Transcript Chapter 8

Chapter 8
Why do
Economies Grow?
For many people, the thought
of poverty conjures up poor,
African children, but since
1995, African poverty rates
have been falling steadily.
Prepared By Brock Williams
Learning Objectives
1. Calculate economic growth rates
2. Explain the role of capital in economic
growth
3. Apply growth accounting to measure
technological progress
4. Discuss the sources of technological
progress
5. Assess the role of government in assisting
economic growth
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8.1 ECONOMIC GROWTH RATES
● capital deepening
Increases in the stock of capital per worker.
● technological progress
More efficient ways of organizing economic affairs that
allow an economy to increase output without
increasing inputs.
● human capital
The knowledge and skills acquired by a worker
through education and experience and used to
produce goods and services.
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8.1 ECONOMIC GROWTH RATES
 FIGURE 8.1
What Is Economic Growth?
Economic growth means
an expanded production
possibilities curve (PPC).
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8.1 ECONOMIC GROWTH RATES
Measuring Economic Growth
● real GDP per capita
Gross domestic product per person adjusted for
changes in prices. It is the usual measure of living
standards across time and between countries.
● growth rate
The percentage rate of change of a variable
from one period to another.
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8.1 ECONOMIC GROWTH RATES
Measuring Economic Growth
● rule of 70
A rule of thumb that says output will double in 70/x
years, where x is the percentage rate of growth.
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8.1 ECONOMIC GROWTH RATES
Comparing the Growth Rates of Various Countries
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8.1 ECONOMIC GROWTH RATES
Are Poor Countries Catching Up?
● convergence
The process by which poorer countries close the gap with richer
countries in terms of real GDP per capita.
► FIGURE 8.2
Growth Rates versus Per Capita Income,
1870–1979
Each point on the graph represents a different
currently developed country.
Notice that the countries with the lowest per
capita incomes in 1870 (shown along the
horizontal axis) are plotted higher on the graph.
In other words, the tendency was for countries
with lower levels of initial income to grow faster.
SOURCE: M. Obstfeld and K. Rogoff,
Foundations of International Macroeconomics
(Cambridge, MA: MIT Press, 1996), Table 7.1.
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APPLICATION
2
ECONOMIC EQUALITY MAY SUSTAIN ECONOMIC GROWTH
APPLYING THE CONCEPTS #2: Is there a necessary tradeoff
between equality and growth?
What is the connection between inequality and economic growth? Is there a trade-off
such that higher growth can only occur if there is increased inequality. Recent
research suggests that this may not be the case—equality may be beneficial to
economic growth.
Andrew Beg and Jonathan Ostry explored the factors that determined why some
countries had longer spells of sustained growth than others. Almost all countries can
begin to grow, but it is more difficult to sustain growth. What they found was that
when there was more equality, spells of growth within a country tended to last longer.
Why might equality have a beneficial effect? The authors speculate that when there
is more equality governments may be able to have enough power and authority to
make the tough choices to sustain growth. Growth and equality could, however, be
possibly caused by some common factor. For example, well-functioning markets for
credit and loans may lead to both more growth and more equality. The good news is
that it does not appear necessary to create inequality in order to promote growth.
.
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8.2 CAPITAL DEEPENING
► FIGURE 8.3
Increase in the Supply of
Capital
An increase in the supply of
capital will shift the production
function upward, as shown in
Panel A, and increase the
demand for labor, as shown in
Panel B.
Real wages will increase from
W1 to W2, and potential output
will increase from Y1 to Y2.
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8.2 CAPITAL DEEPENING
Saving and Investment
● saving
Income that is not consumed.
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8.2 CAPITAL DEEPENING
How Do Population Growth, Government, and Trade Affect Capital Deepening?
PRINCIPLE OF DIMINISHING RETURNS
Suppose output is produced with two or more inputs, and we increase one
input while holding the other input or inputs fixed. Beyond some point—called
the point of diminishing returns—output will increase at a decreasing rate.
► FIGURE 8.4
Taxes and Government Investment
If the government raises taxes by $100
and the people tend to save 20 percent
of changes in income, then private
savings and investment will fall by $20.
However, if the government invests the
funds, then total investment—private and
public— will increase by $80.
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8.3 THE KEY ROLE OF
TECHNOLOGICAL PROGRESS
How Do We Measure Technological Progress?
● growth accounting
A method to determine the contribution to
economic growth from increased capital,
labor, and technological progress.
