2 Long-run Economic Growth: Main Topics Long-run economic growth is measured as the increase in real GDP per capitaReal GDP per capita differences over time and across countriesProductivity is the key to long-run economic growth.Productivity is driven by physical capital, human capital, and technological progressThe factors that explain why long-run growth rates differ so much among countriesHow growth has varied among regions of the world.Growth and sustainability: challenges posed by scarcity of natural resources and environmental degradationLong-run Economic Growth: Main Topics
3 Levels and Growth Main focus in the chapter is on Real GDP per capita. Real GDP per capita = Real GDP/PopulationInterested in differences between countries at a point in time (2010 data in 1990 $) as an indicator of relative well-being:Canada $24, China $8, India $3,372Also 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 $24,941Growth rates in real GDP per capita also a focus e.g. annual growth100% x (GDP this year – GDP last year)/GDP last year
4 Economic Growth Across Time and Space Figure Caption: Figure 9(24)-1: Economic Growth in Canada, the United States, India, and China over the Past CenturyReal GDP per capita from 1900 to 2011, measured in 1990 international dollars, is shown for Canada, the United States, India, and China. Equal percent changes in real GDP per capita are drawn the same size. As the steeper slopes of the lines representing China and India show, since 1980 India and China had a much higher growth rate than Canada and the United States. In 1995, China attained the standard of living achieved in Canada in In 2011, India still had not attained the standard of living Canadians had in 1900.Sources: Angus Maddison, “Statistics on World Population, GDP, and Per Capita GDP, AD,” The Conference Board, Total Economy Database,
5 Real GDP per Capita 1820-2010 Selected Countries CanadaUnited StatesArgentinaS. KoreaChinaIndia1820$904$1,361$998$335$6001900$2,911$4,091$2,875$455$545$5991960$8,753$11,328$5,559$1,226$662$7532010$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.
6 Canadian Real GDP per Capita: Growth over time Table 9(24)-1: Canadian Real GDP per CapitaSources: Angus Maddison, “Statistics on World Population, GDP, and Per Capita GDP, AD,” The Conference Board, Total Economy Database,
7 Income Around the World, 2010 Figure Caption: Figure 9(24)-2: Incomes Around the World, 2010Although the countries of Europe and North America—along with a few in the Pacific—have high incomes, much of the world is still very poor. Today, about 50% of the world’s population lives in countries with a lower standard of living than Canada had a century ago.Source: International Monetary Fund.(Source: World Bank, World Development Indicators)
8 Growth RatesHow 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 in 2011 (see Table 9.1)8.69= (1+g) (solve for g) )
9 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.Canada at 1.95% (above): Doubling time = 70/1.95 = 35.7 years.Notes to the instructor:If real GDP per capita grows at 1% per year, it will take 70 years to double. If it grows at 2% per year, it will take only 35 years to double. In fact, Canadian real GDP per capita rose on average 1.95% per year from 1900 to Applying the Rule of 70 to this information implies that it should have taken 36 years for real GDP per capita to double; it would have taken 108 years—three periods of 36 years each—for Canadian real GDP per capita to double three times. That is, the Rule of 70 implies that over the course of 108 years Canadian real GDP per capita should have increased by a factor of 2 × 2 × 2 = 8. And this does turn out to be a pretty good approximation to reality, once we adjust for the fact that a century is a bit less than 108 years. During the twentieth century, Canadian real GDP per capita rose more than seven-fold, a bit less than eight-fold.( Why? If g is growth rate (g=.02 is 2%) and d=doubling time. Then:(1+g)d = 2takes logs: d ln(1+g) = ln(2)d = ln(2)/ln(1+g) = .693/ln(1+g) ≈ .70/g ! )
10 Cross-Country Comparison of Growth Rates Figure Caption: Figure 9-3: Comparing Recent Growth RatesThe average annual rate of growth of real GDP per capita from 1980 to 2010 is shown here for selected countries. China and, to a lesser extent, India and Ireland achieved impressive growth. Canada, the United States, and France had moderate growth. Once considered an economically advanced country, Argentina had more sluggish growth. Still others, such as Zimbabwe, slid backward.Source: International Monetary Fund.
11 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.
12 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).
