23 Economic Growth: Theory and Policy Once one starts to think about... [differences in growth rates across countries], it is hard to think about anything else. ROBERT E. LUCAS, 1995 NOBEL PRIZE WINNER IN ECONOMICS Economic Growth: Theory and Policy Once one starts to think about... [differences in growth rates across countries], it is hard to think about anything else. ROBERT E. LUCAS, 1995 NOBEL PRIZE WINNER IN ECONOMICS

●The Three Pillars of Productivity Growth ●Levels, Growth Rates, and the Convergence Hypothesis ●Growth Policy: Encouraging Capital Formation ●Growth Policy: Improving Education and Training ●The Three Pillars of Productivity Growth ●Levels, Growth Rates, and the Convergence Hypothesis ●Growth Policy: Encouraging Capital Formation ●Growth Policy: Improving Education and Training Contents Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

●Growth Policy: Spurring Technological Change ●The Productivity Slowdown and Speed-Up in the United States ●Linking the Long-Run to the Short-Run ●Growth Policy: Spurring Technological Change ●The Productivity Slowdown and Speed-Up in the United States ●Linking the Long-Run to the Short-Run Contents Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Copyright© 2003 Southwestern/Thomson Learning All rights reserved. The Three Pillars of Productivity Growth ●Capital ♦For a given technology and labor force, labor productivity will be higher when the capital stock is larger. ●Capital ♦For a given technology and labor force, labor productivity will be higher when the capital stock is larger.

FIGURE 23-1 Production Functions Copyright © 2003 South-Western/Thomson Learning. All rights reserved. K 3 K 2 K 1 c Hours of Labor Input b a L 1 0 Y a Y b Output Y c

Copyright© 2003 Southwestern/Thomson Learning All rights reserved. The Three Pillars of Productivity Growth ●Technology ♦For given inputs of labor and capital, labor productivity will be higher when technology is better. ●Technology ♦For given inputs of labor and capital, labor productivity will be higher when technology is better.

Copyright© 2003 Southwestern/Thomson Learning All rights reserved. The Three Pillars of Productivity Growth ●Labor Quality: Education and Training ♦Human Capital = The amount of skill embedded in the workforce. Measured by amounts of education and training. ♦For a given capital stock and given technology, labor productivity will be higher when the workforce has more education and training. ●Labor Quality: Education and Training ♦Human Capital = The amount of skill embedded in the workforce. Measured by amounts of education and training. ♦For a given capital stock and given technology, labor productivity will be higher when the workforce has more education and training.

Copyright© 2003 Southwestern/Thomson Learning All rights reserved. ●Rate of increase of capital, technology, and workforce size and quality directly related to rate of productivity growth. ●Convergence hypothesis: The productivity growth rates of poorer countries tend to be higher than those of richer countries. ●Rate of increase of capital, technology, and workforce size and quality directly related to rate of productivity growth. ●Convergence hypothesis: The productivity growth rates of poorer countries tend to be higher than those of richer countries. Levels, Growth Rates, and the Convergence Hypothesis

Figure 23-2 Productivity Levels and Growth Rates Copyright © 2003 South-Western/Thomson Learning. All rights reserved. Poorer country Richer country Real GDP per Capita Time $10,000 $2,000

TABLE 23-3 GDP per Capita and GDP Growth Rates Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Copyright© 2003 Southwestern/Thomson Learning All rights reserved. ●Capital Formation = Forming new capital. Synonymous with investment. ●Investment = The flow of resources into the production of new capital. ●Capital Formation = Forming new capital. Synonymous with investment. ●Investment = The flow of resources into the production of new capital. Growth Policy: Encouraging Capital Formation

Copyright© 2003 Southwestern/Thomson Learning All rights reserved. ●Investment is encouraged by ♦Lower interest rates ♦Changes to tax laws ♦Technological advances ♦Higher demand ♦Greater political stability and respect for property rights ●Investment is encouraged by ♦Lower interest rates ♦Changes to tax laws ♦Technological advances ♦Higher demand ♦Greater political stability and respect for property rights Growth Policy: Encouraging Capital Formation

Copyright© 2003 Southwestern/Thomson Learning All rights reserved. Growth Policy: Improving Education and Training ●More-educated, better-trained workers are more productive and earn higher wages. ●Education and training enhance productivity. ●More-educated, better-trained workers are more productive and earn higher wages. ●Education and training enhance productivity.

FIGURE 23-3 Wage Premium for College Graduates Copyright © 2003 South-Western/Thomson Learning. All rights reserved. Percentage Wage Advantage Males Females Year

Copyright© 2003 Southwestern/Thomson Learning All rights reserved. ●Technological advance spurred by ♦More education ♦More capital formation ♦Research and development ●Technological advance spurred by ♦More education ♦More capital formation ♦Research and development Growth Policy: Spurring Technological Change

Copyright© 2003 Southwestern/Thomson Learning All rights reserved. The Productivity Slowdown and Speed-Up in the U.S. ●The Productivity Slowdown, ♦Growth rate of productivity declined sharply from the early 1970s through the mid 1990s. ●The Productivity Slowdown, ♦Growth rate of productivity declined sharply from the early 1970s through the mid 1990s.

Copyright© 2003 Southwestern/Thomson Learning All rights reserved. The Productivity Slowdown and Speed-Up in the U.S. ♦Explanations include: ■Lagging investment; BUT statistics show that investment as a percentage of GDP stayed constant during this period. ■High Energy Prices; BUT energy prices fell sharply in mid-1980s while productivity growth failed to rise. ♦Explanations include: ■Lagging investment; BUT statistics show that investment as a percentage of GDP stayed constant during this period. ■High Energy Prices; BUT energy prices fell sharply in mid-1980s while productivity growth failed to rise.

Copyright© 2003 Southwestern/Thomson Learning All rights reserved. The Productivity Slowdown and Speed-Up in the U.S. ♦Explanations include: ■Inadequate workforce skills; BUT standard measures of educational attainment and quality continued to rise. ■Technological slowdown; BUT technological advance may have merely slowed relative to the “golden age” of the ’50s and ’60s before reviving in the computer era. ♦Explanations include: ■Inadequate workforce skills; BUT standard measures of educational attainment and quality continued to rise. ■Technological slowdown; BUT technological advance may have merely slowed relative to the “golden age” of the ’50s and ’60s before reviving in the computer era.

FIGURE 23-4 Avg. Productivity Growth Rates in the U.S. Copyright © 2003 South-Western/Thomson Learning. All rights reserved. Percent per Year 1995– – –

Copyright© 2003 Southwestern/Thomson Learning All rights reserved. ●The Productivity Speed-Up, 1995-?? ♦Productivity growth started speeding up around 1995, rising from 1.4% to about 2.5% per year. ♦Higher productivity growth likely caused by: ■Surging investment ■Falling energy prices ■Advances in information technology ●The Productivity Speed-Up, 1995-?? ♦Productivity growth started speeding up around 1995, rising from 1.4% to about 2.5% per year. ♦Higher productivity growth likely caused by: ■Surging investment ■Falling energy prices ■Advances in information technology The Productivity Slowdown and Speed-Up in the U.S.