Transcript Growth Accounting - Booth School of Business

TOPIC 2
The Supply Side of the Economy
Goals of Lecture 2
• Introduce the Supply Side of the Macro Economy.
• Discuss how countries grow and why some countries grow faster than others.
• Discuss Labor Productivity and ‘the New Economy’
• Determine How Wages are Set in an Economy
• Explain the Differential Unemployment Rates Between the U.S. and Europe.
2
The Production Function
•
GDP (Y) is produced with capital (K, price weighted) and labor (N, hours):
Y = A F(K,N)
•
Sometimes, I will modify the production function such that:
Y = A F(K,N, other inputs) – where other inputs include energy/oil!
•
Realistic Example is a Cobb Douglas function for F(.):
Y = A K.3 N.7
A is Total Factor Productivity (TFP), an index of efficiency (technology)
MUST READ: NOTES 3 (my notes) on the aggregate production function
3
Measurement
•
Y is GDP (it is measured in dollars). As noted above, we want to measure Y in “real”
dollars.<<you should know what this means from lecture 1>>.
•
For our Cobb Douglas production function (previous slide), N and K are both measured
in dollars.
– N often is measured in total wage bill
– K often is measured as the replacement cost of capital
• However, in practice, N can be measured in different ways (hours worked,
number of workers).
– Wage bill is the preferred method (takes into account “skill” differentials).
– However, we will often talk about standard of livings which is income per capita
(Y/N ; where Y is income and N is some population measure).
4
Features of the Aggregate Production Function
Define MPN = Marginal Product of Labor = dY/dN
Define MPK = Marginal Product of Capital = dY/dK
MPN = .7 A (K/N).3 = .7 (Y/N)
Fixing A and K, MPN falls when N increases
MPK = .3 A (N/K).7 = .3 (Y/K)
Fixing A and N, MPK falls when K increases
Increasing A or K, increases MPN
Increasing A or N, increases MPK
Define Y* as F(N*,K*) = A (N*).7(K*).3
5
Two Measures of Productivity
•
Labor Productivity = Y/N = A (K/N).3
Driven by A and K/N
•
Total Factor Productivity (TFP) = A = Y/F(K,N)
•
Basically TFP is a ‘catch-all’ for anything that effects output other than K and N.
–
–
–
–
–
–
–
–
Workweek of labor and capital
Quality of labor and capital
Regulation
Infrastructure
Competition
Specialization
Innovation (including innovation in management practices)
Changes in “discrimination” or “culture”
•
Some components of TFP tends to be procyclical
•
(Definition of Procyclical: Variable increases when Y is high, decreases when Y is low)
6
Sub-Section A
Economic Growth
Growth Accounting
Y = A K.3 N .7 (our production function)
%ΔY = %ΔA + .3%ΔK + .7%ΔN
Output, in a country grows from:
Growth in TFP (see entrepreneurial ability, education, roads, technology, etc.)
Growth in Capital (machines, equipment, plants)
Growth in Hours (workforce, population, labor participation, etc).
Perhaps, we care about growth in Y/pop or Y/N (per capita output).
%Δ(Y/pop) = %ΔA + .3%Δ(K/pop) + .7%Δ(N/pop)
or
%Δ(Y/N) = %ΔA + .3%Δ(K/N)
8
Was the ‘New Economy’ Really ‘New’???
•
U.S. Labor Productivity Growth (Y/N – where N is the number of hours)
1959-1972:
1973-1995:
1996 - 2008:
2.9%
1.5%
2.5%
2001:
2002:
2003:
2004:
2005:
2006:
2007:
2008:
2.5%
4.1%
3.7%
2.8%
1.7%
0.9%
1.4%
2.8%
(going into a recession)
(coming out of recession)
(pretty strong rate)
Y increase!
N constant!
Source: http://www.bls.gov/lpc/
9
Output Per Worker: 1959 – 2008 (Quarterly)
Red Line: Growth in Output per Worker.
10
The Role of Investment
Does a one time increase in investment today increase Y/N today? YES!
Does a one time increase in investment today cause a sustained increase in Y/N
into the future? No!
Back of our mind equations:
S = I + NX (From the first lecture).
Notice the link between saving
and investment.
