Transcript Slide 1

Frank & Bernanke
4th edition, 2009
Ch. 7: Economic Growth
1
Source: http://www.economist.com/displayStory.cfm?story_id=346598
2
http://www.youtube.com/watch?v=jbkSRLYSojo
3
4
Can the gross domestic product per capita be used to
measure human development instead of the HDI?
No. GDP per capita only reflects average national income. It tells nothing of
how that income is distributed or how that income is spent - whether on
universal health, education or military expenditure. Comparing rankings on
GDP per capita and the HDI can reveal much about the results of national
policy choices. For example, a country with a very high GDP per capita such as
Oman, which has a relatively low level of educational attainment, can have a
lower HDI rank than, say, Uruguay, who has roughly 60% of the GDP per capita
of Oman.
5
Human development in animation
http://hdr.undp.org/en/statistics/data/
6
Real GDP per Person In Selected
Countries, 1870-2000 (in 1995 U.S. Dollars)
Annual % Annual %
change 1870- change
2000
1950-2000
Country
1870
1913
1950
1979
2000
Australia
5,626
7,385
9,561
18,033
24,708
1.1
1.9
Canada
2,447
5,791
9,362
20,899
26,604
1.8
2.1
France
2,249
4,401
6,049
17,801
22,447
1.8
2.6
Germany
1,205
2,320
5,005
18,014
23,247
2.3
3.1
Italy
2,248
3,167
4,042
13,331
21,930
1.8
3.4
963
1,825
2,216
16,899
24,772
2.5
4.8
United Kingdom
3,500
5,374
7,832
14,889
21,142
1.4
2.0
United States
2,843
6,745
11,921
22,480
32,629
1.9
2.0
Japan
Observations
1870: Australia had the highest per capital real GDP and Japan the lowest
2000 real per capita GDP in Japan exceeded Australia
Note the difference in the growth rate of 1.1% for Australia and 2.5% for Japan
7
Real GDP per Person in Five
Industrialized Countries, 1870 - 2000
8
Compound Interest
Suppose you put $100 in a savings
account for your retirement. How much
would you have in 50 years?
 You need to know the interest rate.
 At 1%, the savings at the end of one year
will be: 100 + 100*.01 = 100 (1+.01) = 101.
 At the end of two years, the savings will
be: 100(1.01) + 100(1.01)(.01) =
100(1.01)(1.01) = 100 (1.01)2

9
Compound Interest
1%
Beginning Balance 100.00
After one year
101.00
After ten years
110.46
After 30 years
134.78
After 50 years
164.46
2%
100.00
102.00
121.90
181.14
269.16
4%
8%
10%
100.00 100.00 100.00
104.00 108.00 110.00
148.02 215.89 259.37
324.34 1,006.27 1,744.94
710.67 4,690.16 11,739.09
Observations
A small sum compounded over long periods can greatly increase in value
Small differences in interest have a very large impact on value
10
Impact on Living Standards
GDP per capita grew at a rate of 2% per
year for US during the last 50 years.
 Japanese GDP per capita grew at a rate of
5% during the same period.
 Chinese GDP per capita grew about 8%
per year the last twenty years.

11
Real GDP per Capita
Real GDP per capita is found by dividing
the Real GDP by the population: Y/POP.
 We can rewrite Y/POP as Y/N times
N/POP, since the Ns would cancel out
when the two terms are multiplied.
 Y/N is average labor productivity.
 N/POP is employed portion of the
population.

12
Growth Rate of Y/POP
Percentage growth of Y/POP will be
equal to percentage growth of Y/N
(Average Labor Productivity) PLUS
N/POP (Share of population employed).
 We can get these numbers for US from
government web sites: Bureau of Labor
Statistics, Bureau of Economic Analysis,
Federal Reserve Bank of St. Louis.

13
70000
60000
50000
40000
30000
20000
10000
0
1945
1955
1965
1975
GDP/cap
1985
1995
2005
AvLabProd
N/POP
0.600
0.500
0.400
0.300
0.200
0.100
0.000
1945
1955
1965
1975
1985
1995
2005
14
US Experience and Forecast
Why did N/POP increase during the last
30 years?
 What is expected for the future of N/POP?
 How can US expect to raise average living
standards in the future?

15
16
http://www.economist.com/markets/indicators/displaystory.cfm?story_id=8632028
17
Determinants of Average Labor
Productivity
Human Capital
 Physical Capital
 Natural Resources
 Technology
 Entrepreneurship and Management
 Political and Legal Environment

18
Human Capital

Human capital of workers includes the
Talents
 Education
 Training
 Skills

http://www.npr.org/player/v2/mediaPlayer.h
tml?action=1&t=1&islist=false&id=1720344
80&m=172038811
19
Physical Capital

Quantity and quality of machines, tools,
equipment and buildings affect the
productivity of labor.
How productive is a computer programmer
without a computer?
 Using MB vs. MC principle to allocate
machinery.
 Diminishing returns reduces the MB for the
next machine.

20
Natural Resources
Abundant land, energy, raw materials
will allow inputs to be cheap for
producing certain products, giving a
country comparative advantage in these
products.
 Free trade practically frees a country
from the yoke of lack of natural
resources.

