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CHAPTER 11: Economic Growth

CHAPTER 11: Economic Growth. A Hundred Years of Economic Growth in the United States. Economic Growth Around the World: Catch-Up or Not?. Economic Growth Around the World: Catch-Up or Not?. Catch-Up Asia. The international problem. .

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CHAPTER 11: Economic Growth

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  1. CHAPTER 11:Economic Growth

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

  3. Economic Growth Around the World: Catch-Up or Not?

  4. Economic Growth Around the World: Catch-Up or Not?

  5. Catch-Up Asia

  6. The international problem . Output per capita relative to output per capita in the US. How many times larger is output per capita in US Country (1998) US Germany Japan Argentina India Zimbabwe Hong Kong ---- 1.0 Economic Growth- deals with how quickly the production possibilities curve shifts to the right.[PPP data -- purchasing power adjusted] 1.33 0.75 1.27 0.79 2.44 0.41 14.29 0.07 11.11 0.09 1.43 0.70

  7. Growth from another perspective Per Capita Income today $ 1,000 $ 1,000 $ 1,000 $ 1,000 $ 1,000 $ 1,000 $ 1,000 $ 1,000 AnnualGrowth Rate Per Capita IncomeTen Years FromNow Economic Growth (cont.) 1051 0.5 1105 1.0 1218 2.0 1344 3.0 1480 4.0 1629 5.0 2594 10.0 6192 20.0

  8. Economic Growth (cont.) • The data show the importance of the growth rate of per capita income -- the power of compound interest. • Perhaps the most important question in economics is what determines the growth rate of per capita income. • In other words, why do countries grow faster or slower?

  9. The Causes of Economic Growth • Preconditions for economic growth • Markets enable people to specialize and trade and to save and invest. • Property Rights are the social arrangements that govern the ownership, use and disposal of resources, goods, and services. • Money facilitates transactions, and thus specialization and exchange. • The ‘Rule of Law’ reduces uncertainty and risk, and allows investment and complex contracts.

  10. Y = GDP K = capital stock A = technical progress N = labor input The Causes of Economic Growth (cont.) • Incentives must exist to encourage those activities that generate growth. • Savings and investment in physical and human capital • discovery of new technology • The production function - is a relationship that shows how real GDP changes as inputs change. Y = A * F ( K , N )

  11. Y = GDP K = capital stock A = technical progress N= labor input The Causes of Economic Growth (cont.) • The production functionin per capita terms shows the relationship between real GDP per capita and the amount of capital per capita given the level of technology. [Per capita is Latin for ‘per head,’ i.e. per person].

  12. Increases in capital increasecapital perhead, andthus generatea larger outputper head. Effect of increase in capital stock ( ) K N Diagrammatic Representation of the Production Function Outputperhead A1F (Y /N)2 (Y /N)1 ( )2 ( )1 0 K K Capital per head N N

  13. Is the key to increasing output per head increasing the capital stock? • The law of diminishing returns is that as the quantity of one input increases, with the quantities of all other inputs remaining the same, output increases, but eventually by ever smaller increments. [If this was not so, we could grow the world’s wheat supply in a flowerpot]. • This implies that increasing the capital stock by increasing investment is not the only [or perhaps even the best] way to faster growth of output per head.

  14. Dangers of Capital Fundamentalism • The production function shows the potential output, if all inputs are used as well as they could be. • Bad investments -- “white elephants” --or bad organization/system/integration may mean actual output is much less than apparent potential output. Think of Russia, Sudan, Haiti, etc.

  15. The production function and technology change • An advance in technology, A, Y = A * F ( K , N ) - - shifts the production function upward.

  16. A2F Increases in capital increasecapital perhead, andthus generatea larger outputper head. (Y /N)3 Effect of technological change Effect of increase in capital stock ( ) ( ) K K N N Diagrammatic Representation of the Production Function Outputperhead A1F (Y /N)2 (Y /N)1 ( )2 ( )1 0 K K Capital per head N N

  17. The production function and technology changes • An advance in technology, A, Y = A * F ( K , N ) - - shifts the production function upward. • The same amount of capital per head now generates more output per head. • Technological improvements are one key to economic growth.