K(t+1) = (1-δ) K(t) + I(t)
or
ΔK(t, t+1) = I(t) - δ K(t)
Definition of Capital Stock Evolution
All else equal (ie, holding N constant), increasing I causes K tomorrow to
increase causing K/N tomorrow to increase (ie, Y/N tomorrow increases).
11
Time Path of Capital Stock: One time increase in I
K
No investment
No investment
t+1
time
Suppose there is a one time increase in investment at time t (perhaps due to an investment
tax credit). Suppose no investment either prior to or after the tax credit.
12
Can Higher Investment lead to infinite growth?
Does a sustained increase in investment increase Y/N today? YES!
Does a sustained increase in investment cause a sustained increase in Y/N? No!
Suppose I is fixed at a high level and that K initially is sufficiently small.
K grows if I > δ K: But, notice that δK is also growing each period.
(Summary: To start, higher I will lead to higher K and Y/N will increase).
Eventually, however, I will converge towards δK More and more of the
investment is going to replace outdated capital and the capital stock will grow
by smaller and smaller rates. The increase in Y/N will converge back to zero.
Summary. High levels of investment will increase the capital stock and output,
but both K and Y will eventually converge to a fixed level.
13
Time Path of K: Permanent increase in I
K
The new level of investment has successively less effect
due to growing depreciation of the capital stock.
No investment
t+1
time
Suppose there is a permanent increase in investment at time t. Suppose no investment
prior to t. In all periods after t, the level of investment remains fixed at the level in t.
14
Can Higher Investment Growth Cause Infinite Growth?
If a one time increase in I gives an increase in Y, why not continuously raise I to
higher and higher amounts??? Answer: Diminishing MPK!!!
MPK = .3 A (N/K) .7; As K increases, MPK falls.
As K goes to infinity, MPK goes to zero (Y stops increasing).
Suppose, we keep rising I (each year), K will increase by the amount of I (after
controlling for depreciation), but Y will increase by continuously smaller and
smaller amounts.
Remember Y = C + I + G + NX. I/Y (investment rate) is bounded by 1 (if you
invest all your output). This caps the increase in I. I cannot grow forever!
Continuously increasing I will NOT lead to sustained economic growth!
NOTE: Investment decisions are NOT made in the dark (ie, something must
15
drive firm investment!!!!!)
Then What Does Cause Sustained Growth ?
Sustained Increases in the growth of A are the only thing that can cause a
sustained growth in Y/N.
Empirically, when a country exhibits faster Y/N growth …..
33% typically comes from growth in K/N
67% typically comes from growth in A
(where N = employment (not hours) - limited data).
16
Growth Across Countries
Most developed economies grow at the same rate that the “technological frontier”
grows.
Convergence – countries inside of the technological frontier move towards the
technological frontier.
Divergence – countries inside of the technological frontier grow at a rate less than
the technological frontier.
17
Some Data: Distribution of World GDP in 2000
From Barro, 2003 – includes 147 countries. Horizontal axis is a log scale.
All data are in 1995 U.S. dollars.
18
Some Data: Distribution of World GDP in 1960
From Barro, 2003 – includes 113 countries. Horizontal axis is a log scale.
All data are in 1995 U.S. dollars.
19
Growth Rate of GDP Per Capita: 1960 - 2000
From Barro, 2003 – includes 111 countries.
20
Relative Growth Rate of GDP Per Capita: 1960 - 1988
US is anchored at 1 in both years. Countries above the line have made gains relative to U.S.
21
Convergence of Income Across U.S. States: 1940 - 1980
Historical Trends in Convergence
Unadjusted 1940-1960
1
MS
.8
ARAL
ND
SD
OK
KY
NC
GA NM
TN
LA
SC
KS
NE
TX
.6
WV
UT
MOCO
IA
MNWI
ID
VA AZ
IN
WY
FL
NHOR
VT MT
ME
WA
OH
PA MI
IL
.4
MD
CA
NV
MA NJ NY
CT
RI
.2
DE
2000
4000
6000
8000
Per Capita Income 1940
Fitted values
10000
12000
gr_ipc_40_60
22
Convergence of Income Across U.S. States: 1980 - 2000
Recent Trends in Convergence
Unadjusted 1980-2000
.5
MA
NH
CT
NC GA
NJ
.4
VT
SCNDSD TN
ME
AL
KY
MS
MO
IN
.3
AR
UTID
WV
.2
RI
NE
NM
IA
AZ
MN
VA
PA
FL
TX
MI
WI
OH
KSOR
NY
CO
WAIL
DE
CA
LA
MT
MD
NV
OK
.1
WY
15000
20000
Per Capita Income 1980
Fitted values
25000
gr_ipc_80_00
23
The Importance of Economic Growth
Baseline:
Y/person in U.S. grows roughly by 2%/year (real).
