prelim 2015, Essay 3, part a).

The presence of large profits is required for future R&D and to allow dynamic efficiency (Dunman H2 Prelim 2015, Case Study 1, part c).

What “Dynamic Efficiency” Means to Economists

Among economists, there is clear consensus as to what “DE” means. Informally, it is that we cannot make one generation (of consumers) better off, without also making another generation worse off. (It is thus simply the usual concept of efficiency, but applied across generations of consumers.)

Two early and seminal instances in which the phrase was employed were Phelps (1965) and Diamond (1965). (It is not entirely a coincidence that both are Nobel Prize winners.)

dynamically inefficient in the sense that there always exists another path which, starting from the same initial capital stock, produces more consumption at least some of the time and never less consumption.”

If the central planners choose a higher capital-labor ratio, they would be selecting an inefficient solution …  in that they could discard capital, lowering the capital-labor ratio to the Golden Rule level, and preserve this capital-labor ratio forever, permitting a higher level of consumption in each period forever.

Abel, Mankiw, Summers, and Zeckhauser (1989) is another famous paper that uses the term “DE” in the same sense (see their mathematical definition on p. 5).

Lest one believes that this usage is now outdated, see this recent paper and textbook: Geerolf (2013), Romer (2012, Ch 2.11).

There is no doubt as to what DE means, at least to economists.

My recommendations as to what Singapore JCs should do

Previously, JC teachers simply taught their own version of what they thought “DE” meant. This didn’t matter too much, since DE wasn’t explicitly listed in the syllabus.

However, the new A-Level H2 Economics syllabus (9757) (to be examined for the first time in 2017) explicitly includes “DE”. But we cannot be sure what the designers of the syllabus mean by “DE” — do they mean DE as correctly used by economists? Or do they mean “DE” as incorrectly used by JC teachers?

There is at present a glaring and unbearable inconsistency between the practice of professional economists and what is taught in H2 economics. JCs in Singapore mean one thing and professional economists another. We could easily rid ourselves of this confusion by substituting the term “DE” (as used in the Singapore JC sense) with another term.

Indeed, there is a very simple substitute: the word “innovation”. This would entirely capture the ideas contained in the RI notes and Prelim Suggested Solutions quoted above. So why not just say “innovation” if that’s all we mean?

P.S. Regarding this matter, I’ve emailed all five individuals listed under the government directories as being in charge of curriculum planning for economics. I have received absolutely no reply. I will update this post if ever I get any sort of reply.

Addendum: To be fair, (some) Austrians do (sometimes) use the term “DE” in a different sense. But this term is used mainly as a contrast to and a critique of the mainstream, “static” view of efficiency. For example, Kirzner (1997, p. 51) speaks of:

evaluating economic policies and/ or historical events, not in terms of the flawed notion of social efficiency, but in terms of a different criterion – ability to encourage entrepreneurial alertness to valuable knowledge the very existence of which has not previously been suspected.

(In any case, A-Level economics is 100% mainstream/neoclassical; there is no hint whatsoever of the Austrian worldview. It would therefore be quite odd if all of a sudden, in one isolated instance, we choose to use the terminology of some Austrians. And even if this be the case, the Austrian usage of the term is still somewhat different and not at all what Singapore JC teachers are thinking of.)

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