Questions What causes long-term GDP (potential GDP) and per-capita GDP (standard of living) to grow over time? What types of economic policies can the government use to stimulate GDP growth?
Growth and Production Function The key to growth in potential GDP is growth in labor/worker productivity: Y p = L* x (Y/L*) = (Hours of work) x (Labor productivity) What drives labor productivity growth?
Three Pillars of Productivity Growth: (i)Capital (K) (ii)Technology (TFP) (iii)Human capital (HK) - One measure is educational attainment. Productivity Growth and shifts in the production function.
Growth Accounting in US Labor Productivity2.8%1.4% 2.8% Capital0.9%1.0% 1.7% Technology1.9%0.4% 1.1%
TABLE 4: Average Years of Schooling for Selected Countries
Growth and Production Possibilities Goods can be classified into two types: (i)Consumption goods – to be consumed (not used to make goods). (ii)Capital goods – to be used in the manufacturing of other goods (may include human capital) GDP must be divided between consumption and capital goods.
GDP and Society’s Choices Today Capital Goods c PPF 0 b a Consumption Goods
GDP and Society’s Choices: Tomorrow (if No Capital Depreciation): Choice a Capital Goods c Consumption Goods b a PPF 0 = PPF a
GDP and Society’s Choices Tomorrow: Choice b Capital Goods c Consumption Goods b a PPF a PPF b
GDP and Society’s Choices Tomorrow: Choice c Capital Goods c Consumption Goods b a PPF a PPF c PPF b
For a given level of technology investment in physical or human capital is necessary for economic growth. Increases in TFP can increase economic growth for any given capital-consumption combination.
GDP and Society’s Choices: Growth in TFP Capital Goods c PPF 0 b a Consumption Goods PPF 1
International Comparisons What explains international differences in standard of living? How have these differences changed over time? Poorer countries low per-capita GDP Richer countries high per-capita GDP
Productivity and Growth in Selected Countries GDP/Hour 1998 Country(% of US)Growth US France982.5 UK792.2 Germany772.4
The convergence hypothesis: Productivity growth of poorer countries tend to be higher than richer countries. Per-capita GDP among countries tend to converge.
Productivity in Selected Countries GDP/Hour Country(% of US)(% of US)Growth US France UK Germany
Figure 2 The Convergence Hypothesis
Reasons for International Convergence (i)Diminishing Returns (ii)Learning from Richer Countries Problem: Poorest countries are falling behind. They don’t have (i)Infrastructure, facilities (ii)Educational structure
Productivity in Selected Countries GDP/Hour Country(% of US)(% of US)Growth US France UK Germany Argentina Mexico Peru
Growth Policies Capital Formation Policies: *Lower Interest Rates *Tax Provisions (capital gains/corporate) *Political Stability/Property Rights *Direct Government Investment Education and Training Helping Developing Countries (foreign direct investment, World Bank Aid)
Historical Record of U.S. Productivity Post WWII: *Confidence and business optimism high *Low Interest Rates *High government spending on infrastructure Productivity Slowdown: *High energy prices *Slow pace of technical progress?
1995-present *Lower energy prices *Peace Dividend *Computing and Information Technology