Transcript 19.2 Determinants of Economic Growth

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Exploring Economics
Second Edition
by Robert L. Sexton
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Chapter 19
Economic Growth in the
Global Economy
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19.1 Economic Growth

John Maynard Keynes
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primarily concerned with explaining and
reducing short-term fluctuations in the level
of business activity
once said, “in the long run we are all dead.”
He wanted to smooth out the business
cycle, largely because of the
implications that cyclical fluctuations
had for buyers and sellers in terms of
unemployment and price instability.
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19.1 Economic Growth


Keynes’ concerns were important and
legitimate.
At the same time, his flippant remark
about the long run ignores the fact that
human welfare is greatly influenced by
long-term changes in a nation's capacity
to produce goods and services.
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19.1 Economic Growth


Emphasis on the short-run business
cycle ignores the longer term dynamic
changes that affect output, leisure, real
incomes and life styles.
Many would argue that in the long run,
economic growth is a crucial
determinant of well-being.
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Real per Capita Output
Real per Capita Output
Growth Versus Stability
0
Time
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0
Time
19.1 Economic Growth

Important questions we wish to explore
about economic growth include:
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What are the determinants of long-run
economic change in our ability to produce
goods and services?
What are some of the consequences of
rapid economic change?
Why are some nations rich while others are
poor?
Does growth in output improve our
economic welfare?
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19.1 Economic Growth


Economic growth is usually measured
by the annual percent change in real
output of goods and services per capita
(real GDP per capita).
Along the production possibilities curve,
the economy is producing at its potential
output.
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19.1 Economic Growth

How much the economy will produce at
its potential output, sometimes called its
natural level of output, depends on the
quantity and quality of an economy’s
resources, including labor, capital, and
natural resources.
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19.1 Economic Growth
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Technology can increase the economy’s
production capabilities.
Improvements in and greater stocks of
land, labor, and capital can shift out the
production possibilities curve.
Another way of saying that economic
growth has shifted the production
possibilities curve out is to say that
growth has increased potential output.
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Capital Goods
Economic Growth and the Shifting
Production Possibilities Curves
0
Consumer Goods
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19.1 Economic Growth


A nation with greater economic growth
will end up with a much higher standard
of living, ceteris paribus.
A simple formula called the Rule of 70
can tell how long it will take a nation to
double its output.

The number of years necessary is
approximately equal to the nation’s growth
rate divided into 70.
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19.1 Economic Growth


The “richest” or “most-developed”
countries today have many times the
per capita output of the “poorest” or
“least-developed” countries.
The international differences in income,
output, and wealth are striking and have
caused a great deal of friction between
developed and less-developed
countries.
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Growth in Real Per Capita GDP,
Selected Industrial Countries
Ten-Year Averages
1982–1991
1992–2001
United States
Japan
Germany
France
Italy
United Kingdom
Canada
2.3%
3.5
2.4
2.0
2.1
2.4
1.1
2.1%
0.9
1.4
1.7
1.8
2.5
2.1
SOURCE: International Monetary Fund, World Economic Outlook, September 2000
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19.2 Determinants of Economic
Growth
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Many economists have had theories of
economic growth.
Adam Smith
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The wealth of nations is derived from
accumulation of capital, which results from
thrift and savings.
He thought specialization and division of
labor were important.
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He criticized then-accepted ideas of mercantilism.
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barriers to trade between people and countries
need for various types of governmental regulation
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19.2 Determinants of Economic
Growth
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Karl Marx
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Essentially, all value ultimately derives from
labor and economic growth, therefore,
depends on increasing contributions by
labor.
Joseph Schumpeter
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Growth depends to a considerable extent
on innovation and technological change,
for which the role of managerial or
entrepreneurial skills was particularly vital.
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19.2 Determinants of Economic
Growth

Thomas Malthus
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In the long run, per capita economic growth
will not occur at all!
Montesquieu
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A French philosopher, he argued that
output levels are lower in tropical zones,
partly because work effort is less intense in
the heat of the tropics.
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19.2 Determinants of Economic
Growth
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Many separate explanations of
economic growth have been proposed,
but none of them, by themselves, can
completely explain economic growth.
However, each of the explanations may
be part of a more complicated reality.
Economic growth is a complex process
involving many important factors, no
one of which completely dominates.
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19.2 Determinants of Economic
Growth

Nearly everyone agrees that several
factors have contributed to economic
growth in some or all countries.
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growth in the quantity and quality of labor
resources used
increase in the use of inputs provided by
land
growth in physical capital inputs
technological advances allowing greater
output than previously possible
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19.2 Determinants of Economic
Growth


Labor is needed in all forms of
productive activity.
Other things being equal, an increase in
labor input does not necessarily
increase output per capita.
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19.2 Determinants of Economic
Growth

