Long-run economic growth is measured as the increase in real GDP per capita Real GDP per capita differences over time and across countries Productivity is the key to long-run economic growth. Productivity is driven by physical capital, human capital, and technological progress The factors that explain why long-run growth rates differ so much among countries How growth has varied among regions of the world. Growth and sustainability: challenges posed by scarcity of natural resources and environmental degradation Long-run Economic Growth: Main Topics
Levels and Growth Main focus in the chapter is on Real GDP per capita. Real GDP per capita = Real GDP/Population Interested in differences between countries at a point in time (2010 data in 1990 $) as an indicator of relative well-being: Canada $24,941 China $8,032 India $3,372 Also interested in differences in levels of Real GDP per capita in a given country across time (in 1990 $) as an indicator of progress: Canada$904$24,941 Growth rates in real GDP per capita also a focus e.g. annual growth 100% x (GDP this year – GDP last year)/GDP last year
Economic Growth Across Time and Space
Real GDP per Capita Selected Countries CanadaUnited StatesArgentinaS. KoreaChinaIndia 1820$904$1,361$998$335$ $2,911$4,091$2,875$455$545$ $8,753$11,328$5,559$1,226$662$ $24,941$30,491$10,256$21,701$8,032$3,372 (Maddison Project Data units are 1990 international $s) Big differences between countries at a point in time. Big differences in growth over time: US, Canada: significant growth over time. Argentina falls behind; South Korea catching up. China started growing rapidly in the 1980s.
Canadian Real GDP per Capita: Growth over time
Income Around the World, 2010 (Source: World Bank, World Development Indicators)
Growth Rates How did Canada manage to produce over eight times as much per person in 2011 than in 1900? A little bit at a time! Long-run economic growth is normally a gradual process in which real GDP per capita grows at most a few percent per year. From 1900 to 2011, real GDP per capita in Canada increased an average of 1.95% each year. (How? Higher by factor of 8.69 in 2011 (see Table 9.1) 8.69= (1+g) 111 (solve for g) )
Rule of 70 and Approximate Doubling Time The Rule of 70 approximates how long it takes real GDP per capita, or any other variable that grows gradually over time, to double. ( Why? If g is growth rate (g=.02 is 2%) and d=doubling time. Then: (1+g) d = 2 takes logs:d ln(1+g) = ln(2) d = ln(2)/ln(1+g) =.693/ln(1+g) ≈.70/g ! ) Canada at 1.95% (above): Doubling time = 70/1.95 = 35.7 years.
Cross-Country Comparison of Growth Rates
Growth rates and Growth Miracles Growth miracles are periods of sustained high growth rates. e.g. China since 1980, East Asian Miracle countries 1960s-90s. How high can they go? M. Spence The Next Convergence identifies 12 episodes of 7% or higher growth that lasted 25 or more years. (see table on course site) Who tends to experience these high, persistent growth rates? Initially poor countries experiencing “catch-up” growth.
Accounting for Growth: some definitions Labour productivity, often referred to simply as productivity, is output per worker (Y/L). Physical capital consists of human-made resources such as buildings and machines (K). Human capital is the improvement in labour created by the education and knowledge embodied in the workforce (H). Technology is the technical means for the production of goods and services (A).
The Sources of Long-Run Growth Two possible sources of growth in Real GDP (Y): (1) More inputs More labour (L) More physical capital (K) More skills (human capital), (H) More natural resources (land, raw materials) (2) More output per unit input, i.e. higher productivity Why?Better technology and organization (A). This can be summarized using an “Aggregate Production Function”
The aggregate production function shows how the aggregate real quantity of output is produced using the available factors of production and technology. The per worker production function shows how productivity (Y/L) depends on physical capital per worker (K/L) and human capital per worker (H/L) and technology (A). Accounting for Growth: The Aggregate Production Function
A recent example of an aggregate production function applied to real data is a comparative study of Chinese and Indian economic growth by the economists Bosworth and Collins of the Brookings Institution. They used the following aggregate production function:
Accounting for Growth: The Aggregate Production Function Using this function, they tried to explain why China grew faster than India between 1978 and About half the difference was due to China’s higher levels of investment spending, which raised its level of physical capital per worker faster than India’s. The other half was due to faster Chinese technological progress.
