Productivity and Growth

Standard of Living • Economy’s standard of living as measured by the amount of goods and services available per person grows over the long run because of • increases in the amount and quality of resources, especially labor and capital • better technology • improvements in the rules of the game that facilitate production and exchange • tax laws • property rights • patent laws • legal system

Growth and the PPF • Recall that the production possibilities frontier – PPF – shows alternative combinations of goods that an economy can produce if available resources are used efficiently • Quantity of resources in the economy fixed • Level of technology fixed • Rules of the game remain fixed • Two broad categories of goods – consumer goods and capital goods

Economic Growth • Causes of economic growth • Increase in the availability of resources • Growth in the labor supply • Population increases • Existing population supplies more labor • Growth in the capital stock • The more capital goods produced this year, the more the economy will grow • Improvement in Technology • Expand the frontier by making more efficient use of existing resources • Improvements in the Rules of the game • Improvements that nurture production and exchange will promote growth

What is Productivity? • Production is a process that transforms resources into products • Productivity • measures how efficiently resources are employed • the higher the productivity, the more goods and services that can be produced from a given amount of resources  the farther out will be the PPF • defined as the ratio of total output to a specific measure of input • total output divided by the amount of a particular kind of resource employed

Labor Productivity • Output per unit of labor and measures total output divided by the hours of labor employed to produce that output • Most commonly used resource to measure productivity • Accounts for a relatively large share of the cost of production – 70% on average • More easily measured than other inputs • Can be measured as hours per week or full-time workers per year

Labor Productivity • The resource most responsible for increasing labor productivity is capital • As the economy accumulates more capital per worker, labor productivity increases  standard of living increases • Two broad categories of capital • Human Capital • Accumulated knowledge, skill, and experience of the labor force • As individual workers acquire more human capital, their productivity and income increase • Physical Capital • Includes the machines, buildings, roads, airports, communication networks and other manufactured creations used to produce goods and services

Per Worker Production Function • The shape of the per-worker production function reflects the law of diminishing marginal returns • When applied to capital says that the more capital per worker there is already, the less additional output can be gained by increasing capital stock per worker even more • An increase in the amount of capital per worker is called capital deepening and is one source of rising labor productivity economic growth

Economic Growth • Two kinds of changes in capital improve worker productivity • An increase in the quantity of capital per worker • is reflected by a movement along the per-worker production function • According to Simon Kuznets, changes in the quantities of labor and capital account for only one-tenth of the increase in economic growth • An improvement in the quality of capital per worker • is reflected by technological change that rotates the curve upward • Accounts for nine-tenths of the increase in economic growth • As technological breakthroughs become embodied in new capital, resources are combined in more efficient ways

Rules of the Game • Refers to the formal and informal institutions that promote economic activity • Laws, customs, conventions, and other institutional elements that encourage people to undertake productive activity • Stable political environment and system of well-defined property rights • Improvements in the rules of the game could result in more output for each level of capital  upward rotation in the per-worker production function

Productivity / Growth in Practice • Differences in the standard of living among countries are profound • Per capita output in the U.S. is more than fifty times that of the world’s poorest countries • With only 5% of the world’s population, the U.S. produces more than all the nations comprising the bottom 50% of the world’s population put together • World’s economies can be sorted into two broad groups • Industrial market countries or developed countries • Developing or third-world countries

Industrial market countries • Developed countries which make up about 20% of the world’s population • Economically advanced capitalistic countries • Western Europe, North America, Australia, New Zealand, and Japan • Were the first to experience long-term economic growth and have the highest standard of living

Developing Countries • 80% of the world’s population • Have a lower standard of living because of relatively less human and physical capital • On average, the majority of workers in these countries are employed in agriculture

Education and Economic Development • Important source of productivity is the quality of labor • What exactly is the contribution of education to the process of economic development • Education makes workers aware of the latest production techniques • Makes workers more receptive to new ideas and methods • Countries with the most advanced educational systems were first to develop while developing economies have far lower levels of education

