Economic Growth Chapter 10
Basics of Economic Growth • How to calculate growth rate • Growth rate of real GDP = (real GDP in current year – real GDP in previous yea) / real GDP in previous year * 100 • Growth rate of real GDP per capita = growth rate of real GDP – growth rate of population • Rule of 70 • The number of years it takes for the level of any variable to double is approximately 70 divided by the annual growth rate of the variable
Sources of Economic Growth • Sources • Increase in labor (aggregate hours) • Physical capital growth • Human capital growth • Technology advance • The last three sources contribute to economic growth through labor productivity • Labor productivity = real GDP / aggregate hours
Sources of Economic GrowthContinued • Productivity curve • Relationship between labor productivity (real GDP per hour of labor) and the amount of physical per hour of labor • Movement along the productivity curve is caused by changes in capital per hour of labor. • One third rule: 1% capital increase 1/3 % labor productivity • Shift of the productivity curve is caused by changes in human capital and technological advance. • Why lower labor productivity growth in the 1970s?
Theories of Economic Growth • Classical growth theory • A pessimistic view that an exploding population and limited resources will eventually bring economic growth to an end. • Also called Malthusian theory • Process • Initially economic growth from subsistence level with more capital and technology advance population growth and no more resources push the economy back to the subsistence level • Background: population explosion of 18th c. Europe
Theories of Economic GrowthContinued • Neoclassical growth theory • Population growth and technology advance will affect economic growth, but as long as technology keeps advancing, the economy will grow. • Technology advance is exogenous (a result of chance). • Background: no more population explosion in the 19th and 20th c. • Shortcoming: no explanation of how technology advances.
Theories of Economic GrowthContinued • New growth theory • Our unlimited wants will lead us to ever greater productivity and perpetual economic growth. • Our choices and preference for better living and profits lead us new discoveries and accumulation of human capital. • Competition squeeze profits seeking new discoveries • Continuous shift up of the productivity curve
Preconditions for Economic Growth • Preconditions: Economic freedom • Freedom of individuals and businesses from government restraints on economic activities • Legal and institutional frameworks to safeguard economic freedom (such as property rights and contract laws) • Visit www.heritage.org for ranking of individual countries.
Policies to Achieve Economic Growth • Create the incentive mechanisms • Promote competition • Promote international trade • Encourage saving • Encourage investment, particularly R & D. • Improve quality of education and training