  18. Malthusian Theory of Growth [‘ Classical Growth Theory’] • The view that real GDP growth is temporary and that when real GDP per person rises above the subsistence level, a population increase eventually brings real GDP per person back down to the subsistence level. • The subsistence real wage is the minimum real wage rate needed to maintain life, given local conditions and expectations.

  19. A1F • is the subsistence output per head level. (Y (Y 1/N1)s 1/N1)S • Introduce a productivity shock which shifts the production function upward. ( ) ( ) ( ) K K K1 N N N1 Malthusian Theory of Growth • Consider a subsistence economy. Outputperhead A0F 0 Capital per head

  20. 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)

  21. is the new output per head level. (Y 2/N1) (Y (Y 1/N1)S 2/N1) ( ) ( ) ( ) K K K1 N N N1 Malthusian Theory of Growth • We can see that the tech shock results in an output level above subsistence level. Outputperhead A1F A0F • What will happen now? 0 Capital per head

  22. Malthus said the population will increase. (Y (Y 2/N2)= 1/N1)S • Capital per head falls. ( ) ( ) ( ) ( ) K K K1 K1 N N N2 N1 Malthusian Theory of Growth • What will happen now? Outputperhead A1F A0F (Y 2/N1) • The gain in output per head was only temporary. 0 Capital per head

  23. 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)

  24. Neoclassical Theory of Growth • For developed [high income] economies, increases in income per person seem to result in a decrease in the population growth rate [parents prefer better quality children rather than more children?]. • Neoclassical growth theory suggests that real GDP per person grows because technological change induces savings and investment.

  25. 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)

  26. A1F • is the output per head level. (Y (Y 1/N1) 1/N1) • Introduce a productivity shock which shifts the production function upward. ( ) ( ) ( ) K K K1 N N N1 Neoclassical Theory of Growth • Consider a developed economy. Outputperhead A0F 0 Capital per head

  27. We can see that the tech shock results in a new larger output level (Y 2/N1) • The greater output results in more capital, K2, which leads to another increase in output.. (Y (Y (Y 2/N1) 3/N2) 1/N1) ( ) ( ) ( ) ( ) K K K2 K1 N N N2 N1 Neoclassical Theory of Growth Outputperhead A1F A0F 0 Capital per head

  28. (Y (Y 3/N2) 1/N1) ( ) ( ) ( ) ( ) K K K2 K1 N N N2 N1 Neoclassical Theory of Growth • Without further tech change, the law of diminishing marginal returns will halt the process. Outputperhead A1F A0F (Y 2/N1) 0 Capital per head

  29. 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)

  30. Growth Theory “New” growth theory begins with two stylized facts about market economies: 1) Discoveries result, at least in part, from choices. 2) Discoveries bring profit, and competition destroys profit in excess of the normal real rate of return on capital.

  31. “New” Growth Theory Discoveries and Choices • The pace of discoveries is not wholly determined by chance. • It also depends on how many people are looking for a new technology and how intensively they are looking. In the modern world, firms invest in research and development (“R&D”). • Because competition erodes the advantage of new knowledge, firms have incentives to keep looking for yet newer discoveries. • People also choose how much investment to make in human capital – e.g. how much education to get.

  32. “New” Growth Theory Discoveries Used by All: • Once a profitable new discovery has been made, everyone can use it [at least eventually]. But for a while, it is super-profitable for the discoverer. • Knowledge can have strong externalities -- enough new knowledge, technical change, may mean diminishing returns to more capital never happen. So more capital, more investment, may mean growth for ever, so long as knowledge continues to grow.

  33. 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)

  34. Factors in achieving faster growth • Ensure the preconditions • Stimulate saving (e.g. by tax policy) • Stimulate research and development. • Encourage efficiency and competition, e.g. by open international trade • Improve the quality, quantity, and efficiency of education

  35. Benefits and Costs of Economic Growth • Benefits • Expanded production possibilities • health care, medical research, etc. • space exploration, science, etc. • environmental improvements (if resources are devoted to solving environmental problems) • in general, MORE CHOICE, more goodies, more consumption/person

  36. Benefits and Costs of Economic Growth • Costs: 1) Foregone consumption 2) Depletion of natural resources 3) Increased pollution 4) More frequent job and location changes 5) Changed culture and society

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