0. © 2007 Thomson South-Western

1. Table 1.1

2. Table 1 The Variety of Growth Experiences

3. Turkey’s Growth:
According to data from Penn World Tables, Turkey’s real GDP in 1950 was $1543, in 2004 was $5982 (in 2000 dollars).
Turkey’s real GDP grew at an annual average growth rate of 5.3 percent between 1950 and This puts Turkey in the “growth miracles” group with Hong Kong and Singapore. If the same growth continues, the economy will double every 13 years (log(2)/log(1.053)).

4. Production and Growth
How can we explain differences in levels of income and growth rates of income across countries?
Levels: Why are some countries rich now (Japan, Western Europe, US) and others are poor now?
Growth Rates: Why are some countries growing fast (India, China, South Korea) and others are not growing at all (African countries)?

5. Production and Growth
Productivity is the amount of goods and services that an average worker produces in one hour.
A country’s standard of living is determined largely by the productivity of its workers.

6. Productivity: Its Role and Determinants
Why Productivity Is So Important
Productivity determines living standards for all nations in the world.
To understand the large differences in living standards across countries, we must focus on the production of goods and services.

7. How Productivity Is Determined
What determines productivity? The factors of production determines productivity.
The inputs used to produce goods and services are called the factors of production.
The factors of production include:
Physical capital (machinery, equipment, buildings)
Human capital (education, training, experience)
Natural resources (Land, natural gas, oil, etc.)
Technological knowledge (expertise)

8. How Productivity Is Determined
Physical capital is the stock of machinery, equipment and infrastructure that are used to produce goods and services.
Physical capital includes:
Machines used to manufacture automobiles, furniture, other machines (lathe), etc.
Construction: Office buildings, schools, etc.
Infrastructure: Roads, electricity and telecommunication networks.
Physical capital is a produced factor of production.
It is both an input into the production process and an output from the production process.

9. How Productivity Is Determined
Human capital is the knowledge and skills that workers acquire through education, training, and experience.
Like physical capital, human capital raises amount of goods and services that one worker can produce.

10. How Productivity Is Determined
Natural resources are inputs used in production that are provided by nature, such as arable land, seaports, rivers, oil, natural gas, copper, iron etc.
Renewable resources include trees and forests.
Nonrenewable resources include petroleum, gas, coal.
Natural resources are important but are not absolutely necessary for an economy to be highly productive. Consider Japan. Imports many raw materials and energy.

11. How Productivity Is Determined
Technological knowledge includes society’s understanding of the best methods to produce goods and services. Two types:
Common knowledge (math, assembly line, tractors)
Patented knowledge (BMW engine design, Coca-cola formula, Intel core duo processor, etc.)
Consider farming technology in 1970 and % of Turkey’s population were working in farming sector in In 2004, only 40% was working in farming. Use of tractors, fertilizers, etc. increased productivity in the sector.

12. The Production Function
Economists often use a production function to describe the relationship between the quantity of inputs used in production and the quantity of output.

13. The Production Function
Y = A F(L, K, H, N)
Y = quantity of output
A = level of technology
L = quantity of labor (number of workers or hours)
K = quantity of physical capital
H = quantity of human capital
N = quantity of natural resources
F( ) is a function that shows how the inputs are combined.

14. The Production Function
A production function has constant returns to scale if, for any positive number x,
xY = A F(xL, xK, xH, xN)
That is, if we double all inputs (if x = 2), then the amount of output doubles too.
If xY < (>) A F(xL, xK, xH, xN) then there is increasing (decreasing) returns to scale.

15. The Production Function
Production functions with constant returns to scale property can be written in ‘per worker’ terms.
Setting x = 1/L,
Y/L = A F(1, K/L, H/L, N/L)
Where:
Y/L = output (GDP) per worker
K/L = physical capital per worker
H/L = human capital per worker
N/L = natural resources per worker

16. The Production Function
Then Productivity (Output per worker, Y/L) depends on:
physical capital per worker (K/L),
human capital per worker (H/L),
natural resources per worker (N/L),
and the level of technology (A).

17. Economic Growth And Public Policy
Government policies that raise productivity and living standards
Encourage saving and investment. (Increase K) Asian economies have high saving rates.
Encourage investment from abroad (two types: FDI and FPI, which one is better?).
Encourage education and training (Increase H).
Establish secure property rights and maintain political stability. Decrease uncertainty about future.
Promote free trade.
Promote research and development to improve technology.

18. Saving and Investment
One way to raise future productivity is to invest more current resources in the production of physical capital (machines, infrastructure: roads, telecommunication, etc.). But for this we need to consume less now and save more. Saving and Investment Rates are important. Turkey’s saving rate = 19%, investment rate: 25% in 2005.

