Transcript 8. Why Do Economies Grow?

Economics
NINTH EDITION
Chapter 8
Why Do Economies
Grow?
Prepared by Brock Williams
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Learning Objectives
8.1 Calculate economic growth rates.
8.2 Explain the role of capital in economic growth.
8.3 Explain the importance of technological progress to
economic growth.
8.4 Discuss the sources of technological progress.
8.5 Assess the role of government in assisting economic
growth.
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8.1 ECONOMIC GROWTH RATES (1 of 5)
• 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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▼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 (2 of 5)
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 (3 of 5)
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 (4 of 5)
Comparing the Growth Rates of Various Countries
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8.1 ECONOMIC GROWTH RATES (5 of 5)
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.
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 1
GLOBAL WARMING, RICH COUNTRIES, AND POOR COUNTRIES
APPLYING THE CONCEPTS #1: How may global warming affect economic growth?
The effects of global warming on economic development are very complex
• The effect of increases in temperature seem to be confined to poor countries
• In Latin and South America, each 1 degree Celsius increase resulted in a 1.2 to 1.9 percent
decline in per capita income
• Exports also declined between 2.0 and 5.7 percent.
• By deferring global warming into the future, poor countries may have time to develop and
avoid the worst of the impact.
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APPLICATION 2
BEHAVIORAL INCENTIVES IN DEVELOPMENT
APPLYING THE CONCEPTS #2: How can we persuade very poor people in developing
countries to immunize their children?
•
•
•
•
Public health officials in India noticed that parents typically would begin to get vaccines for
their children, but often failed to finish the entire sequence of vaccines. Were their incentives
that might work?
Ester Duflo and Abhijit Banerjee of MIT persuaded a group trying to increase immunizations
to experiment with economic incentives.
In the experiment, parents would receive some dal (a common Indian food) after each shot
for their children. When they completed the entire sequence of shots, they would receive a
set of cooking pans.
The incentive worked extremely well in increasing the success rate for immunizations.
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8.2 CAPITAL DEEPENING
(1 of 3)
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
(2 of 3)
Saving and Investment
• Saving
Income that is not consumed.
C+S=Y
C+I=Y
S=I
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8.2 CAPITAL DEEPENING
(3 of 3)
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.
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
(1 of 4)
How Do We Measure Technological Progress?
Y = F(K, L)
Y = F(K, L, A)
• 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?
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(2 of 4)
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
(3 of 4)
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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Using Growth Accounting (4 of 4)
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.
SOURCE: Bureau of Labor Statistics, 2015.
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APPLICATION 4
THE END OF GROWTH?
APPLYING THE CONCEPTS #4: Can we predict future productivity growth from past
historical episodes?
•
•
•
•
•
•
•
Robert J. Gordon a professor of economics at Northwestern University, has recently predicted that
economic growth in the U.S. in this century will be only slightly positive and very close to zero. Why is
Gordon so pessimistic?
Gordon notes that economic growth as we know it is a fairly recent phenomenon in world history. The
U.S. has had robust growth over its history, but major innovations were concentrated in three waves.
The first wave, 1750–1830, centered on steam generation and railroads.
The second wave, 1870–1900, was driven by electricity ad communications.
The third wave, 1960–present, was generated by telecommunications and computers.
Based on work in growth accounting, Gordon thinks we may have exhausted the benefits of the third
wave of innovations.
Others believe that computer technology and global interconnectedness of the Internet will allow room
or more growth.
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8.4 WHAT CAUSES
TECHNOLOGICAL PROGRESS?
Research and
Development Funding
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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(1 of 3)
8.4 WHAT CAUSES
TECHNOLOGICAL PROGRESS?
(2 of 3)
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?
(3 of 3)
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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APPLICATION 6
CULTURE, EVOLUTION AND ECONOMIC GROWTH
APPLYING THE CONCEPTS #6: Did culture or evolution spark the Industrial Revolution?
In studying the economic history of England before the Industrial Revolution, Professor Clark
discovered an interesting fact.
• He found that children of the more affluent members of English society were
more likely to survive than those of the less affluent.
• With the slow growth of population over several centuries, this differential survival of the wealthy
had the effect of creating downward mobility for the rich, as their sons and daughters increasingly
populated the society.
This change had profound effects on English society. The cultural habits of the rich filtered
through the entire society.
• Social virtues such as thrift, prudence, and hard work became more commonplace, while
impulsive and violent behaviors were reduced.
•
Eventually, these changes in culture became sufficiently pronounced that a qualitative change
took place in society.
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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
Convergence
Creative destruction
Growth accounting
Growth rate
Human capital
Labor productivity
New growth theory
Real GDP per capita
Rule of 70
Saving
Technological progress
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APPENDIX A A MODEL OF CAPITAL
DEEPENING (1 of 4)
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.
Holding labor constant, increases in the
stock of capital increase output, but at a
decreasing rate.
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▼FIGURE 8A.2
Saving and Depreciation as Functions of the Stock of Capital
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APPENDIX A A MODEL OF CAPITAL
DEEPENING (2 of 4)
Change in the stock of capital =
salving - depreciation = sY - dK
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 (3 of 4)
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 (4 of 4)
Technological progress shifts up
the saving function and promotes
capital deepening.
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