17:Long-Term Economic Growth What are the long-term growth trends in the United States and other countries? What are the main factors that influence long-term growth? What policies might be used to speed up economic growth? Students may wonder what the big deal is about growing at 2% per year versus 2.5% per year. Indeed, the numerical differences in growth rates are so small as to be seemingly unimportant. Make the point that if real GDP per person had grown 1 percentage point faster between 1960 and today, an average family would have $15,000 more income. That’s a lot of purchasing power, probably enough to get the attention of most of the class.

Economic Miracles U.S. real GDP per person almost doubled between 1960 and 1995. However, this growth has been uneven with periods of recession and expansion. Incomes in Asian economics have grown eightfold between 1960 and 1995.

Long-Term Growth Trends Long-term growth is the trend growth rate of potential GDP. Potential GDP grows for two reasons: Population growth Growth in potential GDP per person Only the second brings rising living standards.

Growth in the U.S. Economy U.S. economic growth averaged 1.7 percent per year between 1895 and 1995. During the 1960s growth was 2.5 percent per year. Since 1973 growth has slowed to 1.4 percent per year due to the slowing of productivity growth.

A Hundred Years of Economic Growth in the United States Instructor Notes: 1) During the 100 years from 1896 to 1996, real GDP per person in the United States grew by 2 percent a year, on the average. 2) The growth rate was above average during the 1920s and 1960s, and it was below average in 1903-1920, the 1950s, and 1973-1996.

Two Extraordinary Events The Great Depression of the 1930s saw a fall in real GDP unlike anything else in the past 100 years. The boom created by World War II was a major expansion of real GDP. However, between 1929 and 1953, growth averaged 1.8 percent a year.

Real GDP Growth in the World Economy Among the richest countries, the United States and Canada have had the highest real GDP per person since 1960. However, Japan has been growing the fastest - until recently. Africa and Central and South America grew at a slower rate.

Figure 10.2 page 215 Fig. 9.2a (26.2a)

Figure 10.2 page 215 Fig. 9.2b (26.2b)

Catch-Up in Asia Hong Kong, Korea, Singapore, and Taiwan are catching up with the United States. China has a high growth rate, but started very far behind the United States and still has a long way to go. Continued growth of China’s economy is important for world gdp for 21st century

Note the rate of growth here has slowed in 97.98 Fig. 9.3 (26.3)

The Sources of Economic Growth Societies that do not experience economic growth lack some fundamental social institutions and arrangements that are essential preconditions for economic growth: Markets Property rights Monetary exchange

Markets Markets enable buyers and sellers to get information and to do business with each other. Market prices send signals to buyers and sellers that create incentives to increase or decrease the quantities demanded and supplied. Markets encourage specialization and trade.

Property Rights Property rights are the social arrangements that govern the ownership, use, and disposal of factors of production such as: physical property (land, buildings) financial property (claims by one person against another) intellectual property (inventions)

Monetary Exchange Monetary exchange facilitates transactions of all kinds, including the orderly transfer of private property from one person to another. Property rights and monetary exchange create incentives for people to specialize and trade, to save and invest, and to invent new technologies.

Specialization and Growth Specialization leads to growth, improving the standard of living. For growth to continue, people must have incentives to pursue three activities: Saving and investment in new capital Investment in human capital Discovery of new technologies

Saving and Investment in New Capital Saving and investment in new capital increase the amount of capital per worker and increase human productivity. Production methods that use large amounts of capital per worker (such as assembly lines) are much more productive than using hand tools.

Investment in Human Capital Human capital is the accumulated skill and knowledge of human beings. Investment in human capital is a source of both increased productivity and technological advance.

Discovery of New Technologies Technological change makes an enormous contribution to our increased productivity. It arises from research and development as well as trial and error. Most technologies must be embodied in physical capital.

Growth Accounting Labor Productivity Labor productivity is real GDP per hour of work. Equals real GDP divided by aggregate labor hours Determines how much income an hour of labor generates

Growth Accounting Instructor Notes: 1) Real GDP divided by aggregate hours equals real GDP per hour of work, which is a broad measure of productivity. 2) During the 1960s, the productivity growth rate was high. 3) It slowed during the 1970s and speeded up again after 1983.

Growth Accounting Growth accounting divides growth into two components. 1) Growth in capital per hour of labor 2) Technological change Includes everything that contributes to labor productivity growth that is not included in growth in capital per hour

Growth Accounting The Productivity Function A relationship that shows how real GDP per hour of labor changes as the amount of capital per hour of labor changes with a given state of technology.

