Transcript Chapter 22: Why Do Economies Grow?

CHAPTER
16
Why Do Economies Grow?
C H A P T E R 16: Why Do Economies Grow?
Why Do Economies Grow?
• Economists believe that there are two basic
mechanisms that increase GDP per capita
over the long term:
1. Capital deepening: an increase in the economy’s
stock of capital—plant and equipment—relative to
its workforce.
2. Technological progress: the ability to produce
more output without using any more inputs—capital
or labor.
• The role of education and investment in
human beings in fostering economic
development is called human capital.
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C H A P T E R 16: Why Do Economies Grow?
Economic Growth Rates
• A meaningful measure of the standard of
living in a given country is real GDP per
capita, or real GDP per person.
• Real GDP per capita typically grows over
time. The growth rate of a variable is the
percentage change in that variable from
one period to another:
GDP in year 2  GDP in year 1
%GDP 
x100%
GDP in year 1
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C H A P T E R 16: Why Do Economies Grow?
Measuring Economic Growth
• If the economy started at 100 and grew at a
rate g for n years, then real GDP after n years
equals:
GDPn YEARS LATER  (1  g) n (100)
• At 4% for the next ten years, GDP will be:
GDP 10 YEARS LATER  (1  0.04)10 (100) = 148
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C H A P T E R 16: Why Do Economies Grow?
Measuring Economic Growth (Continued)
• To find out how many years it would take
for GDP to double, we use the rule of 72:
If an economy grows at x percent per year,
output will double in 72/x years.
Rule of 72: Divide 72 by the annual
growth rate to determine the number of
years it will take to double in size.
• For example, If a country has a 4 percent
annual growth rate, then real GDP will take
18 years to double (72/4) = 18.
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C H A P T E R 16: Why Do Economies Grow?
Comparing the Growth Rates
of Various Countries
GNP Per Capita and Economic Growth
Country
United States
GNP Per Capita
in 2001 dollars
$34,280
Per Capita Growth Rate,
1960-2001
2.18%
Japan
25,550
4.16
Italy
24,530
3.07
United Kingdom
24,340
2.17
France
24,080
2.70
Costa Rica
9,260
2.50
Mexico
8,240
2.27
India
2,820
2.43
Zimbabwe
2,220
.82
Pakistan
1,860
.98
750
-1.15.
Zambia
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C H A P T E R 16: Why Do Economies Grow?
Are Poor Countries Catching Up?
• Economists question whether poorer
countries can close the gap between their
level of GDP per capita and that of richer
countries.
• The process by which poorer countries
catch up with richer countries in terms of
real GDP per capita is called convergence.
• To converge, poor countries have to grow at
more rapid rates than richer countries are
growing.
• In the last twenty years, there has been little
convergence.
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C H A P T E R 16: Why Do Economies Grow?
Capital Deepening
• One of the most important mechanisms of
economic growth economists have
identified is increases in the amount of
capital per worker due to capital
deepening.
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C H A P T E R 16: Why Do Economies Grow?
Capital Deepening (Continued)
• An increase in capital
means more output can be
produced.
• Firms will increase their
demand for labor and, as
they compete for a fixed
labor supply, real wages
will rise.
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C H A P T E R 16: Why Do Economies Grow?
Capital Deepening (Continued)
• How does an economy increase its stock of
capital?
• The economy must increase its net investment.
• To increase net investment, gross investment
must also rise.
• The amount of income available for investment
comes from saving.
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C H A P T E R 16: Why Do Economies Grow?
Saving and Investment
• Total income minus consumption is saving.
By definition, consumption plus saving equals
income:
C+S=Y
• At the same time, income—which is equivalent
to output—also equals consumption plus
investment:
C+I=Y
• Thus, saving must equal investment:
S=I
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C H A P T E R 16: Why Do Economies Grow?
Saving and Investment (Continued)
• This means, whatever consumers decide to
save goes directly into investment.
• It follows that in order for the stock of capital to
increase, gross investment must exceed
depreciation.
• The stock of capital increases with any gross
investment spending but decreases with any
depreciation.