13 The Sources of Long-Run Growth Two possible sources of growth in Real GDP (Y):(1) More inputsMore 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 productivityWhy? Better technology and organization (A).This can be summarized using an “Aggregate Production Function”
14 Accounting for Growth: The 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).𝑌=𝐴×𝐹(𝐾, 𝐿, 𝐻)𝑌 𝐿 =𝐴×𝑓 𝐾 𝐿 , 𝐻 𝐿
15 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:𝐺𝐷𝑃 𝑝𝑒𝑟 𝑤𝑜𝑟𝑘𝑒𝑟=𝐴× 𝑃ℎ𝑦𝑠𝑖𝑐𝑎𝑙 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑝𝑒𝑟 𝑤𝑜𝑟𝑘𝑒𝑟 0.4× 𝐻𝑢𝑚𝑎𝑛 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑝𝑒𝑟 𝑤𝑜𝑟𝑘𝑒𝑟 0.6Notes to the instructor:where A represented an estimate of the level of technology and they assumed that each year of education raises workers’ human capital by 7%.
16 Accounting for Growth: The Aggregate Production Function Using this function, they tried to explain why China grew faster than India between 1978 and 2004.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.
17 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).
18 Physical Capital and Productivity Figure Caption: Figure 9-4: Physical Capital and ProductivityThe per worker production function shows how, in this case, holding human capital per worker and technology fixed, productivity increases as physical capital per worker rises. Other things equal, a greater quantity of physical capital per worker leads to higher real GDP per worker but is subject to diminishing returns. Starting at the origin, 0, a $20,000 increase in physical capital per worker leads to an increase in real GDP per worker of $30,000, indicated by point A. Starting from point A, another $20,000 increase in physical capital per worker leads to an increase in real GDP per worker but only of $20,000, indicated by point B. Finally, a third $20,000 increase in physical capital per worker leads to only a $10,000 increase in real GDP per worker, indicated by point C.
19 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?
20 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.
21 Technological Progress and Productivity Growth Figure Caption: Figure 9(24)-5: Technological Progress and Productivity GrowthTechnological progress raises productivity at any given level of physical capital per worker, and therefore shifts the per worker production function upward. Here we hold human capital per worker fixed. We assume that the lower curve (the same curve as in Figure 9(24)-4) reflects technology in 1940 and the upper curve reflects technology in Holding technology and human capital fixed, tripling physical capital per worker from $20,000 to $60,000 leads to a doubling of real GDP per worker, from $30,000 to $60,000. This is shown by the movement from point A to point C, reflecting an approximately 1% per year rise in real GDP per worker. In reality, technological progress raised productivity at any given level of physical capital-shown here by the upward shift of the curve-and the actual rise in real GDP per worker is shown by the movement from point A to point D. Real GDP per worker grew 2% per year, leading to a quadrupling during the period. The extra 1% in annual growth of real GDP per worker is due to higher total factor productivity.
22 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.
23 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.
24 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.
25 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.
26 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)
27 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.
28 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.
29 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.
30 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.”
31 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.
32 ECONOMICS IN ACTION: two growth stories The Brazilian BreadbasketIn 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 developmentimproved economic policiesaddition of physical capitalBrazil has overtaken the United States as the world’s largest beef exporter and may not be far behind in soybeans.
33 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 developmentaddition of physical capital
34 Success, Disappointment, and Failure Figure Caption: Figure 9(24)-11: Success and DisappointmentReal GDP per capita from 1960 to 2010, measured in 2000 dollars, is shown for Argentina, South Korea, and Nigeria, using a logarithmic scale. South Korea and some other East Asian countries have been highly successful at achieving economic growth. Argentina, like much of Latin America, has had several setbacks, slowing its growth. Nigeria’s standard of living in 2010 was only barely higher than it had been in 1960, an experience shared by many African countries. Neither Argentina nor Nigeria exhibited much growth over the 50-year period, although both have had significantly higher growth in recent years.Source: World Bank.
35 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.
36 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.