Diminishing Returns to Physical Capital An aggregate production function exhibits diminishing returns to physical capital when, holding the amount of human capital and the state of technology fixed, each successive increase in the amount of physical capital leads to a smaller increase in productivity. If there are diminishing returns the slope of the aggregate production function is flatter at higher levels of capital per worker (see next slide).
Physical Capital and Productivity
Diminishing Returns: a good assumption? Plausible? Each extra bit of K has less L to work with and is less productive as a result. Initial K: used in the highest payoff ways, later K in next highest, etc. R. Allen Global Economic History – seems to fit the data! Consequences of diminishing returns? Rich countries have high K/L but less ability to grow by adding capital. Poor countries have low K/L and high ability to grow by adding capital. Returns to capital investment will be higher in poor countries. Why do growth miracles end? Diminishing returns? China?
Growth Accounting, Capital and Growth Growth accounting estimates the contribution of each major factor in the aggregate production function to economic growth. The amount of physical capital per worker grows 3% a year. According to estimates of the aggregate production function, each 1% rise in physical capital per worker, holding human capital and technology constant, raises output per worker by one-third of 1%, or 0.33%. Total factor productivity (TFP) captures all inputs and technological features left out of the aggregate production function.
Technological Progress and Productivity Growth
What About Natural Resources? Straightforward to add them to the aggregate production function. Then resources per worker are another determinant of Y/L. In contrast to earlier times, natural resources are a much less important determinant of productivity than human or physical capital for the great majority of countries. For example, some nations with very high real GDP per capita, such as Japan, have very few natural resources. Some resource-rich nations, such as Nigeria, are very poor.
Industrial Revolutions and Growth Accounting Sustained economic growth is a modern phenomenon. - UK the first: associated with the Industrial Revolution. UK’s Industrial revolution (starts in mid-late 1700s): Technological change (UK: steam power!) Changes in economic organization (urban factories) Creation of lots of new capital (machines, factories, railways and canals). So: more inputs (capital) and higher productivity (TFP) via technological advance and organizational change. Later cases: copy rich country technology and organization.
ECONOMICS IN ACTION Information Technology and Productivity Output per worker is a simple proxy for the standard of living of members of a society in the long-run. From the early 1970s through the mid-1990s, Canada went through a slump in growth of both output per worker and total factor productivity. A significant portion of the growth of output per worker comes from total factor productivity (TFP). Technological progress is a key determinant of TFP growth.
ECONOMICS IN ACTION The Information Technology Paradox Why didn’t information technology show large rewards? Info tech revolution: well under way by the mid-1980s. Productivity only takes off when people change their way of doing business to take advantage of the new technology—e.g. replacing letters and phone calls with electronic communications. This takes time! Sure enough, productivity growth accelerated dramatically in the second half of the 1990s.
Why Growth Rates Differ A number of factors influence differences among countries in their growth rates. These are government policies and institutions that alter: savings and investment spending (creates capital) foreign investment (creates capital) Education (via human capital) Infrastructure (capital) research and development (technology) maintaining a well-functioning financial system (via capital) the protection of property rights (R&D, K investment, incentives) political stability and good governance (R&D, investment)
The Role of Government in Promoting Economic Growth Government subsidies play an important role in building infrastructure, provision of education, and promoting R&D. A well-functioning financial system requires appropriate government regulation to efficiently channel savings into investment spending. Political stability and protection of property rights are crucial ingredients in long-run economic growth.
The Role of Government in Promoting Economic Growth BUT: Even when governments aren’t corrupt, excessive government intervention can be a brake on economic growth. If large parts of the economy are supported by government subsidies, protected from imports, or otherwise insulated from competition, productivity tends to suffer because of a lack of incentives.