• However, as capital grows, depreciation also
grows, eventually catching up to the level of
gross investment, and putting a stop to the
growth of capital deepening.
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C H A P T E R 16: Why Do Economies Grow?
How Does Population Growth
Affect Capital Deepening?
• Population growth, which increases the
size of the labor force, will cause the
capital per worker ratio to decrease.
• With less capital per worker, output per
worker will also tend to be less because
each worker has fewer machines to use.
This is an illustration of the principle of
diminishing returns.
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.
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C H A P T E R 16: Why Do Economies Grow?
How Does the Government Affect Capital
Deepening?
• The government can affect the process of capital
deepening in several ways:
• Higher taxes will reduce total income. Assuming that
households save a fixed fraction of their income, an
increase in taxes will cause savings to fall.
• As the government drains savings from the private
sector, the amount of total investment decreases, and
there is less capital deepening.
• This occurs when the government uses the taxes
collected from the private sector to engage in
consumption spending, not investment. However, if the
government taxes the private sector in order to increase
investment, then it will be promoting capital deepening.
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C H A P T E R 16: Why Do Economies Grow?
How Does Trade Affect Capital Deepening?
• The foreign sector can also affect capital
deepening.
• An economy can run a trade deficit and import
investment goods to aid capital deepening. It
can finance the purchase of those goods by
borrowing and, as investment raises, GDP
and economic wealth rises and the country
can afford to pay back the borrowed funds.
• Trade deficits that fund current consumption
do not aid in the process of capital deepening.
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C H A P T E R 16: Why Do Economies Grow?
The Key Role of Technological Progress
• Technological progress is the ability of an
economy to produce more output without
using any more inputs.
• With higher output per person, we enjoy a
higher standard of living.
• Technological progress, or the birth of new
ideas, is what makes us more productive.
Per capita output will rise when we
discover new and more effective uses of
capital and labor.
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C H A P T E R 16: Why Do Economies Grow?
How Do We Measure Technological
Progress?
• Robert Solow, a Nobel laureate in economics
from MIT, developed a method for determining the
contributions to economic growth from increased
capital, labor, and technological progress, called
growth accounting.
Y = F(K,L,A)
• Increases in A represent technological progress,
or more output produced from the same level of
inputs, K and L.
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C H A P T E R 16: Why Do Economies Grow?
How Do We Measure Technological
Progress? (Continued)
Percentage Contributions to Real GDP Growth
Technological
Progress
35%
Capital Growth
19%
Labor Growth
46%
•
Sources of Real GDP Growth,
1929-1982
(average annual percentage rates)
Growth due to capital growth
0.56%
Growth due to labor growth
1.34
+ technological progress
1.02
Total output growth
2.92
Total output grew at a rate of nearly 3%. Because capital
and labor growth are measured at 0.56% and 1.34%,
respectively, the remaining portion of output growth, 1.02%,
must be due to technological progress. That means that
approximately 35% of output growth came directly from
technological progress.
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C H A P T E R 16: Why Do Economies Grow?
Examples of Growth Accounting
• From 1980 to 1985, the economies of Hong
Kong and Singapore both grew at impressive
rates of about 6%, yet the causes and results
of growth in each country were very different.
• Singapore’s growth was attributed to
increases in labor and capital, while in Hong
Kong technological progress was the key to
growth.
• Residents of Hong Kong could enjoy the same
level of GDP but consume, not save, a higher
fraction of their GDP.
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C H A P T E R 16: Why Do Economies Grow?
What Caused Lower U.S. Labor
Productivity?
• Labor productivity is defined as output per
hour of work for the economy as a whole.
• Labor productivity measures how much a
typical worker can produce with the current
amount of capital and given the state of
technological progress.
• A significant slow-down in productivity in the
United States since 1973 meant slow growth
in real wages and in GDP.
• In recent years, there has been a resurgence
in productivity growth, which reached 2.5%
from 1994-2000.
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C H A P T E R 16: Why Do Economies Grow?