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8.3 THE KEY ROLE OF
TECHNOLOGICAL PROGRESS
How Do We Measure Technological Progress?
► FIGURE 8.5
Contributions to Real GDP
Growth, 1929–1982 (average
annual percentage rates)
SOURCE: Edward F. Denison,
Trends in American Economic
Growth 1929–1982 (Washington,
D.C.: The Brookings Institution,
1985).
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APPLICATION
3
SOURCES OF GROWTH IN CHINA AND INDIA
APPLYING THE CONCEPTS #3: How can we use economic analysis to
understand the sources of growth in different countries?
China and India are the two most populous countries and have also grown very
rapidly in recent years.
From 1978 to 2004, GDP in China grew at the rate of 9.3 percent per year while
India’s GDP grew at a lower rate of 5.4 percent per year.
Economists Barry Bosworth from the Brookings Institution and Susan Collins
from the University of Michigan used growth accounting to answer this question.
▪ China’s rapid growth was caused by more rapid accumulation of
physical capital and more rapid technological progress.
▪ China invested much more in physical capital and was able to
increase its technological progress at a more rapid rate.
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8.3 THE KEY ROLE OF
TECHNOLOGICAL PROGRESS
Using Growth Accounting
• Growth accounting is a useful tool for understanding different aspects of
economic growth.
• As an example, economic growth slowed throughout the entire world during
the 1970s.
• Using growth accounting methods, economists typically found the
slowdown could not be attributed to changes in the quality or quantity
of labor inputs or to capital deepening.
• Either a slowdown in technological progress or other factors not
directly included in the analysis, such as higher worldwide energy
prices, must have been responsible.
• This led economists to suspect that higher energy prices were the
primary explanation for the reduction in economic growth.
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APPLICATION
4
GROWTH ACCOUNTING AND INTANGIBLE CAPITAL
APPLYING THE CONCEPTS #4: How do you measure the
technological revolution?
Traditional growth theory focused on easily measured items, such as hours of work or the
amount of physical capital. But as our economy advances, the factors that contribute to
production are harder to measure. For example, why has Google had such a big impact on
our economy? They do not produce machines or cars—they mostly produce ideas and
information-related products. Can we still use growth accounting in this new world?
Economists have made considerable progress in adapting growth accounting to this new
environment. The idea they use is to create a measures of “intangible” capital based on
expenditures on research and development, marketing, design and customer support.
Once they have this measure of intangible capital, they can use it along with conventional
measures of capital and labor to understand the sources of economic growth.
Estimates by economists Carol Corrado and Charles Hulten suggest that intangible capital
is an important source of economic growth. They found that in recent years, the
contribution from intangible capital actually exceeded the contribution from traditional or
tangible capital. Together, the two capital measures also contributed more to economic
growth than technological progress.
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Using Growth Accounting
(cont’d)
Labor productivity
Output per hour of work, labor productivity is a simple measure of how much a typical worker
can produce given the amount of capital in the economy and the state of technological
progress.
From 1947 to the worldwide oil crisis in 1973, labor productivity grew rapidly. Productivity
growth fell in the remainder of the 1970s and slowly increased over the next two decades.
Since 2007, productivity growth has also slowed from recent trends, partly due to the
recession.
Economists have used growth accounting to help explain these trends in productivity growth
in the United States. Economic research suggests that the oil shocks in the 1970s reduced
technological progress but the information revolution in the 1980s and 1990s led to a
resurgence of technological progress.
▶ Figure 8.6
U.S. Annual Productivity Growth,
1947–2011
SOURCE: Bureau of Labor Statistics, 2012.
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8.4 WHAT CAUSES
TECHNOLOGICAL PROGRESS?
Research and Development Funding
▼ FIGURE 8.7
Research and Development as a
Percent of GDP, 1999
The United States spends more
total money than any other country
on research and development.
However, when the spending is
measured as a percentage of each
nation’s GDP, Japan spends more.
A big part of U.S. spending on
research and development is in
defense-related areas.
SOURCE: National Science
Foundation, National Patterns of
R&D Resources, 2002, Washington
D.C.
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8.4 WHAT CAUSES
TECHNOLOGICAL PROGRESS?
Monopolies That Spur Innovation
● creative destruction
The view that a firm will try to come up with new
products and more efficient ways to produce
products to earn monopoly profits.
The Scale of the Market
• Adam Smith stressed that the size of a market was important for economic
development.