20. Diminishing Marginal Returns and the Convergence Effect
As the stock of capital rises, the extra output produced from an additional unit of capital falls; this property is called diminishing marginal returns of capital.
Because of diminishing marginal returns, an increase in the saving rate leads to higher growth only for a while.
In the long run, the higher saving rate leads to a higher level of productivity and income, but not to higher growth rate in these areas.

21. Illustrating the Production Function
Output
per worker
2. When the economy has a
high level of capital, an
extra unit of capital leads to
a small increase in output. 1
1. When the economy has a low level of capital, an
extra unit of capital leads to a large increase in output. 1
Capital per
worker

22. Diminishing Marginal Returns and the Convergence Effect
The convergence (catch-up) effect is a property where countries that start off poor tend to grow more rapidly than countries that start off rich.

24. Investment from Abroad
Governments can increase capital accumulation and long-term economic growth by encouraging investment from foreign sources. Turkey received 6% Net Capital Inflows in 2005.
S = 19%, I = S + NCI = 25%.

25. Investment from Abroad
Investment from abroad takes two forms:
Foreign Direct Investment
Capital investment owned and operated by a foreign firm. It can also be a partnership with a Turkish firm. Ex: Toyota plant in Kocaeli.
Foreign Portfolio Investment
Investments financed with foreign money but operated by domestic residents. Ex: German residents buy Akbank stocks at ISE.

26. Investment from Abroad
Why FDI is low in Turkey:
Labor Market: In Turkey, severance pay (cost of firing), social security premium, unemployment insurance premium and taxes are high. Thus domestic and foreign investors escape Turkey to other low-cost countries like Ukraine, China, Romania, Poland etc.
There is political instability in Turkey.
Labor force is not educated- low human capital.

27. Education
For a country’s long-run growth, education is at least as important as investment in physical capital.
In the United States, each year of schooling raises a person’s wage, on average, by about 10 percent.
Thus, the government can increase the standard of living by support schools. But strategically accroding to the needs of the economy.

28. Education
The social benefit of society from an educated person might be larger than his private benefit from education. He provides an external benefit to others. This is called a positive externality.
One problem facing some poor countries is the brain drain — the emigration of many of the most highly educated workers to rich countries. Why do they emigrate? How can we reverse brain drain?

29. Property Rights and Political Stability
Property rights refer to the ability of people to exercise authority over the resources they own.
Justice system must protect property rights. An economy-wide respect for property rights is an important prerequisite for the price system to work.

30. Property Rights and Political Stability
Also, countries with a history of frequent revolutions are not rich today. Political stability is necessary for growth.
It is necessary for investors to feel that their investments are secure.
Ex: Recently, Hugo Chavez’s Venezuela nationalized some of the oil extracting companies. Some Persian Gulf countries require 51% ownership of home citizens of any new company.

31. Free Trade Some countries engage in . . .
. . . inward-oriented trade policies, avoiding trade with other countries. Like Cuba.
. . . outward-oriented trade policies, encouraging trade with other countries. Like Hong Kong.
Which one is the right policy? Most economists believe that openness helps development.

32. Research and Development
The advance of technological knowledge has led to higher standards of living.
Most technological advance comes from private research by firms and individual inventors.
Government can encourage the development of new technologies through research grants, tax breaks, and the patent system.

33. Population Growth
Economists and other social scientists have long debated how population growth affects a society.
Malthus’ mistaken theory: geometric population growth, linear food growth.
Earlier economic theory: faster population growth causes poverty because it reduces capital per worker. (if population grows faster than capital)
More recent theories by Paul Romer and Michael Kremer argue that population growth is the driving force behind technological growth.

35. Population Growth
Slower population growth also creates risks for the social security system. Ratio of number of current workers / number of retirees decreases. Smaller inflow and larger outflow of money. Currently big problem for Turkey.
Why do developed countries promote birth control in less developed countries but give incentives for more children in their own countries?

36. Summary
Economic prosperity, as measured by real GDP per person, varies substantially around the world.
The average income of the world’s richest countries is more than ten times that in the world’s poorest countries.
The standard of living in an economy depends on the economy’s ability to produce goods and services.

37. Summary
Productivity depends on the amounts of physical capital, human capital, natural resources, and technological knowledge available to workers.
Government policies can influence the economy’s growth rate in many different ways.

38. Summary The accumulation of capital is subject to diminishing returns.
Because of diminishing returns, higher saving leads to a higher growth for a period of time, but growth will eventually slow down.
Also because of diminishing returns, the return to capital is especially high in poor countries.