ECONOMICS OF GROWTH INTRODUCTION San Francisco State University| Michael Bar ECON 560, Introduction 11/17/2018

Visualization of 200 Years of Growth ECON 560, Introduction 11/17/2018

Economic Growth Defined Economic growth is the growth in real GDP per capita, also known as standard of living. GDP is the market value of final goods and services produced within the borders of a country (measured in country’s currency). Real means adjusted for inflation. Per capita means per person ( 𝑅𝐺𝐷𝑃 𝑃𝑜𝑝𝑢𝑙𝑎𝑡𝑖𝑜𝑛 ). For international comparison, we need to use some exchange rate. ECON 560, Introduction 11/17/2018

Facts to be Explained Differences in the Levels of Income per Capital Among Countries. That is, why some countries are poor, while others are rich? ECON 560, Introduction 11/17/2018

Country GDP per Capita (PPP $, 2017) Somalia $300-$600 Liberia $900 North Korea $1,000 Madagascar $1,600 U.S.A. $59,500 Norway $70,600 Singapore $90,500 Qatar $124,900 Somalia: civil war 2009 – present. ECON 560, Introduction 11/17/2018

Facts to be Explained Differences in the Rate of Income Growth Among Countries. ECON 560, Introduction 11/17/2018

Is the average growth rate a. Increasing, b. decreasing, c. constant ECON 560, Introduction 11/17/2018

Math of Growth Rates Growth rate of 𝑥: 𝑥 = 𝑥 𝑡+1 − 𝑥 𝑡 𝑥 𝑡 = 𝑥 𝑡+1 𝑥 𝑡 −1 Variable growing at constant rate g 𝑦 𝑡 = 𝑦 0 1+𝑔 𝑡 Log of constant growing variable is linear function of time: ln⁡(𝑦 𝑡 )= ln⁡( 𝑦 0 ) 𝑖𝑛𝑡𝑒𝑟𝑐𝑒𝑝𝑡 +𝑡∙ ln 1+𝑔 𝑠𝑙𝑜𝑝𝑒 ECON 560, Introduction 11/17/2018

Math of Growth Rates Important Approximation Rules (for small growth rates): For small 𝑔: ln 1+𝑔 ≈𝑔 Growth of product and ratio: 𝑥∙𝑦 ≈ 𝑥 + 𝑦 𝑥 𝑦 ≈ 𝑥 − 𝑦 Rule of 70: 𝑑𝑜𝑢𝑏𝑙𝑖𝑛𝑔 𝑡𝑖𝑚𝑒 𝑡≈ 70 100∙𝑔 ECON 560, Introduction 11/17/2018

ECON 560, Introduction 11/17/2018

ECON 560, Introduction 11/17/2018

Is the growth rate in the U.S. real GNP per capita constant since 1900? From the above figure, which plots the ln(real GNP pre capita) against time, we see that the growth rate in the U.S. is more or less constant (because the ln(real GNP per capita) is a linear function of time). Also, we can see that the average growth rate is about 2% per year (the slope of the ln(real GNP per capita) is approximately 2%). ECON 560, Introduction 11/17/2018

Is the growth rate in the U.S. real GNP per capita constant since 1900? “Their policies produced 1.2% growth, the weakest so- called recovery since the Great Depression, and a doubling of the national debt.” Donald Trump, Detroit, August 08, 2016 ECON 560, Introduction 11/17/2018

Growth in U.S. Since Great Recession Growth trend based on pre-recession ≈𝟐.𝟐% per year After recession, ≈𝟏.𝟒% per year The gap between trend and actual in 2018-Q1 is 21% or $11,146. ECON 560, Introduction 11/17/2018

Future of Economic Growth in U.S. “We're looking at a 3 percent, but we think it could be 5, it could even be 6. We're going to have growth that will be tremendous.” Donald Trump, December 29, 2016 ECON 560, Introduction 11/17/2018

Small differences in growth rates make big differences in income Annual growth Doubling time 1% 70 years 2% 35 years 3% 23 years ECON 560, Introduction 11/17/2018

GDP per Capita in the United States, the United Kingdom, and Japan, 1870–2009 Sources: Maddison (1995), Heston, Summers, And Aten (2011). ECON 560, Introduction 11/17/2018

ECON 560, Introduction 11/17/2018

ECON 560, Introduction 11/17/2018

The Distribution of Growth Rates, 1975–2009 ECON 560, Introduction 11/17/2018 Source: Heston, Summers, and Aten (2011).

Figure 1.7 GDP per Capita by Country Group, 1820–2008 Sources: Maddison (2008), Heston, Summers, and Aten (2011). ECON 560, Introduction 11/17/2018

World Inequality and Its Components, 1820–1992 Source: Bourguignon and Morrison (2002). ECON 560, Introduction 11/17/2018

From the above graph, we see that All regions grow The gap between the regions is widening (because of different growth rates). ECON 560, Introduction 11/17/2018

Growth before 1820 Years Growth in income per capita in the world 1700-1820 0.07% 1500-1700 0.04% 0-1500 ~0% ECON 560, Introduction 11/17/2018

Relatively small differences between the richest and the poorest, before 1820 (factor of 2). ECON 560, Introduction 11/17/2018

The case of China 8th – 12th centuries China is economic and technological leader in the world. Important inventions: gunpowder, printing, water- powered spinning wheel, use of coal in smelting iron, digging of canals and waterways, world exploration. ECON 560, Introduction 11/17/2018

Zheng He (1371–1433) ship vs. Santa Maria (1492) ECON 560, Introduction 11/17/2018

Summary of main facts Before 1820 very little growth and no big differences between countries. After 1820 unprecedented growth in the world as a whole. Very unequal distribution of income among countries. Uneven distribution of growth among countries, widening the gap between the rich and the poor. ECON 560, Introduction 11/17/2018

Questions What factors determine which countries prospered? Can we point to specific economic policies? Are there specific country characteristics that determine economic fate? Is prosperity just a result of luck? ECON 560, Introduction 11/17/2018

Our Methodology ECON 560, Introduction 11/17/2018

Step 1: Decomposing the cross-country difference in output per worker into differences in inputs and productivity We use something similar to the next formula: 𝑦 𝐴 𝑦 𝐵 = 𝐸 𝐴 𝐸 𝐵 𝑇 𝐴 𝑇 𝐵 𝑘 𝐴 𝑘 𝐵 Where 𝑦 – output per capita (or per worker) 𝑘 – capital per worker 𝑇 – technology level (knowledge how to combine inputs to produce output). 𝐸 – efficiency (includes effort, institutional bureaucracy, customs, other factors that affect productivity that are not captured by technology). ECON 560, Introduction 11/17/2018

Step 2: Why are there differences in capital? Constructing theory that relates investment and future capital. Main idea: higher saving rate leads to higher investment rate and higher capital per worker. Learn how to measure “human” capital. ECON 560, Introduction 11/17/2018

Step 3: Digging deeper – why are there differences in investment rate, technology, efficiency? Looking at fundamental (exogenous) cross-country differences such as geography, climate, natural resources, political regimes. ECON 560, Introduction 11/17/2018