Assume a constant growth rate of 2% per year (real) for next 30 years.
After 30 years, U.S. Y/person will be 81% higher than today.
Scenario 1: Major recession today
Suppose U.S. Y/person contracts 3% this year and next and then grows at 2% for
next 28 years.
After 30 years, U.S. Y/person will be 64% higher than today.
24
The Importance of Economic Growth
Scenario 2:
Major recession today and we fight it using tax and spending
policy with little detriment to future growth
Suppose U.S. Y/person grows at -1% this year, 0% next and then grows at 1.9% for
next 28 years.
After 30 years, U.S. Y/person will be 68% higher than today.
Take Away:
Y/person in the future is HIGHER relative to doing nothing!
68% > 64%
25
The Importance of Economic Growth
Scenario 3:
Major recession today and we fight it using tax and spending
policy with BIG detriment to future growth
Suppose U.S. Y/person grows at -1% this year, 0% next and then grows at 1.7% for
next 28 years.
After 30 years, U.S. Y/person will be 59% higher than today.
Take Away:
Y/person in the future is LOWE relative to doing nothing!
59% < 64%
Conclusion:
Fighting recessions today may have affects on future growth.
Benefits of fighting recession depends on whether the policies
used to prevent the recession affect future growth!
26
Bonus Section
New Research Project:
Discrimination and Economic Growth
(Trying to Shed Light on the Black Box of TFP Growth)
Erik Hurst and Chang Tai Hsieh
Measuring TFP
The way TFP is usually measured is via a statistical decomposition (referred to
as the “Solow Residual”).
Remember our assumed production function:
•
Y = AK.3N.7
Take logs of the production function
ln(Y) = ln(A) + α0ln(K) + α1ln(N) (where α0 = 1 – α1 ≈ 0.3)
(1)
•
Given that we measure Y, K and N in the data, we can estimate (1) using
standard regression techniques.
•
ln(A) is the constant from the regression. This is our standard TFP
measure.
28
Measuring TFP
Because A (TFP) is a catch all term for anything that affects production, the
assumed production function does not impose any structure on how to measure
the components of TFP.
Economists are very good at measuring the extent to which TFP changes over
time within a country.
It is much harder to measure “why” TFP has changed over time.
Economists try to measure this by using detailed firm and household level data
to measure production and wages.
29
Our Project
Question:
How much of the observed TFP growth in the U.S. since 1940
is due to better labor market outcomes (including human
capital formation) for blacks and women?
A better allocation of resources leads to higher economic growth!
There have been HUGE changes in the allocation of women and blacks in the
labor market since 1940.
Question:
How much of the convergence of the U.S. south to the U.S.
north is due to a decline in discrimination of the south?
Project is still in its early stages. We do not have a TFP number yet – but, we
have a bunch of interesting facts.
30
Black Men Occ. Distribution and Wages (Relative to White Men)
White Men
Occupation Decile
1940
1960
1980
2000
1
2
3
4
5
6
7
8
9
10
0.298
0.286
0.171
0.055
0.095
0.032
0.022
0.019
0.011
0.012
0.454
0.100
0.155
0.092
0.051
0.075
0.029
0.023
0.013
0.009
0.220
0.130
0.168
0.147
0.070
0.075
0.058
0.057
0.035
0.041
0.179
0.171
0.100
0.147
0.094
0.092
0.052
0.078
0.056
0.030
Occupational Gini
0.543
0.545
0.310
0.253
Wage Gap
Wage | Education
Wage | Ed. and Occ.