If the increase in labor input results from
an increase in population, per capita
growth might not occur because the
increase in output could be offset by the
increase in population.
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19.2 Determinants of Economic
Growth

If a greater proportion of the population
works or if workers put in longer hours,
output per capita will increase—
assuming that the additional work
activity adds something to output.
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19.2 Determinants of Economic
Growth
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Qualitative improvements in workers
(learning new skills, for example) can
also enhance output.
It has become popular to view labor as
"human capital" that can be augmented
or improved by education and
on-the-job training.
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19.2 Determinants of Economic
Growth

Abundant natural resources also can
enhance output whereas a limited
resource base is an important obstacle
to economic growth.
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19.1 Economic Growth
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Resources are not the whole story.
The natural resource base can affect
the initial development process, but
sustained growth is influenced by other
factors.
There is nearly universal agreement
that capital formation has played a
significant role in the economic
development of nations.
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19.2 Determinants of Economic
Growth
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Technological advances stem from
man's ingenuity and creativity in
developing new ways of combining the
factors of production to enhance the
amount of output from a given quantity
of resources.
It involves invention and innovation.

Innovation is the adoption of a new product
or process.
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19.2 Determinants of Economic
Growth
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New technology must be introduced into
productive use by managers or
entrepreneurs who must weigh their
estimates of benefits of the new
technology against their estimates of
costs.
The entrepreneur is an important
economic factor in the growth process.
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19.2 Determinants of Economic
Growth
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Technological advances permit us to
economize on one or more inputs used
in the production process.
It can permit savings of labor, as occurs
when a new machine is invented that
does the work of many workers.
It can also be land (natural resource)
saving or even capital saving.
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19.2 Determinants of Economic
Growth

Nuclear fission has permitted us to build
power plants that economize on the use
of coal, a natural resource.
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19.2 Determinants of Economic
Growth

The reduction in transportation time that
accompanied the invention of the
railroad allowed businesses to reduce
the capital they needed in the form of
inventories.

Because goods could be obtained quickly,
businesses could reduce the stock kept on
their shelves.
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19.3 Raising the Level of Economic
Growth
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Economic growth means more than an
increase in the real income (output) of
the population.
Changes in output are accompanied by
a number of other important changes.
There are a number of policies that a
nation can pursue to increase economic
growth.
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19.3 Raising the Level of Economic
Growth

One of the most important determinants
of economic growth is the saving rate.

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In order to consume more in the future, we
must save more now.
Generally speaking, higher levels of saving
will lead to higher levels of investment and
capital formation and, therefore, to greater
economic growth.
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19.3 Raising the Level of Economic
Growth
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Sustained rapid economic growth is
associated with high rates of saving and
investment around the world.
Investment alone does not guarantee
economic growth, which hinges
importantly on the quality and the type
of investment as well as on investment
in human capital and improvements in
technology.
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Saving Rates and GDP Growth During HighGrowth Periods in Selected Economies
Fed. Rep. of
Germany
1951–55
Botswana
Thailand
1979–94
1987–94
10
9
Vietnam
1991–94
8
Greece
1961–73
Chile
1987–94
7
Mauritius
1985–94
6
Malaysia
1987–94
Indonesia
1968–94
Portugal
1965–73
Côte d’Ivoire
1968–78
China
1978–94
Japan
1961–73
Rep. of Korea
1983–94
Singapore
1961–94
Hong Kong
1961–94
0
0
15
20
25
30
35
Gross National Saving (percent of GDP)
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40
19.3 Raising the Level of Economic
Growth
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Some scholars believe that the
importance of research and
development (R&D) is understated.
can include
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new products,
management improvements,
production innovations, or
simply learning by doing
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19.3 Raising the Level of Economic
Growth

It is clear that investments in R&D and
rewarding innovators with patents has
paid big dividends in the past 50 to 60
years.
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19.3 Raising the Level of Economic
Growth
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There is an important link between
research and development and capital
investment.
When capital depreciates over time, it is
replaced with new equipment that
embodies the latest technology.

Consequently, R&D may work hand-inhand with investment to improve growth
and productivity.
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19.3 Raising the Level of Economic
Growth
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Economic growth rates tend to be
higher in countries where the
government enforces property rights.
In most developed countries, property
rights are effectively protected by the
government, but in developing
countries, this is not normally the case.
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19.3 Raising the Level of Economic
Growth
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And if the government is not enforcing
property rights, the private sector must
respond in costly ways that stifle
economic growth.
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private security
bribes
corruption
confiscation
the risk of takeovers from a new
government
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19.3 Raising the Level of Economic
Growth

