9 Economic Growth Economic growth rate Real GDP per person CHAPTER EYE ONS Economic growth rate Real GDP per person Classical growth theory Rule of 70 Neoclassical growth theory Property rights New growth theory Labor productivity Malthusian theory Economic freedom 2

Sustained growth of RGDP per Person will make a poor country rich. DEFINITION Economic Growth Sustained expansion of PPF measured as an increase in RGDP Economic Growth rate Percentage change of RGDP RGDP per Person Measures contribution of RGDP standard of living change RGDP per Person ONLY GROWS if RGDP grows faster than population Sustained growth of RGDP per Person will make a poor country rich.

DEFINITION Rule of 70 Calculates the number of years it takes any variable to double (70/annual % growth rate) Table 9.1 Growth Rates Growth rate Years for level (% per year) to double Example 2 35 U.S. real GDP per person 7 10 China real GDP per person

WHAT DETERMINES RGDP GROWTH RATE To Understand Growth Rate of RGDP Must understand: What determines the growth rate of the factors of production All influences on RGDP Growth Increase either: Quantity of Labor (Aggregate Hours) Labor Productivity RGDP Land Labor Capital Entrepreneurship

WHAT DETERMINES RGDP GROWTH RATE Quantity of Labor (Aggregate Hours) Increase in average hours worked per week [this # iin U.S.] Increase when labor force increases Participation in labor force [there is a limit] Population growth [only sustainable source] Must be accompanied by more productive labor Labor Productivity Quantity of RGDP produced by one hour of labor Labor productivity grows  RGDP per Person grows Growth in labor productivity  increased standard of living

WHAT DETERMINES QUANTITY OF LABOR GROWTH Population Growth Labor Force Participation Rate Average Hours Worked Labor Force depends on Labor force participation rate Labor Force has upper limits Population Population growth is ONLY sustainable source of growth in quantity of labor Population Growth = economic growth But only brings RGDP growth if labor becomes more productive

WHAT DETERMINES LABOR PRODUCTIVITY GROWTH Saving and Investment in Physical Capital Increase amount of capital per worker Increase labor productivity. Expansion of Human Capital Education and training 90% graduate High School 60% attend college {that is not the # that graduate} Job experience Discovery of New Technologies Physical Capital must increase to benefit from Technology Advancements Human Capital is more powerful but Physical Capital is more plentiful

WHAT DETERMINES LABOR PRODUCTIVITY GROWTH Capital must increase Physical capital: cars vs horse & carriage, machines, R&D departments Human capital: writing, mathematics [physics, plastics]

How Fast Has Real GDP per Person Grown? Real GDP per person hovered around $100 per year from until 1350! Around 1750, the Industrial Revolution began and by 1850, real GDP per person was twice its 1650 level. By 1950, real GDP per person was more than five times its 1850 level. And by 2000, it was four times its 1950 level.

How Fast Has Real GDP per Person Grown? 1999-2009 growth rate is lower than in any decade except the 1930s. 2000’s PGDP growth rate was higher the that of 1990s 2009, RGDP/person was almost 8 times the 1909 level -an average growth rate of 2% But growth has been uneven: 1930s = no growth 1940s = fastest growth. Growth has slowed since the 1960s. Divide the 1990s into before and after the Internet, growth has picked up since 1994. 2009 was a year of deep recession.

U.S. Labor Productivity Growth Since 1960 The 1960s were years of rapid human capital growth and technological change . The contribution of human capital growth and technological change slowed during the 1970s. Why? Contribution of human capital and technology remained low until the 1990’s spurring two decades of labor productivity growth

U.S. Labor Productivity Growth Since 1960 1. Oil price hikes in 19731974 and in 19791980 diverted technological change toward saving energy rather than increasing labor productivity. Three reasons: 2. Taxes and government regulation increased during the late 1960s and 1970s, which weakened incentives and labor productivity growth slowed. 3. Rapid inflation distorted saving and investment decisions and shortened the time horizon over which firms made their borrowing and lending plans. The contribution of human capital and technological change remained low until the new economy era of the 1990s, when… Computer and information technologies kicked in to bring faster labor productivity growth again.

ECONOMIC GROWTH THEORIES Classical Growth Theory – Smith, Malthus in the 18th century Exploding population and limited resources will result in an END to economic growth Technology advances & accumulation of capital bring increased productivity and increased RGDP/person Increase in RGDP per Person is temporary because Prosperity brings population growth Increased population = decrease in amount of capital per hour Thus, RGDP per Person and productivity decrease By 2200 we run out of resources and return to primitive living Technological change would not help the situation Economics = Dismal science [All of this happened before America existed] [There was a population explosion occurring at the time of this theory’s development]

EFFECTS of POPULATION GROWTH Draw the Graph

ECONOMIC GROWTH THEORIES Neoclassical Growth Theory – Robert Solow of MIT in 1960s RGDP per Person will increase as long as technology keeps advancing BASICALLY- Population growth and technological change determine but are not influenced by the RGDP growth rate Neoclassical Theory Predicts: RGDP growth rate will = population growth +labor productivity growth RGDP per person will increase as long as technology advances  economic growth persists Population growth (two opposing forces offset each other): As income increases the birth rate decreases As income increases the death rate decreases