• In larger markets, firms have more incentives to come up with new products
and new methods of production. The lure of profits guides the activities of
firms, and larger markets provide firms the opportunity to make larger
profits.
• This supplies another rationale for free trade. With free trade, markets are
larger, and there is more incentive to engage in technological progress.
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8.4 WHAT CAUSES
TECHNOLOGICAL PROGRESS?
Induced Innovations
Some economists have emphasized that innovations come about through
inventive activity designed specifically to reduce costs. This is known as
induced innovation.
Education, Human Capital, and the Accumulation of
Knowledge
Education can contribute to economic growth in two ways.
•
First, the increased knowledge and skills of people complement our current
investments in physical capital.
•
Second, education can enable the workforce in an economy to use its skills
to develop new ideas or to copy ideas or import them from abroad.
New Growth Theory
● new growth theory
Modern theories of growth that try to explain the
origins of technological progress.
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APPLICATION
5
THE ROLE OF POLITICAL FACTORS IN ECONOMIC
GROWTH
APPLYING THE CONCEPTS #5 How do varying political
institutions affect economic growth?
Growth can, and has, occurred in both authoritarian and participatory governments.
Transformative economic growth like the Industrial Revolution usually requires
participatory institutions.
▪ Sustained technological progress is disruptive and authoritarian regimes
have difficulty dealing with the change.
▪ The old monarchies of Europe fell and were replaced with democracies or
limited monarchies.
▪ Can China maintain strong economic growth without political
transformation?
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8.5 A KEY GOVERNMENTAL ROLE: PROVIDING
THE CORRECT INCENTIVES AND PROPERTY
RIGHTS
What is the connection between property rights and economic growth?
• Without clear property rights, there are no proper incentives to invest in the future—
the essence of economic growth.
What else can go wrong?
• Governments in developing countries often:
• Adopt policies that effectively tax exports
• Pursue policies that lead to rampant inflation
• Enforce laws that inhibit the growth of the banking and financial sectors
Results:
• Fewer exports
• Uncertain financial environment
• Reduced saving and investment
With the right incentives, individuals and firms in developing countries will take actions
that promote economic growth.
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APPLICATION
7
LACK OF PROPERTY RIGHTS HINDERS
GROWTH IN PERU
APPLYING THE CONCEPTS #7: Why are clear property rights
important for economic growth in developing countries?
Throughout the developing world, property is often not held with clear title.
Without clear title, property cannot be used as collateral for loans.
• Result: The poor living on very valuable land may be unable to borrow
against that land to start a new business.
• Producing palm oil in Peru is very profitable, but it depends upon the ability
to borrow funds.
• Production of coca paste—an ingredient to cocaine—does not take as much
time and does not depend on finance.
• Switching farmers away from production of coca paste to palm oil also
requires improvements in finance, which are very difficult without clear
property rights.
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KEY
TERMS
capital deepening
labor productivity
convergence
new growth theory
creative destruction
real GDP per capita
growth accounting
rule of 70
growth rate
saving
human capital
technological progress
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APPENDIX A A MODEL OF CAPITAL DEEPENING
PRINCIPLE OF DIMINISHING RETURNS
Suppose output is produced with two or more inputs, and we increase one
input while holding the other input or inputs fixed. Beyond some point—called
the point of diminishing returns—output will increase at a decreasing rate.
► FIGURE 8A.1
Diminishing Returns to
Capital
Holding labor constant,
increases in the stock of
capital increase output, but at
a decreasing rate.
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APPENDIX A A MODEL OF CAPITAL DEEPENING
 FIGURE 8A.2
Saving and Depreciation as Functions of the Stock of Capital
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APPENDIX A A MODEL OF CAPITAL DEEPENING
► FIGURE 8A.3
Basic Growth Model
Starting at K0, saving exceeds
depreciation. The stock of
capital increases.
This process continues until the
stock of capital reaches its
long-run equilibrium at K*.
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APPENDIX A A MODEL OF CAPITAL DEEPENING
FIGURE 8A.4
Increase in the Saving Rate
A higher saving rate will lead to a higher stock of capital in the long run. Starting from an
initial capital stock of K1, the increase in the saving rate leads the economy to K2.
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APPENDIX A A MODEL OF CAPITAL DEEPENING
▲FIGURE
8A.5
Technological Progress and Growth
Technological progress shifts up the saving function and promotes capital deepening.
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Questions?
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