-0.877
-0.515
-0.341
-0.621
-0.423
-0.222
-0.352
-0.256
-0.189
-0.263
-0.182
31
-0.113
Black Men Occ. Distribution and Wages (Relative to White Men)
White Men
Occupation Decile
1940
1960
1980
2000
1
2
3
4
5
6
7
8
9
10
0.139
0.047
0.061
0.181
0.017
0.121
0.217
0.173
0.019
0.024
0.124
0.171
0.102
0.050
0.131
0.138
0.048
0.184
0.026
0.025
0.235
0.041
0.123
0.080
0.142
0.157
0.070
0.055
0.042
0.055
0.149
0.074
0.068
0.082
0.156
0.121
0.101
0.110
0.076
0.062
Occupational Gini
0.045
0.149
0.200
0.053
Wage Gap
Wage | Education
Wage | Ed. and Occ.
-0.424
-0.484
-0.468
-0.641
-0.676
-0.613
-0.509
-0.512
-0.440
-0.240
-0.283
32
-0.225
Black Men Occ. Distribution and Wages (Relative to White Men)
White Men
Occupation Decile
1940
1960
1980
2000
1
2
3
4
5
6
7
8
9
10
0.780
0.021
0.077
0.032
0.009
0.013
0.009
0.054
0.002
0.004
0.517
0.204
0.077
0.005
0.049
0.085
0.020
0.032
0.007
0.004
0.385
0.050
0.150
0.062
0.120
0.101
0.035
0.047
0.025
0.026
0.245
0.098
0.095
0.085
0.144
0.093
0.076
0.078
0.052
0.036
Occupational Gini
0.731
0.614
0.403
0.239
Wage Gap
Wage | Education
Wage | Ed. and Occ.
-1.350
-1.078
-0.783
-1.190
-1.088
-0.718
-0.613
-0.568
-0.409
-0.359
-0.331
33
-0.232
Labor Force Participation (Fraction Working Full Time 21-65)
Year
White
Men
Black
Men
White
Women
Black
Women
1940
0.73
0.67
0.21
0.29
2000
0.76
0.56
0.56
0.55
34
Labor Force Participation (Fraction Working Full Time 21-65)
Growth in Y/N 1960-1980
Relationship Between Change in Y/N (N = # of Men Aged 25 - 55)
and Change in Racial Wage Gap For Those Same Men
1.600
Years: 1960-1980
1.500
1.400
1.300
y = 0.5513x + 1.2029
R² = 0.4683
1.200
1.100
Each obs. is a U.S. State. The states with the biggest decline in racial wage
gaps grew the fastest during that period (in terms of Y/N)
1.000
-0.100
0.000
0.100
0.200
0.300
0.400
Decline in Black White Wage Gap 1960-1980
0.500
35
Sub-Section B
The Labor Market
Labor Market: Firm Profit Decisions
• In a competitive market, firms can sell as much Y as it wants at the going price
p, and can hire as much N as it wants at the going wage w.
• Facing w and p, a profit maximizing firm will hire N to the point were MPN =
w/p (the benefit from an additional worker (in terms of additional output) must
equal the cost which they are paid). <<This is straight from micro>>
• With Cobb-Douglas: MPN = .7 Y/N = .7 A (K/N).3
• If firms maximize profits: w/p = .7 Y/N = .7 A (K/N).3
• If MPN > w/p then the firm can increase profits by increasing N.
• If MPN < w/p then the firm can increase profits by decreasing N.
37
The Labor Demand Curve
real wage
w/p *
MPN = Nd
N*
N
38
Notes on the Labor Demand Curve
• Nd slopes downward (Nd = MPN = .7 A * (K/N).3)
• Nd rises with A and K (complementarity)
• Assumption: Y is not Fixed! Firms optimally chose, N, K, Y and (to some
extent) A to maximize profits.
• Caveat: Who says that there is a demand for more Y?
– Need to look at the demand side of economy (introduced last -discussed in depth
throughout the course).
39
The Other 1/2 of the Labor Market: Labor Supply
• Labor Supply (Ns) Results from Individual Optimization Decisions
• Households compare benefits of working (additional lifetime resources) with
cost of working (forgone leisure)
• Factors Affecting Labor Supply
–
–
–
–
–
–
The Real Wage (w/p)
The Household’s Present Value of Lifetime Resources (PVLR)
The Marginal Tax Rate on Labor Income (tn)
The Marginal Tax Rate on Consumption (tc)
Value of Leisure (reservation wage) - non-’work’ status (VL)
The Working Age Population (pop)
40
The Labor Supply Curve
Ns(PVLR, tc, tn, pop, VL)
w/p
N
41
Labor Supply Notes
•
In terms of ‘wages and earnings’, there is both an income and substitution effect - we
will look at them separately – in the real world, they often occur jointly!!!!