ECONOMIC GROWTH THEORIES Neoclassical Growth Theory – Robert Solow of MIT in 1960s RGDP per Person will increase as long as technology keeps advancing Technological Change (result from chance (luck)) Businesses expand and are created to exploit new technologies Investment and savings increase  capital per hour of labor increase Prosperity lasts because there is no population explosion Growth will only last as long as technology advances Biggest Issue with this theory: They do not explain what determines technological change [The population explosion ended and people realized population was related to economic factors but not as stated under the classical theory]

ECONOMIC GROWTH THEORIES New Growth Theory – Romer of Stanford in 1980s (Schumpeter in the 1930’s Our unlimited wants will lead us to ever greater productivity and perpetual economic growth RGDP Grows because of the choices people make pursuing a profit Facts about Market Economies emphasized: Human capital grows because of choices People decide about school, education, and training Discoveries result from choices New technologies depend on how many people are looking and how hard they are trying – not by chance Discoveries bring profit, competition destroys profit Competition drives people to find better ways, reduce costs, etc. Physical capital can be replicated Benefits spread Many people can use technology at the same time The economy does not experience diminishing returns by adding new facilities

EFFECT of INCREASE IN LABOR PRODUCTIVITY Graph it

EFFECT of PERPETUAL MOTION New Growth Theory describes…

PRE CONDITIONS to ECONOMIC GROWTH Economic Freedom – People can make personal choices Society is free of corruption, barriers to trade, illegal markets, high taxes, stringent regulations on firms, banks, and labor. Does not have to be a democracy {Hong Kong} Property Rights – Social arrangements that govern the protection of private property Physical, Financial, Intellectual property rights are incentives to work and save Markets – Freely exchange information, products, services Enable people to trade, save, and invest

HOW TO ACHIEVE ECONOMIC GROWTH Must Increase one of the following: Growth rate of capital per hour of labor Growth rate of human capital Pace of technological change Policies that Achieve these things: Create incentives to save, invest, and innovate Encourage savings Encourage research and development International trade Improve quality of education Time table Slow and steady but benefits are large!

FORMULAS – – – Real GDP in current year Growth of real GDP = x 100 Real GDP in previous year x 100 – Growth of real GDP = per Person Real GDP per Person in current year Real GDP in previous year x 100 Real GDP per Person in previous year – Growth of Population = Population in current year Real GDP in previous year x 100 Population in previous year – Growth of real GDP per person Growth rate of real GDP Growth rate of population – = Years to Double = Annual Percentage Growth Rate 70

FORMULAS Real GDP = Aggregate hours x Labor productivity Real GDP Qty labor hours (aggregate hours) Real GDP = Aggregate hours x Labor productivity

EYE on CONVERGENCE AND GAPS Why Are Some Nations Rich and Others Poor? Political stability, property rights protected by the rule of law, limited government intervention in markets: Are key features of the economies that enjoy high incomes and they are the features missing in those that remain poor. Most of the rich nations have experienced sustained economic growth over many decades. Europe’s Big 4 economies (France, Germany, Italy, and the United Kingdom) have been enjoying economic growth for 200 years. The United States started to grow rapidly 150 years ago and overtook Europe in the early 20th century. 25

EYE on CONVERGENCE AND GAPS Why Are Some Nations Rich and Others Poor? In the past 50 years, the gaps between these countries haven’t changed much. In a transition from Communism to a market economy, Central Europe is growing faster than the United States. 26

EYE on CONVERGENCE AND GAPS Why Are Some Nations Rich and Others Poor? Economic growth in Central and South America and Africa has been persistently slow. The gap between the United States and these regions has widened. 27

EYE on CONVERGENCE AND GAPS Why Are Some Nations Rich and Others Poor? Real GDP per person in East Asian economies has converged toward that in the United States. These economies are like fast trains running on the same track at similar speeds with roughly constant gaps. 28

EYE on CONVERGENCE AND GAPS Why Are Some Nations Rich and Others Poor? Hong Kong and Singapore are the lead trains and run about 15 years in front of Taiwan, 20 years in front of South Korea, and almost 40 years in front of China. 29

EYE on CONVERGENCE AND GAPS Why Are Some Nations Rich and Others Poor? Between 1960 and 2008, Hong Kong and Singapore transformed themselves from poor developing economies to take their places among the world’s richest economies. 30

U.S. Labor Productivity Growth Since 1960 The figure shows that labor productivity growth and its changing trends. Rapid growth in the 1960s was followed by slower growth after 1969 and even slower after 1974.

U.S. Labor Productivity Growth Since 1960 It is this productivity growth slowdown that brought the enormous $284,500 per person Lucas wedge. Why does labor productivity growth fluctuate?

How You Influence and Are Influenced by Economic Growth Many of the choices that you make affect your personal economic growth rate—the pace of expansion of your own standard of living. These same choices, in combination with similar choices made by millions of other people, have a profound effect on the economic growth of the nation and the world. The most important of these choices right now is your choice to increase your human capital.

How You Influence and Are Influenced by Economic Growth A choice that will become increasingly important later in your life is to accumulate a pension fund. This choice provides a source of income for you when you eventually retire. But it also provides financial resources that firms can use to finance the expansion of physical capital. Not only do your choices influence economic growth; economic growth also has a big influence on you—on how you earn your income and on the standard of living that your income makes possible.

How You Influence and Are Influenced by Economic Growth Because of economic growth, the jobs available today are more interesting and less dangerous and strenuous than those of 100 years ago. Today’s jobs are hugely better paid. But for many of us, economic growth means that we must accept change and be ready to learn new skills and get new jobs.