FOR INQUIRING MINDS The New Growth Theory Spending on R&D is quite different from investment in new factories or office buildings. As the Stanford economist Paul Romer argued in a series of influential papers in the late 1980s and early 1990s, spending on physical capital increases the economy’s resources; R&D, on the other hand, involves the creation of “improved instructions” for working with resources.
FOR INQUIRING MINDS The New Growth Theory There’s a fundamental difference between, say, manufacturing a tractor and developing an improved set of instructions for using tractors. If more people want to use tractors, more tractors must be built, but once an improved farming technique has been developed, “the instructions can be used over and over again at no additional cost.”
FOR INQUIRING MINDS The New Growth Theory But what’s the incentive for firms to spend money on the development of new sets of instructions, when others can copy those instructions at no additional cost? The answer suggested by Romer and others was that technological progress depends on the ability of innovators to establish monopolies. For a time after they have created new products or techniques, they are the only ones who can use them, either because of formal patent protection or because they have a head start over imitators.
ECONOMICS IN ACTION: two growth stories The Brazilian Breadbasket In recent years, Brazil’s economy has made a strong showing, especially in agriculture. This success depends on exploiting a natural resource, the tropical savannah known as the cerrado. Three factors changed this land into a useable resource: technological progress due to research and development improved economic policies addition of physical capital Brazil has overtaken the United States as the world’s largest beef exporter and may not be far behind in soybeans.
ECONOMICS IN ACTION The Alberta Oilsands Alberta has experience strong growth in recent years from exploiting its oilsands. Like Brazil, Alberta’s growth required: technological progress due to research and development addition of physical capital
Success, Disappointment, and Failure
The world economy contains examples of success and failure in the effort to achieve long-run economic growth. East Asian economies have done many things right and achieved very high growth rates. In Latin America, where some important conditions are lacking, growth has generally been disappointing. In Africa, real GDP per capita has declined for several decades, although there are some signs of progress now.
Success, Disappointment, and Failure East Asia’s spectacular growth was generated by high savings and investment spending rates, emphasis on education, and adoption of technological advances from other countries. (↑K, ↑H, ↑A (TFP) ) Poor education, political instability, and irresponsible government policies are major factors in the slow growth of Latin America. In sub-Saharan Africa, severe instability, war, and poor infrastructure— particularly affecting public health—have resulted in a catastrophic failure of growth. Encouragingly, the economic performance since the mid-1990s has been much better than in preceding years.
ECONOMICS IN ACTION Are Economies Converging? The growth rates of economically advanced countries have converged, but not the growth rates of countries across the world. This has led economists to believe that the convergence hypothesis fits the data only when factors that affect growth, such as education, infrastructure, and favorable policies and institutions, are held equal across countries. If a country can establish preconditions for growth it appears it can converge toward the leaders.
Real Income per Capita: the Hockey Stick
Convergence since the Industrial Revolution Economic history: the hockey stick again! Shaft: Real GDP per capita flat for centuries. Blade: Real GDP per capita grows in industrialized countries. Periodically new countries seen to move from shaft to blade, i.e. move into sustained economic growth. UK in late 1700s; Western Europe early-mid 1800s. Western offshoots (US, Canada, Australia, NZ): 1800s. Japan: later 1800s, early 1900s. Russia and Eastern Europe. East Asian miracle countries (Taiwan, S. Korea, HK, Singapore) China right now, perhaps some other South-east Asian countries. Others: start and stop in Latin America and N. Africa. Will all countries eventually join this rich country group?
ECONOMICS IN ACTION
Is World Economic Growth Sustainable? Long-run economic growth is sustainable if it can continue given limited natural resources and impacts of growth on the environment. Natural resources and limits to growth. Finite non-renewable resources (oil, iron ore, etc.) Renewable resources: less of an issue if well managed. Do limited resources limit growth? Key: how does the economy respond to resource scarcity? Resource prices rise: creates incentives to conserve and find alternatives; incentives for resource-using industries to shrink. New ways of producing goods & changes in what the economy produces means growth can continue even if some resources are exhausted. Technology and new physical capital can allow growth to continue. Resource intensity of output falls.
