Economics 285

1. Economics 285 Economic Growth I.B.M. Will Invest $5 Billion To Produce Newer Microchips– NY Times 10/10/2000

2. Economic Growth • Long-Term Growth Trends • The Sources of Economic Growth • Growth Accounting • Growth Theory • Achieving Faster Growth

3. Long-Term Growth Trends • Long-term growth trends are the trends in potential GDP

4. A Hundred Years of Economic Growth in the United States

5. Economic Growth in Canada Figure shows long-term growth in Canada since 1895. Growth was fastest during the 1960s.

6. Long-Term Growth Trends • Fig. 11.2(a) shows growth in the biggest economies since 1960. • Japan has caught up with the other big economies.

7. Long-Term Growth Trends • Fig. 11.2(b) shows gaps in real GDP per person have been very persistent for most groups of countries.

8. Long-Term Growth Trends • Fig. 11.3 shows some Asian economies closing the gap in real GDP per person.

9. The Sources of Economic Growth • Economic growth occurs when incentives are created by: • markets • property rights • monetary exchange

10. The Sources of Economic Growth • The activities that generate growth are: • saving and investment • growth of human capital • discovery of new technologies

11. Growth Accounting • Growth accountingis the attempt to measure the contributions to growth of labor, capital, and technological change. • Real GDP growth equals the growth of real GDP per hour of work plus the growth rate of aggregate hours.

12. Growth Accounting • The growth rate of real GDP per hour of work depends on: • Growth of capital per hour of labor • Technological change • Fig 11.4 is a time series plot of GDP per hour of work for US

13. Real GDP per Hour of Work Fig 11.4 -- time series plot of GDP per hour of work for US

14. Productivity function • Separates the effects of: • Growth of capital per hour of labor • Technological change • Hold technology constant, vary capital per hour of work

15. PF0 Effect of technological change Effect of increase in capital stock How Productivity Grows 32 PF0 25 Real GDP per hour of work (1992 dollars) 20 0 30 60 Capital per hour of work (1992 dollars) Fig. 11.5

16. Growth Accounting • One-third rule. Goal: Divide the increase in real GDP per hour of work into • capital effect • technological change effect

17. Growth Accounting • Anx percent increase in capital per hour of work brings a 1/3 of x percent increase in output per hour of work.

18. Growth Accounting • The remaining increase in output per hour of work is attributed to technological change (and unidentified factors).

19. Growth Accounting • Growth accounting is used to account for the productivity growth slowdown. • Figure 11.6 shows how this type of breakdown is made.

20. Growth Accounting and the Productivity Growth Slowdown

21. Growth Accounting Technological Change During the Productivity Growth Slowdown Technology was directed toward coping with two major problems. 1) Energy price shocks 2) The environment

22. Growth Accounting Achieving Faster Growth • Stimulate Saving • Encourage international trade • Improve the quality of education • Stimulate high-technology industries? • Target high-technology industries?

23. Growth Theory • The task of growth theory is to explainthe trends in economic growth. • Three main theories have been proposed: • Classical growth theory • Neoclassical growth theory • New growth theory

24. Classical Growth Theory Real GDP growth is temporary • Real GDP per person above subsistence • Brings population explosion • Returns real GDP per person back to the subsistence level. • Malthusian theory.

25. Classical Growth Theory The Basic Idea (1776) • Real GDP has increased • Real wage rate has increased • Population growth increases labor supply • Wage falls due to diminishing returns... ... to labor

26. Classical Growth Theory Subsistence real wage rate • Minimum needed to maintain life. • If the real wage rate falls below subsistence, some people cannot survive and population growth subsides

27. LD1 Growth Begins LS0 5 New technologies and more capital increase the productivity of labor 4 Real wage rate (1776 shillings per day) 3 2 1 LD0 0 1 2 3 4 5 6 Labor (millions)

28. LS1 Subsistence real wage rate A Dismal Outcome LS0 5 When the real wage rate exceeds the subsistence level, the population increases 4 3 Real wage rate (1776 shillings per day) 2 LD1 1 0 1 2 3 4 5 6 Labor (millions)

29. Modern Theory ofPopulation Growth • Income levels and population growth may be inversely related • Opposite of Malthus • Income  death rate falls • Income  birth rate falls • Relationship is weak

30. Neoclassical Growth Theory • Technological change • Induces saving and investment • Makes capital per person grow

31. Neoclassical Growth Theory The Basic Idea • Technological advances promise new profit opportunities • ID increases, real interest rate rises • Saving increases • K stock grows • Real GDP and YD grow

32. Neoclassical Growth Theory The Basic Idea (cont.) • Prosperity will persist • Growth will stop if technology stops advancing: • profit leads to K accumulation • diminishing returns to capital

33. Neoclassical Growth Theory Target Rate and Long-Run Saving • When real interest rate exceeds the target rate, the K stock increases • When the target rate exceeds real interest rate, the K stock decreases • When real interest rate = the target rate, the K stock is constant

34. Neoclassical Growth Theory Target Rate and Long-Run Saving (cont.) • Technology advances, real GDP grows but the growth rate diminishes • New advances increase the demand for capital, raising the real interest rate and inducing saving • Rate of technological progress is unpredictable

35. Neoclassical Growth Theory Target Rate and Long-Run Saving (cont.) • The process repeats as long as technology advances, creating an on-going process of long-term economic growth.

36. Neoclassical Growth Theory A contradicted hypothesis? • Technology and capital are mobile • Therefore growth rates and per-capita income levels converge • Data reveal that convergence is slow or absent Why?

37. Technological advances increase investment demand... …real interest rate, saving, and investment increase ID1 Neoclassical Growth Begins 10 SS0 8 Real interest rate (percent per year) 6 4 2 ID0 0 0.5 1.0 1.5 2.0 2.5 Savings and investment (trillions of 1992 dollars)

38. KS1 b KD1 Neoclassical Growth Ends KS0 10 When the real interest rate exceeds the target rate, saving and investment increase the supply of capital. 8 Real interest rate (percent per year) 6 a LKS 4 2 KD0 0 5 10 15 20 25 Capital stock (trillions of 1992 dollars)

39. New Growth Theory Holds that real GDP per person grows because of the choices that people make in the pursuit of profit and that growth can persist indefinitely.

40. New Growth Theory New growth theory begins with two facts about market economies: 1) Discoveries result from choices. 2) Discoveries bring profit, and competition destroys profit.

41. New Growth Theory Discoveries and Choices • The pace of discoveries is not determined by chance. • It depends on how many people are looking for a new technology and how intensively they are looking.

42. New Growth Theory Two other facts are key to new growth theory: 1) Discoveries can be used by many people at the same time. 2) Physical activities can be replicated.

43. KS1 KS2 KS3 KD1 New Growth Theory KS0 10 8 Real interest rate (percent per year) 6 LKS 4 a KD0 2 0 1 2 3 4 5 Capital (trillions of 1992 dollars)