•
The Real Wage - HOLDING PVLR fixed: A higher w/p encourages individuals to
substitute away from leisure and toward work (leisure becomes more expensive). This
is a substitution effect. <<This is why the labor supply curve slopes upwards!!>>
– Estimating this substitution effect is difficult since PVLR is not easily held constant.
Estimates range from 0 - 2% (For a 1% increase in after-tax w/p holding PVLR fixed, labor
supply either increases by 0% or 2%). Very Wide Range – little consensus.
•
PVLR = initial wealth + present discounted value of earnings
– A higher PVLR induces individuals to work less (lower Ns) for a given after-tax wage,
allowing them to enjoy more leisure (If leisure is preferred to work – as I get richer, I can
afford to work less).
– PVLR is net of taxes and non-work governmental transfers and inclusive of all other
transfers.
42
Labor Supply Notes
• Marginal tax rate on labor income - Should have same substitution effect as the
before tax real wage. Studies of the 1986 U.S. Tax Reform found that only
high-earning married women worked more in response to lower marginal
income tax rates.
• Marginal tax rate on consumption - see above
• Value of Leisure - If leisure/no-work becomes more/less attractive, households
will less/more (reservation wage). (Welfare programs, child care, etc.).
• Working Age Population: Usually defined as 16-64. (Includes changes in
Labor Force Participation Rates)
43
Recap on Labor Supply
• Substitution Effect:
– For a given PVLR, a higher after tax wage increases NS.
• This is why Labor Supply Curve Slopes Upward
• Income Effect
– For a given after-tax wage, higher PVLR decreases Ns.
• Evidence:
– Weak Consensus is that, with equal (%) increase in PVLR and the after-tax wage,
Ns falls (income effect dominates).
• A must read: Notes 4 (on labor markets) in the course pack.
44
Temporary Increase in A
Ns(PVLR, tc, tn, pop, VL)
w/p
w/p *
N d(A,K)
N*
N
45
Permanent Increase in A
Ns(PVLR, tc, tn, pop, VL)
w/p
w/p *
N d(A,K)
N*
N
46
Can Technological Progress destroy jobs?
Facts:
A, N, w/p are trending up over time.
N/pop is trending down (except in U.S. since 1980).
Higher A countries have higher w/p and lower N/pop.
Implications:
Adjusting for pop, higher A goes with lower N.
Higher A reduces Nd and destroys jobs? - NO!
Labor Demand Increases.
Higher A increases PVLR and reduces Ns - The Effect on Labor Demand
is to fall.
47
Permanent Increase in pop ...
Ns(PVLR, tc, tn, pop, VL)
w/p
w/p *
N d(A,K)
N*
N
48
Population and Jobs
More People = More Jobs
1990 Employment (000s)
1000000
100000
10000
1000
100
100
1000
10000
100000
1000000
1990 Working-Age Population (000s)
49
Temporary Increase in Taxes (tc or tn)
Ns(PVLR, tc, tn, pop, VL)
w/p
w/p *
N d(A,K)
N*
N
50
Permanent Increase in Taxes (tc or tn)
Ns(PVLR, tc, tn, pop, VL)
w/p
w/p *
N d(A,K)
N*
N
51
Labor Market Equilibrium (in long run!)
•
We define Long Run Equilibrium in macroeconomics as occurring when the labor
market clears.
•
By definition, long run macro equilibrium exists when N = N*.
•
At N*, labor demand = labor supply. So, by definition, all workers who want a job
(the suppliers) are able to find a firm looking for a worker (the demanders).
•
•
•
Implies that cyclical unemployment = zero at N*.
Long run equilibrium is characterized by zero cyclical unemployment!
It is an equilibrium in that there is no incentive for real wages to change at N*
•
Real wages (w/p) has two components: nominal wages (w) and the price
level (p).