Output Per Capita • Even if labor productivity did not increase, total output would grow if the quantity of labor increased • Labor productivity equals real GDP divided by the quantity of labor  real GDP equals labor productivity times the quantity of labor • Therefore total output can grow as a result of greater labor productivity, more labor, or both

Output Per Capita • Output per capita • Real GDP divided by the population • Best measure of economy’s standard of living • Indicates how much an economy produces on average per person • Relationship between output per capita and labor productivity • Suppose labor productivity is $60,000 per worker per year • If there is one worker for every two people in the economy, then output per capital equals output per worker divided by 2  $60,000 / 2 = $30,000

Output Per Capita • Output will increase if • labor productivity increases for a given worker-population ratio • the worker-population ratio increases for given labor productivity • labor productivity and the worker-population both increase • In fact, output per capita would increase as long as an increase in one of these three factors more than offsets any decrease in the other two

Technological Change and Unemployment • Technological change usually reduces the number of workers needed to produce a given amount of output • Therefore, some fear that new technology will throw people out of work and lead to higher unemployment • However, it is also true that technological change can also increase production and employment by making products more affordable

Technological Change and Unemployment • If technological change caused unemployment • Then the slowdown in productivity growth that occurred from 1974 to 1982 should have resulted in lower unemployment than during the period of higher productivity growth from 1996 to 2001 • In fact, the unemployment rate during the former period was much higher than in the latter period • Also, if this argument were true, we should expect unemployment rates should be lower in the developing countries. Again, this is not borne out by the facts

Research and Development • Improvements in technology arise from scientific discovery, which is the fruit of research • We can distinguish between • Basic research • Search for knowledge without regard to how that knowledge will be used • First step toward technological advancement • Less immediate payoff yet yields a higher rate of return to society as a whole • Applied research • Seeks to answer particular questions or to apply scientific knowledge to the development of specific products

Research and Development • Since technological change is the fruit of research and development (R&D), investment in R&D reflects the economy’s efforts to improve productivity • One way to track R&D spending is to measure it relative to GDP • During the 1990s, R&D as a share of GDP in the U.S. ranked second among the major economies, behind only Japan

Research and Development • Business R&D is more likely to be targeted toward applied research and innovations • Averaged 1.9% of GDP in the 1990s • Only Japan had higher business R&D than the U.S. • R&D spending by governments and nonprofits may generate basic knowledge that has specific applications in the long run • For example, the Internet sprang from R&D spending on national defense

Convergence Theory Will poor countries eventually catch up with rich ones? • Convergence theory argues that developing countries can grow faster than advanced ones  should eventually close the gap • It is easier to copy new technology once it is developed than to develop new technology • Thus countries that start out far behind can grow faster by copying technology

Convergence Theory • What’s the evidence on convergence? • Some poor countries have begun to catch up with the richer ones • Newly industrialized Asian economies of Hong Kong, Singapore, South Korea, and Taiwan • However, these “Asian Tigers” are more the exception than the rule • Among the nations that comprise the poorest third of the world’s population, consumption per capita has grown significantly slower than in the rest of the world  the standard of living in these countries has fallen farther behind in relative terms

Convergence Theory • Reasons why the poorest countries have not gained • Birth rates are nearly double those in richer ones  the poor economies must produce still more just to keep up with a growing population • Vast differences in the quality of human capital across countries • While technology may be portable, the knowledge, skill, and training required to take advantage of this technology may not be • Some countries lack the stable macroeconomic environment, established institutions, and infrastructures needed to nurture economic growth

Industrial Policy • Two concerns with respect to technologies of the future • They will require huge sums to develop and implement and firms may not easily raise or put at risk these large sums • Some technological breakthroughs spill over to other firms and other industries; thus the firm that develops the breakthrough may not be in a position to reap benefits from these spillover effects  individual firms may under-invest in such research

Industrial Policy • One possible solution to these two problems was more government involvement through industrial policy • Industrial policy • Idea that government, using taxes, subsidies, regulations, and coordination in the private sector, could help nurture the industries and technologies of the future • Gives domestic industries and advantage over foreign competition with the objective one of securing a leading global role for domestic industries

Productivity and Growth