What Caused Lower U.S. Labor
Productivity? (Continued)
•
U.S. Annual Productivity
Growth, 1959-2002
Years
Annual Growth Rate
1959-1968
3.5%
1968-1973
2.5
1973-1980
1.2
•
1980-1986
2.1
1986-1994
1.4
1994-2000
2.6
The period of slower labor
productivity growth cannot be
explained by reduced rates of
capital deepening, nor by
changes in the quality of the
labor force.
A slowdown in technological
progress and higher energy
prices have been linked by
some economists to the
slowdown in productivity.
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C H A P T E R 16: Why Do Economies Grow?
Real Hourly Earnings and Total
Compensation in the United States
•
The slowdown in productivity
growth also meant slower
growth in real wages and in
GDP since 1973.
•
Total compensation did
continue to rise through the
1980s and 1990s.
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C H A P T E R 16: Why Do Economies Grow?
How Have the Internet and Information
Technology Affected GDP?
• “New economy” proponents believe the
computer and Internet revolution are
responsible for the increase in productivity
growth in the last half of the 1990s.
• Productivity growth continued to be rapid,
even during the recessionary period at the
beginning of this century, when most
economists believed it would slow down.
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C H A P T E R 16: Why Do Economies Grow?
What Causes Technological Progress?
•
Research and development in science.
•
Government or large firms who employ workers
and scientists to advance physics, chemistry, and
biology are engaged in technological progress in
the long run.
•
The United States has the highest percentage of
scientists and engineers in the labor force in the
world.
•
Not all technological progress is “high tech.”
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Research and Development Funding as a Percent
of GDP, 1999
Total
3.5
Non-Defense
3
2.5
2
1.5
1
0.5
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Fr
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m
an
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G
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te
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St
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s
0
U
Percent of GDP
C H A P T E R 16: Why Do Economies Grow?
Research and Development
Funding as a Percent of GDP, 1999
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C H A P T E R 16: Why Do Economies Grow?
What Causes Technological Progress?
(Continued)
• Monopolies that spur innovation
(Joseph Schumpeter).
• The process by which competition for
monopoly profits leads to technological
progress is called creative destruction
by Schumpeter.
• By allowing firms to compete to be
monopolies, society benefits from
increased innovation.
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C H A P T E R 16: Why Do Economies Grow?
What Causes Technological Progress?
• The scale of the market.
• Adam Smith stressed the importance of
the size of a market for economic
development.
• There are more incentives for firms to
come up with new products and
methods of production in larger
markets.
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C H A P T E R 16: Why Do Economies Grow?
What Causes Technological Progress?
• Induced innovations.
• Some economists emphasize that
innovations come about through
inventive activity designed specifically
to reduce costs.
• Education and the accumulation of
knowledge.
• Modern theories of growth that try to
explain the origins of technological
progress are know as new growth
theory.
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C H A P T E R 16: Why Do Economies Grow?
A Key Governmental Role: Getting the
Incentives Right
• Governments must design institutions in a
society in which individuals and firms work,
save, and invest.
• One of the basic laws of economics is that
individuals and firms respond to incentives.
• Policies that tax exports, lead to rampant
inflation, or inhibit the growth of the
banking and financial sectors can cripple
the economy’s growth prospects.
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C H A P T E R 16: Why Do Economies Grow?
Human Capital
• Human capital is an investment in human
beings—in their knowledge, skills, and health.
• In terms of understanding economic growth,
human capital investment has two implications:
• Not all labor is equal. Individuals with more
education will, on average, be more productive.
• Health and fitness affect productivity. If workers
are frail and ill, they can’t contribute much to
national output.
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C H A P T E R 16: Why Do Economies Grow?
New Growth Theory
• The work of economists that developed
models of growth that contained
technological progress as essential features
came to be known as new growth theory,
which accounts for technological progress
within a model of growth-- technology is
endogenous; it is a central part of the
economic system.
• Economists in this field study how incentives
for research and development, new product
development, or international trade interact
with the accumulation of physical capital.
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C H A P T E R 16: Why Do Economies Grow?
Coming Up (Ch. 17): International Trade
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