21
Technology
New technologies that increase the
productivity of labor is commonplace in
our age.
 New ways of organizing, presenting,
sequencing, etc. are also considered
technological advances.
 Technological improvements in one area
may have positive spillover effects in
another industry.

22
Entrepreneurship and Management
Entrepreneurs take risks to introduce new
products, new processes into the
economy.
 Societies that provide secure property
rights, low and predictable taxation and
independent, incorruptible legal system
support the flourishing of entrepreneurial
activity. (See M. Olson, Power and
Prosperity.)

23
Entrepreneurship and
Management
China in the Middle Ages was far superior
to the West technologically. However, the
social system stifled economic growth:
application of technology to production.
 Management is every day operation of the
establishment. Education is supposed to
reduce the incidences of wrong decisions
in everyday operations.

24
Political and Legal Environment
It is the function of the government to
provide an environment where
individuals and firms are not subjected to
arbitrary rules, increasing the uncertainty
of efforts.
 Enforceable contracts, well-defined
property rights, political and social
environment conducive to taking risks in
production are responsibilities of
governments.

25
The Determinants of Average
Labor Productivity

Economic Naturalist

Why did communism fail?
 There




was an absence of:
Private property rights.
Free markets.
Political stability.
Modern legal framework.
26
Worldwide Productivity
Slowdown
Starting with 1973, industrialized nation
experienced a significant productivity
slowdown.
 Slow growth brings social problems.
 Redistribution can exacerbate these
problems.

27
Average Labor Productivity Growth
Rates in Selected Countries, 1960-2000
Percentage growth, annual rates
Country
1960-1973
1973-1979
1979-2000
France
4.6
2.3
1.8
Germany
4.0
2.6
2.0
Japan
7.6
2.7
2.0
United Kingdom
2.8
1.3
1.7
United States
2.3
0.6
1.7
28
Why Did Productivity Slow Down?
Decline in public education?
 Oil price shocks?
 Poor measurement of productivity gains in
service sector?
 The exceptional experience of the 50s and
60s?

29
Costs of Economic Growth
Resources allocated to capital formation
will reduce production of consumer goods.
 Unsanitary, unsafe conditions for industrial
workers (historical for US, current for
many LDCs).
 Is the sacrifice today, worth better living
conditions tomorrow?

30
How to Increase Growth Rates?

The factors that determine average labor
productivity may be enhanced by public
policy.
31
Policies to Increase Human
Capital
Education increases human capital.
 Why does the government provide “free”
K-12 education?



Positive externalities: Private demand does
not capture all the societal benefits.
Who should decide the content of
curriculum?
32
Policies to Promote Saving and
Investment
Capital stock in a country increases
through investment activities.
 Investments require resources diverted
from consumption goods to capital goods.
 If consumers do not restrict their
consumption (if they don’t save) total
expenditures will exceed the value of
production and inflation will ensue.

33
Policies to Promote Saving and
Investment
High rates of saving allow a country to
channel resources into capital formation.
 Governments can pass laws to promote
saving and laws to promote investment.
 Governments also can create capital stock
directly (how does it pay?)

34
Policies to Support R&D
Public good aspect of knowledge reduces
private investment in knowledge.
 Collective decision-making is required for
activities with higher social benefits than
individual benefits, e.g. basic research.

35
Legal and Political Framework
Political stability
 Free and open exchange of ideas
 Secure property rights
 Well functioning legal system
 Free markets (except for those with
significant externalities)

36
Promoting Economic Growth

The Poorest Countries: A Special Case?

Improve the legal and political framework
 Corrupt
legal systems create uncertainty about
property rights
 Taxation and regulation discourages
entrepreneurship
 Markets are not allowed to function
 Lack of political stability discourages foreign
investment
37
The Economist, Dec 23, 2006
38
Promoting Economic Growth

The Poorest Countries: A Special Case?

Without political stability, foreign aid will not
be effective.
39
Limits to Growth?

Will we run out of oil (natural resources)?


Will we spoil the environment completely?


Market mechanisms: price incentives
Change in tastes and preferences
Can we solve the global warming
problem?

Limits to collective decision-making.
40
Are There Limits to Growth?

Limits to growth, assumes economic
growth will take the form of what we have
now.
41
Are There Limits to Growth?
Limits to growth, overlooks that growth
expands society’s capacity to safeguard
the environment.
 Limits to growth, underestimates the
power of markets to deal with scarcity.

42
The Relationship between Air
Pollution and Real GDP per Person
Air pollution
A
Real GDP per person
43
Commodity Prices
FIRST published in 1864, with figures
stretching back to 1845, The Economist's
commodity-price index is probably the
world's oldest regularly published price
index. Since October 2001, our dollarbased industrials index has risen by
76%, fuelled by Chinese demand for
raw materials and, in part, the weakness
of the dollar. Yet in real terms, industrial
commodity prices are a mere 30% of
their value in 1845
http://www.economist.com/printedition/displayStory.c
fm?Story_ID=3651836
44
45