MACROECONOMICS AND THE GLOBAL BUSINESS ENVIRONMENT The Wealth of Nations The Supply Side

3-2 Key Concepts Economic Growth Total output (GDP) Growth Importance of Trend Growth Output per capita growth Elements of Growth Labor Capital Total Factor Productivity

3-3 Economic Growth Economic Growth: an increase over time in the quantity of goods and services produced by an economy Rate of economic growth Real GDP: adjusts for inflation Real GDP per capita: adjusts for size of population Why do we care about economic growth? Affects human welfare A little increase in growth over a long period makes a huge difference Trend growth more important than business cycle

3-4 The Importance of Economic Growth Business Cycles still occur, but trend is key difference

3-5 The Importance of Economic Growth Is higher trend growth possible? Thomas Malthus (1798): No finite resources => limit to both economic and population growth (i.e. more people, less economic growth) “Malthusian Perspective” Economist Perspective- “Half a Billion Americans?”(8/22/02 ): Yes More people, more economic growth How do we reconcile different views on growth? What view does the empirical evidence support?

3-6 The Importance of Economic Growth

3-7 The Evidence

3-8 The Evidence

3-9 The Evidence

3-10 The Evidence

3-11 The Evidence

3-12 The Evidence Real Per Capita GDP

3-13 Evidence does suggest higher trend growth possible for many countries Evidence also indicates that wide range of growth rates for many countries Why the difference? Why do some countries take off when others do not? Again, important question since even a little difference over a long time makes a big impact The Evidence

3-14 Benefits of Economic Growth Growing population Sustain more people Life expectancy Longer lives, more accomplishments Improved standards of living Higher income levels, afford more leisure Poverty reduction A function of both inequality and economic growth Recent emphasis on increasing growth Inequality may not change

3-15 Inequality and Growth Growth Rate More Inequality 

Real Per Capita GDP (PPP)

3-17 Explaining Differences in GDP per capita GDP per capita = GDP Population Labor Productivity Average Hours Worked Employment Rate Labor Force Participation Rate Labor Force Participation Rate

3-18 Explaining Differences in GDP per capita (2001) GDP per capita U.S. success more than labor productivity: avg. hours worked, employment rate, & participation rate important Two policy implications: focus on factors that (1) boost labor productivity and (2) increase labor market flexibility However, only increases in labor productivity can produced sustained increased in GDP per capita

3-19 Role of Inputs More inputs means more output Diminishing returns 1 worker = $10 in output 2 workers = $18 in output 3 workers = $24 in output Marginal return is $8 in output Marginal return is $6 in output

3-20 Analysis of Growth Capital (buildings, infrastructure and machines) Capital (buildings, infrastructure and machines) Total Factor Productivity (technological knowledge and efficiency) Total Factor Productivity (technological knowledge and efficiency) Output (GDP) Labor (Hours worked, number of workers) Labor (Hours worked, number of workers)

3-21 Production Function Output = TFP  Capital Stock a  Labor Hours (1-a) Real GDP Total Factor Productivity A parameter (a number, 0 < a < 1) Total factor productivity (TFP) measures how effectively the inputs are turned into output True impact of capital and labor depend on their marginal product: how much output will the next additional input add to output diminishing marginal returns: holding other inputs and TFP fixed, the marginal product of an input increases at a decreasing rate

3-22 Cobb-Douglas example Real GDP Hours worked TFP = 1 Capital = 500 a=0.6

3-23 Hours Worked Real GDP

3-24 Capital Stock Output

3-25 Implications for labor productivity Output = TFP  Capital Stock a  Labor Hours (1-a) Labor Productivity Changes in Labor Productivity (1) Total Factor Productivity (2) Capital per Labor Hour

3-26 Implications for Labor Productivity implies…

3-27 Capital Stock per labor hour Labor Productivity Labor Productivity = TFP  (Capital Stock/Labor Hours) a

3-28 Capital Stock per Labor Hour Labor Productivity k1k1 y1y1 y2y2 Output/Labor Hour = TFP  (Capital/Labor Hour) a Increase in TFP

3-29

3-30

3-31 U.S. Labor Productivity Decomposition

3-32 Growth in Output Increase in labor supply May have no impact on GDP per capita Not sustainable Diminishing returns Increase in capital stock Must increase at faster rate than labor & depreciation Diminishing returns Increase in TFP No diminishing returns in this framework Intensive vs. extensive economic growth More of the same growth vs. more growth with less resources

3-33 Growth Accounting Production Function Take the logarithms, and then changes in the logarithms %∆ Output = %∆TFP + a x %∆Capital Stock + (1-a) x %∆ Labor Hours Steps Find percent change in capital stock and labor inputs multiplied by their weights Find percent change in output Difference between two or the residual is the percent change in total factor productivity

3-34 Growth accounting for Japan, Germany, the UK, and the United States, 1913–1950.

3-35 Growth accounting for Japan, Germany, the UK, and the United States, 1950–1973.

3-36 Growth accounting for Japan, Germany, the UK, and the United States, 1973–1992.

3-37 Europe and Asia Total Output:Of Which CapitalLaborTFP Golden Age France5.0%1.6%0.3%3.1% UK3.0%1.6%0.2%1.2% W. Germany6.0%2.2%0.5%3.3% Asian Miracle China6.8%2.3%1.9%2.6% Hong Kong7.3%2.8%2.1%2.4% Indonesia5.6%2.9%1.9%0.8% Korea8.3%4.3%2.5%1.5% Thailand7.5%3.7%2.0%1.8% Singapore8.5%4.4%2.2%1.5% Europe relied on capital and TFP – Asian countries have relied on capital

3-38 Growth Accounting Japan Capital growth important through out Labor, TFP important ’50 – ’73 US TFP important until ’73 Labor important after ’73 thru mid 1990s Productivity strengthens in mid1990s UK and Germany rely less on labor

3-39 Growth Accounting Asian Tigers,

3-40 China vs. India

3-41 Growth accounting in emerging markets, 1960–1994.

3-42 Summary Importance of Growth Sources of Growth GDP per capita Hourly productivity Number of hours worked Productivity Capital Accumulation TFP Growth Accounting