Growth Accounting The Productivity Function The shape of the productivity function reflects the law of diminishing returns. The law of diminishing returns states that as the quantity of one input increases with the quantities of all other inputs remaining the same, output increases but by ever smaller increments.

How Productivity Grows 32 25 Real GDP per hour of work (1992 dollars) 20 30 60 Capital per hour of work (1992 dollars)

How Productivity Grows 32 PF0 25 Real GDP per hour of work (1992 dollars) 20 GDP/HW=A*F(CAP/HW) Instructor Notes: 1) Productivity is measured by real GDP per hour of work, and it can grow for two reasons: (1) Capital per hour of work increases, and (2) technological advances occur. 2) The productivity function, PF0 shows the effects of an increase in capital per hour of work on productivity. 30 60 Capital per hour of work (1992 dollars)

How Productivity Grows 32 PF0 25 Real GDP per hour of work (1992 dollars) 20 Instructor Notes: Here, when capital per hour of work increases from $30 to $60, real GDP per hour of work increases from $20 to $25 along the productivity curve PF0 . 30 60 Capital per hour of work (1992 dollars)

How Productivity Grows PF0 32 PF0 25 Real GDP per hour of work (1992 dollars) 20 Effect of technological change Effect of increase in capital stock Instructor Notes: 1) Technological advance shifts the productivity function upward. 2) Here, an advance in technology shifts the productivity function from PF0 to PF1. 3) With this technological advance, real GDP per hour of work increases from $25 to $32 when there is $60 of capital per hour of work. 30 60 Capital per hour of work (1992 dollars)

Growth Accounting The Productivity Function Applying the law of diminishing returns to capital, the law states that if a given number of hours of labor use more capital, the additional output that results from the additional capital gets smaller as the amount of capital increases. The one third rule explains how much less.

Growth Accounting The One Third Rule Robert Solow of MIT discovered that on average, with no change in technology, a 1 percent increase in capital per hour of labor brings a one third of a 1 percent increase in real GDP per hour of labor.

Growth Accounting Accounting for the Productivity Growth Slowdown and Speedup We can use the one third rule to study U.S. productivity growth and the productivity growth slowdown.

Growth Accounting Accounting for the Productivity Growth Slowdown and Speedup 1960 to 1973 The economy grew due to rapid technological changes. Real GDP per hour expanded by 39% Capital per hour increased by 24% With no change in technology, the economy would have expanded by only 8% (1/3 of 24%)

Growth Accounting Accounting for the Productivity Growth Slowdown and Speedup 1973 to 1983 Predominantly, the reason for the productivity growth slowdown can be attributed to a decline in the rate of technological change. Real GDP per hour expanded by 8% Capital per hour increased by 15% With no change in technology, the economy would have expanded by 5% (1/3 of 15%)

Growth Accounting Accounting for the Productivity Growth Slowdown and Speedup 1983 to 1995 The economy grew due to more rapid technological change. Real GDP per hour expanded by 18.5% Capital per hour increased by 11% With no change in technology, the economy would have expanded by only 3.7% (1/3 of 11%)

Growth Accounting and the Productivity Growth Slowdown Instructor Notes: 1) Between 1960 and 1973, which was a period of rapid productivity growth, capital per hour of work increased from $49 to $61, and technological progress shifted the productivity function upward from PF0 to PF1. 2) Between 1973 and 1983, when potential GDP grew slowly, capital per hour of work increased from $61 to $70 and the productivity function shifted to PF2. 3) The effect of technological change was offset by oil price shocks. 4) Between 1983 and 1995, capital per hour of work increased from $70 to $78 and technological progress shifted the productivity function upward from PF2 to PF3. 5) Although productivity growth was not as rapid as in the 1960s, the productivity growth rate did increase.

Growth Accounting Technological Change During the Productivity Growth Slowdown Technology was directed toward coping with two major problems. 1) Energy price shocks 2) The environment

Growth Accounting Technological Change During the Productivity Growth Slowdown Energy Price Shocks 1973–1974 and 1979—1980 Fuel inefficient methods of transportation and production were scrapped at an increased rate Technological change focused on saving energy rather than enhancing productivity

Growth Accounting Technological Change During the Productivity Growth Slowdown The Environment The 1970s saw an expansion of laws and resources devoted to protecting the environment and improving the quality of the workplace. These benefits are not included in real GDP.