Transcript Chapter 11

Chapter 11
The Economy in the Long Run: An
Introduction to Economic Growth
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11–1
Chapter 11: The Economy in the Long
Run: An Introduction to Economic Growth
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An introduction to economic growth
Economic growth and potential output
Growth rates and differences in living standards
Why nations become rich: the crucial role of
average labour productivity
• The costs of economic growth
• Promoting economic growth
• Are there limits to growth?
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Measuring Growth
• Long-term growth refers to a rise in living
standards, not the rise in total GDP
• Material living standards reflected in GDP per
capita
• The key to rises in GDP per capita is rises in GDP
per worker, or labour productivity
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Comparative Growth Rates
11–4
Comparative Growth Rates
11–5
Comparative Growth Rates: Asia
11–6
World Inequality
11–7
Doubling the Standard of Living
• The faster the growth rate, the shorter the time it
takes to double the standard of living – 36 years at
2% p.a. and only 14.4 years at 5% p.a
• At 2% p.a., your real income will be four times that
of your grandparents
• Time taken is less than proportional to the growth
rate because of the principle of compound interest
• The ‘Rule of 72’ tells us that the standard of living
will double in a period such that this period times
the growth rate equals 72
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Growth Theory and Supply
• In the long run the economy corrects so that
GDP = potential GDP (Y = Y*)
• Growth theory is concerned with the rise in Y*
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Constraints on Long-Run Growth
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Growth in labour or worker productivity
Growth in population
Growth in worker/population ratio
Y/Population = Y/worker x worker/population
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When the Population Ages
• Because a constant or declining population is an
ageing one, a reduction in the worker/population
ratio is a problem in high-income countries (and
will be in China) where population is constant or
falling
• A fall (negative growth rate) in the
worker/population ratio reduces the growth rate of
Y/population
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Factors in Labour Productivity
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Human capital per worker (skills)
Physical capital per worker
Land and natural resources per worker
The level of technology which is reflected in the
age of the physical capital stock
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The Age of the Capital Stock
• New machinery embodies the latest technology
and is more productive
• Ironically, Germany and Japan gained a
competitive advantage from the devastation of
World War II – new equipment
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Other Factors in Productivity
• Entrepreneurship and quality of management
• Political and legal environment: the peaceful
settlement of international, political, commercial
and employment disputes, and protection of
property rights, are essential
• The social status accorded to productive people as
opposed to those who are merely rich or well
educated
• Incentives to effort provided by the taxation and
welfare systems
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Capital & Production Per Worker
11–15
Productivity Slowdown
11–16
Explanations of Slowdown
• Slowdown may be illusory, because quality
improvements are not measured
• The period immediately following the Great
Depression and World War II was one of unusually
high productivity growth
• Time will tell whether productivity growth has
resumed with improved information and other
technology dating from the late 1990s
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Costs of Economic Growth
• Growth raises future consumption possibilities at
the expense of current consumption, including
leisure
• For long-term investment projects this involves
older persons making sacrifices for younger ones
• This is because older persons make the sacrifice
of saving, while younger ones enjoy the future
fruits of that saving
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Early Growth May Be Painful
• Growth requires a rise in saving and investment
• A rise in saving when income and consumption are
already low can hurt
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Policies to Promote Growth
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Human capital: education, training and research
Physical capital: saving and investment
Knowledge: research and development
Incentives can be given with taxes and subsidies
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Example of Tax Incentives
• Accelerated depreciation allows companies to
write off their capital expenditures against their
taxable income at a faster rate than it wears out
• Such capital expenditures can include research
and development
• Accelerated depreciation raises the after-tax rate
of profit because investors’ capital is returned more
quickly
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Other Policies
• Sensible regulation which is targeted towards the
outcome being sought: no regulation for its own
sake
• Enforcement of property rights
• Peaceful settlement of disputes
• Transparent government and justice system
• Some of these things are absent in poor countries
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Inflation and Growth
• Low and predictable inflation helps investment and
growth:
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By reducing uncertainty
By keeping nominal interest rates low
By maintaining the household incentive to save
By maintaining confidence in money, which
maximises the specialisation of labour
– By avoiding the social waste of productive people
using their time to profit from inflation at the
expense of others (negative sum games)
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Are There Limits to Growth?
• Individual resources like fossil fuels are finite, but
substitutes are being developed through research
and development
• This process of finding substitutes for resources in
short supply is more affordable in high-income
countries because science is more affordable
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Growth and the Environment
• Degradation of the environment is not due to
growth of GDP per capita, but is due to mis-pricing
of energy sources (such as fossil fuels) and of
methods of waste disposal, and population growth
• Environmental standards tend to be higher in highincome countries because environmental quality is
valued more highly in those countries because of
their higher income
• They also have the means to clean up
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A Qualification
• If resources continue to be mis-priced because of
defects in the political process, then growth as we
have known it may have to be curbed
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Economic Growth & Population
• Population growth is lower in high-income
countries because people do not have to rely on
their children to support them in old age
• This helps the environment by reducing population
density
• However, as noted earlier, zero or low population
growth raises problems for future growth by
causing the population to age and the
worker/population ratio to fall
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Economic Growth and Health
• Health is more affordable in high-income countries
• This raises worker productivity and helps offset the
impact of a fall in the worker/population ratio on
the future growth rate
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