Transcript The Art and Science of Economics

Productivity and Growth
CHAPTER
21
© 2003 South-Western/Thomson Learning
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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
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tax laws
property rights
patent laws
legal system
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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
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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
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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
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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 fulltime workers per year
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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 workerpopulation 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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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