Introduction to ECONOMIC GROWTH SECOND EDITION Charles I. Jones

Chapter 1 Introduction: The Facts of Economic Growth Charles I. Jones

What Creates Differences in the Economic Well-Being?

Some Preliminary Concepts GDP Gross Domestic Product: the market value of all final goods and services produced within a country in a particular year. South Korea: 1.6 trillion USD North Korea: 40 billion USD (~2.5% of South Korean GDP) United States: 16.24 trillion USD (~10 times South Korean GDP) China: 12.26 trillion USD (~75% US GDP) GDP per Capita: a welfare measure Is equal to the ratio of GDP to the total population: GDP/L South Korea: 36700 USD North Korea: 1800 USD (~4.9% of South Korean GDP per capita) United States: 56300 USD (~1.53 times South Korean GDP per capita) China: 14300 USD (~25.4% US GDP per capita)

Some Preliminary Concepts GDP per Worker: a productivity measure Is equal to the ratio of GDP to the total number of workers. Since not everybody (e.g. babies) necessarily works, the GDP per worker tends to be larger than GDP per capita. Labor Force Number of people who are currently working or looking for work. Some people may choose not to work even if they can. (How?) Labor Force Participation Rate Share of the working-age population (>16) that is in the labor force, i.e. the share of people working or looking for work to the total number of people of the working-age population.

Some Preliminary Concepts Growth Rate of GDP Rule to remember: the derivative with respect to time of the log of some variable is the growth rate of that variable Growth Rate of GDP Per Capita Is defined analogously, only the variable of interest is GDP per capita. Why does it make more sense to think of growth in terms of GDP per capita? Hint: think about fast-growing population.

Some Preliminary Concepts Years to Double The number of years it takes for a country’s GDP to become twice its current size. Rule of 70 Suppose the country’s GDP grows at a rate of g=5% per year. Mathematically, it means for instance that: In two years the following formula applies: In N years: According to the rule of 70, Indeed,

A Note on Stylized Facts What is a stylized fact? A stylized fact is an informal, verbal description of some phenomenon. Why do we need stylized facts? Stylized facts are a concise summary of what we know about economic reality. Theory and stylized facts Economists develop their theories in order to explain the observable stylized facts.

Introduction to Economic Growth, 3rd Edition Copyright © 2013, W.W. Norton & Company

Stylized Fact #1 There is enormous variation in per capita income across countries. The poorest countries have per capita incomes less than 5% of those in the richest countries. The size of the economy (GDP) has little to do with wealth (GDP per capita or GDP per worker) International comparisons are difficult because market exchange rates fluctuate a lot and are subject to speculation Purchasing power parity (PPP) comparisons are used to solve the comparison problem If labor force participation rate is low, GDP per worker can be substantially higher compared to GDP per capita (Japan vs France)

Purchasing Power Parity Theory Suppose a hamburger costs $1 in the US The same hamburger costs ½ GBP in the UK According to the PPP theory, $1 should buy exactly 1/2 GBP. A currency is overvalued if it buys more abroad, undervalued otherwise Excercise: is your currency over- or under-valued? The idea is, $1 should buy the same amount of goods and services anywhere in the world after conversion according to the going exchange rate PPP is based on the idea of arbitrage Most goods and services are not standardized Many goods and services are non-tradable Exchange rates fluctuate and are subject to speculation

2/3 of the world’s population lives in countries with less than 20% of the US GDP per worker China and India account for the bulk of this part of the world’s population, 40% 39 sub-Saharan countries account for 12%

Introduction to Economic Growth, 3rd Edition Copyright © 2013, W.W. Norton & Company

Share of the world population with less than 10% of the US GDP per worker decreased China, India grew fast South Korea, Hong Kong, Singapore demonstrate fast growth is possible We want to know why: Countries differ in their wealth Countries differ in how fast they grow

Stylized Fact #2 Rates of economic growth vary substantially across countries. Wealthy countries do not always grow fast: US average growth rate only 1.6% South Korea grew fast, making it a growth miracle: 4.5% China grew even faster at 5.6%, but it is still relatively poor due to its huge population and a low starting base Some countries like Zimbabwe or Venezuela experienced negative growth rates Given enough time, small differences in growth rate can lead to huge differences in per capita incomes

Stylized Fact #3 Growth rates are generally not constant over time. For most of history, growth rates were close to zero. Growth rates have increased only during recent decennia. Growth rates change for individual countries as well. Increasing slope means increasing rate of growth due to log scale Before 1870 world growth rate is only 0.2% Rapid acceleration of growth in the 20th century Some countries have recently increased their growth rates significantly, e.g. China

Stylized Fact #4 A country’s relative position in the world distribution of per capita incomes is not immutable. Countries can move from being “poor” to being “rich,” and vice versa. Argentina: 1800s: one of the world’s richest countries Natural resources Foreign investment Infrastructure Immigration 1930s: Per-capita income greater than that of Australia and Canada 10th largest per-capita income in the world Compare to today’s Kuwait or Norway 2011: per capita GDP $17900, which is only 35% of the US level

Stylized Fact #5 (US case) Real rate of return to capital, r, stays relatively constant over time Shares of income devoted to capital, rK/Y, and labor, wL/Y, show no trend Average growth rate of output per person has been positive and relatively constant over time Return to capital can be approximated by real interest rate on US government debt, which has been relatively constant Real interest rate = Nominal (bank) interest rate – Inflation Labor share is around 0.7, capital share in case of no economic profits is equal to 1-Labor Share=0.3 Corollary: capital-output ratio K/Y is constant In terms of logs, the slope of the GDP per capita growth trend is constant over time

Fig. 1.4 In terms of logs, the slope of the GDP per capita growth trend is constant over time.

Introduction to Economic Growth, 3rd Edition Copyright © 2013, W.W. Norton & Company

Stylized Fact #6 Growth in output and growth in the volume of international trade are closely related. Trade volume is the sum of exports and imports The trade volume has been growing faster than GDP for most countries since 1960s Countries with relatively large values of trade volumes are called open economies Some countries crucially depend on trade: Hong Kong, Singapore, Luxembourg: trade volume >150% of GDP Korea: 70% (by PPP) or 99% (by official exchange rate) Production chain in the trade-intensive countries: Import component parts or unfinished products Add value by assembling (a car) or finishing a product (e.g. refine crude oil) Export the finished product

In general, there is a positive relationship between GDP growth and the growth rate of trade volume.

Introduction to Economic Growth, 3rd Edition Copyright © 2013, W.W. Norton & Company

Stylized Fact #7 Both skilled and unskilled workers tend to migrate from poor to rich countries or regions Why would skilled labor migrate? Returns must be higher in the rich countries for skilled labor However, skilled labor is scarce in poorer regions Scarcity implies higher returns (think of gold or diamonds) Why then don’t skilled workers migrate from Korea to the Philippines?

Three Main Questions Why are the world’s countries different with respect to the level of their development? Solow model: chapters 2,3; chapter 7 What is driving the process of economic growth? Technological progress: chapters 4 and 5 What explains growth miracles? South Korea, Singapore, Hong Kong… Chapters 6 and 7