1. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. Chapter 11 The Big Questions of Economic Growth

2. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-2 The Big Questions of Economic Growth Why are we so rich and they so poor? – More than half of the world’s population lives on less than $3,200 per year, 1/10 of the $32,000 average level of U.S. per person consumption. What creates a growth miracle? – A “growth miracle” is a country that experiences sustained growth rates of 5% or more for several decades. What caused the worldwide growth slowdown and subsequent revival? – The period of most rapid growth in the U.S. was between 1913 and 1973. Growth slowed until 1995, and then picked up again in the 1995-2007 period.

3. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-3 Figure 11-1 Saving, Investment, and Capital Per Hour in Long-run Equilibrium for a Poor Nation

4. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-4 Figure 11-2 Output per Hour of Rich and Poor Nations During the Period of Convergence

5. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-5 Standard of Living vs. Labor Productivity “Output Per Person,” “Labor Productivity,” and “Output Per Hour” all can be represented by Y/N. – The growth rate of Y/N = y – n The growth rate of labor input (n) does not need to equal the growth rate of the population (q). – Example: The increase in women participation in the labor force caused n > q in the 1970s and 1980s. The Standard of Living is real GDP per member of the population, or “Real Output Per Capita.” – The growth rate of the standard of living = y – q – The difference in labor productivity growth and the growth of a country’s standard of living = n – q

6. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-6 Multifactor Productivity Recall: Multifactor Productivity (MFP) differs from labor productivity in that it expresses the amount of output produces relative to both labor and capital inputs (not just relative to the labor inputs only). – The growth rate of MFP is given by: a = y – bk – (1 – b)n where b is the elasticity of output to capital and (1 – b) is the elasticity of output to labor – To compare a to the growth rate of labor productivity (y – n), we can rearrange the above equation to yield: a = (y – n) – b(k – n)

7. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-7 Productivity and Real Wage Growth If labor productivity (Y/N) grows slowly, the real wage (W/P) also tends to grow slowly. Why? (1 – b) from the equation for MFP can be estimated as labor’s share of national income: Labor’s share = 1 – b = Expressed in term’s of growth rates: Growth rate of labor’s share = (w – p) – (y – n) If the growth rate of labor’s share of income is zero, then the real wage grows exactly at the rate of labor productivity!

8. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-8 The Failure of Convergence The Solow model predicts that poor countries will converge to the same level of output per capita of rich countries. – A key empirical prediction is that poorer countries will have faster rates of growth of labor productivity. Problem: While many countries converge empirically, several chronically poor countries do not. One way to adjust the Solow model to account for this failure of convergence is to remove the unrealistic assumption that all nations have the same production function, saving rate, n, and d.

9. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-9 Figure 11-3 Output per Worker Relative to the United States in 1960 and the Growth of Output Per Person, 1960–2004 Source: Alan Heston, Robert Summers, and Bettina Aten, Penn World Table Version 6.2, Center for International Comparisons of Production, Income, and Prices at the University of Pennsylvania, September 2006. See pwt.econ.upenn.edu/php_site/pwt62/pwt62_form.php.

10. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-10 Table 11-1 Examples of Countries Displaying Convergence, Anti-Convergence, or Neither (Levels and Growth Rates in Percent)

11. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-11 Figure 11-4 The Effect of a Low Saving Rate or High Rate of Population Growth on Output Per Person

12. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-12 Technological Change and Human Capital The Solow model assumes unrealistically that the rate of technological change is the same in every country and the best available technology is freely available to all countries. How can poor countries acquire technology given that most research takes place in rich countries? – Engineers in poor countries can copy modern products made in rich countries. – Poor countries can purchase imported machinery that embeds the latest technology. – Poor countries can obtain investment by foreign firms. But poor countries may also need additional human capital to use acquired technology.

13. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-13 Political Capital, Infrastructure, and Geography Recently economists have identified fundamental underlying sources of growth that help us understand why some countries “take off” while others do not. The legal and political environment – The free market system requires that entrepreneurs who take risks have a high probability of making a decent profit. The legal system must protect private property. The tax system must be fairly administered so “diversion” is minimized as it reduces profits. – Infrastructure is crucial, for instance, in the production of highways, airports, ports, telephone networks, and electricity systems. Geography cannot be controlled by the government but also plays a role.

14. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-14 Physical Infrastructure and Growth Infrastructure is any type of capital not owned by the individual business firm that makes the firm’s production more efficient. – Example: Highways, railroads, airports, and ports In some poor countries the value of a business investment is reduced by poor highways and airports and other shortages of physical infrastructure.

15. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-15 Geography and Growth Jeffrey Sachs of CU proposed four hypotheses regarding the role of geography in growth: – Technologies developed in temperate areas may not be applicable to tropical areas. – Technological development often involves high development costs and low production costs suitable to large economics. Small economies in tropical regions may be too small to justify significant investment. – Poor productivity in rural agriculture in tropical countries and the prevalence of tropical diseases directly affect population growth. – Colonial domination of many tropical countries impeded the process of economic growth by neglecting the formation of human capital.

16. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-16 The 1973-95 Productivity Slowdown Here are the leading explanations for why productivity growth slowed in from 1973-95 – The growth of K/N slowed because k slowed and n increased. – Higher energy prices led to a large slowdown in energy dependent industries. – More teenagers and women caused a slowdown in productivity, or else the slowdown was measured because of discrimination against women. – Inadequate infrastructure investment may have caused productivity to slow.

17. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-17 Figure 11-5 Growth Rate of Labor Productivity in the United States, 1960–2007 Source: Bureau of Labor Statistics data for the nonfarm private business sector.. Details in Appendix C-4.

18. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-18 Figure 11-6 The Effect on the Labor Market of an Adverse Productivity Shock and a Downward Shift in Labor Supply

19. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-19 Figure 11-7 Level of Labor Productivity in Europe and the United States, 1970–2006 Source: Groningen Growth and Development Center, Total Economy Database. Details in Appendix C-4.

20. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-20 Chapter Equations

21. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-21 Chapter Equations

22. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-22 Chapter Equations

23. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 11-23 Chapter Equations