Module 38: Productivity and Growth Andrea Taylor Aleks Tiefenbach Lisa Altieri Sue Kim Eric Wilson

Barry Bosworth & Susan Collins aggregate production function applied to real data GDP per worker= T x (physical capital per worker)^0.4 x (human capital per worker)^0.6 Where T represents the estimate of the level of technology assumed each year of education raised workers human capital by 7%

Diminishing returns to physical capital- aggregate production function exhibits this when holding the amount of human capital per worker and the state of technology fixed, each successive increase in the amount of physical capital per worker leads to a smaller increase in productivity When the amount of human capital per worker and state of technology are not affected/changed, every increase in the amount of physical capital per worker drives productivity down

A little bit of equipment makes a big difference in productivity ex: someone with a tractor will be more productive than someone without one All things fixed, more expensive the equipment, more productive the worker More physical capital per worker leads to more output per worker Physical capital per worker rises, output per worker rises but at a DIMINISHING RATE “other things equal”- additional amounts of physical capital are less productive when amount of human capital per worker and technology are the same

How to get rid of diminishing returns? Increase amount of human capital per worker Improve technology Both when amount of physical capital per worker is increased

Growth Accounting Growth accounting allows you to find how much each a factor of production (human capital, physical capital, technology) will contribute to economic growth. This is done to measure the effect of each factor individually, and not as a whole.

Growth Accounting With Physical Capital To find the productivity growth caused by an increase in physical capital, we would assume two things: For every 1% increase in physical capital per worker, productivity per worker increases by 0.33% In this case, the amount of physical capital per worker grows by 3% By multiplying 3% and 0.33, we would find that economic growth increased by 1% as a result of increased physical capital per worker.

Accounting for Technological Growth The effects of technological growth on an economy are only taken into account after the effects of human capital and physical capital are found.

Accounting for Technological Growth An improvement in technology will cause an upward shift of the production function curve. A movement along the curve is caused by an increase in physical capital (human capital is fixed).

Accounting for Technological Growth If between 1940 and 2010 physical capital increased from $20,000 to $80,000 without any technological advancements, the economy would move from A to C instead of A to D.

Accounting for Technological Growth In this graph, it took 70 years to double real GDP by adding physical capital. Using the Rule of 70, you’ll find that the growth rate is 1% per year. Rule of 70: Years to double = 70/percent rate of growth

Accounting for Technological Growth Between points A and D, real GDP increases from $30,000 to $120,000, meaning that the growth rate is 2% per year.

Total Factor Productivity The advancements in technology will contribute to total factor productivity, which is the total amount an economy can produce from a given amount of factor inputs. When technology improves while the other factors are constant, the economy produces more without needing to change its other factors. For this reason, technological advancements are considered crucial to a country’s economic growth.

What About Natural Resources? Other things equal, countries that are abundant in valuable natural resources, such as highly fertile land or rich mineral deposits, have higher real GDP per capita than less fortunate countries. EX: Middle East’s oil deposits …But other things are often not equal; in the modern world, natural resources are a much less important determinant of productivity than human or physical capital for the great majority of countries. EX: Japan has high real GDP per capita but very few natural resources Historically, natural resources played a much more prominent role in determining productivity. EX: In the 19th century, countries with highest real GDP were those abundant in rich farmland and mineral deposits

Natural Resources: An Essay on the Principle of Population Thomas Malthus published “An Essay on the Principle of Population” in 1798, which states that the fixed quantity of land in the world is the basis of a pessimistic prediction about future productivity. Population grows  Amount of land per worker declines  Other things equal, productivity falls. He also believed technology could only aid productivity in the short run. His negative view was as so: the majority of people were condemned to living on the edge of starvation, and only then would death rates be high enough and birth rates low enough to prevent rapid population growth from outstripping productivity growth.

East Asia’s Miracle Rates of long-run economic growth differ markedly around the world. In 1960, South Korea was a very poor country, but it rebounded in the next few years: real GDP per capita grew about 7% per year for more than 30 years. It took the country only 35 years to achieve this growth that required centuries elsewhere. The “East Asian Phenomenon” refers to the high growth rates that first appeared in South Korea, Taiwan, Hong Kong, and Singapore and then spread across the region, most notably to China.

East Asia’s miracle Asian countries achieved such high growth rates by having very high savings rates that allowed for significant increase in in the amount of physical capital per worker. Very good basic education has also permitted rapid improvement in human capital. Some believe that East Asian economies experienced such great growth because of their “backwardness” – or, as they could move into the modern world, their ability to benefit from adopting technological advances that had been generated in technologically advanced countries (like the US).

East Asia’s miracle The East Asian experience demonstrates that economic growth can be especially fast in countries that are playing catch-up to other countries with higher GDP per capita. Thus we have the convergence hypothesis, or the principle that states that differences in real GDP per capita among countries tend to narrow over time because countries that start with lower real GDP per capita tend to have higher growth rates.

Latin America’s Disappointment In 1900: Latin America had abundant natural resources. They were not considered as the economically backward region. Why has Latin America stagnated? The rate of savings& investments was low The basic education has been not emphasized enough Political instability Too much government intervention in the economy Only Chile achieved the rapid growth

Africa’s Trouble Africa is very poor, and their living standard is not even close to that of 200 years ago of U.S. Problem of the political instability Since 1975, many of Africa countries had civil wars It made productive investment spending impossible Could not concentrate on the education Problem of the property rights The lack of the safeguards- the corrupted government often take away the property.

Africa’s Trouble Health problem Diseases lowers the worker productivity A lot of tropical diseases can control by the public health infrastructure The solution of health problem can also increase the attendance to the school. Although many believe that Africa is poor because Africa is politically unstable, some believes Africa is politically unstable because Africa is poor. Extremely unfavorable geographic condition However, the economy of Africa is getting better since mid 1990s.

Economic Growth differences between Latin America, East Asia & Africa

Are Economics Converging? Convergence hypothesis- relatively poor countries should have higher rates of growth of real GDP per capita than relatively rich countries The hypothesis seems true among the wealthy countries. On the graph, Japan has higher rates of growth than U.S.

Are Economics Converging? It does not work in the relatively poor countries. However, the convergence hypothesis is not wrong : it is true if other things are all equal. However, the other things (education, law, etc) are not equal in this world. That’s why the hypothesis is not working in the world as a whole.

Question 1 What two things does the aggregate production function show productivity depends on? Real GDP per worker and human capital per worker Physical capital per worker and human capital per worker Real GDP per worker and physical capital per worker Utilities per worker and output per worker Human capital per worker and technology per worker

Question 2 What is the aggregate production equation T= technology T*(PC)r*(HC)r T*(PC)r*(RGDP)r T*(HC)r*(RGDP)r r*(PC)T*(HC)T r*(PC)T *(RGDP)T

Question 3 When are additional amounts of physical capital less productive? When the government implements a price ceiling When physical capital exceeds the human capital When the government implements a price floor When human capital per worker and the technology are held fixed always

Question 4 What is the convergence hypothesis? International differences in physical capital tend to narrow overtime. International differences in physical capital tend to widen over time. International differences in real GDP tend to narrow over time International differences in real GDP tend to widen over time. Physical capital and real GDP tend to widen overtime between international difference

Question 5 What is a good indicator to how rich a country is? Amount of physical capital per worker Amount of human capital per worker Amount of real GDP per worker Amount of natural resources Amount of technology

Answers 1- B 2- A 3- D 4- C 5- D