37 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.Figure Caption: Figure 9(24)-9: Do Economies Converge?Data on today’s wealthy economies (measured in 1990 dollars) seem to support the convergence hypothesis. In panel (a) we see that among wealthy countries, those that had low levels of real GDP per capita in 1955 have had high growth rates since then, and vice versa. But for the world as a whole, there has been little sign of convergence. Panel (b) shows real GDP per capita in 1955 (also measured in 2000 dollars) and subsequent growth rates in major world regions. Poorer regions did not consistently have higher growth rates than richer regions: poor Africa turned in the worst performance, and relatively wealthy Europe grew faster than Latin America.Source: Angus Maddison, Statistics on World Population, GDP, and Per Capita GDP, 1–2006AD,
39 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?
40 ECONOMICS IN ACTIONFigure Caption: Figure 9(24)-12: Are Economies Converging?Data on today’s wealthy economies (measured in 1990 dollars) seem to support the convergence hypothesis. In panel (a) we see that among wealthy countries, those that had low levels of real GDP per capita in 1955 have had high growth rates since then, and vice versa. But for the world as a whole, there has been little sign of convergence. Panel (b) shows real GDP per capita in 1955 (also measured in 1990 dollars) and subsequent growth rates in major world regions. Poorer regions did not consistently have higher growth rates than richer regions: poor Africa turned in the worst performance, and relatively wealthy Europe grew faster than Latin America. Conditional convergence may still exist when holding other things – education, infrastructure, rule of law, and so on – constant.Source: Angus Maddison, Statistics on World Population, GDP, and Per Capita GDP, 1–2008AD,
41 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.
42 The Real Price of Oil,Figure Caption: Figure 9(24)-13: The Real Price of Oil, 1949–2010The real price of natural resources, like oil, rose dramatically in the 1970s and then fell just as dramatically in the 1980s. Since 2005, however, the real prices of natural resources have soared.Source: The U.S. Energy Information Administration.42
43 Oil Consumption in Canada: Responding to Oil Prices Figure Caption: Figure 9(24)-14: Oil Consumption and Growth in CanadaWhen oil prices increased in the early 1970s, Canadians responded by lowering their oil consumption in the early 1980s – the switch to more efficient automobiles and technologies takes time, so consumption decrease can occur with a lag. It happened also in the mid-2000s when oil prices again rose sharply. Regardless of whether oil consumption was rising or falling, however, the real GDP continued to grow, which suggests that economies can deal with scarce resources.Source: Oil consumption: The U.S. Energy Information Administration; Real GDP per capital: Statistics Canada.43
44 Economic Growth and the Environment Growth and the Environment: two pointsReal 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.
45 Climate Change and Growth Figure Caption: Figure 9(24)-15: Climate Change and GrowthGreenhouse gas emissions are related positively to economic growth. Panel (a) shows the level of CO2 emissions by Canada, the United States, and China from 1970 to Developed countries have more complex industries and more vehicles in use, plus they consume more non-essential items than less developed countries do. Consequently, developed countries produce far more greenhouse gas emissions. As the economies of China and other emerging nations begin to grow more quickly, these countries will also begin to emit even more CO2 than they do now. As Panel (b) shows, in recent years China has emitted a greater percent of the world’s total CO2 than the U.S., and hence more CO2 than the United States, largely as a result of China’s rapid transformation over the past three decades into the world’s factory. In 2010, China produced about 26% of the world’s CO2 emissions.We can also look at the level of CO2 emissions on a per capita base. According to the World Bank, in 2008, the average CO2 emission per capita was 4.76 tonnes for the world as a whole. China, Canada, and the U.S. were all above the world average in this regard. China produced 5.31 tonnes per capita, Canada produced tonnes per capita, and the U.S. produced tonnes per capita.Source: The U.S. Energy Information Administration.45
46 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.
47 SummaryGrowth 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.
48 SummaryGrowth 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.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.
49 Summary(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.
50 SummaryThe 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.
51 SummaryGovernment 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.
52 SummaryThe 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.
53 Summary(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.
54 SummaryEconomists 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.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.
55 SummaryThere 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.
56 Key Term Rule of 70 Research and development (R&D) Labour productivity InfrastructureProductivityConvergence hypothesisPhysical capitalSustainableHuman capitalTechnologyAggregate production functionDiminishing returns to physical capitalGrowth accountingTotal factor productivity