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Chapter 7 Economic Growth: Theory and Policy Once one starts to think about... [differences in growth rates among countries], it is hard to think about.

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Presentation on theme: "Chapter 7 Economic Growth: Theory and Policy Once one starts to think about... [differences in growth rates among countries], it is hard to think about."— Presentation transcript:

1 Chapter 7 Economic Growth: Theory and Policy Once one starts to think about... [differences in growth rates among countries], it is hard to think about anything else. ROBERT E. LUCAS, JR.

2 Three Pillars of Productivity Growth Growth policy –High sustainable long-run growth Potential GDP Represented by production function Y=zF(K,L) Stabilization policy –Keep actual GDP Close to potential GDP - short run No high unemployment No high inflation 2

3 Three Pillars of Productivity Growth Labor productivity grows: –Larger capital stock (K↑) Given technology & labor force –Better technology (z↑) Given capital & labor –Workforce quality (L↑) More education & training Given capital, technology, labor force Human capitalHuman capital (education & training) –Amount of skill embodied in workforce –Labor (L) = number of worker (N) * H 3

4 Production functions corresponding to three different capital stocks Figure Hours of Labor Input Output L1L1 YaYa K1K1 YbYb YcYc K2K2 K3K3 c b a

5 Levels, Growth Rates, & Convergence Level of productivity –Higher in rich countries –Depends on Supply of human & physical capital State of technology Growth rate of productivity –Depends on growth rates of Capital (K) Workforce skills (H) Technology (z) 5

6 Productivity levels and productivity growth rates in selected countries Table 1 6 Country GDP per hour of work 1980 (as percentage of U.S.) GDP per hour of work 2005 (as percentage of U.S.) Growth rate United States France United Kingdom Spain Ireland Argentina Mexico Brazil South Korea

7 Levels, Growth Rates, & Convergence ConvergenceConvergence hypothesis –Nations with low levels of productivity High productivity growth rates –International productivity differences Shrink over time –Poorer countries Higher productivity growth 7

8 The Convergence Hypothesis Figure Time Real GDP per capita $2,000 Poorer country $10,000 Richer country

9 Levels, Growth Rates, & Convergence Technological laggards –Can close the income gap –Imitation, not innovation Adopt existing technologies –Example: Boeing 767 in domestic airline, cell phone and internet access in China –“Convergence club” Productivity growth rates - higher –Where productivity levels are lower (South Korea, China, India, Ireland, …) Poorest nations –Unable to join 9

10 Levels and growth rates of GDP per capita in selected poor countries Table 2 10 CountryGDP per capita 2005* GDP per capita growth rate, Belarus Russia Ukraine Peru Haiti Burundi Sierra Leone $1,868 2, , % *in constant 2000 U.S. dollars

11 Growth Policy: Capital Formation Nation’s capital –Available supply Plant, equipment, software –Result of past decisions – investments Investment –Flow of resources Production of new capital –Inputs Construction of capital –Period of time 11

12 Growth Policy: Capital Formation Capital formation –Investment –Process of building up capital stock Trade-off –More capital formation Quicker growth Consume less today –More consumption today Less capital formation Slower growth 12

13 Choosing between investment and consumption Figure Consumer Goods Produced Investment Goods Produced D C I A

14 Growth Policy: Capital Formation Speed up capital formation / investment –Lower real interest rates –Tax provisions –Technical change –Growth of demand –Political stability –Property rights Laws and/or conventions Owners - rights to use their property 14

15 Selected countries ranked by level of investor protection Table 3 15 CountryRating (0-10 scale) Singapore United States Canada United Kingdom Japan Mexico India Sweden Brazil Italy China Swaziland

16 Growth Policy: Education & Training More-educated & better-trained workers –Higher productivity –Higher wages Education policy –Improve quality of education Earning gap High school graduates College graduates On-the-job-training –Skills acquired at work 16

17 Wage premium for college graduates over high school graduates Figure 4 17

18 Growth Policy: Technological Change Advancement of technology –More education Scientific, engineering, managerial –More capital formation –Research & development (R&D) Inventing new products/processes Improving existing ones R&D – encouraged by government –Tax credit –Collaborative research –Spending on R&D 18

19 Productivity Slowdown & Speed-up, U.S : 2.8% Productivity slowdown, 1.4% –Lagging investment –High energy prices –Inadequate workforce skills –Not: technological slowdown 19

20 Average productivity growth rates in the United States, 1948–2007 Figure 5 20

21 Productivity Slowdown & Speed-up, U.S Productivity speed-up, 2.5% –IT revolution –Surging investment –Falling energy prices –Advances in information technology 21

22 Growth in the Developing Countries Poorly endowed with capital –Difficult to accumulate capital Development assistance – foreign aid –Outright grants & Low-interest loans –From rich countries & multinational institutions –To spur economic development 22

23 Growth in the Developing Countries Foreign direct investment –Purchase/construction Real business assets –Multinational corporations Low level of technology Low levels of education & training Poor geographical conditions Poor health Governance 23

24 Average educational attainment in selected countries, 2000 Table 4 24 United States Canada South Korea Japan United Kingdom Italy Mexico India Brazil Sudan For people older than 25 years of age

25 From the Long Run to the Short Run Over long periods of time –Similar growth rates Actual GDP Potential GDP Macroeconomic fluctuations –GDP shrinks – recessions Needed: a short-run theory of AD (next chapter) 25

26 Summary Source of economic growth (K, z, and H) Convergence hypothesis Growth policy –Capital formation –Improve education and training –Spur technical change Productivity slowdown and speed-up Growth in the developing countries

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