The Real Price of Oil,
Oil Consumption in Canada: Responding to Oil Prices
Economic Growth and the Environment Growth and the Environment: two points Real GDP per capita measure: omits environmental quality. A problem! Well-being is affected by $ and environment. Growth could make us worse off if costs of environmental degradation outweigh benefits of extra real GDP. Environmental degradation may limit the ability of the economy to produce output in the future. Resource scarcity: incentives can likely deal with this. Environmental degradation: requires effective government intervention. Individuals (businesses, people) have limited private incentives to deal with environmental problems.
Climate Change and Growth
Climate Change Climate change and real GDP. Consequences for GDP via effects on agriculture, forestry, rising sea levels, possible geopolitical instability etc. (See IPCC reports: There is broad consensus that government action to address climate change and greenhouse gases should be in the form of market-based incentives, like a carbon tax or a cap and trade system. It will also require rich and poor countries to come to some agreement on how the cost of emissions reductions will be shared.
1.Growth is measured as changes in real GDP per capita in order to eliminate the effects of changes in the price level and changes in population size. Levels of real GDP per capita vary greatly around the world: about half of the world’s people live in countries with a lower standard of living than Canadians had a century ago. Over the course of the twentieth century, real GDP per capita in Canada increased more than six-folds. Summary
2.Growth rates of real GDP per capita also vary widely. According to the Rule of 70, the number of years it takes for real GDP per capita to double is equal to 70 divided by the annual growth rate of real GDP per capita. 3.The key to long-run economic growth is rising labour productivity, or just productivity, which is output per worker. Increases in productivity arise from increases in physical capital per worker and human capital per worker, as well as advances in technology. The aggregate production function shows how real GDP per worker depends on these three factors. Summary
3.(Cont.) Other things equal, there are diminishing returns to physical capital: holding human capital per worker and technology fixed, each successive addition to physical capital per worker yields a smaller increase in productivity than the one before. Growth accounting, which estimates the contribution of each factor to a country’s economic growth, has shown that rising total factor productivity is key to long-run growth. It is usually interpreted as the effect of technological progress. Summary
4.The large differences in countries’ growth rates are largely due to differences in their rates of accumulation of physical and human capital as well as differences in technological progress. A prime factor is differences in savings and investment rates. Technological progress is largely a result of research and development, or R&D. Summary
5.Government actions that help growth are the building of infrastructure, particularly for public health, the creation and regulation of a well-functioning banking system that channels savings and investment spending, and the financing of both education and R&D. Government actions that retard growth are political instability, the neglect or violation of property rights, corruption, and excessive government intervention. Summary
6.The world economy contains examples of success and failure in the effort to achieve long-run economic growth. East Asian economies have done many things right and achieved very high growth rates. In Latin America, where some important conditions are lacking, growth has generally been disappointing. In Africa, real GDP per capita has declined for several decades, although there are recent signs of progress. Summary
6.(Cont.) The growth rates of economically advanced countries have converged, but not the growth rates of countries across the world. This has led economists to believe that the convergence hypothesis fits the data only when factors that affect growth, such as education, infrastructure, and favorable policies and institutions, are held equal across countries. Summary
7.Economists generally believe that environmental degradation poses a greater problem for long-run economic growth is sustainable than does natural resource scarcity. Addressing environmental degradation requires effective governmental intervention, but the problem of natural resource scarcity is often well handled by the market price response. 8.The emission of greenhouse gases is clearly linked to growth, and limiting them will require some reduction in growth. However, the best available estimates suggest that a large reduction in emissions would require only a modest reduction in the growth rate. Summary
9.There is broad consensus that government action to address climate change and greenhouse gases should be in the form of market-based incentives, like a carbon tax or a cap and trade system. It will also require rich and poor countries to come to some agreement on how the cost of emissions reductions will be shared. Summary
Rule of 70 Labour productivity Productivity Physical capital Human capital Technology Aggregate production function Diminishing returns to physical capital Growth accounting Total factor productivity Research and development (R&D) Infrastructure Convergence hypothesis Sustainable Key Term