Transcript The Wealth of Nations and Economic Growth

CHAPTER
7
DYNAMIC P OWERP OINT™ S LIDES BY S OLINA L INDAHL
The Wealth of Nations
and Economic Growth
CHAPTER OUTLINE
Key Facts about the Wealth of Nations and
Economic Growth
Understanding the Wealth of Nations
Incentives and Institutions
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Food for Thought….
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SEE THE INVISIBLE HAND
Economic growth is a matter of life and death to the 1.8 million children
who die of diarrhea each year globally.
Key Facts about the Wealth of Nations and
Economic Growth
Fact One: GDP per Capita Today Varies Enormously among Nations
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Key Facts about the Wealth of Nations and
Economic Growth
Wealth and Health go Together.
Source: Penn World Tables and World Bank Group, World Development Indicators, 2005 B
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Key Facts about the Wealth of Nations and
Economic Growth
Fact Two: Everyone Used to be Poor
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Key Facts about the Wealth of Nations and
Economic Growth
A Primer on Growth Rates
How is economic growth measured?
y t  y t 1
gt 
 100
y t 1
Where yt is per capita real GDP in year t
Example:
Year
real GDP per capita
2008
2009
g2009
$15,000
$15,500
15,500  15,000

 100  3.33%
15,000
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The Rule of 70 (The Magic of Compounding)
The rule of 70:
70
Doubling time 
growth rate in %
Example: If real GDP per capita is growing at an
annual growth rate of 3.5%, it will double in:
70
 20 years.
3.5
The moral? Small improvements in growth add up
fast (the power of compounding).
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A Little Growth Goes
a Long Way
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Key Facts about the Wealth of Nations and
Economic Growth
Fact Three: There are Growth Miracles and Growth Disasters
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Understanding the Wealth
of Nations
The Factors of Production are important
Physical capital: the stock of tools including
machines, structures, and equipment.
Human capital: is the productive knowledge
and skills that workers acquire through
education, training and experience.
Technological knowledge: knowledge about
how the world works that is used to produce
goods and services.
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What Causes Economic Growth?
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Understanding the Wealth
of Nations
Why do some nations have faster growth
than others?
Besides factors of production, incentives and
institutions matter.
Institutions = “rules of the game” that
structure economic incentives.
Institutions of Economic Growth
1.
2.
3.
4.
5.
Property rights
Honest government
Political stability
A dependable legal system
Competitive and open markets
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Korea’s Experiment
Before division after WWII: similar
Culture, physical capital, technology.
North Korea became a communist state with a
centrally planned economy.
South Korea adopted the capitalist free market
model.
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SEE THE INVISIBLE HAND
North and
South
Korea at
night
Institutions
1. Property rights:
Provide incentives to work hard.
Encourage investment and innovation.
Without property rights:
Effort is divorced from payment, reducing
incentives.
Free riders become a problem.
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Institutions
Free Rider = someone who consumes a
resources without working or contributing to
the resource’s upkeep.
China’s “Great Leap Forward”- which introduced
farming collectives- reduced incentives. 20-40
million starved.
1978, farmers in Xiaogang met in secret to devise
a plan to keep some of their produce.
(background photo)
Productivity improved so quickly the government
allowed the experiment to proceed.
Food production increased 50% in 5 years 1978-1983.
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Institutions
2. Honest Government
Property rights are meaningless unless
government guarantees property rights.
Corruption bleeds resources away from
productive entrepreneurs.
Corruption takes resources away from
more productive government activity.
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Corruption and Growth
Don’t go Together
Source: Penn World Tables and World Bank Group, World Development Indicators, 2005
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Corruption Who’s Who List
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Institutions
3. Political Stability
Changing governments without the rule
of law creates uncertainty which leads
to less investment in physical and
human capital.
In many nations civil war, military
dictatorship, and anarchy have
destroyed the institutions necessary for
economic growth.
Bullet casings from Liberia’s Civil War: Bad soil for anything to grow.
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Institutions
4. Dependable Legal System
A good legal system facilitates
contracts and protects property from
others (including government).
Poorly protected property rights can
result from too much government or
too little government.
In India, residents who purchase land have
to do so more than once because of lack
of proper record keeping.
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Institutions
5. Competitive and Open Markets
Encourage the efficient organization of
resources.
One study found: if India used its physical and
human capital as efficiently as the U.S., India
would be 4x richer than it is today.
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Institutions
Why do poor countries use their capital
inefficiently?
Whether inadvertently or not, inefficient
and unnecessary regulations:
Create monopolies and impede markets
Example: until recently in India, it was illegal
to produce shirts using large-scale
production
Economies of scale = the advantages of
large-scale production that reduce
average cost as quantity increases
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Institutions and Growth Miracles
Revisited
Why did England’s Industrial Revolution
bring us:






large scale factories
mass production
the steam engine
the railroad
the beginnings of a consumer society
the first sustained rise in human living
standards above subsistence?
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Institutions and Growth Miracles
Revisited
Property rights?
England’s geography and Navy helped protect property
rights
Honest government
Growth of Parliament (and religious changes) reduced
royal tyranny
Political stability
Middle class developed from growth
A dependable legal system
Less corruption as royal and Catholic power is reduced
Competitive and open markets
England opened itself more to trade
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