•
Note:
•
Y* is the long run equilibrium level of output (output where labor market is in
equilibrium)
Y* (by definition) = A K.3(N*).7
52
Our first aggregate supply curve……
•
Suppose prices (p) increase. What happens in the labor market?
•
•
•
In terms of equilibrium, nothing happens!
Increasing prices have no effect on labor demand (A and K do not change).
Increasing prices have no effect on labor supply (taxes, population, etc. do not
change).
•
You may ask “Doesn’t PVLR change when prices increase???” No!
•
•
•
As long as nominal wages adjust, real wages will be unchanged when p
increases.
The % change in prices will be match exactly by the % change in nominal
wages – real wages will not change (so PVLR will not change).
No effect on labor supply.
•
Key: Because real wages will not change, changes in prices will have NO
effect on the labor market (i.e., it will have no effect on N*).
•
Conclusion: Changing prices will have NO effect on Y* (since N* is constant).
53
Our first aggregate supply curve……
LRAS – Long Run Aggregate Supply Curve
p
Y*
Y
•
If labor market clears, changes in prices will lead to equal changes in nominal wages.
As a result, there will be no change in N* and hence, no change in Y*.
•
Leads to a vertical LRAS curve. Prices do not affect production in the long run! 54
What shifts Y*? (the LRAS)
•
Anything that affects the labor market will affect Y*!
•
If N* increases, Y* will shift to the right.
•
If N* decreases, Y* will shift to the left.
•
Summary: Y* will shift right if:
–
–
–
–
–
A increases
K increases
population increases
labor income taxes fall (and income effect is small relative to substitution effect)
labor income taxes rise (and income effect is large relative to substitution effect)
55
Things to remember!
•
The demand side of the economy is NOT important for determining Y*!
–
All we need to know is A, K and N and we know Y*!
–
The demand side of the economy is not important for economic growth!
–
Key: If I ever ask you about what determines Y* (i.e., output/income/expenditure in the
long run), you should think about A, K and the labor market.
•
•
As a rule, K will be fixed unless I tell you otherwise (for simplicity, you will
see why soon).
Why do we care about the demand side of the economy?
–
–
–
In the long run, prices will be determined by demand.
Also, LRAS is dependent on labor market being in equilibrium. In the short run, labor
market need not be in equilibrium.
Demand will determine output in the SHORT RUN!
56
Summary….
•
In the long run – when labor markets clear.
–
Supply side of economy (labor market, K, A, other inputs like oil) determines
output.
–
Demand side of economy (C+I+G+NX) will determine prices.
•
In the short run – when labor markets do not clear:
–
Demand and Supply jointly determine prices and output (think of the simple
examples I gave graphically in the lecture for topic 1).
–
Three outstanding issues (we will get to them soon):
•
•
•
When is the labor market NOT in equilibrium?
What does the supply curve look like when labor market doesn’t clear?
What determines demand?
57
When are labor markets in disequilibrium?
•
Labor market is in disequilibrium when labor demand is not equal to labor supply.
•
Any time labor demand = labor supply, there is no cyclical unemployment (by
definition)!
•
Nominal wages do not adjust to clear the labor market
– We refer to this as ‘sticky’ wages.
– Because of wage contracts (and uncertainty), nominal wages no not always adjust
immediately.
– Need a model for short run disequilibrium --- we will do that in topic 6.
58
Cyclical Unemployment in Labor Markets
•
When do we get cyclical unemployment in our models?
•
Cyclical unemployment occurs when there are no jobs available (labor demand) for
those with the skills and the desire to work (labor supply) at current wages.
•
Cyclical unemployment occurs only in disequilibrium! (when desired labor demand <
desired labor supply - at given wages)
Ns
w’/p’
a
b
Unemployment
N(1)
N(0)
Nd
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What Have We Learned So Far?
•
There are microeconomic fundamentals to the supply side of the economy –
– Capital accumulation, Labor and TFP are important for production AND Growth!!!
•
Some countries grow faster than others because they have rapid growth in TFP or K/N.
•
Only growth in TFP can lead to sustained growth in Y/N
•
How Labor Markets Work - The Role of Taxes, Technological Progress, Capital
Accumulation, And Demographics on Wages and Employment.
•
Demand is not important for determining long run output (i.e., income, standard of
livings, etc.). Supply (production) is the only thing that determines output in the long
run!
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