Free Trade can lead to greater output
because of the principle of comparative
advantage.
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If two nations or individuals with different
resource endowments and production
capabilities specialize in producing a
smaller number of goods and services,
then they are relatively better at and
engage in trade.
Both parties will benefit as total output
rises.
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19.3 Raising the Level of Economic
Growth
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Education, investment in human capital,
is just as important as improvements in
physical capital.
Accepting a reduction in current income
to acquire education and training can
increase future earning ability, which
can raise the standard of living.
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19.3 Raising the Level of Economic
Growth
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With economic growth, illiteracy rates
fall and formal education grows.
The correlation between per capita
output and the proportion of the
population that is unable to read or write
is striking.
Improvements in literacy stimulate
economic growth by reducing barriers to
the flow of information and raise labor
productivity.
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19.3 Raising the Level of Economic
Growth
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Since children in developing countries
are an important part of the labor force
at a young age, there is a higher
opportunity cost of education in terms of
forgone contribution to family income.
Education is a consequence of
economic growth, becoming a
consumption good, as well as a cause
of economic growth, creating human
capital.
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Literacy and Economic Development
Country
United States
Japan
Italy
Brazil
India
Haiti
Ethiopia
Output
per Capita
Adult
Literacy Rates
$30,200
24,000
21,500
6,300
1,600
1,070
530
NOTE: The literacy rates are based on the ability to read and write at an elementary school level.
SOURCE: Time Almanac, 2000.
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97%
99
97
81
52
53
28
19.4 Population and Economic
Growth
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The impact of population growth on per
capita economic growth is far from
obvious.
If population were to expand faster than
output, per capita output would fall;
population growth would be
growth-inhibiting.
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19.4 Population and Economic
Growth
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With a greater population comes a
greater labor force.
Economies of large scale production
may exist in some forms of production,
so larger markets associated with
greater populations lead to more
efficient-sized production units.
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19.4 Population and Economic
Growth
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
Very rapid population growth did not
seem to impede American economic
growth in the mid-19th century.
America's economic growth until at least
World War I was accompanied by
population growth that was among the
highest in the world for the time.
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19.4 Population and Economic
Growth
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In many of the less-developed countries
today, rapid population growth threatens
sustained economic growth.
These are countries that have low landlabor ratios and are predominantly
agricultural with very modest natural
resources, especially land.
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19.4 Population and Economic
Growth

Two centuries ago, the English
economist Rev. Thomas Malthus
formulated a model that predicted that
per capita economic growth would
eventually become negative, and that
wages would ultimately reach an
equilibrium at a subsistence level, or
just large enough to provide enough
income to stay alive.
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19.4 Population and Economic
Growth

Malthus assumed an agricultural society
where goods were produced by two
inputs, land and labor.
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19.4 Population and Economic
Growth

Malthus assumed that the supply of
land was fixed in quantity.
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
He assumed that the sexual desires of
humans would work to increase population.
As population increased, the number of
workers would increase.
Thus with greater labor inputs available,
output would also go up.
continued . . .
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19.4 Population and Economic
Growth
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
At some point output would increase by
diminishing amounts because of the law of
diminishing returns, which states that if you
add variable amounts of one input (in this
case labor) to fixed quantities of another
input (in this case land), output would rise
but by diminishing amounts.
As the land-labor ratio falls, there is less
land per worker.
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19.4 Population and Economic
Growth
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
Fortunately, Malthus’ theory proved
spectacularly wrong for much of the
world.
While the law of diminishing returns is a
valid concept, Malthus' other
assumptions were unrealistic.


Agricultural land is not completely fixed in
quantity or quality.
Irrigation, fertilizer, and conservation
techniques have increased arable land.
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19.4 Population and Economic
Growth


Malthus implicitly assumed there would
be no technological advance, and
ignored the real possibility that
improved technology, often embodied in
capital, could overcome the impact of
the law of diminishing returns.
The Malthusian assumption that sexual
desire would necessarily lead to
population increase did not take birth
control techniques into account.
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19.4 Population and Economic
Growth


The Malthusian assumptions are not too
widely at variance with several lessdeveloped countries today.
Some nations are having substantial
population increases, with a virtually
fixed supply of land and little
technological advance.
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19.4 Population and Economic
Growth

Population growth has a negative
impact on per capita output in this case,
since the added output derived from
having more workers on the land is very
small.
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19.4 Population and Economic
Growth
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
In short, for some places in the modern
world, the Malthusian model may be
relevant.
It is scarcely surprising that population
control is considered to be critical in
many less-developed countries.
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19.4 Population and Economic
Growth

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The implementation of birth control has
been far from routine.
While greater population may lower per
capita output, other things equal, from
the perspective of an individual family,
the production of children means
greater security in old age, more labor
for the farm now, etc.
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19.4 Population and Economic
Growth
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
In most countries, population control
efforts have been only modestly
successful.
It remains a key factor in the growth
patterns in countries with high
populations in relation to natural
resources and capital equipment.
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